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Frequently Asked Questions

Frequently Asked Questions

An appraisal is an opinion of value by a real estate appraiser for real property on a specific day. The day of the value is called the effective date. Most of the time, the value opinion’s effective date is the day the property was viewed by the appraiser, but sometimes, an effective date can be back in time, called retrospective, or in the future, called prospective. In addition to the value of the property and the effective date, the appraiser will estimate the marketing time, meaning the time the property would need to be marketed to the public in order to sell for the value opined in the report.
A retrospective value means a value some time prior to the date of inspection. This mainly occurs in legal cases where the historical value of real property is needed. For instance, in estates, in order to set the basis value of a property, we often value the property retrospectively, as of the date of death. This allows the accountants to determine capital gains for tax purposes between the date of death, which is usually when property is inherited, and the sale date, when the party that inherited the property sells it. In my practice, we have valued property up to 20 years in the past, although this is not typical. For most estate work, the effective date is within 24 months of the inspection date.
Real estate refers to an identified parcel or tract of land. It is referencing the physical land and building(s), if any, on a property. Real property refers to the interest in the real estate. This can also be referred to as the benefits and rights held by the owner. As appraisers, we actually value real property, not real estate, although the terms are somewhat interchangeable in conversation.

As appraisers, we use (3) main approaches: cost approach, sales comparison approach, and income capitalization approach.

The cost approach is sometimes referred to as the “build up” method because we find the value of the land as if it were vacant. Then we figure the cost to rebuild the improvements using current cost figures, then we depreciate that cost.

The sales comparison approach is the most familiar because we use similar sales, or “comps” to compare to the subject. For example, for a single-family home, we would try to find homes in the same neighborhood, of similar size, finishes and age to compare to the subject.

The income approach uses the concept of “the present value of future benefits” because it analyzes the rental potential of a property, less expenses, to convert income to a value.

Not every property is generally valued based on rental potential. The appraiser first has to analyze whether buyers of similar properties are valuing the property based on income potential or mainly on resale value. If the property has rental potential, then we can review market rents and expenses to determine the net operating income, or profit, on the rental, on an annual basis. Then, we use a capitalization rate to apply the appropriate level of risk to that income stream, which converts the profit to a value.

Quite simply, a capitalization rate reflects risk. A lower rate equates to a higher value; a higher rate equates to a lower value. I have often explained that a capitalization rate is the chance the owner won’t get that profit every year. An owner would rather have a 5% change of not getting their profit compared to a 10% chance. The least risky properties in real estate are single-tenant net leased properties (STNL), such as Starbucks, Chick-fil-A, and Discount Tire.

There are three main categories of depreciation: physical deterioration, functional obsolescence, and external obsolescence.

Physical deterioration occurs as soon as the building is complete. Simply, no building lasts forever. The elements and time begin to wear away at different components of the structure over time.

Functional obsolescence is generally thought of as a problem with the building or site. For the site, there could be too few parking spaces for the type of property. For the building, it could be ceilings that are too low to be ideal in the market.

External obsolescence is generally the result of some outside force on the property that impacts value. For instance, a garbage landfill that emits an odor would impact a residential neighborhood negatively.

Remember that physical deterioration is the impact of time and use on an improvement. Just like we age, so do buildings and parking lots. There are three main types of physical deterioration
  1. Deferred maintenance is generally fixable (we call it curable) maintenance items with a property that are common, such as fixing a roof leak, changing lights, and repairing a broken window. This is called curable physical deterioration. An owner will fix the item(s) to keep the building in good working order for either the owner or a tenant.
  2. Short-lived physical deterioration is the first type of incurable deterioration remaining after deferred maintenance is figured. These are items that are generally replaced a few times during the life of the building, such as paint, HVAC, roof, flooring and water heaters. They are separated from long-lived items due to a shorter economic life, such as 10 to 15 years.
  3. Long-lived physical deterioration is the second type of incurable deterioration remaining after deferred maintenance. These are items that depreciate, but are not generally replaced, such as the foundation, structure, roof structure and underground piping.
This is a functional problem with the design of the structure, materials used, layout or site problem (must be within the boundaries of the site). This depreciation is determined when the subject is compared to the highest and best use at the time of appraisal. The majority of problems arise when building trends change or occupant demands change over time. For instance, in the 1980s, it was common to have 16′ clear ceiling heights in industrial properties, whereas current occupants are demanding over 32′ ceilings.
Like physical deterioration, there is curable and incurable functional obsolescence. For example, in a house built around 1930, it was common to have the only bathrooms on the upper floors where the bedrooms were located. However, current occupants demand at least a 1/2 bath on the first floor. If the cost to install a 1/2 bath is $20,000, but the increase in value to the whole home is $30,000, then it is considerable curable. However, if the cost is more than the value increase, then it is incurable.
Simply, external obsolescence is when a subject property’s value is impacted by something outside the site. Most of the time, it’s incurable. For instance, a home’s location next to a highway is not likely to ever change since highways aren’t often moved. Generally, the influences are locational or economic. The highway example is locational. A temporary lack of supply of a certain property type, say flex space in an area by a car manufacturing plant, would be a positive externality.
During COVID, the inventory of homes was very low, which was driving prices up. Then, buyers that were flush with cash, were making aggressive offers over list price just to obtain a home, even it was over market value. For example, the site value is $100,000 and the house cost new is $600,000 and there is $50,000 in depreciation and $10,000 in site improvements. Assume no functional depreciation. The cost approach would yield a value of $660,000, without considering external obsolescence. However, homes in that timeframe were listed at $700,000 and selling for $900,000 due to escalators and waiving of appraisal contingencies. The $240,000 in difference can be attributed to either a positive externality from lack of supply, or could possibly be considered to be non-arms-length, since the buyer was knowingly paying over market.