Defining the Appraisal Assignment: Problem & Scope

Chapter: Defining the Appraisal Assignment: Problem & Scope

This chapter delves into the critical first steps in the appraisal process: defining the appraisal problem and determining the necessary resources to solve it. Mastering these steps is fundamental to producing a credible and defensible appraisal. These initial steps, along with the subsequent ones, are grounded in the Uniform Standards of Professional Appraisal Practice (USPAP), which emphasizes the appraiser’s responsibility to understand the problem and scope of work required.

I. The Importance of Defining the Problem and Scope

USPAP Standard 1 mandates that appraisers❓ must:

• Identify the problem to be solved.
• Determine the scope of work necessary to solve the problem.
• Correctly complete the research and analysis necessary to produce a credible appraisal.

These steps aren’t merely procedural; they form the bedrock upon which the entire appraisal rests. A poorly defined problem or an inadequate scope of work can lead to inaccurate value estimates and potentially misleading conclusions. The appraisal process itself can be broken down into a series of steps, although these steps often overlap and are not necessarily completed in a strictly linear fashion:

1. Define the appraisal problem.
2. Preliminary analysis (determine necessary and available resources).
3. Collect, verify, and analyze the necessary data.
4. Determine the property’s highest and best use.
5. Estimate the value of the site.
6. Apply the three approaches to value (Cost, Sales Comparison, and Income Capitalization).
7. Reconcile the various value indicators to reach a final value estimate.
8. Prepare and deliver an appropriate appraisal report.

II. Step 1: Defining the Appraisal Problem – The “Four W’s and an H”

Defining the appraisal problem involves clearly answering a series of fundamental questions. It’s about understanding both the client’s needs (what they want to know) and the conditions of the appraisal assignment (how the appraiser will carry it out). We can frame these questions using the “Four W’s and an H” framework:

1. What is to be appraised?
2. When is it to be appraised?
3. Why is it to be appraised?
4. How is it to be appraised?

Let’s break down each of these questions in detail:

A. WHAT is to be Appraised? – Identifying the Subject of the Appraisal

Determining “what” is to be appraised requires identifying three key aspects of the subject property:

1. The Real Estate.
2. The Real Property Interest.
3. The Standard of Value.

1. The Real Estate:

• Definition: Real estate refers to the physical land and any improvements permanently attached to it (buildings, fixtures, etc.).
• Identification: Real estate is commonly identified using a street address, building name, or, most importantly, a legal description.
• Legal Descriptions: Legal descriptions are paramount for accuracy❓ and minimizing ambiguity. They provide a precise and unambiguous way to identify the property.
• Types of Legal Descriptions:
  • Metes and Bounds: Describes property boundaries by specifying distances (metes) and directions (bounds). Often uses landmarks and monuments as reference points. This system is more prevalent in older areas and is less mathematically precise than other methods.
  • Rectangular (Government) Survey System: Divides land into a grid system of townships and sections. Townships are six miles square and are identified by their location relative to a principal meridian and a base line. Sections are one mile square and contain 640 acres. This system relies heavily on cardinal directions.

    • Mathematical Representation: An area of land in the Rectangular Survey System can be calculated by multiplying the fractions representing its location within a section. For example, the area of the NW 1/4 of the SE 1/4 of a section is:

      A = (1/4) * (1/4) * 640 acres = 40 acres
      * Lot, Block, and Tract System: Used in platted subdivisions. The land is divided into lots within blocks, and blocks are located within a larger tract. The plat map, recorded in the county records, provides the legal description.
      * Example: As seen in the provided example, multiple identifiers can refer to the same property (building name, common address, legal description). An appraisal should include all, but must include the legal description.
      * Data Sources: Legal descriptions can be obtained from the client, property owner/manager, real estate broker, or the local county records office (Recorder’s office, Registry of Deeds).

2. The Real Property Interest:

• Definition: This refers to the rights and interests associated with owning or using the real estate. It’s not just about the physical property but also what rights are being appraised.
• Examples:
  • Fee Simple Estate: The most complete form of ownership, granting the owner the greatest bundle of rights (possession, use, control, enjoyment, disposition).
  • Leased Fee Estate: The ownership interest held by a landlord with the right of use and occupancy conveyed by a lease to others. The value reflects the present value of the future rent stream and reversionary interest.
  • Leasehold Estate: The right to use and occupy a property under the terms of a lease. The value represents the difference between the market rent and the contract rent, capitalized over the remaining lease term.
  • Life Estate: Ownership limited to the lifetime of a specified person.
  • Easement: A right granted to another party to use the land for a specific purpose (e.g., right-of-way).
• Impact on Value: The specific property interest being appraised significantly impacts the valuation process. For example, valuing a leased fee estate requires analyzing the lease terms, market rents, and reversionary value, which differs significantly from valuing a fee simple estate.

3. The Standard of Value:

• Definition: The standard of value defines what type of value is being sought. It provides the fundamental premise upon which the value opinion is based.
• Common Standards of Value:
  • Market Value: 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. (Requires hypothetical conditions). The conceptual framework for market value can be represented using probability distributions of potential selling prices and the likelihood of each price occurring within a given time frame in the specific market.
  • investment value❓❓: The value of a property to a particular investor based on their specific investment criteria and requirements.
  • Use Value: The value of a property for a specific use, regardless of its highest and best use.
  • Liquidation Value: The likely price that an asset will bring when it is allowed an insufficient amount of time to be sold on the open market.
• Importance: The standard of value dictates the methodologies and data used in the appraisal. An appraisal for market value will focus on comparable sales in the open market, while an appraisal for investment value will consider the specific investor’s financial goals and risk tolerance.

B. WHEN is it to be Appraised? – Effective Date and Date of Report

The “when” aspect has two critical components:

1. Effective Date of the Appraisal: This is the date to which the value opinion applies. It is the specific point in time for which the value estimate is relevant. This date may be retrospective, current, or prospective.
2. Date of the Appraisal Report: This is the date the appraisal report is prepared and submitted to the client. It reflects the appraiser’s perspective and understanding of the market as of that date.

C. WHY is it to be Appraised? – Intended Use and Intended Users

Understanding “why” the appraisal is being performed involves identifying:

1. Intended Use: The purpose for which the appraisal is being conducted (e.g., mortgage financing, estate planning, litigation support, tax assessment, eminent domain). The intended use directly influences the scope of work, the level of detail required, and the types of analyses performed.
2. Intended Users: The parties who will be relying on the appraisal report (e.g., the lender, the borrower, the court, the attorneys). Identifying intended users helps the appraiser understand their needs and tailor the report to their specific requirements.

D. HOW is it to be Appraised? – Scope of Work, Assumptions, and Limiting Conditions

The “how” question addresses the methodology of the appraisal:

1. Scope of Work: The extent of the data collection, research, and analysis performed in the appraisal. It encompasses the procedures the appraiser will employ to develop credible assignment results. The scope of work should be sufficient to produce credible results for the intended use of the appraisal.
   • Examples: Type of property inspection (exterior only vs. full interior), data sources to be consulted (public records, interviews, market surveys), approaches to value to be applied (sales comparison, cost, income).
2. Assumptions: Statements taken to be true for the purposes of the appraisal, even if their accuracy is not guaranteed. Assumptions are crucial for dealing with uncertainties and simplifying complex situations.
   • Example: Assuming that the property is free from environmental contamination.
3. Limiting Conditions: Statements that restrict the appraiser’s responsibility or liability. These conditions clarify the boundaries of the appraiser’s work and protect them from potential claims.
   • Example: The appraiser is not responsible for discovering hidden defects in the property.

III. The Interconnectedness of the Appraisal Process Steps

It’s crucial to remember that the steps in the appraisal process are not isolated tasks. They are interconnected and often overlap. Data collection might begin before the appraisal problem is fully defined, and data analysis may occur throughout the entire process. The entire process is unified by the goal of determining value.

In conclusion, clearly defining the appraisal problem and establishing an appropriate scope of work are paramount for producing a credible and reliable appraisal. By thoroughly addressing the “Four W’s and an H,” the appraiser lays a solid foundation for the subsequent steps in the valuation process.