The purpose of any real estate appraisal is to determine the market value of the property being appraised. The handbook of 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.”
If we put this another way, the value of a particular property is made up of the future benefits that the owner of the property can expect to receive from rental or other income. In determining the future benefits that an owner can receive from a property, the current use of the property is considered, and all other uses that it may be capable of in the foreseeable future. As an example, a property that is being used as farmland could be usable for a residential subdivision in a few years, but later might be usable as commercial or industrial sites.
Knowing the value of the property is a vital part of the decision-making process of all buyers, sellers, and users of real estate. Therefore, valuation is an integral part of all real estate activity. It is needed for your personal planning. Also, zoning, community planning, and taxation require a knowledge and use of appraisal.
If the property is held or will be held for investment purposes (and most are, even small residential properties) an additional question might be, “What will it be worth in the future?”
There can never be perfectly sure answers, but the closest that anyone can come to it is by the appraisal from a professional appraiser. This trained specialist can give a good accurate estimate of a property’s value.
When an Appraisal is Needed
When we refer to “Market Value” we have 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 individual 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 always required. Here are some of the recommended times to get an appraisal:
Purchase and sale
To determine whether a proposed purchase or sale is at a fair price or competitive price. The value fixed by the appraiser may strongly affect the final price, but the financing and tax aspects of the overall transaction may be such that a buyer might offer more, or a seller could be willing to take less for the property.
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.
Always when a new loan is required for a new 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.
Before entering into a long-term lease, both the lessor and lessee may need a very 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.
What if a renovation or modernization of an older building is being planned? The appraisal may be requested to be made based on the property as it is now and as it will be when the renovation is completed. The purpose of the appraisal 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 regularly, 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
To estimate adequate damages, 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.
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.
For estate tax purposes
To determine inheritance and estate tax liability when real estate was owned by a decedent at the time of his or her death.
For gift tax purposes
To determine the tax liability when real estate is the taxable gift.
As a basis for offering investors an interest in real estate through syndication or participation in a corporation or real estate investment trust