What Is Value?
A real estate appraisal is used to determine the market value of a property and is necessary for a variety of reasons. The Appraisal Institute defines market value as:
“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: (a) buyer and seller are typically motivated: (b) both parties are well informed or well advised, and each acting in what he considers his own best interest; (c) a reasonable time is allowed for exposure in the open market; (d) payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and (e) 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.”
The value of a property is the future benefit that the owner of the property can expect to receive from rental or other income. In determining what future benefit an owner could receive from a property, the current use of the property is considered as well as all other uses that might be possible in the foreseeable future. For example, cropland could be usable for a residential development in several years, but later might be usable as commercial property.
Knowing the value of property is important to the decision-making process for all buyers, sellers and users of real estate, so valuation is an integral part of all real estate activity. It is needed for personal planning, as well as zoning, community planning and calculating taxes.
If the property is held for investment purposes, an additional question would be what the value of the property might be in the future. One can never know for sure, but the closest that anyone can approximate what that value might be will be by an appraisal from a professional appraiser. This trained specialist can give a good accurate estimate of a property’s value.
When Is An Appraisal Needed?
When we refer to market value one needs to remember that it is not necessarily the same as market price. Market price represents the actual dollar amount put on a property by a buyer and a seller at the time of a negotiated transaction. This might be higher or lower than the value an appraiser might place on the property. This difference might be due to differences of opinion, or it may be that the property, to this particular buyer or seller, has a greater or lesser value because of some special consideration, such as financing that the buyer can obtain or the need of a seller to raise cash quickly.
While the owner or a prospective buyer can order an appraisal at any time, there are times when it is almost always required. Some examples of this would be:
- Purchase or sale. An appraisal is needed in determining whether a proposed purchase or sale will be at a fair price or competitive price. The valuation by the appraiser may strongly affect the final sale price, but the financing and tax aspects of the overall transaction may be such that a buyer may be prepared to offer more or a seller could be willing to take less for the property.
- Exchange. Appraisals of each of the properties in a planned exchange should be made if the exchange will have prices on the properties (rather than just equity for equity). A good estimate of value on each will assist everyone involved to establish equities in the priced exchange.
- Finance. An appraisal will be required to obtain a new loan for a buyer. Often, the lender will appraise the property conservatively and slightly lower than the new buyer. This can be understandable when the buyer may be prepared to put up as little as 10% of the value, and the lender is being asked to put up all or most of the balance of the purchase price.
- Lease. Before entering into a long-term lease, both the lessor and lessee each may need an accurate idea of the value. This might be a basis for negotiation by either person, to determine if the proposed lease is for a fair rental amount.
- Remodel. If a renovation or modernization of an older building is being planned, an appraisal may be requested on the property as it is now and as it will be when the renovation is completed. The purpose would be to determine if the additional income would be sufficient to amortize the capital investment and also return a profit to the owner.
- For insurance purposes. It may be important to establish replacement costs, less the physical depreciation, to determine how much fire and casualty insurance should be purchased to adequately cover the property. An appraisal, updated on a regular basis, may also be needed to establish proof of loss or to establish the basis for settlement in cases of partial or total loss under insurance contracts.
- For condemnation purposes. An appraisal may be used to estimate damages that are adequate, but not in excess of fair compensation, when negotiating a condemnation award, or seeking the determination of fair compensation for a condemned property in court.
- For property tax purposes. To make a proper assessment for local real estate taxes, or to review and contest an assessment to reduce real estate taxes an appraisal may be required.
- Income tax liability. It may be necessary to appraise a property to determine the liability for income taxes in a taxable exchange, or in a liquidation of a corporation owning real estate.