Real Estate Appraiser
01-21-2006, 04:27 PM
Appraisal Valuation methods
In the UK, real estate appraisal, or property valuation, is regulated by the RICS, which publishes the Red Book. The Red Book takes a more subtle approach to valuation than the three approaches to appraisal outlined above. The Red Book recognises five methods of valuation:
(1) Comparable method. Used for most types of property where there is good evidence of previous sales. This is analogous to the sales comparison approach outlined above.
(2) Investment/income method. Used for most commercial (and residential) property that is producing future cash flows through the letting of the property. If the current rental value and the passing income are known, as well as the market-determined equivalent yield, then the property value can be determined by means of a simple model. Note that this method is really a comparison method, since the main variables are determined in the market. In standard US practise, however, the closely related capitalising of NOI is confounded with the DCF method under the general classification of the income capitalization approach (see above).
(3) Accounts/profits method. Used for trading properties where evidence of rates is slight, such as hotels, restaurants and old-age homes. A three-year average of operating income (derived from the profit and loss or income statement) is capitalised using an appropriate yield. Since any income stream can be simulated by an appropriate choice of yield, this method is comparable to DCF (see above). Note that since the variables used are inherent to the property and are not market-derived, the resulting value is value-in-use and not market value.
(4) Development/residual method. Used for properties ripe for development or redevolopment or for bare land only.
(5) Contractor's/cost method. Used for only those properties not bought and sold on the market. Both the development/residual method and the contractor's/cost method would be grouped in the US under the cost approach.
Automated valuation models
Automated valuation models (AVMs) are growing in acceptance. These rely on statistical models such as multiple regression analysis and geographic information systems (GIS). While AVMs can be quite accurate, particularly when used in a very homogeneous area, there is also evidence that AVMs are not accurate in other instances such as when they are used in rural areas, or when the appraised property does not conform well to the neighborhood.
This is most evident where there is a renewal or "revitalization" of a particular area or neighborhood. There can exist within a single city block homes that are in poor condition to homes that have been completely rehabilitated and are in good to excellent condition. The differential of sales prices can be demonstrated to be from 50% to 125%. This can lead to an inaccurate model. Extreme caution should be exercised when relying on these AVMs.
Because of the limitations, AVMs have begun to fall out of favor with many lenders but are widely used in other appraisal problems such as mass appraisals for ad valorem real estate tax purposes.
In the UK, real estate appraisal, or property valuation, is regulated by the RICS, which publishes the Red Book. The Red Book takes a more subtle approach to valuation than the three approaches to appraisal outlined above. The Red Book recognises five methods of valuation:
(1) Comparable method. Used for most types of property where there is good evidence of previous sales. This is analogous to the sales comparison approach outlined above.
(2) Investment/income method. Used for most commercial (and residential) property that is producing future cash flows through the letting of the property. If the current rental value and the passing income are known, as well as the market-determined equivalent yield, then the property value can be determined by means of a simple model. Note that this method is really a comparison method, since the main variables are determined in the market. In standard US practise, however, the closely related capitalising of NOI is confounded with the DCF method under the general classification of the income capitalization approach (see above).
(3) Accounts/profits method. Used for trading properties where evidence of rates is slight, such as hotels, restaurants and old-age homes. A three-year average of operating income (derived from the profit and loss or income statement) is capitalised using an appropriate yield. Since any income stream can be simulated by an appropriate choice of yield, this method is comparable to DCF (see above). Note that since the variables used are inherent to the property and are not market-derived, the resulting value is value-in-use and not market value.
(4) Development/residual method. Used for properties ripe for development or redevolopment or for bare land only.
(5) Contractor's/cost method. Used for only those properties not bought and sold on the market. Both the development/residual method and the contractor's/cost method would be grouped in the US under the cost approach.
Automated valuation models
Automated valuation models (AVMs) are growing in acceptance. These rely on statistical models such as multiple regression analysis and geographic information systems (GIS). While AVMs can be quite accurate, particularly when used in a very homogeneous area, there is also evidence that AVMs are not accurate in other instances such as when they are used in rural areas, or when the appraised property does not conform well to the neighborhood.
This is most evident where there is a renewal or "revitalization" of a particular area or neighborhood. There can exist within a single city block homes that are in poor condition to homes that have been completely rehabilitated and are in good to excellent condition. The differential of sales prices can be demonstrated to be from 50% to 125%. This can lead to an inaccurate model. Extreme caution should be exercised when relying on these AVMs.
Because of the limitations, AVMs have begun to fall out of favor with many lenders but are widely used in other appraisal problems such as mass appraisals for ad valorem real estate tax purposes.