Appraising the Property
How will my property be appraised?
Appraisers generally use three methods of appraisal to estimate the value of real estate: the market approach, the cost approach and the income approach.
Which one will they use to appraise my property?
Appraisers generally prefer to use as many of the three approaches as they deem appropriate. It is not unusual, for example, for an appraiser to use all three approaches when valuing an office building.
Appraisers may choose not to apply one or more of the three approaches if they feel application of a given approach would be inappropriate, given the particular approach or the particular property. Since the cost approach considers the cost of reconstructing buildings on the property, the cost approach is obviously not used to estimate the value of vacant property. Since the income approach is based upon the amount of rent an owner would receive for the property, the income approach is seldom used to value properties not typically rented.
How does the market approach work?
Under the market approach, appraisers search for properties they feel are comparable to your property. They then use the sale prices of those properties to arrive at an estimate of value for your property.
Since no two properties are exactly alike and since some of the dissimilarities between the appraiser’s “comparable” properties and your property may be significant, the appraiser makes adjustments to the sales prices of the comparable properties before using the prices to arrive at an estimate of value for your property.
These adjustments may be positive or negative, depending on whether the comparable property is viewed by the appraiser as having superior or inferior characteristics when compared to your property. If the adjustment is positive, the appraiser will increase the price of the comparable property before he compares that price to your property. If the adjustment is negative, the appraiser will decrease the price of the comparable property when using it to appraise your property.
Can you give me an example of how an appraiser may make adjustment?
Yes. Let’s say you own a vacant piece of commercially-zoned property on Worthington Boulevard. The appraiser finds that, during the last three years, two other vacant pieces of commercially zoned property sold on Worthington Boulevard. He then uses these properties as his “comparable sales.”
Let’s say the first “comparable sale” sold for $5.00 per square foot, but that property, unlike your property, is on a corner. Let’s assume further that the appraiser observes that buyers pay 10% more for corner locations than for interior sites. Since the comparable property has a characteristic (corner location) superior to your property, the appraiser may utilize an adjusted price per square foot of $4.50 ($5.00 minus $.50 10% of $5.00 = $.50) when appraising your property.
Let’s say that the second “comparable sale” sold for $4.00 per square foot, but that property, unlike yours, is next to a railroad line. Let’s assume further that the appraiser observes that buyers pay 20% less for properties next to the railroad tracks than others. Since this “comparable property” has an inferior characteristic (proximity to the railroad line), the appraiser may make a positive or upward adjustment to the price paid for this “comparable sale.” Under this assumption, the appraiser may utilize an adjusted price per square foot of $4.80 [($4.00 plus $.80 (20% of $4.00)] when appraising your property.
I just bought my property recently. Will the appraisers use the price that I paid for the property recently in appraising its value today?
Probably. In general, appraisers consider the purchase of the subject property as the most comparable sale available. If, however, the property itself or market conditions have changed dramatically between the date of purchase and the date of condemnation, the appraiser may choose not to use the sale of the subject property in preparing the appraisal.
A property similar to mine recently sold for a very low price; however, it was sold by a couple going through a divorce who needed to sell it quickly in order to liquidate their properties and to pay off their joint debts, including the monthly mortgage payments which were three months in arrears. They sold it to a company which buys up “distress” properties and then resells them for a profit. Will the appraisers use the sale of this property in appraising my property?
Probably not. “Fair market value” is the price which a seller willing, but not compelled, to sell would receive from a buyer willing, but not compelled, to buy. It is the most probable price for which the specified property should sell after reasonable exposure in a competitive market under conditions requisite to a fair sale, with the buyer and seller each acting prudently and assuming neither is under any undue duress.
Most appraisers would view this sale as involving a seller compelled and under undue duress to sell. The appraisers may also find that the property was not sold after reasonable exposure in a competitive market and was not sold under conditions requisite to a fair sale.
Notwithstanding the above, appraisers often disagree as to whether a given sale should be eliminated from consideration because of the motivational factors influencing the buyer and the seller.
How does the cost approach work?
Under the cost approach, the appraiser first estimates the value of the land, as if the land were vacant.
He then estimates how much it would cost to rebuild, at today’s prices, all of the improvements on the property.
He then estimates the amount by which the improvements have depreciated and subtracts the depreciation from the cost of reconstruction new. He then adds the depreciated cost of reconstructing the improvements to the land value to arrive at a total estimate.
I have taken great care of my building. Will that affect my depreciation rate?
Yes. Part of depreciation is physical depreciation. Physical depreciation is simply the wear and tear on your buildings. Everything else being equal, a building which is better maintained is less depreciated and, therefore, more valuable than one which is not well maintained.
How does the income approach work?
First the appraiser estimates how much your property would rent for in the open market. He does this by finding rental rates of comparable properties. He, thus, arrives at an estimate for annual gross income.
He then estimates an amount for vacancy and collection and subtracts that amount from gross income to arrive at an estimate of adjusted gross income.
The appraiser then estimates the annual expenses which would be paid by an owner of your type of property and subtracts the total amount of those expenses to arrive at an estimate of annual net income.
Finally, the appraiser converts his estimate of annual net income to value by dividing his estimate of annual net income by a capitalization rate.
What are the types of expenses appraisers usually consider when arriving at annual net income?
Maintenance, management, taxes and insurance.
Of the three approaches to value – market, cost and income – which approach will lead to the highest value for my property?
The answer to this question depends upon your property, your appraiser and the real estate data used in the appraisal. More often then not, however, the estimates arrived at by all three approaches are very similar.
In using the income approach to appraise my property, will the appraisers use the actual rents on my property? I’m concerned because I rent out half of my property for rents based on a ten-year old lease and the other half I rent for half-price because, with the property about to be taken, I’m having a hard time finding tenants.
Under the income approach, the appraiser determines gross income by estimating economic or market, rather than actual, rent. Economic or market rent is the rent which property similar to yours is renting for on the open market. This means that the appraiser will generally use your actual rents only when they are the same as economic or market rent.
The appraisal must reflect the value of the property as of the date of condemnation. If the actual rents on the property were set ten years ago and are substantially below the rents paid on properties similar to yours around the date of valuation, then it is highly unlikely the appraisers will use the actual rents to appraise the property.
The law also provides that the value of your property is not to be diminished by the threat of condemnation. If the rents paid on your property are substantially below the rents paid for properties similar to yours, but not under the threat of condemnation, then the appraisals may not be based upon those rents.
Why are some appraisal estimates so different from others for the same property?
An appraisal is a subjective opinion of value. The appraiser’s understanding of the facts, his or her factual assumptions, and his or her understanding of eminent domain law may all operate to affect dramatically the final dollar amount of value estimate.