Determining the value of real property is essential to many business activities. Among the most frequent such activities are buying and selling property, lending money secured by a mortgage on real property, settling a probate estate or determining the value of property that is subject to eminent domain proceedings. The appraisal industry in Philadelphia and elsewhere has established uniform standards for conducting appraisals of real property, and while this brief blog post cannot cover the entire field, a summary of essential techniques can be quite useful.
The basic purpose of an appraisal is to establish the fair market value of the land in question. Fair market value is defined as the price that a willing seller will accept and that a willing buyer will pay. Appraisers use three basic approaches to value. First, the replacement cost approach uses the cost of duplicating a structure reduced by an estimate for depreciation and the value of the land. The sales comparison determines value by examining sales of comparable properties in the same general area. Finally, the income capitalization uses the earning power of the property reduced to present value.
The replacement cost approach and sales comparison approach are straightforward. The central issue with both is obtaining reliable data on which to base the calculation of value. The income approach to value is more complex. It can be used, of course, only for income producing properties. In using this approach, the appraiser first calculates a reasonable level of earnings by subtracting operating costs and taxes from gross revenues. Then, the appraiser chooses an appropriate capitalization rate — what rate of return would a reasonable investor require in order to invest in the property – and uses this rate to reduce the income stream to present value. Each of these methods has several variations that depend upon the nature of the property.
In real estate litigation involving properties of substantial value, each party to the dispute may submit its own appraisal report with significantly different estimates of value. In these cases, a knowledgeable real property attorney can be very useful in defending a favorable report or in attacking an unfavorable report.
Source: Appraisal Institute, “Understanding the Appraisal,” accessed on May 10, 2016