Defining the Appraisal Scope

Chapter: Defining the appraisal scope❓

Mastering Appraisal Foundations: Defining the Problem

The process of defining the appraisal scope is the cornerstone upon which a sound and credible valuation is built. This critical initial step involves a thorough understanding of the appraisal assignment’s requirements and limitations. It requires the appraiser to clearly identify the problem, thereby ensuring that the appraisal addresses the specific needs of the client and complies with relevant ethical and professional standards. This chapter will delve into the key components of defining the appraisal scope, providing a comprehensive overview of the process and its scientific underpinnings.

I. The Importance of Defining the Appraisal Problem

Before embarking on any appraisal assignment, the appraiser must define the appraisal problem. This involves answering fundamental questions to clarify the purpose, extent, and limitations of the appraisal. Properly defining the scope sets the stage for a reliable and defensible valuation. Two main components must be considered: (1) what the client wants to know, and (2) the terms and conditions of the appraisal assignment.

II. Key Questions in Defining the Appraisal Problem

Defining the appraisal problem necessitates addressing the following fundamental questions:

1. What is to be appraised? This question addresses the identification of the subject property, the specific property interest being appraised, and the standard of value.
2. When is it to be appraised? This question defines the effective date of the appraisal, a crucial factor influencing the valuation.
3. Why is it to be appraised? This question establishes the intended use of the appraisal, which dictates the scope of work and the appropriate valuation methods.
4. How is it to be appraised? This question outlines the appraisal process, including the data sources, valuation techniques, and reporting requirements.

III. Identifying the Subject of the Appraisal: The “What” Question

Accurately identifying what is to be appraised is paramount. This involves a three-pronged approach:

1. Identification of the Real Estate:

   • Methods of Identification: Real estate can be identified through various means, including street addresses, building names, and, most importantly, legal descriptions. While a common address might suffice for casual conversation, legal descriptions are essential for formal documentation due to their precision and lack of ambiguity.
   • Legal Descriptions: Legal descriptions precisely delineate the boundaries of the property, ensuring clarity and preventing disputes. Appraisals should always include the legal description. There are three major categories of legal descriptions:
     1. Metes and Bounds System: This system describes the property boundary by specifying its shape and dimensions, referencing monuments (physical markers) and directions.
     2. Rectangular or Government Survey System: Also known as the Public Land Survey System (PLSS), this system divides land into townships, ranges, and sections, creating a grid-like pattern. This system is prevalent in the United States.
     3. Lot, Block, and Tract System: This system is commonly used in urban areas and subdivisions. It references a recorded plat map that shows the individual lots, blocks, and tracts within the development.
   • Verification of Legal Description: While the client often provides the legal description, the appraiser can verify it by consulting the property owner’s deed or obtaining records from the local county records office. Unless agreed otherwise, appraisers are not expected to guarantee the accuracy of the legal description.

   • Example:

     • Building Name: The Smith Tower, an office building
     • Common Address: 1024 Western Avenue, Seattle, Washington
     • Legal Description: Lot 17, Division 3, Pierce Addition, City of Seattle, County of King, as recorded in King County, Washington
       2. Identification of the Real Property Interest:

   • Bundle of Rights: Real property encompasses both the physical land and buildings and the rights associated with ownership and use. These rights are often referred to as the “bundle of rights.”

   • Fee Simple vs. Partial Interests: The most common interest appraised is fee simple, which represents complete ownership. However, appraisals may also involve partial interests, such as leasehold interests (the right to use property for a specific period) or partial ownership interests (e.g., a one-half partnership interest).
   • Importance of Specification: The value of a fee simple interest will differ significantly from that of a partial interest. Therefore, clearly identifying the property interest is crucial.

2. Identification of Personal Property and Repairs/New Construction:

   • Personal Property: Sometimes, an appraisal may need to include personal property, e.g., equipment or furnishings included in the terms of sale. In these cases, the personal property to be appraised must be included in an addendum to the report.
   • Repairs and New Construction: The appraiser must identify any repairs, improvements, or new construction that will take place. If any repairs will impact the estimate of value, they must be identified and specified in the appraisal report. In the case of new construction, adequate plans and specifications must exist to allow the appraiser to form a reasonable opinion of the value of the new improvements.

3. Identification of the Standard of Value:

   • Definition: The standard of value (e.g., market value❓❓, fair value, liquidation value) dictates the fundamental assumptions and principles underlying the appraisal.
   • Market Value: Market value is the most common standard and is typically 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.

   • Formulaic Representation (Market Value): While a precise mathematical formula for market value is not possible due to its subjective elements, we can represent its dependence on various factors:

     • MV = f( P, C, M, T )

     Where:

     *   *MV* = Market Value
     *   *P* = Property Characteristics (size, location, condition, etc.)
     *   *C* = Market Conditions (supply, demand, interest rates, etc.)
     *   *M* = Motivation of Buyer and Seller (willingness to transact)
     *   *T* = Time (exposure time on the market)
     *   **Impact on Valuation:** The chosen standard of value profoundly impacts the appraisal process, influencing the selection of appropriate data, valuation methods, and reporting requirements.
     

IV. Determining the Effective Date of the Appraisal: The “When” Question

The effective date of the appraisal is the specific date upon which the appraiser’s opinion of value applies. This date is critical because property values are dynamic and influenced by market conditions at a specific point in time. The effective date can be:

• Current: Reflecting the present-day value.
• Retrospective: Reflecting a value as of a past date.
• Prospective: Reflecting a value as of a future date (e.g., in a new construction scenario).

V. Understanding the Intended Use of the Appraisal: The “Why” Question

The intended use of the appraisal clarifies why the valuation is being performed. This drives the scope of work, the level of detail required, and the appropriate valuation methods. Common intended uses include:

• Mortgage Lending: To assess the collateral value of a property for loan purposes.
• Estate Planning: To determine the value of assets for inheritance purposes.
• Litigation Support: To provide expert testimony in legal proceedings.
• Property Tax Assessment: To determine the taxable value of a property.
• Purchase Decisions: To inform a buyer’s decision-making process.
• Sale Decisions: To inform a seller’s decision-making process.

VI. Defining the Appraisal Process: The “How” Question

The “how” question outlines the methodology the appraiser will employ to arrive at a credible opinion of value. This includes:

1. Data Sources: Specifying the data sources used, such as:

   • Market data (comparable sales, listings, market trends).
   • Property data (deeds, surveys, building permits).

   • Cost data (construction costs, material costs).
     2. Valuation Approaches: Selecting the appropriate valuation approaches:

   • Sales Comparison Approach: Analyzing comparable sales to derive an indication of value.

   • Cost Approach: Estimating the cost to reproduce or replace the property, less depreciation.

   • Income Capitalization Approach: Converting the property’s income stream into an indication of value.
     3. Scope Limitations: Clearly stating any limitations or assumptions that might impact the appraisal. Examples of Scope limitations include:

   • Limited Property Inspection (e.g. only exterior inspection)

   • Reliance on Client Data (e.g. legal description)
   • Exclusion of Specific Property Components (e.g. Personal property)

VII. Ethical Considerations

Defining the appraisal scope is not only a technical exercise but also a matter of ethical responsibility. Appraisers must adhere to the ethical standards outlined in the Uniform Standards of Professional Appraisal Practice (USPAP), which emphasize objectivity, impartiality, and confidentiality.

VIII. Practical Applications and Experiments

While the exact nature of experiments might be limited in this field, the following practical applications demonstrate the impact of scope definition:

1. Case Study Analysis: Analyze real-world appraisal reports to identify the elements of scope definition and evaluate their effectiveness. Focus on situations where unclear scope definition led to flawed valuations.
2. Scenario-Based Exercises: Present trainees with different appraisal scenarios and require them to define the appraisal scope, considering factors such as intended use, property type, and data availability.
3. Sensitivity Analysis: Demonstrate how changes in assumptions within the defined scope can affect the final value conclusion. This highlights the importance of clearly documenting all assumptions and limitations.

IX. Conclusion

Defining the appraisal scope is a critical step that requires careful consideration of various factors. By systematically addressing the “what,” “when,” “why,” and “how” questions, appraisers can establish a clear understanding of the appraisal assignment and ensure that the valuation is relevant, reliable, and defensible. A well-defined scope not only benefits the client but also safeguards the appraiser’s professional reputation and integrity.