Real Estate Appraisal Fundamentals
Value, price, and cost
Appraisal fundamentals begin with distinguishing market value from price, cost, and investment value. Market value is an opinion of the most probable price in a competitive and open market under specified conditions; it assumes informed, willing parties, reasonable exposure, and no undue stimulus. Price is what a transaction actually brings, and cost is an expenditure-neither automatically equals value. Questions often test the assumptions behind market value, such as whether financing or concessions are typical. Another trap is confusing retrospective or prospective value dates with the date of the report.
Economic principles
Know substitution, anticipation, supply and demand, conformity, contribution, surplus productivity, and externalities. Highest and best use is the reasonably probable use that is legally permissible, physically possible, financially feasible, and maximally productive. Apply the four tests in that order; a use that fails legality cannot be rescued by profitability. The appraisal process moves from problem identification and scope of work through data collection, market analysis, highest and best use, application of the approaches, reconciliation, and reporting.
Worked rule
For direct capitalization, value = net operating income ÷ capitalization rate. If NOI is $120,000 and the market cap rate is 8%, value is $120,000 ÷ 0.08 = $1,500,000. Do not subtract mortgage payments; NOI is before debt service. A common exam trap is using gross income or after-tax cash flow in place of NOI.
Exam traps
Watch for absolute wording, mismatched value dates, and treating assessed value or asking price as market value. Also separate an appraisal from an appraisal review and identify the client and intended users before deciding scope.