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There is broad sweeping change in the mindset of the World economy caused by the credit
crisis, economic downturn and long-term uncertainty, which is having a profound impact on the
real estate market. Our job as appraisers is to interpret what is occurring in the economy
including supply/demand conditions, unavailability of financing, rising unemployment and
alternative investment vehicles in order to credibly estimate the value of real property. The
following information provides an introduction to the commercial real estate appraisal process,
and summary statements with regard to how we are adapting our analysis to the changing
economic conditions.
Appraisal: (noun) the act or process of developing an opinion of value; an opinion of value.
(adjective) of or pertaining to appraising and related functions such as an appraisal practice or
appraisal service.
Appraiser: one who is expected to perform valuation services competently and in a manner
that is independent, impartial, and objective.
Appraisal Process
1) Define the problem
Identify the real estate
Identify the rights to be valued
Establish the intended user of the appraisal
Determine the definition of value
Determine the effective date of the appraisal
Identify the scope of the appraisal
Establish any assumptions and limiting conditions
2) Preliminary Analysis and Data Collection
3) Highest and Best Use Analysis
4) Land Value Estimate
5) Apply the Appropriate Valuation Techniques (Cost, Income, and Sales)
6) Reconciliation of Value and Final Value Conclusion
7) Report the Defined Value
Scope of Work: the type and extent of research and analysis in an assignment.
The scope of work is defined by the appraiser and the client. However, the appraiser
can not limit the scope of work to such a degree that is jeopardizes the reliability of the
value conclusion.
The most common value scenario requested is the As Is Market Value. Market Value is
defined below:
The most probable price which a property should bring in a competitive and open market under
all conditions requisite to a fair sale, the buyer and seller each acting prudently,
knowledgeably, and assuming that the price is not affected by undue stimulus. Implicit in this
definition is the consummation of a sale as of a specified date and the passing of title from seller
to buyer under conditions whereby:
2. Both parties are well informed or well advised, and acting in what they consider their own
best interests;
5. The price represents the normal consideration for the property sold unaffected by special
or creative financing or sales concessions granted by anyone associated with the sale.1
The scope of work may be defined by the appraiser, however, the scope of work must meet or
exceed 1) the expectations of parties who are regularly intended users for similar assignments;
and 2) what an appraiser’s peers’ actions would be in performing the same or similar
assignment.
Cost Approach
Income Approach
Sales Comparison Approach
1
Office of Comptroller of the Currency (OCC), Title 12 of the Code of Federal Regulation, Part 34, Subpart C - Appraisals, 34.42 (g);
Office of Thrift Supervision (OTS), 12 CFR 564.2 (g); This is also compatible with the RTC, FDIC, FRS and NCUA definitions of
market value.
COPYRIGHT © 2009 PGP VALUATION INC. ALL RIGHTS RESERVED
COST APPROACH
The cost approach is based upon the principle that the value of the property is significantly
related to its physical characteristics, and that no one would pay more for a facility than it would
cost to build a like facility in today's market on a comparable site. In this approach, the market
value of the site is estimated and added to the estimated depreciated value of the
improvements.
Or
Replace Cost of Improvements w/ profit – Depreciation + site value = Cost Approach Value
____________________________________________________________________________
Ent re pre n e ur ia l Pr ofit 20.0% of Imp ro veme nt Cost & Lan d V alue $ 699 ,4 11
Re plac e m e nt C os t Ne w $ 3,016 ,4 66
DEPRECIATION
Cur able De pr eciation $0
Mar ket Extr action Me th od
Ef fec tiv e A ge 5 Y ea rs
Total Eco no mic L ife 4 5 Y ea rs
% De pr ecia te d 4 .0 %
S ubtotal ($ 120 ,6 59)
Tot al De pr e ciat io n ( $1 20,65 9)
Many new projects are not financially feasible. The lease-up or absorption/sell-out of a project
becomes extended. Many projects appraised 18 months ago that are nearing completion are
no longer profitable due to extended marketing periods.
Land value assumptions change. In an active construction market, land is purchased for
immediate development. If a development parcel is purchased now, the buyer’s assumption
would be to hold until development is feasible. Additional holding costs may require a
downward adjustment to the land sales that sold in 2007.
• Estimate income
• Estimate Vacancy and Expenses
• Derive an estimate of Net Operating Income (NOI)
• Derive a capitalization rate from a) market sales, b) band of investment analysis
• Divide the NOI by the Capitalization rate to estimate the value
The fundamental principle in this approach if anticipation. The anticipated risk associated
with the income stream is implicit in the cap rate.
The Income Capitalization Approach is the best measure of value for income-producing
investment properties. One challenging task in the current economy is accurately estimating
market rents, which requires the appraiser to measure the impacts that softer market
conditions are having on rents.
Without a doubt, the most difficult and important modifications to our appraisals are
occurring in the capitalization and discount rate analysis. Due to the drastic decline in
investment sales over the past year, it takes a lot of creative analysis to reasonably estimate
current capitalization rates. We look in the rearview mirror on past transactions, consider
current listing and review national trends in order to provide the most reasonable estimate.
The Sales Comparison (Market) Approach is based on the principle of substitution, which
asserts that no one would pay more for a property than the value of similar property in the
market. In this approach, the subject property is compared directly with other recent sales of
similar properties in the marketplace. This comparison is typically accomplished by extracting
“units of comparison,” for example, price per square foot, and then adjusting these units of
comparison for the comparable sales for differences between the subject and each comparable.
The reliability of an indication found by this method depends on the quality and quantity of the
comparable data found and the ability of the appraiser to make reasonable and supportable
adjustments. In active markets with a large number of sales that are physically similar
comparables, this approach is generally a good indicator of value.
Limited sales activity is making the sales approach more difficult. Investment sales are off 60%
to 80%. As much as 50% of those sales now include assumed debt.
The factors affecting value and pricing have changed. This includes buyer’s assumption on the
future. For example, capitalization rates at 6% and investors IRR of 15% imply substantial
increases in income over a holding period. With flat rents, higher vacancy costs to ownership,
difficulty financing, the conditions in which sales took place in 2007 are much different that they
are today.
Appraiser now need to do a better job interviewing brokers, analyzing active listings, and
drawing a conclusion from possibly older sales prior to 2007.
Our Services “PGP’s technology platform is cutting edge. Their ReportBuilder software
creates a uniform, easy-to-read report which greatly assists us in
Portfolio Valuations aggregating the appraisal data in our underwriting templates.”
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development/conversion
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