The valuation process
I. Defining the problem
i.
Identification of the real estate to be appraised
Address, common name, legal description
ii. Identification of the property rights to be valued
i.
ii.
Fee simple
Partial interests; lease, life estate, undivided interests
iii. Use of the appraisal
i.
Value for purchase or sale, loan, tax, lease, other
iv. Definition of value; market, use, investment, etc
v. Date, scope, other limiting factors to the
appraisal
The valuation process
• Preliminary analysis, data selection and
collection
– General; local neighborhood, government,
environmental, etc.
– Specific; the site itself, improvements,
depreciation, history of ownership and use,
income and expenses,
– Supply and demand; other properties around,
demand studies, how long have they been on the
market,
The valuation process
• Highest and best use
– Vacant land
– With improvements
• Legal uses
• Physically possible
• Financially feasible (with non-monetary
benefits)
• Maximum income
The valuation process
1. Cost approach
1. The idea is that you estimate the market value
today with the estimated reproduction costs of
improvements considered. The reproduction
costs are depreciated to reflect physical
depreciation, functional obsolescence, and
external obsolescence
2. The depreciated reproduction costs are added to
the market value of the land to obtain the
estimated value of the land and improvements
The valuation process
• Cost approach;
– The whole idea is that the buyer could buy the
farm with the existing improvements or they could
buy bare land and make the improvements
– The buyer then looks at the farm with the
buildings considering the utility of the buildings as
well as their conditions and construction of new
improvements
The valuation process
2. Comparable Sales approach;
– This approach provides the estimate of the value
based on market prices paid and current market
listings
– You analyze and adjust the sales to reflect the
conditions of the subject property . This analysis
lets you estimate the market value for the
subject.
– The whole idea is based on the notion that an
informed buyer would not pay more for a
property than the cost of the existing property
with the same utility
The valuation process
• Comparable sales can be tricky if the market is
moving rapidly or if you can’t find good
comparables.
• Think of the example Fred used; $7,000 and
just a few miles away it was $6 something.
• Land is an unusual commodity. “The same
utility” is a hard thing to measure some times.
The valuation process
3. The income approach;
• This is the third approach to estimating the
market value of the subject property
• The whole idea is to convert the anticipated
benefits from ownership into a value estimate
• Four basic steps:
1. Estimate net economic rent for comparable
properties
2. Estimate relationship between rent and value for
them
3. Estimate the net economic rent for the subject
4. Capitalize net rent for subject into an indication of
value
The valuation process
• Income approach;
• Four basic steps:
1. Estimate net economic income for comparable
properties
2. Estimate relationship between income and value for
them
3. Estimate the net economic income for the subject
4. Capitalize net income for subject into an indication of
value
The valuation process
• Net income and net economic rent are used
synonymously but the point is how much
money can you earn from the property.
• This creates issues when the purchase is for
non-monetary reasons
• Value = income/capitalization rate
The valuation process
• Reconciling the values found in the three
different approaches takes some time and
thought.
• If we had the perfect markets and the perfect
person analyzing them, we’d be OK
• Remember that if you put garbage into the
analysis that’s what you’ll get out
• Never forget to ask yourself if this property
really worth it