USPAP Essentials: Foundations of Appraisal Practice

USPAP Essentials: Foundations of appraisal❓ Practice

Introduction

This chapter establishes the scientific foundation upon which sound appraisal practice rests. It covers core definitions, principles, and economic theories that influence property valuation. Understanding these concepts is crucial for ethical, competent appraisal work that adheres to the Uniform Standards of Professional Appraisal Practice (USPAP).

Core Definitions

• Appraisal: The act or process of developing an opinion of value; an opinion of value. It is crucial to understand that an appraisal is an opinion, not a fact. This opinion must be expressed numerically (as a specific amount, a range, or a relationship to a benchmark). (USPAP)
• Appraisal Review: Developing and communicating an opinion about the quality of another appraiser’s work. The subject of review can be the report, work file, or both. (USPAP)
• Appraisal Consulting: Developing an analysis, recommendation, or opinion to solve a problem, where an opinion of value is a component of the analysis. (USPAP) Note that the opinion of value is not the primary purpose of the assignment.
• Appraisal Practice: Valuation services performed by an appraiser, including appraisal, appraisal review, and appraisal consulting. (USPAP)
• Value: The monetary relationship between properties and those who buy, sell, or use them. Value is an economic concept and is always an opinion, not a fact. It must be qualified (e.g., market value, investment value). (USPAP)

Fundamental Economic Principles

Appraisal is deeply rooted in economic principles. Understanding these principles is essential for analyzing market data and forming credible value opinions.

1. Supply and Demand:

   • Market value is determined by the interaction of supply (the amount of a good or service available) and demand (the desire and ability to purchase that good or service).
   • When demand exceeds supply, prices tend to rise. Conversely, when supply exceeds demand, prices tend to fall.
   • This principle can be mathematically represented in its most basic form by the intersection of supply and demand curves:

   Qd = f(P, Y, Pop, T, E) // Demand is a function of price, income, population, tastes, expectations Qs = f(P, Cost, Tech, E) // Supply is a function of price, costs of inputs, technology, expectations Qd = Qs // Equilibrium condition (where supply equals demand)
   * Example: A surge in population to an area with a limited housing supply will drive up home prices (increased demand, constrained supply).

2. Substitution:

   • A buyer will pay no more for a property than the cost of acquiring an equally desirable substitute. This principle is the foundation of the Sales Comparison Approach.
   • Example: If two similar houses are for sale in the same neighborhood, a buyer will likely choose the lower-priced one, assuming all other factors are equal.

3. Anticipation:

   • Value is influenced by the perceived future benefits a property is expected to provide.
   • This principle applies to all three approaches to value (Cost, Sales Comparison, and Income).
   • Example: A developer might pay a premium for land zoned for commercial use, anticipating future profits from a retail development.

4. Change:

   • Real estate values are not static; they are constantly changing due to market forces, economic conditions, and social trends.
   • Appraisers must consider past, present, and anticipated future conditions to arrive at a credible value opinion.
   • The real estate cycle (development, maturity, decline, revitalization) illustrates this principle.

5. Contribution:

   • The value of an improvement is equal to the amount it contributes to the overall value of the property, not necessarily its cost.
   • Example: A high-end kitchen remodel may not add its full cost to the property’s value if it is not in line with the overall quality and features of the house.

6. Highest and Best Use:

   • The legally permissible, physically possible, financially feasible, and maximally productive use of a property.

   • It is the use that produces the highest present value.

     • Example: A vacant lot in a commercial district might have a highest and best use as a retail building, even if it is currently used for parking.
       • This principle is foundational to all appraisals.

Agents of Production

These are the factors that contribute to the creation of wealth and, consequently, real estate value.

• Land: The natural resource, including its location.
• Labor: Human effort directed towards production.
• Capital: The financial resources used in production.
• Coordination (Entrepreneurship): The organization and management of the other factors of production.

The principle of surplus productivity suggests that after compensating labor, capital, and coordination, any remaining income is attributable to the land.

Forces Influencing Value

External factors constantly influence real estate values. Appraisers must be aware of these forces and their potential impact on property values.

• Economic Forces:

  • Interest rates
  • Inflation
  • Unemployment
  • Economic growth

• Social Forces:

  • Population trends
  • Lifestyle preferences
  • Demographic shifts

• Political Forces:

  • Zoning regulations
  • Building codes
  • Government policies
  • Taxation

• Environmental (Physical) Forces:

  • Climate
  • Topography
  • Natural resources
  • Environmental hazards

Types of Value

Appraisers must clearly identify the type of value being estimated, as this significantly influences the appraisal process.

• 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. (USPAP broadly defines Market Value in this manner).
• Investment Value: The value to a particular investor, based on their specific investment criteria and goals.
• Liquidation Value: The value that could be realized from a forced sale, typically within a short period.
• Insurable Value: The value of a property that is insurable, typically representing the cost to replace or rebuild it.
• Assessed Value: The value assigned to a property by a taxing authority for property tax purposes.
• Value in Use: The value of a property for a specific use, which may or may not be its highest and best use.
• Going Concern Value: The value of an operating business, including both real and personal property.

Real vs. Personal Property

Distinguishing between real and personal property is crucial in appraisal practice.

• Real Property: Land and anything permanently attached to it (buildings, fixtures).
• Personal Property: Movable items not permanently attached to the land.

The determination is based on:

1. Method of Attachment: How permanently is the item affixed?
2. Adaptability: Is the item specifically adapted to the property?
3. Intention: What was the intention of the installer?
4. Agreement of the Parties: What does the contract say?
5. Relationship of the Parties: Landlord-tenant?

Real Property Interests

Understanding different property rights and ownership interests is essential.

• Fee Simple: The most complete form of ownership, granting the owner all possible rights.
• Leasehold Estate: The right to possess and use property for a specified period, granted by a lease agreement.
• Life Estate: Ownership for the duration of someone’s life.

Encumbrances are interests that affect property rights:

• Liens: Financial claims against the property (mortgages, taxes).
• Easements: The right to use another’s property for a specific purpose (access, utilities).

Legal Descriptions

Accurate property identification is paramount. Common methods include:

• Metes and Bounds: A system of describing property boundaries using distances (metes) and directions (bounds) from a point of beginning (POB).

• Rectangular (U.S. Government) Survey System: A system that divides land into townships, ranges, sections, and quarter-sections.

• Lot and Block System: A system used for subdivided land, referencing lot numbers within a recorded plat.

Appraisal Reporting

Clear and accurate communication is essential. Appraisal reports must comply with USPAP standards and include:

• Problem Identification: Defining the intended use, the type of value, and the effective date of the appraisal.
• Scope of Work: Describing the extent of the research and analysis performed.
• Data Collection and Analysis: Summarizing the relevant data and analysis.
• Value Conclusion: Stating the appraiser’s opinion of value.
• Certification: Certifying compliance with USPAP.

Conclusion

A strong foundation in these core principles is critical for ethical and competent appraisal practice. Continued learning and application of these concepts are essential for maintaining professional standards. This chapter serves as a starting point for a deeper exploration of appraisal theory and techniques.