URBAN INSTITUTE OF REAL ESTATE AND CONSTRUCTION

Tel. No. 509-7402, CP 0915-457-3596 or 0939-137-9242, email: urbanet.ph@gmail.com

REAL ESTATE APPRAISAL

APPRAISAL - the process of estimating or making an opinion on the market value of an adequately
described property as of a specified date.

NEEDS FOR AN APPRAISAL

1. In connection with the transfer of ownership:

a. To help prospective buyers decide on offering prices.

b. To help prospective sellers determine acceptable selling price.
c. To establish a fair basis for exchange of real property.
d. To establish a basis for reorganization or merger of business companies.
e. To distribute the assets of an estate.

2. In connection with financing and credits:

a. To arrive at the value of the security offered as collateral for a mortgage loan.
b. To provide an investor with a sound basis for deciding whether to purchase real estate
mortgage or bond.

3. To establish just compensation in condemnation proceeding:

a. To estimate value as a whole or before the taking.

b. To estimate value after the taking.
c. To allocate value between the part taken and damage to the residue.

4. To establish a basis for taxes.

a. To distribute assets into depreciable items such as building and non-depreciation items such
as land and to estimate applicable depreciation rates.
b. To determine gift or inheritance taxes.

FACTORS AFFECTING ACCURACY OF APPRAISAL

1. competence of the appraiser

2. integrity of the appraiser
3. soundness of the procedure used in the appraisal
4. availability of the pertinent data

VALUE

1. As per U. S. Society of Residential Appraisers

“Value is the present worth of future benefits to a typical buyer.”

2. As per American Inst. of Real Estate Appraisers

“Value (Actual cash) is the price the property will bring in a fair market, after a fair and
reasonable effort has been made to find a purchaser who will give the highest price.”

Generally, however, “value” refers to what a willing buyer, not forced to buy, will pay, and what a
willing seller, not forced to sell, will accept, after exposing the subject property in a free and an open
market within a reasonable period of time.

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REAL ESTATE APPRAISAL
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URBAN INSTITUTE OF REAL ESTATE AND CONSTRUCTION
Tel. No. 509-7402, CP 0915-457-3596 or 0939-137-9242, email: urbanet.ph@gmail.com

Market Value - is the highest price in terms of money which a property will 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.

OTHER VALUES DERIVED BY APPRAISAL

1. Insurable Value - to serve the need of insured, insurer and adjuster.

2. Going concern value - to serve for corporate mergers the issuance of stock, revision of book
figures and so forth.
3. Liquidation value or price - for forced sale or auction proceedings.
4. Assessed value - to establish a uniform schedule for property and ad valorem taxation.
5. Condemnation Value - for eminent domain cases.

This list does not include all the function of appraisals but does indicate the broad scope of the
professional appraiser’s activities.

COST AND PRICE

Price is the amount of money paid for a certain property regardless of market value.
Cost is the amount of money expended to develop or to acquire a certain property. (Price plus
expenses such as transfer taxes and notarial)

REPLACEMENT COST AND REPRODUCTION COST

Replacement Cost is the cost of replacing the property being appraised with that of another having
equivalent utility and amenities.
Reproduction Cost is the amount of money required for the exact reconstruction of the
improvements being appraised similar to the original.

FACTORS CREATING VALUE

1. Utility - or the ability of the property to meet certain needs or wants; this must however be
isolated from the other characteristics of which in their totality constitute value.
2. Scarcity - a positive characteristic of value; it refers to the fact that if the goods/service is
abundant and free, its value will naturally be reduced accordingly.
3. Demand - this should not be equated with necessity; it refers to the necessity coupled with
purchasing power that is adequate to satisfy the demand.
4. Supply - if the supply is greater than demand the value will decline.
5. Ability to Pay - the higher the ability of the buyer, the higher the value of the property, and
when the ability to pay decreases, the property value tends to decline.
6. Adequate Value Knowledge on the part of the buyer - if the interested buyer to a certain
property have adequate knowledge of the values including that of the alternatives, then the result
will be a reliable and stable value for the property.

GUIDING PRINCIPLES IN VALUATION

1. Principle of Anticipation - states that the property’s market value is based on the investor’s
expectation of a future event. Example: The value of an income property depends in part on the
future net operating income the property will provide and the present value of net operating
income.

2. Principle of Substitution - states that a prudent buyer will pay no more for a property than the
cost of a substitute or comparable property that will provide equivalent usefulness. This
principle is the basis for Cost Approach and Market Data Approach.

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URBAN INSTITUTE OF REAL ESTATE AND CONSTRUCTION
Tel. No. 509-7402, CP 0915-457-3596 or 0939-137-9242, email: urbanet.ph@gmail.com

3. Principle of Change - states that the real estate market is dynamic rather than static; socio-
economic forces are constantly changing, causing constant changes in value. Thus, market value
today may not be the same as market value yesterday or tomorrow.

4. Principle of Contribution - states that the value of a given feature of a property is worth only as
much as the amount of money it contributes to the value of the property as a whole. For
example, improvements to property may add more, less, or as much value to the property as the
cost, depending on what the market is willing to pay for the features.

5. Principle of Diminishing and Increasing Returns - states that with each additional unit of
improvement, the marginal utility of each unit declines until the point at which any additional
units cost more than the additional value they add to the property.

6. Principle of Highest and Best Use - of a property is the most profitable legally and physically
allowed use that will bring the owner the highest economic benefit on the long run. Determining
highest and best use is central to estimating market value because the use of a property for other
than the current (or proposed) use may yield higher benefits to both the investor and the lender
regarding greater investment returns and/or less risk than originally anticipated.

7. Principle of Balance - states that: (1) the four agents of production - land, labor, capital and
management - should be in balance with regard to a property improvement for land to be its
highest and best use. (2) Balance also refers to a mix use of land to maximize land value such as
an appropriate allocation of residential, commercial and other land uses.

8. Principle of Conformity, Progression and Regression – Principle of Conformity states that

improvements should be similar to other improvements in the neighborhood. In terms of value,
nonconformity maybe advantageous or disadvanatageous to the owner of the nonconforming
property. Principle of Regression states that the value of an over-improved property in a certain
neighborhood of similar level of value will be lower than its cost while the Principle of
Progression states that the value of an under-improved property may be perceived to be higher
than its cost.

9. Principle of Competition – states that when the supply is low, creating an opportunity for
higher profit, more supply will be attracted stabilizing the market. On the other hand, if the
demand is low, production of supply will be reduced.

10. Principle of Supply and Demand – states that in a specific location, as the more desirable lots
are being bought, with consistent demand, the remaining similarly desirable lots will increase in
value more than the price the first lots were sold.

11. Principle of Externalities – states that external factors outside of a property may affect its value
positively or negatively. Example. Construction of a new highway near a 20 hectare land.
Another example is the effect of high crime rate in a certain city.

FACTORS THAT INFLUENCE REAL ESTATE VALUE

1. Location, shape, topography, depreciation, climate condition, soil depth & fertility, size, etc.
2. Economic Factors such as purchasing power, population density, business & trade opportunities,
inflation or deflation, etc.
3. Political and Governmental Factors such as monetary and credit policies, taxes and licenses,
zoning and building regulations, rent control, etc.

THE THREE BASIC APPROACH TO VALUATION

Appraisers commonly think of value in three ways:

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URBAN INSTITUTE OF REAL ESTATE AND CONSTRUCTION
Tel. No. 509-7402, CP 0915-457-3596 or 0939-137-9242, email: urbanet.ph@gmail.com

1. COST APPROACH - The current cost of reproducing a property less depreciation from all
source that is, deterioration, and functional and economic obsolescence.

2. INCOME APPROACH - The value which the property’s net earning power will support based
upon a capitalization of net income

3. MARKET DATA APPROACH - The value indicated by recent sales of comparable properties in
the market The appraiser utilizes all three approaches in most of his appraisal works. He may
believe that the value indicated by one approach will be more significant than that of the other
two, yet he will use all three as a check against each other and to test his own judgment.
However, there are appraisal problems in which they cannot be applied such as in vacant land,
the use of the cost approach, or in the case of an owner-occupied home, the use of income
approach. All three approaches are needed in the solution of most appraisal problems.

COST APPROACH

In cost approach, the appraiser obtains a preliminary valuation by adding to his estimate of the land’s
value, his estimate of the depreciated reproduction cost of the building and other improvements. This
approach is based on the assumption that the reproduction cost is the upper limit of value. This also
assumes that a newly constructed building would have advantages over the existing building so, the
appraiser must also evaluate any disadvantage or deficiency of the existing building as compared with the
new building. The measure of this deficiency is called depreciation. For valuation purposes, depreciation
is defined as a loss in value from any cause. It represents the difference in value between the building
under appraisal and a new, substitute building. Depreciation for valuation purposes is not in any way
related to depreciation used in accounting sense or in income tax accounting.

THREE KINDS OF DEPRECIATION

1. Deterioration or the physical wearing out of the property.

a. curable - if by treating the defects, the expected increase in value of the property will at
least be more than the cost of treatment.

b. incurable - if the cost of treating the defect will be more than the expected increase in the property
value.

2. Functional obsolescence or lack of desirability in terms of layout, style, and design as

compared with that of a new property serving the same function.

3. Economic obsolescence relating to loss of value from causes outside the property itself.

FOUR STEPS IN COST APPROACH

1. The estimate of the land’s value as if it is vacant.

2. The estimate of the current cost of reproduction of the existing improvements.
3. The estimate and deduction of depreciation from all causes.
4. The addition of the land’s value and the depreciated reproduction of improvements.

MARKET DATA APPROACH

The market data approach is essential in almost every appraisal of the value of the real property. The
resulting value by this approach frequently is defined as the “price at which a willing seller would sell
and a willing buyer would buy, neither being under abnormal pressure”.

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URBAN INSTITUTE OF REAL ESTATE AND CONSTRUCTION
Tel. No. 509-7402, CP 0915-457-3596 or 0939-137-9242, email: urbanet.ph@gmail.com

This definition assumes that both buyer and seller are fully informed as to the property and state of
the market for that type of property, and that the property has been exposed in the open market for a
reasonable time.

This approach produces an estimate of value of a property by comparing it with similar properties of
the same type and class which have been recently sold or currently being offered for sale in the same
areas. The comparative process utilized in determining the degree of comparability between two
properties involves judgment as to their similarity with respect to many value factors such as location,
orientation, plottage, elevation, and size. The prices of those comparable properties will set the range in
which the value of the subject property will be.

DATA NEEDED:

1. Sales or asking prices of comparable properties.

2. Condition influencing each sale.
3. Location of each property.
4. Description of the land and improvements of each property.

INCOME APPROACH

In income approach, the appraiser is concerned with the present worth of the future net income of a
property which will be produced in its remaining economic life. These future net incomes are then
capitalized by computing its present worth. Choosing what capitalization rate to apply is one of the most
critical steps in the income approach. A variation of only one half of one percent can make a difference
of many thousands of pesos in the capitalized value of the income.

STEPS IN INCOME APPROACH

1. Obtaining the rent schedule and the percentage of occupancy for the subject property and for
comparable properties for the current year and for several years in the past. This information
provides gross rental and the trends in rental and occupancy. This data is then related and
adjusted by the comparative method to ascertain the estimate of gross income which the subject
property should produce to attract investors in the market.
2. Obtaining expense data such as taxes, insurance, and operating cost being paid by the subject
property and by comparable properties. The trend in these expenses is also necessary.
3. Estimating the remaining useful economic life of the building to establish the probable duration
of its income.
4. Selecting the appropriate capitalization rate and the applicable technique and methods for
processing the net income.

CAPITALIZATION IN PERPETUITY

In capitalizing net income earned on land, it is assumed that it will continue to earn income
indefinitely. The market value by Capitalization in Perpetuity formula is:

I
MV = -------- , where I is the income and R is the rate of return.
R

CORRELATION, FINAL ESTIMATE AND THE APPRAISAL REPORT

The last stage in the appraisal process is the correlation of the three values derived by the cost,
income, and market data approaches. In correlating these approaches into his final estimate of value, the
appraiser should take into account the purpose of the appraisal, the type of property, and the adequacy of
the data available and used in each of the three approaches. These will determine the weight to be given
to each approach. The appraiser should not average the three value arrived at by means of the cost,

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REAL ESTATE APPRAISAL
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URBAN INSTITUTE OF REAL ESTATE AND CONSTRUCTION
Tel. No. 509-7402, CP 0915-457-3596 or 0939-137-9242, email: urbanet.ph@gmail.com

market date and income approaches. The appraiser instead should take the three value estimate and
examines the spread between the minimum and maximum figures. He should then consider the approach
which appears to be the most reliable. Then he should make adjustments in accordance with his judgment
and experience.

APPRAISAL REPORT

A word portrayal of the property, the facts concerning that property, and the reasoning by which the
appraiser has developed his estimate of value. The best report is the one which, in the fewest number of
words, permit the reader to follow intelligently the appraiser’s reasoning and to concur in the conclusions
reached thereby. As every report is an answer to a question by a client, it should show the facts
considered and clearly outline the reasoning employed by the appraiser in arriving at his valuation.

MORE ON APPRAISAL

Principle of Conformity, Progression and Regression

Principle of Conformity states that improvements should be similar to other improvements in the
neighborhood. In terms of value, non-conformity maybe advantageous or disadvanatageous to the owner
of the non-conforming property.

Principle of Regression states that the value of an over-improved property in a certain neighborhood of
similar level of value will be lower than its cost while the Principle of Progression states that the value of
an under-improved property may be perceived to be higher than its cost.

Additional Terminology

AGE-LIFE METHOD OF DEPRECIATION – similar to straight line method. Where cost of building is
depreciated at fixed annual percentage rate (rate of depreciation)

BAND OF INVESTMENT METHOD – a method of developing a discount rate based on:

1. the rate of interest rate for mortgages
2. the rate of returned by equity investors (ROE)
3. and the ration of deft and equity sharing

BUILDING CAPITALIZATION RATE or simply CAPITALIZATION RATE – the sum of the discount
rate (interest rate) and capital recapture (similar to depreciation rate) rate
DEMOGRAPHY – the statistical study of human populations, especially in reference to size, density, and
didtribution.Important in Market Analysis and Highest and Best Use Analysis.
EFFECTIVE AGE – The age of the building based on actual depreciation. Effective age of a house may
be higher than actual age because of lack of maintenance.
GROUND LEASE – a lease on land only where lessee puts up the building. Usually long term lease.
GROUND RENT – rent for the use of the land in a ground lease.
LEASEHOLD ESTATE – the lessee’s right to possess and use the property during the period of lease.

RECAPTURE RATE – the rate at which the cost of the property is recovered during its economic life by
the owner. Equals to 1 / economic life.

SANDWICH LEASE – the ownership interest of a sub-lessee.

SUBDIVISION DEVELOPMENT METHOD OF APPRAISAL – a method of valuing rawland intended

to be developed as a subdivision project. Also known as LAND DEVELOPMENT METHOD.

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