Real Estate Appraisal

A real estate appraisal is a service performed, by an appraiser, that develops an opinion of value based upon the highest and best use of real property. The highest and best use is that use which produces the highest possible value for the property. This use must be profitable and probable. Also of importance is the definition of the type of value being developed and this must be included in the appraisal, ie fair market value, condemnation value, quick sale value, etc. For improved residential property, this value is most often reported on a standardized form, the Uniform Residential Appraisal Report.

In the UK, real estate appraisal is known as property valuation and a real estate appraiser is a property valuation surveyor. Property valuation in the UK is regulated by the Royal Institution of Chartered Surveyors (RICS), a professional body encompassing all of the building and property-related professions. The RICS professional guidelines for valuers are published in the Red Book.

The reader should be aware that differences in nomenclature exist between the different countries. Although the overall concepts are very similar, the reader should be careful to ascertain that the proper nomenclature is being used for their particular area.

Types of value
There are several types and definitions of value sought by a real estate appraisal. Some of the most common are listed:

Market Value The price at which an asset would trade in a competitive Walrasian auction setting. Market value is usually interchangeable with fair market value or fair value. The legal definition of market value is usually given by some variant of the following: "The most probable price at which a property would trade in an arms-length transaction in a competitive and open market, in which the buyer and seller each act prudently and knowledgeably and in which the price is not affected by any special relationship between them".
Value-in-use The net present value (NPV) of a cash flow that an asset generates for a specific owner under a specific use. Value-in-use is the value to one particular user, which may be above or below the fair market value of a property.
Investment value - is the value to one particular investor, which may be above or below the fair market value of a property.
Insurable value - is the value of real property covered by an insurance policy. Generally it does not include the site value.
It is important to distinguish between market value and price. A price obtained for a specific property under a specific transaction may or may not represent that property's market value: special considerations may have been present, such as a family relationship between the buyer and seller, or else the transaction may have been part of a larger set of transactions in which the parties had engaged. Another possibility is that a specific buyer would be willing to pay a price higher than the market value. Such situations often arise in corporate finance, as per example when a merger or acquisition is concluded at a price which is higher than the value represented by the price of the underlying stock. The usual rationale for these valuations is that the 'sum is greater than its parts', since full ownership of a company entails special privileges for the buyer for which he is willing to pay. Such situations arise in real estate/property markets as well (see value-in-use). It is the task of the real estate appraiser/property valuer to judge whether a certain price obtained under a certain transaction is indicative of market value.

Market value definitions in the US
In the US, "Fair Market Value" and "Fair Value" are commonly used as accounting terms. The equivalent appraisal term is "Market Value." (USPAP Advisory Opinion 8.) USPAP defines Market Value as "a type of value, stated as an opinion, that presumes the transfer of a property (i.e., a right of ownership or a bundle of such rights), as of a certain date, under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal".

Forming an opinion of market value is the purpose of many real property appraisal assignments, particularly when the clients intended use includes more than one intended user. The conditions included in market value definitions establish market perspectives for development of the opinion. These conditions may vary from definition to definition but generally fall into three categories:

1) The relationship, knowledge, and motivation of the parties (i.e., seller and buyer);
2) The terms of sale (e.g., cash, cash equivalent, or other terms); and
3) The conditions of sale (e.g., exposure in a competitive market for a reasonable time prior to sale).
(Definitions: USPAP 2005.)
In the US, a typical definition of market value can be found on the FNMA residential appraisal forms, as the FNMA 1025, which states the following:

DEFINITION OF MARKET VALUE: The most probable price which 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, knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: (1) buyer and seller are typically motivated; (2) both parties are well informed or well advised, and each acting in what he or she considers his or her own best interest; (3) a reasonable time is allowed for exposure in the open market; (4) payment is made in terms of cash in U. S. dollars or in terms of financial arrangements comparable thereto; and (5) the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions* granted by anyone associated with the sale.
'*'Adjustments to the comparables must be made for special or creative financing or sales concessions. No adjustments are necessary for those costs which are normally paid by sellers as a result of tradition or law in a market area; these costs are readily identifiable since the seller pays these costs in virtually all sales transactions. Special or creative financing adjustments can be made to the comparable property by comparisons to financing terms offered by a third party institutional lender that is not already involved in the property or transaction. Any adjustment should not be calculated on a mechanical dollar for dollar cost of the financing or concession but the dollar amount of any adjustment should approximate the markets reaction to the financing or concessions based on the appraisers judgment.(FNMA form 1025, March 2005.)