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Chemistry and The Approaches to Value

When it’s all said and done, an appraisal report provides the appraiser’s opinion of value. But how does the appraiser reach that opinion?

Remember back to one of your high school science classes when you were in a laboratory creating concoctions, boiling them into steam until they condensed and flowed into a funnel and magically, at the end of the funnel, was the product of your work.

You had to follow a set of standard procedures for each experiment and document each step and each result that was made. Well, appraising property follows a standard set of procedures as well. It is known as The Valuation Process.

The process involves defining the reason for the appraisal, who the intended users will be, describing the property, and any conditions that may be unusual for the assignment.

Information is collected from the market including general characteristics of the various geographic areas, describing the property to be appraised, and then gathering comparable property data. Supply and demand studies may be performed and an analysis of the highest and best use of the property is determined.

It is the highest and best use conclusion that defines how the rest of the appraisal report is structured and the approaches to be employed to get to that value conclusion. These “approaches” include the sales comparison approach, the income capitalization approach, and the cost approach. The sales comparison approach is described in this article.

The sales comparison approach compares market information for similar properties with the property being appraised and then identifying appropriate units of comparison (square feet, acres, front feet, cubic feet, number of rooms or beds, number of loading docks, etc.), and making qualitative or quantitative adjustments to the sales prices of the comparable properties based on relevant, market-derived elements of comparison.

The elements of comparison are the characteristics or attributes of properties and transactions that cause the prices of real property to vary. These elements include property rights conveyed (was the property leased or owner-occupied), financing terms, conditions of sale (was it arm’s length), expenditures made right after the purchase, market conditions, location, physical characteristics, economic characteristics, use, and non-realty components of value.

So, the appraiser is required to find recent sales of similar properties located within the same general market as the property to be appraised and then research the terms of its sale or lease and analyze the physical characteristics in order to make meaningful comparisons and adjustments.

The product at the bottom of the sales comparison approach funnel may be the concluded market value of the property or it may be one of three values based on the “experiments” with the income capitalization approach and the cost approach. These approaches will be discussed in future articles.

Eric Lehmayer, MAI / MRICS / LEED AP, Director of Appraisal Services, High Associates Ltd.