Lesson 4

Using An Appraiser

       In this course we differentiate between a valuation and an appraisal in that an appraisal (1) must utilize certain specific methods, (2) results must be presented in a certain format, and (3) must be performed by a certified professional.  While we can utilize the same methods and come up with values that are just as accurate as those of professional appraisers, assuming that we are willing to put enough care and effort into the project, we don't need to meet the same standards of formality.
      No matter how formal the appraisal, it is still an opinion.  The reliability of an appraisal depends upon the expertise and integrity of the appraiser and upon the skill with which he processes available relevant data.
     The savings & loan and bank failures of the 1980's were aggravated by the fact that many loan appraisals were significantly overvalued.  As a result, the federal government and the states moved to require certification of real estate appraisers, particularly those doing appraisals for federally regulated lending institutions.
      Professional appraisers usually analyze a property using three approaches to valuation.  The three methods, in alphabetical order, are:

• Cost Approach
• Income Approach
• Market Data Approach

      These three approaches are based on three facets of value, respectively:

• The current cost of reproducing a property less loss in value from deterioration and functional and economic obsolescence (accrued depreciation)
• The investment value that the  property's net earning power will support, based upon a capitalization of net income
• The value indicated by recent sales of comparable properties in the market

      Ideally, one applies all three methods and obtains results of equal validity and reconciles the different values by averaging them.  However, this is usually not the case in the real world.  There are properties where all three approaches cannot even be applied.  As examples, the Market Data Approach is usually inapplicable for valuing specialized property, such as a garbage disposal plant, and the Income Approach is seldom helpful in valuing an owner-occupied single-family home.
      After completing the analyses for all applicable approaches, the appraiser must reconcile the values resulting from each.  Under no circumstances should these results be "averaged."  The appraiser must consider the relative applicability of each of the three approaches, placing more emphasis on the one or two that appear to produce the most reliable and applicable solution to the specific question of value.  The appraiser then produces a written report of his procedures and results.  The relevance and importance of each method depends upon the type of property and various other factors.  For a single-family home, the most important method is usually the comparative market approach and often this will be the only method considered.  For an office complex, the Income Approach will usually be given the most weight, but the Market Approach will be considered if comparative sales data are available and Cost Approach will also be considered because it can provide an indication of future value.
      You might ask why not hire an appraiser to tell you the value of a property that you are considering.  This is actually something that you can do and some investors do so.  However, there are reasons why you will want to do your own valuations.
      A major reason for not hiring your own appraiser for the purpose of determining the price you are willing to pay for a property is cost.  Full-blown appraisals meeting government  standards are relatively expensive.  While a single-family home appraisal may be available for $250 to $300, an appraisal of a 10-suite office building might cost well over $5,000.  And, in the process of selecting a property you may need to determine the values of several different properties.  Some appraisers may be willing to provide a less formal valuation at a lower price, but even if cost is not the issue, schedule may be a problem.  It often requires several days or even several weeks for an appraiser to complete a formal appraisal, depending upon his work load and the complexity of the subject property, and even an informal valuation may be delayed if the appraiser is busy.  When you are looking at properties, you need to know its value (at least approximately) immediately so that you can decide whether to spend additional time in considering the property or to go on to another potential.
      For these reasons, a buyer would not usually have a professional appraiser involved prior to making an offer, but, if a formal appraisal is desired, may instead include the appropriate contingency and use one after the purchase offer has been accepted.
      The material in this e-course should give you sufficient knowledge to quite accurately determine value for most properties so long as you are able to obtain the necessary data either on your own or with help from your agent or others.
      If you are obtaining new financing, an appraisal by a certified appraiser will almost certainly be done whether you want one or not.  And, since you will be paying for it, you should receive a copy of it - don't use a lender who won't provide it.  You should, of course, be sure to factor the cost into your analysis regarding what you can afford to buy.  You should write a contingency into your purchase offer that requires this appraisal to be equal to or greater than the price you offered.  You should retain the option of waiving this contingency so that you can pay more than appraised value.  Appraisers are now usually relatively conservative and are more likely to undervalue the property than to overvalue it in order to protect themselves from liability.  Also, they may not take into consideration certain relevant factors such as potential - for example, Greyhound is planning to build a bus station across the street from the subject strip center which has the only coffee shop and convenience store in the neighborhood.
      You should not usually depend upon the lender's appraisal to make your purchase decision except as a final confirmation of your decision.  The principal reason for this is that the appraisal is not usually available until shortly before scheduled close of escrow, often only a matter of a week or two, and you may end up spending a couple of months of your time (and that of others) and expending hundreds of dollars on inspections for naught.  This is a primary reason why you need to be able to do your own analyses.
      It is not unusual for a seller to use an appraisal in his marketing of the property.  However, if such an appraisal is provided by the seller, you should (1) be sure that the appraisal is current and not one the seller received when he refinanced several years ago and (2) examine the methods and data used by the appraiser, as not all appraisers are equally competent.  However, even when the appraisal is outdated or flawed, it will likely provide a lot of information regarding the property and the market and data that is still extremely valuable for use in doing your own valuation.  Accordingly, if you know that an appraisal is available, you should acquire a copy before making an offer.
      The Income Approach is usually the most relevant method of determining value - it is after all income property that is our subject.  Also, the necessary data for applying the Market Data approach or the Cost approach is not always easily available to the lay investor.  For these reasons, most investors usually depend upon the Income Approach for determining what price to offer for a property, using whatever Market Data information and/or Cost information might be available.  For example, if you know the sales price of a similar property in the area, you can take this fact into account.  However, it is important that you take all known information about the property into account, including its leases and its expenses.  Identical type and size of a building do not mean identical value.  Two otherwise  identical properties can vary drastically in value due to differences in existing leases and the degree of deferred maintenance.