Real estate appraisal, property valuation or land valuation is the practice of developing an opinion of the value of real property, usually its Market Value. The need for appraisals arises from the heterogeneous nature of property as an investment class: no two properties are identical, and all properties differ from each other in their location - which is one of the most important determinants of their value. So there cannot exist a centralised Walrasian auction setting for the trading of property assets, as there exists for trade in corporate stock. The absence of a market-based pricing mechanism determines the need for an expert appraisal/valuation of real estate/property.
Although some areas require no license or certification at all, a real estate appraisal is generally performed by a licensed or certified appraiser (in many countries known as a Property Valuer or Land Valuer and in British English as a "valuation surveyor"). If the appraiser's opinion is based on Market Value, then it must also be based on the Highest and Best Use of the real property. For mortgage valuations of improved residential property in the US, the appraisal is most often reported on a standardized form, such as the Uniform Residential Appraisal Report. Appraisals of more complex property (e.g. -- income producing, raw land) are usually reported in a narrative appraisal report.
There are several types and definitions of value sought by a real estate appraisal. Some of the most common are:
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 special relationship between the buyer and the 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 special buyer may have been willing to pay a premium over and above the market value, if his subjective valuation of the property (its investment value for him) was higher than the Market Value. An example of this would be the owner of a neighbouring property who, by combining his own property with the subject property, could thereby obtain economies-of-scale. Such situations often arise in corporate finance, as for 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 would be that the 'sum is greater than its parts', since full ownership of a company entails special privileges for which a potential purchaser would be willing to pay. Such situations arise in real estate/property markets as well. It is the task of the real estate appraiser/property valuer to judge whether a specific price obtained under a specific transaction is indicative of Market Value.
In the US, appraisals are performed to a certain standard of value (e.g. -- foreclosure value, fair market value, distressed sale value, investment value). The most commonly used definition of value is Market Value. While USPAP does not define Market Value, it provides general guidance for how Market Value should be defined:
a type of value, stated as an opinion, that presumes the transfer or sale of a property 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.
Thus, the definition of value used in an appraisal or CMA analysis and report is a set of assumptions about the market in which the subject property may transact. It becomes the basis for selecting comparable data for use in the analysis. These assumptions will vary from definition to definition but generally fall into three categories:
There are three general groups of methodologies for determining value. These are usually referred to as the "three approaches to value"which are generally independent of each other:
However, the recent trend of the business tends to be clinging to the scientific methodology of appraisal which lies on the foundation of quantitative-data , risk and geographical based approaches  , . Pagourtzi et al. have provided a review on the methods used in the industry by comparison between conventional approaches and advanced ones .
The appraiser using three approaches will determine which one or more of these approaches may be applicable, based on the scope of work determination, and from that develop an appraisal analysis. Costs, income, and sales vary widely from one situation to the next, and particular importance is given to the specific characteristics of the subject.
Consideration is also given to the market for the property appraised. Appraisals of properties that are typically purchased by investors (e.g. - skyscrapers) may give greater weight to the income approach, while small retail or office properties, often purchased by owner-users, may give greater weighting to the sales comparison approach. While this may seem simple, it is not always obvious. For example, apartment complexes of a given quality tend to sell at a price per apartment, and as such the sales comparison approach may be more applicable. Single family residences are most commonly valued with greatest weighting to the sales comparison approach, but if a single family dwelling is in a neighborhood where all or most of the dwellings are rental units, then some variant of the income approach may be more useful.
The cost approach was formerly called the summation approach. The theory is that the value of a property can be estimated by summing the land value and the depreciated value of any improvements. The value of the improvements is often referred to by the abbreviation RCNLD (reproduction cost new less depreciation or replacement cost new less depreciation). Reproduction refers to reproducing an exact replica. Replacement cost refers to the cost of building a house or other improvement which has the same utility, but using modern design, workmanship and materials. In practice, appraisers use replacement cost and then deduct a factor for any functional disutility associated with the age of the subject property.
In most instances when the cost approach is involved, the overall methodology is a hybrid of the cost and sales comparison approaches. For example, while the replacement cost to construct a building can be determined by adding the labor, material, and other costs, land values and depreciation must be derived from an analysis of comparable data.
The cost approach is considered reliable when used on newer structures, but the method tends to become less reliable for older properties. The cost approach is often the only reliable approach when dealing with special use properties (e.g. -- public assembly, marinas).
The sales comparison approach in a real estate appraisal is based primarily on the principle of substitution. This approach assumes a prudent individual will pay no more for a property than it would cost to purchase a comparable substitute property. The approach recognizes that a typical buyer will compare asking prices and seek to purchase the property that meets his or her wants and needs for the lowest cost. In developing the sales comparison approach, the state licensed real estate appraiser attempts to interpret and measure the actions of parties involved in the marketplace, including buyers, sellers, and investors.
Method of Data Collection Data are collected on recent sales of properties similar to the subject being valued, called comparables. Sources of comparable data include real estate publications, public records, buyers, seller, real estate brokers and/or agents, appraisers, and others. Important details of each comparable sale are described in the appraisal report. Since comparable sales are not always identical to the subject property, adjustments are sometimes make for date of sale, location, style, bathrooms, square foot, site size, etc. The main idea is to simulate the price that would have been paid if each comparable sale were identical to the subject property.If the adjustment to the comparable is superior to the subject, a downward adjustment is necessary. Likewise, if the adjustment to the comparable is inferior to the subject, an upward adjustment is necessary. From the analysis of the group of adjusted sales prices of the comparable sales, the state licensed real estate appraiser selects an indicator of value that is representative of the subject property.
Steps in the Sales Comparison Approach 1. Research the market to obtain information pertaining to sales, listings, pending sales that are similar to the subject property. 2. Investigate the market data to determine whether they are factually correct and accurate. 3. Determine relevant units of comparison (e.g., sales price per square foot), and develop a compararive analysis for each. 4. Compare the subject and comparable sales according to the elements of comparison and adjust as appropriate. 5. Reconcile the multiple value indications that result from the adjustment of the comparable sales into a single value indication.
The income capitalization approach (often referred to simply as the "income approach") is used to value commercial and investment properties. Because it is intended to directly reflect or model the expectations and behaviors of typical market participants, this approach is generally considered the most applicable valuation technique for income-producing properties, where sufficient market data exists to supply the necessary inputs and parameters for this approach.
In a commercial income-producing property this approach capitalizes an income stream into a value indication. This can be done using revenue multipliers or capitalization rates applied to the first-year Net Operating Income. The Net Operating Income (NOI) is gross potential income (GPI), less vacancy and collection loss (= Effective Gross Income) less operating expenses (but excluding debt service, income taxes, and/or depreciation charges applied by accountants).
Alternatively, multiple years of net operating income can be valued by a discounted cash flow analysis (DCF) model. The DCF model is widely used to value larger and more expensive income-producing properties, such as large office towers. This technique applies market-supported yields (or discount rates) to future cash flows (such as annual income figures and typically a lump reversion from the eventual sale of the property) to arrive at a present value indication.
In the United Kingdom, valuation methodology has traditionally been classified into five methods:
While USPAP has always required appraisers to identify the scope of work needed to produce credible results, it became clear in recent years that appraisers did not fully understand the process for developing this adequately. In formulating the scope of work for a credible appraisal, the concept of a limited versus complete appraisal and the use of the Departure Rule caused confusion to clients, appraisers, and appraisal reviewers. In order to deal with this, USPAP was updated in 2006 with what came to be known as the Scope of Work project. In short, USPAP eliminated the Departure Rule and the concept of a limited appraisal and created a new Scope of Work rule. In this, appraisers were to identify six key parts of the appraisal problem at the beginning of each assignment:
Based on these factors, the appraiser must identify the scope of work needed, including the methodologies to be used, the extent of investigation, and the applicable approaches to value. The rule provided the explicit requirement that the minimum standards for scope of work were:
The Scope of Work is the first step in any appraisal process. Without a strictly defined Scope of Work an appraisal's conclusions may not be viable. By defining the Scope of Work an appraiser can begin to actually develop a value for a given property for the intended user, which is the intended use of the appraisal.
Highest and Best Use (HABU) is a term of art in the appraisal process. It is a process to determine the use of the property which produces the highest value for the land, as if vacant. There are four steps to the process. First, the appraiser determines all uses which are legally permissible for the property. Second, of the uses which are legally permissible, which ones are physically possible. Of those, which ones are financially feasible (sometimes referred to as economically supported). Of those uses which are feasible, which one and only use is maximally productive for the site. In a simple context, the appraiser must do this twice, comparing the results—as if the land is vacant and in the as-is-improved state, taking into account the costs of demolishing any existing improvements. The outcome of this process is the highest and best use for the site. An appraisal of market value must explicitly assume that the owner or buyer would employ the property in its highest and best use, and therefore value the site accordingly.
In more complex appraisal assignments (e.g. -- contract disputes, litigation, brownfield or contaminated property valuation), the determination of highest and best use may be much more complex, and may need to take into account the various intermediate or temporary uses of the site, the contamination remediation process, and the timing of various legal issues.
Implicit in the analysis of the subject property is a determination of the interest in the property being appraised. For most common situations (e.g. -- mortgage finance) the fee simple interest is explicitly assumed since it is the most complete bundle of rights available. However, in many situations, and in many societies which do not follow English Common Law or the Napoleanic Code, some other interest may be more common. While there are many different possible interests in real estate, the three most common are:
Automated valuation models (AVMs) are growing in acceptance. These rely on statistical models such as multiple regression analysis or geographic information systems (GIS). While AVMs can be quite accurate, particularly when used in a very homogeneous area, there is also evidence that AVMs are not accurate in other instances such as when they are used in rural areas, or when the appraised property does not conform well to the neighborhood. AVM's have also gained favor in class action litigation, and have been substantiated in numerous cases, both in Federal and state courts, as the appropriate method for dealing with large-scale real estate litigation problems, such as contaminated neighborhoods
The various US and international professional organizations have started collaborating in recent years towards the development of International Valuation Standards which will facilitate global real estate appraisal, a much-needed adjunct to real estate investment portfolios which transcend national boundaries.
The IVSC - The International Valuation Standards Committee, is a Non-governmental Organisation (NGO) member of the UN, with membership that encompasses all the major national valuation standard-setters and professional associations from 41 different countries (including the Appraisal Institute, the RICS and the Appraisal Institute of Canada). IVSC have published the International Valuation Standards (IVS), now in their 8th edition.
In Germany, real estate appraisal is known as real estate valuation (Immobilienbewertung). Real estate appraisers (Immobilienbewerter or Gutachter) can qualify to become a Öffentlich bestellter und vereidigter Sachverständiger (officially appointed and sworn expert). However, this formerly very important title has lost a lot of its importance over the past years, but still is of some value in court procedures. The title is not generally required for appraisals.
The real estate appraisal practice in Germany is partly codified by law. The federal Baugesetzbuch (abbr. BauGB, "German statutory code on building and construction'") contains guidelines on governing authorities, defines the term market value and refers to continuative rules (chapter 3, articles 192 ff.). Each municipality (city or administrative district) has to form a Gutachterausschuss (appraisal committee), consisting of a chairman and honorary members . The committee gathers information on all real estate deals (it is mandatory to send a copy of each notarial purchase contract to the Gutachterausschuss) and includes it in the Kaufpreissammlung (purchase price database). Most committees publish an official real estate market report every two years, in which besides other information on comparables the land value is determined. The committees also perform appraisals on behalf of public authorities.
The BauGB defines the Verkehrswert or Marktwert (market value, both terms with identical meaning) as follows: "The market value is determined by the price that can be realised at the date of valuation, in an arm's length transaction, with due regard to the legal situation and the effective characteristics, the nature and lay of the premises or any other subject of the valuation"  (non-official translation). The intention, as in other countries, is to include all objective influences and to exclude all influences resulting from the subjective circumstances of the involved parties.
This federal law is supported by the Wertermittlungsverordnung (abbr. WertV, "regulation on the determination of value") . The WertV defines the codified valuation approaches and the general valuation technique. German codified valuation approaches (other apporaches such as DCF or residual approach are also permitted, but not codified) are the:
WertV's general regulations are further supported by the Wertermittlungsrichtlinie (abbr. WertR, "directive on the determination of value") . The WertR provides templates for calculations, tables (e. g. economic depreciation) and guidelines for the consideration of different influences. WertV and WertR are not binding for appraisals for nonofficial use, nonetheless they should be regarded as best practice or Generally Accepted (German) Valuation Practice (GAVP).
Comments on German GAVP
In most regards Generally Accepted (German) Valuation Principles is consistent with international practice. The investment market weighs the income approach most heavily. However, there are some important differences:
Mathematically the distinction between land and improvements in the income approach will have no impact on the overall value when the remaining economic life is more than thirty years. For this reason it has become quite common to use the Vereinfachtes Ertragswertverfahren (simplified income approach), omitting the land value and the Liegenschaftszins. However, the separate treatment of land and buildings leads to more precise results for older buildings, especially for commercial buildings, which typically have a shorter economic life than residential buildings.
An advantage of the comparatively high degree of standardization practiced by professional appraisers, is the greater ability to check an appraisal for inconsistency, accuracy and transparency.
The Federal German Organisation of Appointed and Sworn Experts (Bundesverband Deutscher Sachverständiger und Fachgutachter, abbr. BDSF) is the main professional organisation encompassing the majority of licensed appraisers in Germany. In recent years, with the move towards a more global outlook in the valuation profession, the RICS has gained a foothold in Germany, somewhat at the expense of the BDSF.
With special focus on hypothecary value, in 1996, German banks with real estate financing activities formed the HypZert GmbH, an association for the certification of real estate valuers. A HypZert qualification is regarded as mandatory for their appraisers by many German banks.
In Israel, the real estate appraisal profession is regulated by the Council of Land Valuers, an organ of the Ministry of Justice; the largest professional organisation, encompassing the majority of appraisers/land valuers is the Association of Land Valuers. Valuers must be registered with the Council, which is a statutory body set up by law, and which oversees the training and administers the national professional exams that are a prerequisite for attaining registration. In 2005 the Council set up a Valuation Standards Committee with the purpose of developing and promulgating Standards that would reflect best practice; these have tended to follow a rules-based approach.
Historically, most valuations in Israel were statutory valuations (such as valuations performed for purposes of Betterment Tax - a tax administered on any gains accruing to the property by way of changes to the local planning) as well as valuations performed for purposes of bank lending. This is now changing: since the adoption in Israel of International Financial Reporting Standards (IFRS) (were adopted in 2006; will fully come into effect in 2008), the profession has been additionally engaged in performing valuations for purposes of financial reporting.
The Japanese Association of Real Estate Appraisal, established in 1965, is the only certified association and is regulated by the Ministry of Land, Infrastructure, Transportation and Tourism.
In Malaysia, real estate appraisal is known as Property Valuer. Valuer is a professional who
has been educated and trained to determine the value of fixed
property, execute feasibility studies and provide expert advice on
property related matters. An independent Valuer can provide
impartial and motivated reports on the value of real or limited
rights in land.
The Valuer requires a combination of a number of professional qualities and capabilities, and needs a thorough knowledge and understanding of the interacting influences which create, maintain or diminish the value of property or rights therein. The Valuer does not invent value, but interprets market forces, which determine the value. Valuer is a profession closely related to real estate. A Valuer determines the value of property based upon market conditions at a given time.
One of the frequent applications of the Valuer's skill is to determine values for purchase or sale, and for insurance purposes.
Valuers are qualified to undertake valuations in all classes of properties, including commercial and industrial properties; all types of residential properties, agricultural and special use properties. However, most Valuers tend to specialize and do not undertake the full range of valuations. It is therefore vitally important for clients to select and appoint a registered Valuer with the relevant practical experience required to undertake the specific valuation.
While it is essential as professional, the Valuers are governed by The Board of Valuers, Appraisers and Estate Agents under provision of Valuers, Appraisers and Estate Agents Act 1981. Its primary function is to regulate the Valuers, Appraisers and Estate Agents practicing in Malaysia.
In the UK, real estate appraisal is known as property valuation and a real estate appraiser is a land valuer or property valuer (usually a qualified chartered surveyor who specialises in property valuation). 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 RICS Appraisal and Valuation Standards, commonly known as the Red Book. While based in the UK, RICS is a global organization and has become very active in the US in recent years through its affiliation with the Counselors of Real Estate, a division of the National Association of Realtors.
Appraisal practice in the US is regulated by the various states. The Financial Institutions Reform and Recovery and Enforcement Act (FIRREA) of 1989 demanded all the states to develop systems for licensing and certifying real estate appraisers. To accomplish this, the Appraisal Subcommittee (ASC) was formed, with representatives from the various Federal mortgage regulatory agencies.[17 ] Thus, currently all the real estate appraisers must be state-licensed and certified. But prior to the 1990s, there were no commonly accepted standards either for appraisal quality or for appraiser licensure. In the 1980s, an ad-hoc committee representing various appraisal professional organizations in the U.S. and Canada met to codify the best practices into what became known as the Uniform Standards of Professional Appraisal Practice (USPAP). The Savings and Loan Crisis in the U.S. resulted in increased Federal regulation of the mortgage lending process via the Financial Institutions Reform, Recovery and Enforcement Act of 1991. A portion of this act required federal lending regulators to adopt appraisal standards. A not-for-profit organization, the Appraisal Foundation (TAF), was formed by the same organizations which had developed USPAP, and the copyright for USPAP was signed over to TAF. Federal oversight of TAF is provided by the Appraisal Subcommittee, made up of representatives of various Federal lending regulators. TAF carries out its work through two boards: the Appraisal Standards Board promulgates and updates USPAP; the Appraisal Qualifications Board (AQB) promulgates minimum recommended standards for appraiser certification and licensure. During the 1990s, all of the states adopted USPAP as the governing standards within their states and developed licensure standards which met or exceeded the recommendations of TAF. Also, the various state and federal courts have adopted USPAP for real estate litigation and all of the federally lending regulators adopt USPAP for mortgage finance appraisal.[17 ]
In addition, there are professional appraisal organizations, organized as private not-for-profits, which date to the Great Depression of the 1930s. One of the oldest in the U.S. is the American Society of Farm Managers and Rural Appraisers (ASFMRA), founded in 1929. Others were founded as needed and opportunity arose in specialized fields, such as the Appraisal Institute (AI) and the American Society of Appraisers (ASA) founded in the 1930s, the International Right of Way Association and the National Association of Realtors which were founded after World War II. These organizations all existed to establish and enforce standards, but their influence has waned as the government increases appraisal regulation. In March 2007, three of these organizations (ASFMRA, ASA, and AI) announced an agreement in principle to merge. NAIFA (National Association of Independent Fee Appraisers), a charter member of The Appraisal Foundation, helped to write Title XI, the Real Estate Appraisal Reform Amendments. It was founded in 1961.
The best known professional organization of real estate appraisers in America is the Appraisal Institute. It was formed in from the merger of the American Institute of Real Estate Appraisers and the Society of Real Estate Appraisers. Founded along with others in the 1930s, the two organizations merged in the 1990s to form the Appraisal Institute (AI). This group awards two professional designations: SRA, to residential appraisers, and MAI, to commercial appraisers. The Institute has enacted rigorous regulations regarding to the use and display of these designations. For example, contrary to popular belief, "MAI" does not stand for "Member, Appraisal Institute". According to the institute, the letters "do not represent specific words", and an MAI may not use the words "Member, Appraisal Institute" in lieu of the MAI mark. The primary motive for this rule is to prevent dilution of the trademark.
Other leading appraisal organizations include the American Society of Appraisers, National Association of Independent Fee Appraisers, and the National Association of Master Appraisers, which were also founding sponsor-members of the Appraisal Foundation. The Massachusetts Board of Real Estate Appraisers (MBREA), founded in 1934, is the only state appraisal association that has been named a sponsor of the Appraisal Foundation. In recent years, the Royal Institution of Chartered Surveyors (RICS) has become highly regarded in the US, and has formed a collaboration with the Counselors of Real Estate, a division of the National Association of Realtors. RICS, which is headquartered in London, operates on a global scale and awards the designations MRICS and FRICS to Members and Fellows of RICS. The Real Estate Counseling Group of America is a small group of the top appraisers and real estate analysts in the US who collectively have authored a disproportionately large body of appraisal methodology.