Defining the Appraisal Problem & Scope of Work

Defining the Appraisal Problem & Scope of Work

This chapter outlines the crucial initial steps in the property valuation process: defining the appraisal problem and determining the appropriate scope of work. A clear understanding of these elements is paramount for producing credible and reliable appraisal results. Failure to properly define the problem and scope can lead to inaccurate valuations, flawed decision-making, and potential legal ramifications.

1. Identification of the Appraisal Problem

The appraisal problem defines the objective of the valuation assignment. It provides the foundation for all subsequent steps in the valuation process. A poorly defined problem leads to wasted effort, irrelevant data collection, and an ultimately unreliable valuation.

1.1 Core Components of Problem Identification:

Identifying the appraisal problem necessitates defining the following elements:

• 1. Client: The party commissioning the appraisal. Identifying the client is essential for establishing confidentiality and understanding their specific needs and concerns.
• 2. Intended Use: How the appraisal results will be used by the client. Different intended uses (e.g., mortgage lending, estate planning, litigation support) require varying levels of detail and analysis.
• 3. Intended Users: All parties, besides the client, who will rely on the appraisal report. This can include lenders, investors, courts, or government agencies. Understanding the intended users helps determine the appropriate level of communication and disclosure in the report.
• 4. Type of Value and Definition: Specifies the type of value being estimated (e.g., market value, investment value, insurable value) and its precise definition. This definition is critical because it dictates the theoretical basis for the valuation and influences the selection of appropriate methods and data.
  • Example: Market Value is commonly defined as the most probable price 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 and knowledgeably, and assuming the price is not affected by undue stimulus.
• 5. Effective Date of the Opinion: The specific date to which the value opinion applies. Real estate values are time-sensitive, and the effective date anchors the valuation to a particular point in time.
• 6. Relevant Property Characteristics: Identifies the specific physical, legal, and economic attributes of the property that are relevant to the type of value and intended use. This includes:
  • Location: Geographic location and neighborhood characteristics.
  • Property Rights: The specific rights being valued (e.g., fee simple, leasehold, easement).
  • Physical Characteristics: Size, condition, improvements, and other relevant physical features.
  • Legal/Zoning: Existing zoning regulations and any legal encumbrances.
• 7. Assignment Conditions: Any extraordinary assumptions, hypothetical conditions, laws, regulations, or jurisdictional exceptions that affect the scope of work.
  • Extraordinary Assumption: An assumption, directly related to a specific assignment, which, if found to be false, could alter the appraiser’s opinions or conclusions.
  • Hypothetical Condition: An assumption contrary to known facts about physical, legal, or economic characteristics of the subject property; or about conditions external to the property, such as market conditions.

1.2 The Logical Sequence

The process of identifying the appraisal problem follows a logical sequence. The appraiser must identify the client, intended users, intended use, the type and definition of value, and the effective date before analyzing the property’s specific characteristics and assignment conditions. This ensures that the valuation is focused on the client’s needs and the relevant market context.

2. Scope of Work Determination

The scope of work defines the extent of the research and analysis necessary to produce a credible valuation. It is a crucial decision that directly impacts the reliability and defensibility of the appraisal. The scope of work must be sufficient to address the identified appraisal problem.

2.1 Steps in Solving the Appraisal Problem:

1. Identify the Appraisal Problem: As detailed in Section 1.
2. Determine the Scope of Work: Decide on the procedures, extent of data collection, and analysis required.
3. Apply the Scope of Work: Execute the planned procedures and analyze the collected data to arrive at a value opinion.

2.2 Key Elements of the Scope of Work:

• 1. Approaches to Value: Selection of the appropriate valuation approaches (e.g., sales comparison, cost, income capitalization). The choice of approach depends on the property type, data availability, and the specific requirements of the appraisal problem.
  • The fundamental principle behind each approach can be expressed as follows:
    • Sales Comparison: Value(Property) ≈ Σ [Value(Comparableᵢ) + Adjustmentsᵢ] where i ranges over comparable properties.
    • Cost Approach: Value(Property) ≈ Cost(New) - Depreciation + Land Value
    • Income Capitalization: Value(Property) = Net Operating Income / Capitalization Rate
• 2. Data Collection: Defining the type, amount, and sources of data to be gathered. This includes:
  • Market Data: General economic trends, supply and demand factors, and market participants’ behavior.
  • Subject Property Data: Physical characteristics, legal information, and relevant historical data.
  • Comparable Property Data: Sales prices, features, and other relevant information for comparable properties.
• 3. Geographic Area and Time Period: Defining the geographic area from which comparable data will be gathered and the relevant time period for data collection. This ensures that the data is relevant to the subject property and current market conditions.
• 4. Data Verification: Defining the procedures for verifying the accuracy and reliability of the collected data. This may involve contacting market participants, reviewing public records, or conducting physical inspections.
• 5. Property Inspection: Determining the extent of the property inspection, if any. The level of inspection depends on the property type, intended use, and the appraiser’s judgment.
  • This can be related to the concept of information asymmetry in economics. A thorough property inspection reduces information asymmetry between the appraiser and other market participants, leading to a more accurate valuation.

2.3 Acceptability of the Scope of Work:

The scope of work is considered acceptable when it:

• Allows the appraiser to arrive at credible assignment results. The scope must be sufficient to support a well-reasoned and defensible value opinion.
• Is consistent with the expectations of intended users of similar assignments. The scope should meet the standards and expectations of the parties who will rely on the appraisal report.
• Reflects the work that would be performed by the appraiser’s peers in a similar assignment. The scope should be consistent with the generally accepted practices and standards within the appraisal profession.

2.4 Planning the Appraisal

Efficient completion of an assignment hinges on planning and scheduling each step in the valuation process. Time estimates will vary based on the complexity of the appraisal problem.
Appraisers might work alone or assemble appraisal specialists or staff members. External expert opinions on renovation costs, for example, are helpful for valuing a planned building renovation. To improve efficiency and correctness, it is essential to recognize when tasks can or should be delegated.
A work plan will typically include an outline of the proposed report. The plan lists the procedures and data relevant to each report section. This framework facilitates data arrangement, allowing efficient distribution of time across all phases.

2.5 Examples & Practical Applications:

• Example 1: Residential Appraisal for Mortgage Lending. The intended use is mortgage financing, the client is the lender, and the intended users are the lender and potentially secondary market investors. The type of value is market value. The scope of work would likely include a detailed property inspection, a search for comparable sales in the immediate neighborhood, and the application of the sales comparison approach.
• Example 2: Commercial Appraisal for Estate Planning. The intended use is estate planning, the client is the property owner, and the intended users are the owner, their family, and potentially the IRS. The type of value might be fair market value. The scope of work might involve a broader market analysis, consideration of the property’s income potential, and the application of multiple valuation approaches (sales comparison, income capitalization).
• Practical Application (Experiment): To illustrate the impact of scope of work, an appraiser could perform two valuations on the same property with differing scopes. One valuation might include a limited data set and minimal property inspection, while the other involves extensive research and a thorough inspection. Comparing the resulting value opinions would demonstrate the importance of a well-defined and appropriate scope of work.

2.6. Mathematical & Statistical Considerations

The accuracy of appraisal results can be statistically linked to the sample size and the data used.
The principles of statistical analysis and confidence intervals can be applied to assess the reliability of comparable data, particularly in the sales comparison approach. The precision of the value opinion is directly related to the quality and quantity of comparable sales data.
For example, consider the coefficient of variation (CV) of adjusted sale prices of comparable properties:

CV = Standard Deviation / Mean

A lower CV indicates less dispersion in the adjusted sale prices, suggesting a higher level of reliability in the value indication. The appraiser’s scope of work must be sufficient to gather enough comparable data to ensure a statistically sound basis for the value opinion.