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Scope of Work: The Key to Credible Valuation
Scope of Work: The Key to Credible Valuation
Introduction
The scope of work is a cornerstone of the property valuation process. It defines the extent and nature of the work performed by the appraiser and directly impacts the credibility and reliability of the valuation opinion. A well-defined scope of work ensures that the appraisal is relevant to the client’s needs, compliant with applicable standards, and defensible in any potential review or challenge. This chapter explores the scientific principles, practical applications, and essential components of defining an effective scope of work.
- Identifying the Appraisal Problem: The Foundation
Before determining the scope of work, the appraiser must have a clear understanding of the appraisal problem. This foundational step involves identifying several key elements:
1.1 The Client: The party or parties who engage the appraiser and for whom the appraisal is being performed.
1.2 Intended Use: The specific purpose for which the appraisal results will be used (e.g., mortgage lending, estate planning, litigation support). The intended use significantly influences the level of detail and analysis required.
1.3 Intended Users: All parties, in addition to the client, who will rely on the appraisal report. Examples include lenders, investors, or legal counsel. Identifying all intended users ensures that the report meets their specific information needs.
1.4 Type of Value and Definition: The specific type of value sought (e.g., market value, investment value, insurable value) and the corresponding definition. Each value type has a distinct definition and requires a specific approach to valuation. For example, Market Value can be defined as:
MV = Most Probable Price (At which property would transfer)
1.5 Effective Date: The date to which the value opinion applies. This date is crucial because market conditions and property characteristics can change over time.
1.6 Property Characteristics: Relevant physical, legal, and economic characteristics of the property that influence its value. These include location, size, zoning, condition, title encumbrances, and environmental factors.
1.7 Assignment Conditions: Any extraordinary assumptions, hypothetical conditions, laws, regulations, or jurisdictional exceptions that affect the scope of work.
- Defining the Scope of Work: A Multi-Faceted Decision
The scope of work encompasses all aspects of the valuation process, from data collection to report writing. It must be sufficient to produce credible assignment results and align with the expectations of intended users and the practices of similarly qualified appraisers. The scope of work determination involves several key decisions:
2.1 Approaches to Value: Selecting the appropriate valuation approaches (sales comparison, cost, and income capitalization). The selection depends on the property type, data availability, and intended use.
2.1.1 Sales Comparison Approach: This approach relies on the principle of substitution, stating that a buyer will pay no more for a property than they would for a comparable one. The formula for calculating indicated value using this approach is:
Indicated Value = SP +/- Adjustments
Where: SP = Sales Price of Comparable Property
2.1.2 Cost Approach: Based on the principle of contribution, which states that the value of a property component is measured by its contribution to the overall property value. The formula for calculating the indicated value is:
Indicated Value = Land Value + Replacement Cost – Depreciation
2.1.3 Income Capitalization Approach: This approach converts future income into present value. The formula for direct capitalization is:
Value = Net Operating Income (NOI) / Capitalization Rate (Cap Rate)
2.2 Data Collection: Determining the amount and type of data to be gathered, the sources of data, the geographic area to be covered, and the time period to be analyzed.
2.2.1 General Data: Includes information about the region, city, and neighborhood (e.g., economic trends, demographics, zoning regulations).
2.2.2 Specific Data: Includes information about the subject property and comparable properties (e.g., sales prices, rents, expenses, physical characteristics).
2.3 Data Verification: Establishing the extent of the data verification process. This may involve contacting market participants, reviewing public records, and inspecting properties. The level of verification should be commensurate with the risk associated with the assignment.
2.4 Property Inspection: Deciding on the extent of the property inspection, if any. A thorough inspection allows the appraiser to identify physical characteristics, potential defects, and other factors that may affect value.
2.5 Reporting: Deciding on the type of report to be used (e.g., self-contained, summary, or restricted). The report should clearly communicate the scope of work, data and analysis, and value conclusion.
- Scope of Work Acceptability
The scope of work is acceptable when it meets the following criteria:
3.1 Credibility: The scope of work allows the appraiser to arrive at credible assignment results. Credibility requires the appraisal to be unbiased, accurate, and well-supported.
3.2 Intended User Expectations: The scope of work is consistent with the expectations of intended users of similar assignments. Appraisers should be aware of industry standards, regulatory requirements, and the specific needs of their clients.
3.3 Peer Practices: The scope of work aligns with the work that would be performed by the appraiser’s peers in a similar assignment. This ensures consistency and professional competence.
- Planning the Appraisal: Efficiency and Accuracy
4.1 Scheduling: Creating a schedule that outlines the time requirements for each step in the valuation process.
4.2 Delegation: Determining when to delegate work to other staff members or specialists, considering the responsibilities inherent in using reports prepared by others.
4.3 Report Outline: Developing an outline of the proposed appraisal report to guide data assembly and allocate time appropriately to each step.
- Data Collection and Analysis: Foundations of Valuation
Data collection and analysis are critical for developing a credible value opinion. The data needed can be divided into general data and specific data.
5.1 Market Analysis:
A market analysis is a study of market conditions for a specific type of property. It serves two important functions:
Provides a background against which local developments are considered.
Provides an indication of how values change over time.
Formula for Demand Studies:
Demand = Population x Income x Propensity to Consume.
5.2 Highest and Best Use Analysis:
Highest and best use analysis involves identifying the most probable and legal use of a property that is physically possible, appropriately supported, financially feasible, and that results in the highest value.
- Practical Applications and Experiments
6.1 Case Study: A lender requires an appraisal for a proposed commercial development. The scope of work should include a comprehensive market analysis, feasibility study, and discounted cash flow analysis to determine the project’s financial viability.
6.2 Experiment: Varying the scope of work in a residential appraisal assignment. Compare the impact on the value conclusion of using a limited scope inspection versus a complete inspection.
- Importance of Land Value Opinion
Developing an opinion of land value can be considered a separate step in the valuation model or an essential technique for applying certain approaches to value, depending on the defined appraisal problem and on the highest and best use analysis.
7.1 Land Valuation Techniques:
7.1.1 Sales Comparison: The most common way to develop an opinion of land value.
7.1.2 Extraction: Useful when few sales are available.
7.1.3 Allocation: May be applied when value indications produced through sales comparison need additional support
7.1.4 Subdivision development: A specialized valuation method useful in specific land use situations
7.1.5 Land residual: This technique is used more often in highest and best use analysis to test the feasibility of various uses than to estimate land value as part of one of the traditional approaches to value.
7.1.6 Ground rent capitalization: Can be used when land rents and land capitalization rates are readily available.
- Conclusion
The scope of work is not merely a procedural formality; it is a crucial element that ensures the credibility and reliability of the valuation process. A well-defined scope of work, based on a thorough understanding of the appraisal problem, industry standards, and intended user expectations, is essential for producing a defensible and meaningful value opinion. By mastering the principles and practices outlined in this chapter, appraisers can enhance their professional competence and contribute to the integrity of the valuation profession.
Chapter Summary
This chapter, “Scope of Work: The Key to Credible Valuation,” emphasizes the critical role of a well-defined scope of work in achieving credible property valuations. The valuation process starts with a clear identification of the appraisal problem, encompassing: identifying the client, intended users, intended use of the appraisal, type of value sought (and its definition), the effective date of the valuation, relevant property characteristics, and any assignment conditions (e.g., extraordinary assumptions or hypothetical conditions). Only after clearly defining the appraisal problem can the appraiser determine the appropriate scope of work.
Scope of work dictates the development aspects of the valuation process, including the selection of valuation approaches (sales comparison, income capitalization, cost approach), the extent of data collection (sources, geographic area, timeframe), the rigor of data verification, and the depth of property inspection. A scientifically sound scope of work is considered acceptable when it enables the appraiser to produce credible assignment results that meet the expectations of intended users and align with the standards of practice within the appraisal profession.
Effective planning, including outlining the appraisal report and allocating time for each step, enhances efficiency. Data collection, following problem identification and scope definition, involves gathering general data (market trends) and specific data (property characteristics, comparable sales). The amount and type of data collected are directly tied to the chosen valuation approaches and the defined scope of work. Irrelevant data is to be excluded to maintain the credibility of the analysis.
Data analysis comprises market analysis (understanding market conditions) and highest and best use analysis (determining the most profitable use of the property). Market analysis provides context for local market influences and informs the three valuation approaches. Highest and best use analysis identifies the use upon which the final value opinion is based. A land value opinion is developed separately and can be estimated using various techniques, with sales comparison being the most common. Finally, one or more of the three approaches to value (sales comparison, income capitalization, and cost approach) are selected and applied to derive a credible opinion of value. The choice of approaches depends on the property type, the appraisal’s intended use, and the availability of relevant data.
In conclusion, a carefully considered and clearly defined scope of work is not merely a procedural step but a fundamental requirement for ensuring the scientific validity and credibility of a property valuation. By meticulously defining the problem, strategically selecting valuation methodologies, and diligently collecting and analyzing relevant data, appraisers can arrive at well-supported and defensible value opinions.
