Much like asking lawyers or economists their opinion – what you get from an appraiser is an “opinion.” I have seen MAI designated appraisers differ in value by over a million dollars (even on a deal where neither value exceeded 4 million).
Differences can usually be detected in a few areas which I summarize below. Obviously, this is not an exhaustive listing.
First, read the scope of the appraisal. If the appraiser did his or her job, he or she will tell you what they are actually doing in the appraisal. Has he or she limited their work? Has he or she appraised only part of the property? Appraised fair market? Made hypothetical or extraordinary assumptions? For example, I have seen assumptions where leases were ignored, buildings ignored or constructed, and municipal utilities extended or installed. All of these assumptions can make a world of difference in the end number and can explain why two appraisals of the same property are so different.
Second, check the details. Did the appraiser make a mistake on the size of the land or buildings being appraised? Missing 2,000 square feet of building improvements can make a big difference in value. Check the appraiser’s math! We all make mistakes, and it is easy to mix up the numbers.
Next, look to the Highest and Best Use. Highest and Best Use is the very foundation upon which it is all built. Get that wrong and everything that flows from it is wrong. Did the appraiser consider commercial property to have a highest and best use as residential? Did he or she determine that the corn field was the next major drug store chain location? This is where it is important that the appraiser understand the local market and where they need to use their head. Disagreement as to highest and best use can make two appraisals entirely different in their approach and the end number.
Next look at what approaches to value the appraiser used.
Did the appraiser use all three approaches to value? Did they skip one of the approaches that the market would use? For example, did they skip the income approach on a rental property?
If the appraiser did an income approach, check whether he or she used the actual income (sometimes they use market rates and it can make a huge difference)? Then check the cap rate. Cap rates also provide an explanation as to why two appraisers come to different value conclusions.
If the appraiser did a cost approach, check off these three items: (a) was the land valued based upon its highest and best use (not necessarily its current use); (b) how did the appraiser calculated the depreciation of the buildings (i.e. does it make sense given the age and condition of the buildings); and (c) did the appraiser account for obsolescence? If you don’t understand obsolescence, stop now and go read up. It is extremely important to understand this concept. It is more complicated than this but in a simple world view it is just what the word means. For instance if you have a brand new iPhone 3 still in the box it is not worth the same amount as a new iPhone 6 even though it has no physical depreciation. The same works for buildings with low ceilings, small rooms, no elevators etc.
Examine the sales approach. Look at the comparable sales used by the appraiser in the market approach. Do the comparable properties have the same highest and best use as the subject or did they look at apartment land when the subject is retail commercial property? Think about the principle of substitution. If the buyer of the comparable were looking at the subject, would they even be interested? What price changes would they need to make? Appraisers usually don’t agree with me on this point, but for the concept of a market approach to work best (maybe not the only way, but I think to work best) you need to be able to say the buyer of the comparable property would look at the subject and actually consider it. This, of course, is not an absolute, but if you look at it from that perspective, you get a much better reality check. I often see appraisers use finished building ready parcels in comparison with raw land. Better yet, they compare a 1 acre lot on a constructed road, with utilities to the site, grading and drainage installed as part of the plat, electric and gas, street lights etc… to a 20 acre vacant undeveloped parcel with no utilities, roads, etc. The business that bought the comparable lot could pull a permit the next day, and the subject needs to be “developed” first. Just remember, the principle of substitution is the underlying concept of the sales approach. Ask yourself if the buyer would ever have substituted the subject. The answer may be enlightening as to why the appraisal is so different from yours.
Next, look at the sales comparison adjustments. Look first for big adjustments in the sales comparison grid. Bigger adjustments indicate lack of comparability. Then just use common sense and think about percentage adjustments used by the appraiser. Do the adjustments even make sense? What happens when you convert them to dollars and cents – do they still make sense?
- Check the scope, hypothetical assumptions, and extraordinary assumptions.
- Look at the property details – size, zoning, buildings.
- Check the math.
- Consider the critical issue of highest and best use.
- Sit on the curb and consider the three approaches used – income (data used and cap rate), cost approach (review the depreciation and obsolescence), and sales approach (consider the principle of substitution and look for wacky adjustments).
© 2015 Rinke Noonan