In the simplest terms, an appraisal is an opinion of value. When that opinion is formed by a trained and qualified appraiser it is based on a systematic process of defining and planning a solution to the appraisal problem. This includes gathering and analyzing all necessary information, applying the approaches value, and reconciling all of the analysis and data into the opinion of the value. This opinion can be stated in the form of a single value or a value range.
In arriving at a value opinion, an appraiser will consider several methods of appraisal application that approach the concept of the property value from different perspectives. These methods are referred to as the “approach to value” and are the cost approach, market approach and income approach.
What is the Cost Approach?
The cost approach to value combines an estimate of land value with an estimate of depreciated reproduction or replacement cost of the improvements.
The principle of substitution is the basis of the cost approach. The theory of this principle is that no rational person will pay more for a property than the amount for which they can obtain, by purchase of a site and construction of a building, a property of similar desirability and utility.
What is the Market Approach?
The market or direct sales comparison approach to appraising a property involves a process of comparing market data such as property sale prices, asking prices and offers of prospective buyers or tenants willing to purchase or lease.
Usually a comparison grid is used to make adjustments to comparable sales for differences from the subject property for things like location, building size, lot size, condition, construction quality, number of baths, fireplaces, garage stalls, etc.
In the market approach, the appraiser attempts to measure and reflect the reactions that typical potential purchasers would have to the property being appraised.
What is the Income Approach?
The income approach to value is based on an estimate of net income derived from the operation of an income producing property and selecting a capitalization rate from the market indications of similar properties to convert that income to an estimate of present worth for the property.
The principle of anticipation is the basis of the income approach and affirms that value is created by the expectation of financial benefits to be derived from the possession, operation and/or capital gain from selling a property.
What is a comparable sale?
A comparable sale is a property that is similar to the subject in most respects, is located in a similar neighborhood, and has sold recently in an arms length transaction.
The selection of comparable sales, in most residential appraisals is probably the most important factor in establishing value. It is what other properties like the subject are actually selling for.
It is the appraiser’s responsibility to adequately research the local market and determine which comparable sales best represent the value-determining characteristics of the property being appraised.
What is an Arms Length Transaction?
An arms length transaction is one where both the seller and the buyer act independently of each other and have no relationship to each other. It would be a transaction which is freely arrived at in the open market and unaffected by abnormal pressure or by the absence of normal competitive negotiation.
Sales that could possibly not qualify as an arms length transactions would be sales between family members or business partners, foreclosure sales, or an expansion sale where an adjoining property is purchased based solely on location regardless of price.
