The need for appraisals arises from the heterogeneous nature of property as an investment class no two properties are identical, and all properties differ from each other in their location which is the most important determinant of their value. Valuations are required for many purposes financial reporting, sale-purchase transactions and capital investment, securitization, tax settlements, financial regulation, and resolution of disputes over property interests. Today, the worlds financial community and its regulators are putting increasing reliance on value rather than cost, whether it is for investment decisions, risk-profiling or disclosure in financial statements. As a result, there is growing recognition of the urgent need for a single set of comprehensive international valuation standards. Some of the most common valuation systems sought for real estate appraisal are:
Market Value is the price at which an asset would trade in a competitive Market. International Valuation Standards (IVS) define Market Value as the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arms-length transaction after proper marketing wherein the parties had each acted knowledgably, prudently, and without compulsion.
Value-in-use: The net present value (NPV) of a cash flow that an asset generates for a specific owner under a specific use. Value-in-use is the value to one particular user, which may be above or below the market value of a property.
Investment value is the value to one particular investor, which may be above or below the market value of a property.
Insurable value is the value of real property covered by an insurance policy. Generally it does not include the site value.
Liquidation value may be analyzed as either a forced liquidation or an orderly liquidation and is a commonly sought standard of value in bankruptcy proceedings.
Price value It is important to distinguish between Market Value and Price. A price obtained for a specific property under a specific transaction may or may not represent that property's market value. Property appraisal is based on analysis of the factors like the terms of sale cash, cash equivalent, or other terms, the relationship, knowledge, and motivation of the parties ie, seller and buyer and the conditions of sale like exposure in a competitive market for a reasonable time prior to sale. Three approaches to value There are three general groups of methodologies for determining value referred as the three approaches to value:
1. The cost approach
2. The sales comparison approach and
3. The income approach
The appraiser will determine which one or more of these approaches may be applicable, based on the scope of work determination, and from that develop an appraisal analysis. Costs, income, and sales vary widely from one situation to the next, and particular importance is given to the specific characteristics of the subject.
Consideration is also given to the market for the property appraised:
Appraisals of properties that are typically purchased by investors require greater weight to the income approach.
Sales comparison approach is good for small retail or office properties, often purchased by owner-users.
Apartment complexes tend to sell at a price per apartment, and as such the sales comparison approach is more applicable.
Single family residences are most commonly valued with greatest weighting to the sales comparison approach. But single-family dwelling is in a neighbourhood where all or most of the dwellings are rental units, then income approach is more useful.
The cost approach: The cost approach was formerly called the summation approach. The theory is that the value of a property can be estimated by summing the land value and the depreciated value of any improvements. The cost approach is considered reliable when used on newer structures, but the method tends to become less reliable for older properties. The cost approach is often the only reliable approach when dealing with special use properties like public assembly, marinas.
Sales comparison approach: The sales comparison approach examines the price or price per unit area of similar properties being sold in the marketplace. This approach is generally considered the most reliable if adequate comparable sales exist. In any event, it is the only independent check on the reasonability of an appraisal opinion.
UK valuation methods In the UK, valuation methodology has traditionally been classified into five methods:
1. Comparable method: It is analogous to the sales comparison approach and used for most types of property where there is good evidence of previous sales.
2. Investment/income method: Used for most commercial (and residential) property that will produce future cash flows through the letting of the property. If the current Estimated Rental Value (ERV) and the passing income are known, as well as the market-determined equivalent yield, then the property value can be determined by means of a simple model.
3. Accounts/profits method: Used for trading properties such as hotels, restaurants and oldage homes. A three-year average of operating income derived from the profit and loss or income statement is capitalized using an appropriate yield. The resulting value will be Value-in-Use or Investment Value, not Market Value.
4. Development/residual method: Used for properties ripe for development or redevelopment or for bare land only.
5. Contractors/cost method: Used for only those properties not bought and sold on the market. Both the development/residual method and the contractors/cost method would be grouped in the US under the cost approach.
6. Highest and best use: Highest and Best Use (HABU) is a term of art in the appraisal process. It is a process to determine the use of the property which produces the highest value for the land, as if vacant. There are four steps to the process: i) The appraiser determines all uses which are legally permissible for the property. ii) Determine alternatives of the uses which are legally permissible, which ones are physically possible. Of those, which ones are financially feasible. iii) Of those uses which are feasible, which one and only use is maximally productive for the site. In a simple context, the appraiser must do this twice, comparing the results as if the land is vacant and in the as-is-improved state, taking into account the costs of demolishing any existing improvements. iv) The outcome of this process is the highest and best use for the site. An appraisal of market value must explicitly assume that the owner or buyer would employ the property at its highest and best use, and therefore value the site accordingly.
Types of ownership is implicitly considered in the analysis of the subject property in determination of the interest in the property being appraised. For most common situations (like mortgage finance) the fee simple interest is explicitly assumed for enjoyment of full rights available. There are many different possible interests in real estate, the three most common are: Fee simple value (known as freehold): The most complete ownership in real estate, subject in common law countries to the powers reserved to the state (taxation, escheat, eminent domain, and police power). Leased fee value: This is simply the fee simple interest encumbered by a lease. If the lease is at market rent, then the leased fee value and the fee simple value are equal. However, if the tenant pays more or less than market, the residual owned by the leased fee holder, plus the market value of the tenancy, may be more or less than the fee simple value. Leasehold value: The interest held by a tenant. If the tenant pays market rent, then the leasehold has no market value. However, if the tenant pays less than market, the difference between the present value of what is paid and the present value of market rents would be a positive leasehold value. For example, a major chain retailer may be able to negotiate a below-market lease to serve as the anchor tenant for a shopping centre. This leasehold value may be transferable to another anchor tenant, and if so the retail tenant has a positive interest in the real estate. The International Valuation Standards Committee (IVSC) has published the 8th edition of the International Valuation Standards IVS 2007. Various professional organizations have started collaborating internationally for the implementation of international valuation standards which will facilitate global real estate appraisal, a much-needed adjunct to real estate investment portfolios which are transcending national boundaries.
with thanks from TOI (As published in Times of India in Times Property on 19th July 2008)