LECTURE 4: VALUATION AND THE APPRAISAL
In considering the subject of real estate valuation, two particular questions must
1. Can the specific elements or factors that contribute to the value of a parcel of
real estate be identified?
2. What methods can be used to arrive at an estimate of value for a parcel of
An appraisal is first and foremost opinion. It is based on the analysis of facts but
is itself an opinion. The appraisal is of a specific property as of a specific date.
The Appraisal Profession in Canada is governed by the Canadian Uniform
Standards of Appraisal Practice (CUSPAP) which has been adopted by the
Appraisal Foundation made up of the various appraisal institutes in Canada and
U.S. These regulations constitute both a code of ethics and standards of practice
under which appraisers should operate.
CHARACTERISTICS OF VALUE
Real Property Values are affected by four characteristics:
1. Utility – The ability of a good or service – in this case real property – to satisfy
2. Scarcity – Relative availability of a particular good or commodity. Land need
not be scarce in an absolute sense in order to have value, but its value is
highly affected by the scarcity of certain property types (uses) within a given
3. Effective Demand – In order for real property to have value, effective demand
for the property must exist.
4. Transferability – The absence of legal constraints on the owner’s right to sell
or convey his property right to another.
FORCES AFFECTING VALUES
In general, four primary forces exist that influence real estate values
1. Physical-Environmental – Location, size, shape, area, frontage, topsoil,
drainage, contour, topography, vegetation, accessibility, utilities, climate and
view. 2. Economic – Reflect how the property interacts or fits within the economy of
the regional and neighborhood. Such factors as community income, the
availability and terms of mortgage, credit, price levels tax rates, and labour
supply represents economic forces affecting values.
3. Social – Attitudes toward household formation, population trends,
neighborhood character, architectural design, and utility have an impact on
4. Governmental – The impact of local, state and federal governments and are
collectively referred to as public policy. Zoning and building codes, real
property taxation, public housing, and police and fire protection.
Reasons for An Appraisal
1. Transfer of Ownership: To determine the terms of a sale price for a proposed
2. Financing and Credit: To establish the basis for a decision regarding the
insuring or underwriting of a loan on real property.
3. Just Compensation in Expropriation Proceedings: To estimate market value of
a property as a whole before the taking.
4. Tax Matters – To estimate assessed value.
5. To set rental schedules and lease provisions.
6. To determine feasibility of a construction or renovation program.
7. To facilitate corporation or third-party company purchase of the homes of
8. To serve the needs of insured, insurer and adjuster.
9. To aid in corporate mergers, issuance of stock, or revision of book value.
10. To estimate liquidation value for forced sale or auction proceedings.
11. To counsel a client on investment matters, including goals, alternatives,
resources, constraints and timing.
12. To advise zoning boards, courts an planners, among others, regarding the
probable effects of proposed actions.
13. To arbitrate between adversaries.
14. To determine supply and demand trends in a market.
15. To determine the status of real estate markets.
MARKET VALUE Market value is the major focus of most real property appraisal assignments.
Developing an estimate of market value is the purpose of most appraisal
“The highest price in terms of money which a property will bring in a
competitive open market under all conditions requisite to a fair sale, the
buyer and seller each acting prudently, knowledgeably, and assuming the
price is not affected by undue stimulus.”
“The price at which a willing seller would sell and a willing buyer would
buy, neither being under abnormal pressure.”
“The price expected if a reasonable time is allowed to find a purchaser and
if both seller and prospective buyer are fully informed.”
Assumptions made in these definitions:
• Buyer and seller are motivated by self-interest
• Buyer and seller are informed and are acting prudently
• The property is exposed for a reasonable time on the open market
• Payment is made in case, in its equivalent, or in specified financing terms
• Specified financing may be the financing actually in place or on terms
generally available for the property type in its local on the effective
• The effect, if any, on the amount of market value of atypical financing,
services of fees shall be clearly and precisely revealed in the appraisal
VALUE, PRICE AND COST
Value – The power of a good or service to command other goods in the
marketplace. It is the present worth of the future cash flow, or benefits since not
all property provide cash flows.
Price – The amount of money that is actually paid, asked or offered for a good or
service. As such, price represents two people’s estimates of value in terms of
money. Such an estimate may be greater than, equal to, or less than the
objective value of the good or service in question.
Cost – The cost of a particular commodity is a historical figure, a price paid in the
past, or the cost to construct a building today. A property’s cost may have no
effect on its value today.
VALUE INFLUENCES AND PRINCPLES Anticipation – an estimate of value should always be based on future
expectations, rather than past performances.
Change – Change is inevitable and is seen in all the forces affecting value.
The Appraisal Principles:
1. Supply and Demand – In a completely free economy, the interaction of supply
and demand would be the sole determinant of value.
2. Competition and Excess Profit – The Expresses a principle of a free
enterprise system: abnormal profits cannot be expected to continue
indefinitely into the future.
3. Substitution – The key concept of substitution states that when two parcels of
property have the same utility, the property offered at the lower price will sell
4. Surplus Productivity and balance – Of the four factors of production, land is
assumed to be the last one to be paid. This is so because it plays a passive
role, and a return must first be paid to the other three factors – capital, labour
and entrepreneurship – in order to induce them to utilize the land.
5. Conformity – Suggests that maximum value accrues to a parcel when a
reasonable degree of social and economic homogeneity are present in a
6. Contribution – The concept is an application of the law of marginal utility. The
concept says that changes in an existing improvement or in a portion of an
improvement can only be justified in a financial sense if the increase in cash
flow represents a fair return on the additional investment.
7. Externalities – This principle suggests that positive and negative economies
can be generated by factors external to a specific property. E.g. The location
of retail site within easy access to a major thoroughfare.
8. Highest and Best Use – Land is valued on the basis of the use that, at the
time the appraisal is made, is likely to produce the greatest return. The
highest and best use of a parcel of land is likely to change over time. Must be:
• Physically possible
• Legally possible
• Produce the maximum return
• Financially Feasible
THE APPRAISAL PROCESS Definition of the Problems:
The particular parcel of real estate must be identified. Then the particular legal
rights or estates to be appraised must be identified. The date of valuation also is
important. A clear understanding must exist both as to the purpose or objective of
the appraisal and the type of value sought. Finally, any limiting conditions must
be clearly stated.
Preliminary Analysis, Data Selection and Collection
• General Market Data
• Specific Site Data
Highest and Best Use Analysis
Application of the Three Approaches to Value
1. Cost Approach
2. Market Comparison Approach
3. Income Approach
Value Reconciliation and Final Value Conclusion.
THE SALES COMPARISON APPROACH
Relies on the principle of substitution, stating that a property is worth
approximately the same as another property