An appraiser will examine the structure and all its
equipment. He will get data about leases and rents and investigate sales of
comparable properties. The appraiser will usually state three values, one for
the land, one for the structure, and finally one for the combined market value
of the property. Every buyer
should
be protected by a professional appraisal of the building he intends to buy. This
doesn't mean a seat-of-the-pants guess by a broker. It means a careful,
scientific appraisal made by a qualified independent appraiser.
Except when insured by the FHA and VA, few banks will make
loans in excess of 80 percent of the house's value. And the value they use
isn't the sale price but the value the appraiser sets. Don't be surprised if
the appraiser sets the value of the property many thousands of dollars below
the price you had agreed to pay. The seller hasn't necessarily bilked you.
The standards the appraiser used to judge the property probably diverged
from your standards. The actual sales price rarely coincides with the fair
market value of the property for these reasons:
1. Buyers and sellers often act under constraints of time
or other pressures and thus may not be in a position to accurately evaluate
the property.
2. Buyers and sellers are often ignorant of the
replacement value of the improvements and may know even less about how to
measure deprecia-tion.
3. Brokers eager for a sale may try to sell a property
too quickly at too low a price. They may also try to snap it up themselves
if they can wheedle it from an owner at a price below value.
Market Value
The price of a property should equal its "fair market
value." Appraisers define that as the highest price a buyer is willing to
pay and the lowest price a seller is willing to accept when both are operating
in a free market, with full knowledge of all the facts, and acting voluntarily
without compulsion. An alternative definition is that it's the highest price
that a property will bring if exposed for sale in the open market, allowing a
reasonable time for finding a purchaser who buys with knowledge of all the uses
to which it's adapted and for which it's capable of being used. Both these
definitions assume an open, efficient marketplace. Ignorance, fraud, and a
number of external political and economic factors can distort the determination
of market value. These factors include inflation and rent control.
The Market Approach
In arriving at a conclusion on the value of the subject
property, the ap-raiser makes a survey of properties that have sold recently
within the general area. These properties are within an adjustable price range
and are compared feature for feature with the property under consideration.
Consideration is ;iven and adjustments are made on each comparable sale as to
time of sale, size, location, age, and other factors that might affect its
value. Terms of sale,
price, and interior appointments are verified by examination
or consultation with other brokers. As it's impossible to find an identical
property to that of the subject, since no two buildings are identical, the
appraiser must make adjustments to each comparable. This approach is the most
reliable because it reflects the reactions of typical buyers and sellers in the
market. For most commercial property and idiosyncratic houses, this approach may
have limited value.
The Cost Approach
The cost approach is the reproduction cost of all
improvements in new condition, less accrued depreciation, plus the value of the
land. The appraiser has gathered current costs from local contractors engaged in
building similar properties in the area. He has compared these costs to known
costs published in cost manuals and by the Society of Real Estate Appraisers.
The value of improvements is based on the square footage of the structure. To
determine the area of a house, multiply outside measurements above the
foundation, length by width. Square footage includes all heated interior space,
even stair-wells and closets. Excluded are basements, garages, and attics. If a
two-story house measured 40 by 20 feet, it would have 800 square feet on each
floor, for a total of 1,600 feet. A finished basement would be measured inside
and listed separately. Different appraisers have their own standards for the
upper floors of Cape Cods, heated porches, basement rooms with windows above
grade, walkout basements, heated garages, and lower areas on split-level houses.
The goal is to measure usable living space.
The cost approach will result in a fair estimate if all
elements are figured accurately, for no reasonable buyer will exceed the price
of a substitute prop-erty that offers the same amenities. Distortion occurs when
the building has structural elements that are difficult to duplicate. Appraisers
also tend to underestimate the cost of a new replacement. A new building may
cost $60 a square foot to build. The appraiser may set a baseline figure of $30.
Make sure you check all the appraiser's assumptions as to the amount of
depreciation that is deducted.
Depreciation must be subtracted from the replacement cost new
to adjust the property's value because of age. As time goes by, the building
will deteriorate. However, the owner will also maintain or improve the building.
The appraisal should reflect this dual process of deterioration and
rehabilitation. Depreciation represents the loss in value that may come from
age, the presence of undesirable factors, and other circumstances.
Depreciation can be of three kinds. More than one kind of
depreciation may be present.
1. Physical depreciation is the physical wearing out of the structure. If a
building needs painting or has broken windows, it suffers physical
depreciation. Some physical depreciation is curable, such as a leaky roof.
Some is incurable, such as inherent bone structure deterioration.
2. Functional depreciation is the result of undesirable
layout, design, or other features, as compared to a new property. Some
functional depreciation is curable, such as an old kitchen. Some is incurable,
such as inadequate hallways or space.
3. Economic depreciation is the loss of value from causes
outside the property itself. Zoning changes, proximity to nuisances, and
changes in land use are causes of economic obsolescence. Economic depreciation
is al-most always incurable.
To the value of the structure is added the value of the lot,
garage, sheds, and the like. The total indicates the fair market value of the
property. Land value is usually estimated from recent comparable land sales in
the area by the square-foot or front-foot method.
The Income Approach
The income approach is the third approach used to estimate
market value. It's most effectively used with properties that are intended to
produce income. To apply the income approach to the single-family residence, the
appraiser will consider the monthly rent in relation to the sales price and
arrive at the gross rent multiplier. The gross rent multiplier is the number
arrived at by averaging how many times more than their gross monthly rental
value houses are selling for in your area. This multiplier is abstracted from
the market by taking rented properties that have sold and by dividing the sales
price by the assumed monthly rent. The economic rent is estimated by comparing
other comparable rented properties. The gross rent multiplier is then multiplied
by the estimated economic rent to arrive at an estimate of value for the subject
property.
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