Real Estate Appraiser's Reviewer -

Part 1 of 3

[Advance Knowledge for Brokers Series]

As an Exclusive Buyer Agent (EBA), I always keep on saying that I do not allow my client-buyers to be
exposed to properties for sale like canned goods without proper label and full disclosure of contents. This
article explains further the mechanics of real estate appraisal, which is one of the requirement in selling a
property. In this connection, you may want to check out first my article entitled Property Folder Prep
Guide.

This article is a self-help reviewer of Real Estate Appraisers.

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Go to PART 1
Go to PART 2
Go to PART 3
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What is a Real Estate Appraiser?

According to the Real Estate Service Act of the Philippines (RA 9646), Real Estate Appraiser is defined as
someone who is duly registered and licensed natural person who, for a professional fee, compensation or
other valuable consideration, performs or renders, or offers to perform services in estimating and arriving
at an opinion of or acts as an expert on real estate values, such services of which shall be finally rendered
by the preparation of the report in acceptable written form.

What is an Appraisal?

Appraisal is the process of estimating or making an opinion on the market value of an adequately
described property as of a specified date.

What are the factors affecting accuracy of appraisal?

 § Competence of the appraiser

 § Integrity of the appraiser
 § Soundness of the procedure used in the appraisal
 § Availability of the pertinent data

What are the purposes/ functions of appraisal?

For banks/ financing institutions:

 § loans purposes
 § insurance purposes
 § selling purposes

For other purposes:

 § real estate tax assessment purposes

 § zonal valuation purposes
 § merger and consolidation
 § going concern value
 § liquidation purposes
 § joint venture purposes
 § determination of just compensation for eminent domain purposes
 § extrajudicial purposes or to distribute the assets of an estate

Why there is a need for an appraisal?

1. In connection with the transfer of ownership

 § To help prospective buyers decide on offering prices

 § To help prospective sellers determine acceptable selling price
 § To establish a fair basis for exchange of real property
 § To establish a basis for reorganization or merger of business companies
 § To distribute the assets of an estate

2. In connection with financing and credits

 § To arrive at the value of the security offered as collateral for a mortgage loan
 § To provide an investor with a sound basis for deciding whether to purchase real estate
mortgage or bond

3. To establish just compensation in condemnation proceeding

 § To estimate value as a whole or before the taking

 § To estimate value after the taking
 § To allocate value between the part taken and damage to the residue

4. To establish a basis for taxes

 § To distribute assets into depreciable items such as building and non-depreciation items such as
land and to estimate applicable depreciation rates
 § To determine gift or inheritance taxes

What is Value?

 § As per US Society of Residential Appraisers. “Value is the present worth of future benefits to a
typical buyer.”
 § As per American Institute of Real Estate Appraisers. Value (actual cash) is the price property
will bring in a fair market, after a fair and reasonable effort has been made to find a purchaser who will
give the highest price.
 § In general, value refers to what a willing buyer, not forced to buy, will pay, and what a willing
seller, not forced to sell, will accept, after exposing the subject property in a fee and an open market
within a reasonable period of time.

What are the types of value?

 § Sale price vs. value

 § Cost vs. value
 § Value in exchange. This refers to the worth of an object relative to other objects with which it
can be compared and for which it can be exchange.
 § Value in use. This refers to the use an object is put to, the service it renders, and the wants it
satisfies.
 § Market value
 § Fair value
 § Investment value
 § Reversion value
 § Assessed value
 § Condemned value; consequential damage and severance damage
 § Insurable value
 § Loan value
 § Liquidation value
 § Book value

What is Market Value?

It is the highest price in terms of money which a property will 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.

What are other values derived by appraisal?

 § Insurable value- to serve the need of insured, insurer and adjuster

 § Going concern value- to serve for corporate mergers the issuance of stock, revision of book
figures and so forth
 § Liquidation value of price- for forced sale or auction proceedings
 § Assessed value- to establish a uniform schedule and tax roll for ad valorem taxation
 § Condemnation value- for eminent domain case
 § This list does not include all the function of appraisals but does indicate the broad scope of the
professional appraiser’s activities.

What is the history of Value Theory?

 § Ancient Romans and Greeks- value of goods absolute, fixed by state and owner
 § Merchantilism- value in exchange affected by law of supply and demand, gold is the source of
all wealth
 § Physiocrats- productivity of land, not gold as source of wealth; value created by the utility of an
item
 § Adam Smith- natural price, (i.e.) the cost of production is equals the value of an item consuming
land, labor, capital and coordinations
 § Austrians- cost of production is unimportant, value is determined by utility of and demand for the
last, marginal item
 § Today’s concept- value is not objective and absolute, but is subjective and relative to the forces
that create and forces that affect it.

What are the forces affecting value?

 § Utility- usefulness; ability to arouse a desire for possession
 § Scarcity- a relatively short supply; lack of abundance
 § Demand- desire to possess plus the ability to buy; effective purchasing power
 § Transferability- the ability to change ownership or use

What are the forces affecting/influencing value?

Natural Forces - physical resources

 § -location
 § -shape
 § -topography
 § -depreciation
 § -climate condition
 § -soil depth and fertility
 § -size

Social Forces - developed resources

 § Family size and age group distribution

 § Neighborhood stability and attitudes about property
 § Population growth, decline, or shifts at the community, regional and national levels
 § Lifestyles and living standards, often combined with other forces
 § Attitudes about law enforcement, the role of government and individual responsibility
 § Attitudes about development, growth and ecology
 § Attitudes toward public education

Economic forces

 § Income level of neighborhood and community residents

 § Employment opportunities and trends
 § Level of wages
 § Availability of money and credit and interest rate levels
 § Price levels and property tax burdens
 § Personal savings and investment returns
 § General business activity
 § Supply and demand in housing
 § Production of goods and services
Political force

 § Zoning and land use regulations

 § Building and safety regulations
 § Environment protection laws
 § Police, fire and health protection services
 § Crime prevention, education and recreation services
 § Public works, power, water, transportation, sewage and flood control
 § Fiscal policy and taxation
 § Monetary policy and controls
 § Government-sponsored urban redevelopment and housing finance programs
 § Regulation of industry and business

Principles of real estate MARKETABILITY

 § Principle of substitution. This states that a prudent buyer will pay no more for a property than
the cost of a substitute property that will provide equivalent usefulness.
 § Principle of conformity
 § Principle of progression and regression
 § Principle of change. This states that the real estate market is dynamic rather than static; socio-
economic forces are constantly changing, causing constant changes in value. Thus, market value today
may not be the same as market value yesterday or tomorrow.
 § Principle of supply and demand
 § Principle of completion

Principles of real estate PRODUCTIVITY

 § Agents of production: land, labr, capital, coordination

 § The principle of contribution states that the value of a given feature of a property is worth
only as much as the amount of money it contributes to the value of the property as whole. For example,
improvements to property may add more, less, or as much value to the property as they cost, depending
on what the market is willing to pay for the features.
 § The principle of increasing and decreasing/diminishing returns states that states that with
each additional unit of improvement, the marginal utility of each unit declines until the point at which any
additional units cost more than the additional value they add to the property.
 § This principle of “highest and best use” and consistent use states that the “highest and best
use” of a property is the use that will bring the owner the highest economic benefit over the long run.
Determining highest and best use is central to estimating market value because the use of a property for
other than the current (or proposed) use may yield higher benefits to both the investor and the lender
regarding greater investment returns and/or less risk than originally anticipated.
 § Principle of anticipation. This states that the property’s marker value is based on the
investor’s expectation about the future benefits the property will provide and the present value of those
benefits.

What is Replacement Cost?

§ It is the cost of replacing the property being appraised with that of another having equivalent utility and
amenities.

What is Reproduction Cost?

§ It is the amount of money required for the exact reconstruction of the improvements being appraised
similar to the original.

What is Depreciation?

 § For valuation purposes, depreciation is defined as a loss in value from any cause. It represent
the difference in value between the building under appraisal and a new, substitute building.
 § Depreciation for valuation purposes is not in any way related to depreciation used in accounting
sense or in income tax accounting.
 § Depreciation here can be in terms of physical depreciation or functional and economic
obsolescence.

What are the different kinds of Depreciation?

 § Deterioration or the physical wearing out of the property. This is represented by normal wear
and tear, the action of the elements and catastrophic events such as earthquakes, typhoons and fires.
 § Curable- if by treating the defects, the expected increase in value of the property will at least be
more than the cost of treatment
 § Incurable- if the cost of treating the defect will be more than the expected increase in the
property value
 § Functional obsolescence- or lack of desirability in terms of layout, style, and design as
compared with that of a new property serving the same function. The loss in value from a decrease in
functional utility due to technological improvements, new materials, and other innovations that make
existing buildings obsolete for their original purpose.
 § Economic obsolescence- relating to loss of value from causes outside the property itself. The
loss in value from forces external to the property such as the deterioration of a neighborhood,
encroachments of such nuisances as noise and smell.

What are the basic approaches* to valuation?

Cost approach

 § The current cost of reproducing a property less depreciation from all source that is,
deterioration, and functional and economic obsolescence

Income approach

 § The value which the property’s net earning power will support based upon a capitalization of net
income

Market data approach

 § The value indicate by recent sales of comparable properties in the market

*The appraiser utilizes all three approaches in most of his appraisal work. He may believe that the value
indicated by one approach will be more significant than that of the other two, yet he will use all three as a
check against each other and to test his own judgment. However, there are appraisal problems in which
they cannot be applied such as in vacant land, the use of the cost approach, or in the case of an owner-
occupied home, the use of income approach. All three approaches are needed in the solution of most
appraisal problems.
What is a Cost Approach in Real Estate Valuation?

§ In cost approach, the appraiser obtains a preliminary valuation by adding to his estimate of the land’s
value, his estimate of the depreciated reproduction cost of the building and other improvements. This
approach is based on the assumption that the reproduction cost is the upper limit of value. This also
assumes that a newly constructed building would have advantages over the existing building as
compared with the new building. The measure of this deficiency is called depreciation. For valuation
purposes, depreciation is defined as a loss in value from any case. It represents the difference in value
between the building under appraisal and a new, substitute building. Depreciation for valuation purposes
is not in any way related to depreciation used in accounting sense or in income tax accounting.

What are the steps in Cost Approach?

 § The estimate of the land’s value as if it is vacant

 § The estimate of the current cost of reproduction of the existing improvements
 § The estimate and deduction of depreciation from all causes
 § The addition of the land’s value and the depreciated reproduction of improvements

What is Income Approach in Real Estate Valuation?

§ In income approach, the appraiser is concerned with the present worth of the future net income of a
property which will be produced in its remaining economic life. This future net income is then capitalized
by computing its present worth. Choosing what capitalization rate to apply is one of the most critical steps
in the income approach. A variation of only one half of one percent can make a difference of many
thousands of pesos in the capitalized value of the income.

What are the steps in income approach?

 § Obtaining the rent schedule and the percentage of occupancy for the subject property and for
comparable properties for the current year and for several years in the past. This information provides
gross rental and the trends in rental and occupancy. This data is then related and adjusted by the
comparative method to ascertain the estimate of gross income which the subject property should produce
to attract investors in the market.
 § Obtaining expense data such as taxes, insurance, and operating cost being paid by the subject
property and by comparable properties. The trend in these expenses is also necessary.
 § Estimating the remaining useful economic life of the building to establish the probable duration
of its income.
 § Selecting the appropriate capitalization rate and the applicable technique and methods for
processing the net income.

What is capitalization in perpetuity?

 § In capitalizing net income earned on land, it is assumed that it will continue to earn more
income indefinitely. The market value by capitalization in perpetuity formula is MV=I/R where I is the
income and the income and R is the rate of return.

What is Market Data Approach?

 § The market data approach is essential in almost every appraisal of the value of the real
property. The resulting value by this approach frequently is defined as the “price at which a willing seller
would sell and a willing buyer would buy neither being under abnormal pressure.”

 § This definition assumes that both buyer and seller are fully informed as to the property and
state of the market for that type of property, and that the property has been exposed in the open market
for a reasonable time.

 § This approach produces an estimate of value of a property by comparing it with similar

properties of the same type and class which have been recently sold or currently being offered for sale in
the same areas. The comparative process utilized in determining the degree of comparability between
two properties, involves judgment as to their similarity with respect to many value factors such as location,
orientation, plottage, elevation, and size. The prices of those comparable properties will set the range in
which value of the subject property will be.

What data are needed in Market Data Approach?

 § Sales or asking prices of comparable properties

 § Condition influencing each sale

 § Location of each property

 § Description of the land and improvements of each property

What is Correlation?

§ The last stage in the appraisal process is the correlation of the three values derived by the cost, income
and market data approaches. In correlating these approached into his final estimate of value, the
appraiser should take into account the purpose of the appraisal, the type of property, and the adequacy of
the data available and used in each of the three approaches. These will determine the weight to be given
to each approach. The appraiser should not average the three value arrived at by means of the cost,
market date and income approaches. The appraiser instead should take the three value estimate and
examines the spread between the minimum and maximum figures. He should then consider the approach
which appears to be the most reliable. Then he should make adjustments in accordance with his
judgment and experience.

What is an Appraisal Report?

A word portrayal of the property, the facts concerning that property, and the reasoning by which the
appraiser has developed his estimate of value. The best report is the one which, in the fewest number of
words, permit the reader to follow intelligently the appraiser’s reasoning and to concur in the conclusions
reached thereby. As every report is an answer to a question by a client, it should show the facts
considered and clearly outline the reasoning employed by the appraiser in arriving at his valuation.

What are the steps in appraisal process?

1. Definition of the problem

 § Analysis of the TCT

 § Prepare the plotting based on technical description stated in the title.

 § Compute the lot area based on the measurement on your plotting against the area stated in the
title.

2. Determination of property rights

 § -Check the encumbrances annotated at the back of the TCT

 § -Watch for possible annotations that might affect the value of the land.

 § -All annotations, adverse or informative, should be included in the report, such as: lease
contracts, claim of levy, right of way and Sec. 4, Rule 74 of the Rules of Court.

3. Preliminary survey and appraisal

 § Check the exact location at the cadastral map.

 § If the property appears to be an interior lot, which is without road frontage, verify the updated
plan with the following offices: Land Registration Authority, Bureau of Lands, Assessor’s Office Mapping
Section and Department of Public Works and Highways.

4. Preliminary analysis and data selection and collection (ocular inspection)

 § Use the compass to check the direction of the property pointed by the owner against technical
plotting.

 § Check the actual shape and measurements of frontage and depth of the property against the
technical plotting.
 § Observe the development in the area and the effect of the four forces which create value: social
forces, economic forces, political forces and physical forces.

5. Analysis of the highest and best use

 § After observation of the development in the area, the appraiser must determine the use which at
the time of appraisal is most likely to produce the greatest net return.

6. Application of the three approaches

 § market data or sales comparison approach

 § cost approach

 § income approach

7. Reconciliation of value indicators

8. Determination of Final value and written report

What is the summary of the appraisal process?

1. Reason for appraisal

 § advising prospective purchasers of real estate

 § advising prospective sellers of real estate

 § collateral for mortgages

 § ad valorem taxation

 § inheritance (estate) taxation

 § insurance

 § eminent

 § litigation

2. Identify the Problem

 § real estate to be appraised

 § property rights to be appraised

 § purpose of the appraisal

 § function (use) of the appraisal

 § type of value

 § effective date of appraisal

 § type of value

 § effective date of appraisal

 § special limiting conditions

3. Plan the appraisal

 § prepare the general and specific data

 § determine the “highest and best use”

 § do the basic approaches (coast, market, income approach)

 § reconcile and value conclusion

4. Prepare the report

 certification or letter report

 narrative report

 forum report

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There is an anomaly on the appraised value of the property when the Appraiser and the Broker is one and
the same person. Although the function of the appraiser is to render an honest opinion of the current price
of the property, the function of the broker is to protect and serve the interest of the client.

If the client is the property owner who is selling the property, his interest is to sell it at the highest price
that can be justified by the sense of reason. The broker that he hires as his agent is presumed to be loyal
to him and will always protect his interest of selling it at the highest price possible. The broker would be
caught in a situation called "conflict of interest" if he is the same person as the appraiser.

Therefore, we can fairly assume that if the appraiser is at the same time a broker agent of the seller, the
appraised value will most often be jacked-up. The other way around, if the appraiser is at the same time a
broker agent of the buyer, the appraised value price would somewhat be lower than what it should be.