Defining the Appraisal Problem: Scope and Identification

Chapter 3: Defining the Appraisal Problem: Scope and Identification

This chapter delves into the critical first steps of the appraisal process: defining the appraisal problem. Accurately defining the problem is paramount as it shapes the entire appraisal methodology and ensures the final value opinion directly addresses the client’s needs. Failure to properly identify the scope and objectives of the appraisal can lead to inaccurate valuations and ultimately, flawed decision-making. Defining the appraisal problem means answering some basic questions about the particular appraisal assignment.

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?

A. WHAT IS TO BE APPRAISED?

Determining “what is to be appraised” involves identifying three key components:

1. The Real Estate: Precisely defining the physical property that forms the subject of the appraisal.
2. The Real Property Interest: Specifying the exact rights and interests associated with the real estate that are being valued (e.g., fee simple❓❓, leasehold, partial interest).
3. The Standard of Value: Establishing the specific definition of value sought by the client (e.g., market value❓❓, investment value, liquidation value).

1. Identification of the Real Estate

Accurate identification of the real estate is non-negotiable. While a common address or building name may suffice for informal purposes, legal descriptions are essential for formal appraisal reports.

• Importance of Legal Descriptions: Legal descriptions provide an unambiguous and precise identification of the property boundaries. They minimize the potential for misinterpretations and legal disputes.

• Types of Legal Descriptions:

  • Metes and Bounds System: Describes property boundaries by specifying distances (metes) and directions (bounds) from a known point of beginning. This system often involves angles and bearings and may refer to landmarks or monuments.
  • Rectangular (Government) Survey System: Divides land into a grid system of townships, ranges, sections, and quarter-sections. This system uses principal meridians and baselines as reference points.
  • Lot, Block, and Tract System: Uses recorded subdivision plats to identify individual lots within a larger development. Each lot is assigned a number within a specific block, which is part of a larger tract.

• Obtaining Legal Descriptions: Legal descriptions can typically be found in deeds, mortgages, property tax records, and surveys. Clients often provide the legal description, but appraisers should verify its accuracy whenever possible. Appraisers should not accept responsibility for the accuracy of the legal description, since this is beyond the training and expertise of most appraisers.

  Example:

  Consider a property with the following descriptions:

  • Building Name: The Smith Tower
  • 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.

  While the building name and common address are helpful, the legal description provides the most definitive identification of the property.

• URAR (Uniform Residential Appraisal Report) and Real Estate Identification: The URAR form includes specific fields for property address, city, state, zip code, county, and legal description. The “Assessor’s Parcel #” is also critical for linking the property to tax records.

• Impact of Repairs and New Construction: Identification of the real estate also involves identifying any repairs, improvements or new construction that are to be completed. If appraising a property with planned repairs or new construction, clearly specify these aspects and their anticipated impact on value. For new construction, the existence of adequate plans and specifications is essential.

2. Identification of Real Property Interest

Real property encompasses not only the physical land and improvements, but also the bundle of rights associated with ownership. These rights include the right to possess, use, enjoy, and dispose of the property. Identifying the specific real property interest being appraised is crucial.

• Fee Simple: Represents the most complete form of ownership, granting the owner all available rights.
• Leasehold Interest: The right to possess and use a property for a specified period of time, as defined by a lease agreement.

• Partial Interests: Ownership interests that represent less than the full fee simple estate. Examples include:

  • Life Estate: Ownership for the duration of someone’s life.
  • Easements: The right to use another person’s land for a specific purpose.
  • Joint Tenancy: Ownership by two or more people with rights of survivorship.

• Impact on Value: The value of a property will vary depending on the real property interest being appraised. The fee simple value will typically be higher than the value of a leasehold or partial interest.

• Mathematical Representation (Example):

  Let:
  * V_FS = Value of Fee Simple Estate
  * V_LH = Value of Leasehold Interest
  * R = Rental Income per year
  * r = discount rate❓ (reflecting risk and opportunity cost)
  * n = Term of the Lease (in years)

  The present value of the leasehold interest can be estimated using a discounted cash flow approach:

  V_LH = R * [1 - (1 + r)^-n] / r

  This simplified formula demonstrates that the value of the leasehold is directly related to the rental income and inversely related to the discount rate and can never exceed the fee simple value. V_LH <= V_FS

3. Identification of the Standard of Value

The standard of value defines the type of value being sought in the appraisal. The most common standard is market value, but other standards exist and are appropriate in certain situations.

• Market Value: Typically defined as the most probable price that 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.

  • Market value assumes a willing buyer and a willing seller, adequate exposure time on the market, and an arm’s-length transaction.

• Other Standards of Value:

  • Investment Value: The value of a property to a specific investor, based on their individual investment criteria and risk tolerance.
  • Use Value: The value of a property for a specific use, regardless of its highest and best use.
  • Liquidation Value: The value that could be realized from the sale of a property under duress or within a short timeframe.
  • Assessed Value: The value assigned to a property for property tax purposes.

• Client’s Requirements: The appraiser must clearly understand the client’s specific requirements regarding the standard of value. Using the wrong standard can render the appraisal useless for the intended purpose.

B. WHEN IS IT TO BE APPRAISED? (Effective Date)

The effective date of the appraisal is the specific date for which the value opinion is relevant. It’s important to note that the effective date may not be the same as the date of the appraisal report.

• Retrospective Appraisal: An appraisal with an effective date in the past.
• Current Appraisal: An appraisal with an effective date that is the current date.
• Prospective Appraisal: An appraisal with an effective date in the future (e.g., for proposed construction).

C. WHY IS IT TO BE APPRAISED? (Intended Use and User)

The intended use of the appraisal identifies the purpose for which the appraisal will be used (e.g., mortgage lending, estate planning, litigation). The Intended User❓❓❓ is the party or parties who will rely on the appraisal (e.g., the lender, the borrower, the court). Knowing the intended use and user is essential for determining the scope of work and the level of detail required in the appraisal report.

D. HOW IS IT TO BE APPRAISED? (Scope of Work)

The scope of work outlines the procedures and methodologies that the appraiser will employ to develop the value opinion. This includes:

• Data Collection: Identifying the types of data that will be collected (e.g., sales data, cost data, income data).
• Inspection: Determining the extent of the property inspection.
• Analysis: Specifying the appraisal approaches that will be used (e.g., sales comparison approach, cost approach, income capitalization approach).
• Reporting: Determining the type of report that will be prepared (e.g., self-contained report, summary report, restricted use report).

Conclusion

Defining the appraisal problem is a fundamental step in the appraisal process. By carefully identifying the real estate, real property interest, standard of value, effective date, intended use, intended user, and scope of work, the appraiser can ensure that the appraisal is relevant, reliable, and credible. A clear understanding of these elements is essential for developing accurate value opinions and providing clients with the information they need to make informed decisions.