The role of the real estate appraiser and assessor in valuing real property for ad valorem assessment purposes. (Notes and Issues).
BackgroundThe traditional role of the real estate appraiser is to value a property's interests in real estate ownership for many different reasons. Ownership interests (customarily valued) can be the fee simple estate, leased fee estate, leasehold estate, or a fractional interest in real estate ownership.
The role of the assessor is to value the property interests in real estate strictly for ad valorem assessment and tax purposes. The assessor's primary value concern is "value in exchange." Therefore, in order for the real estate appraiser and the assessor to be on common ground with one another for valuation for ad valorem assessment and tax purposes, both the appraiser and assessor must consider basic value theories and definitions and employ applicable valuation theories as the foundation for the value sought.
Value represents the monetary worth of property, goods, or services to buyers and sellers. Property or ownership rights are subject to law. The value of these rights is the focus of real estate appraisal. Value considerations are the central concern of all real estate activities.
Both the assessor and the real estate appraiser must be familiar with and take into consideration federal, state, and local laws, regulations, and jurisdictional rules that govern the land, especially for ad valorem assessment and tax purposes. The law recognizes the possible conflict between private ownership rights and public use rights which, if not clear or defined, set the stage for differing value conclusions and opinions by appraisers and assessors in an ad valorem assessment and tax matter disputes.
The United States Supreme Court and the United States Circuit Court of Appeals have not defined market value of real property in an ad valorem tax case. However, the Supreme Court did define market value for personal property in an ad valorem tax case in 1865. (1)
Value is extrinsic. It is created in the minds of people. It can change. It is complex. In order for property to have value it must have four factors present--utility, scarcity, desire, and purchasing power.
The Term "Value"
The term "value" is often used inaccurately by nonqualified practitioners. It is an abstract word with many meanings. Qualified appraisers and assessors who recognize and employ value and valuation theories can conclude an opinion of value with the following value concepts (subject to proper definition): fair market value (for income, estate, and gift taxes), fair value, book value, intrinsic value, equilibrium value, public interest value, investment value, going concern value, use value, liquidation value, salvage value, insurable value, and assessed value. These are just a few value terms commonly addressed by practitioners. In the economic sense, market value has a specific definition--the present worth of future benefits realized from ownership.
Modern Value Theory
Principles that have influenced modern day value theories began in the 18th and 19th century. Classical theorists, including Adam Smith, suggested that in addition to land and labor, capital becomes a primary agent of production. David Ricardo developed the rent theory relating to highest and best use and land residual returns. John Stewart Mills defined the relationship between value in use and ownership interest (i.e., capital value of the land ownership). Karl Marx, however, expounded that all value is the direct result of labor and that increased wages would lower capitalistic profits. Eugen Von Boehm-Banerk and William Stanley Jevons linked value with utilization of, and demand for, an item and opined that value then becomes a function of demand with utility as a basic precept. Alfred Marshell merged the supply-cost theory with the demand-price theory, which forms the basis for contemporary modern day value theory.
Value Theory vs. Valuation Theory
Arthur J. Mertzke linked modern day value theory with valuation or appraisal theory. He translated value theories into a workable valuation or appraisal theory method and established a clear foundation for utilizing three basic valuation methods or approaches.
K. Lee Hyder, Harry Grant Atkinson, and George L. Schmutz developed the basic systematic procedures for applying the three basic methods or approaches into indicators of value. Today, valuation and appraisal theories continue to evolve. Education requirements are stringent and appraisers and assessors can make use of computer technology in an ever-expanding database that presents new challenges and debates on applicable valuation models, methods, and techniques employed. However, the question being raised by theorists is whether modern valuation tools may not necessarily reflect economic forces and value theories that affect value.
Standards of Professional Appraisal Practice
In the practice of appraisal, the appraiser and assessor are both required to adhere to the Uniform Standards of Professional Appraisal Practice (USPAP) as promulgated by the Appraisal Foundation. The real estate appraiser is required to adhere to standard rules for real property, personal property, consulting, business appraisal, development, and reporting that are covered by (USPAP) Standards 1, 2, 4, 5, 7, 8, 9, and 10.
The assessor is primarily required to adhere to USPAP Standard 6, mass appraisal development, and reporting and/or other USPAP Standards. Both the real estate appraiser and the assessor are also governed by the ethics, departure, jurisdiction exception, and supplemental standards rules, as well as conduct, management, confidentiality, record keeping, and competency. They are also expected to subscribe to the USPAP's definition of market value unless modified by governing law, regulations, and jurisdictional rules.
Methods and Approaches to Value
Both the appraiser and assessor should utilize the following recognized methods or approaches that are supposed to reflect an indicated value. They are commonly known as the cost (summation) approach, sales comparison approach, and income (capitalization) approach. Appraisers and assessors can also utilize derivatives of these methods or approaches, (depending upon the scope and purpose of appraisal) for the type of property under appraisement.
The term "cost," in the cost (summation) approach, relates to production or creating. Cost may be historical, a current act, or an estimate. It includes direct costs of labor and material plus indirect costs, including professional service fees, governmental fees, administration/coordination marketing/sales/leasing and financing expenses, and profit. In the cost (summation) approach, the following economic/appraisal principles apply: substitution, supply and demand, balance, externalities, and highest and best use.
The term "market" (in the sales comparison approach) reflects the interaction of individuals who exchange real property rights for other assets such as money. For a market to exist, there must be enough buyers, sellers, and product to provide competition. Out of this competition, one could find the highest tendency in the central tendency. In an active market, prices rise above the historical price levels that some believe to be normal or intrinsic. The price paid is an accomplished fact whether at the highest level of the tendency, the lowest level of the tendency, or at the central tendency. The price paid may or may not be market value (as defined), which should be at the highest level of the central tendency.
In the sales comparison approach, which reflects prices paid in the market, the following economic/appraisal principles apply: substitution, supply and demand, balance, and externalities. In the term "incomeproducing," in the income (capitalization) approach, the real estate may be considered an investment when the investor views the earning power of the property as a critical element that affects its value. A basic investment premise is that the higher the earnings, the higher the value, provided the degree of risk remains constant.
In the income (capitalization) approach, the following economic/appraisal principles apply: anticipation and change, substitution, supply and demand, balance and externalities, property rights, economic forces, and principals.
Ownership Rights
In real estate ownership, there are six basic rights associated with ownership (identified as SLUGER). (2)
Bundle of Rights Sell the right to sell Lease the right to lease or rent Use the right to use Give away the right to give away Enter the right to enter or leave (real property) Refuse the right to refuse to do any of these (3)
Public and Private Limitations and/or Restrictions
Ownership may be subject to public and private limitations and/or restrictions. The government can impose certain restrictions and limitations for the common good of its citizens. Four basic restrictions that government imposes are: taxation, eminent domain, police power, and escheat. These governmental restrictions or limitations raise money to fund government, take property for the common good of its citizens (with just compensation payment), regulate and/or limit the use of property; and obtain ownership for non-payment of taxes or when there are no legal heirs upon death.
Private restrictions or encumbrances that also may affect ownership rights and value could include rights of co-ownership, life estate(s), condominium and subdivision rights, easements, covenants, conditions and restrictions, liens, mortgages or deed of trusts, judgments, and leases or possessionary interests by non-owners. These public and private restrictions and/or limitations that can affect the value must be known and addressed by both the appraiser and assessor. Depending on state statues, laws and regulations, public and/or private limitations and/or restrictions may or may not properly be factored in ad valorem assessment valuations by the appraiser or assessor.
Economic Forces and Principles
Appraisers and assessors must give consideration to the following economic forces that influence real property values. If their respective value opinions are to be credible. These economic forces are social, economic, governmental, and environmental forces that are always present and must be reflected in the valuation analysis within the three approaches to value.
In addition, appraisers and assessors must also consider economic principles for their understanding and assessment of the market's environment and trends. These principles are:
* Principle of anticipation is the perception that value is created by the expectation of benefits to be derived in the future.
* Principle of change is the result of the relationship between cause and effect.
* Principle of supply and demand reflects the price of a commodity, good, or service which varies directly, but not necessarily proportionately, with demand, and inversely, but not necessarily proportionately, with supply.
* Principle of competition (as related to the principal of supply and demand) is the interactive efforts of two or more potential purchasers to secure a purchase.
* Principle of substitution reflects when several similar or commensurate commodities, goods, or services are available and the one with the lowest or best price attracts the greatest demand and widest distribution.
* Principle of opportunity cost is the cost of options foregone or the opportunities not chosen.
* Principle of contribution states that the value of a particular component is measured in terms of its contribution to the value of the whole, or in absence would detract from the value of the whole.
* Principle of surplus productivity is the net income that remains after the cost of labor, capital, and management or coordination have been paid.
* Principle of conformity holds that value is created and sustained when the physical characteristics conform to the demands in its market.
* Principle of externalities reflects economies or diseconomies outside a property may have a positive or negative effect upon its marketability and value.
Highest and Best Use
The appraiser and assessor's analysis of the property's highest and best use analysis is an essential fundamental foundation for appraisal. The highest and best use focuses on market forces and the feasible uses of a property. Highest and best use must identify the reasonably probable use, the legal use, (vacant or improved) the physically possible use and the financially feasible use or maximally productive use.
Conclusion
In most, if not all, valuation disputes the appraiser and assessors quantitative analysis and determination of highest and best use is not addressed the same, resulting in differing value opinions and conclusions.
However, when the appraiser and assessor systematically follow and employ the appraisal/valuation process, (whether it be property specific or by mass analysis), the appraiser and assessor conclusions and opinion of value should be similar if all economic and physical factors relating to the scope and purpose of the analysis are factored.
Differing opinions and conclusions arise when one or more factors are included or excluded. The appraiser and assessor must also consider all relevant governing laws, statutes, rules or regulations that may influence value for ad valorem assessment purposes.
Note: This speech was first presented by Michael Y. Cannon, Managing Director, Integra Realty Resources AREEA/South Florida for the International Association of Assessing Officers at the 67th Annual Conference in Miami Beach, FL.
(1.) See Cliquot's Champagne, 70 U.S. 125 (1865).
(2.) These legal rights are commonly known as the "bundle of rights," since these ownership rights are divisible. Property ownership may or may not include all of the following basic bundle of rights.
(3.) Property Assessment Valuation, 2nd Edition, International Association of Assessing Officers (IAAO).
References
Appraisal Institute. The Appraisal of Real Estate, 11th ed. (Chicago: Appraisal Institute, 1996).
International Association of Assessing Officers. Property Assessment Valuation, 2nd ed. (Chicago: International Association of Assessing Officers, 1996).
Michael Y. Cannon, MAI, SRA, ASA, CRE, is managing director of Integra Realty Resources AREEA/South Florida and has been recognized as an authority and expert in market and valuation analysis for ad valorem assessment, real property, business/intangible, and partial interests appraisals and studies. Mr. Cannon has been an expert witness in Federal, State, and Bankruptcy Courts and has testified before the U.S. Senate Banking Committee in Washington, D.C. He is certified by American Arbitration as a Commercial Arbitrator. Mr. Cannon has authored a Monogram entitled "Real Estate Market Analysis in the Valuation Process" published in the Technical Report of the Appraisal Institute. Mr. Cannon writes a weekly real estate column for the Miami Herald and is routinely quoted in the local and national media. Integra Realty Resources is the largest real estate appraisal and consulting firm in the U.S. with 45 regional offices located in 28 states.
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| Author: | Cannon, Michael Y. |
|---|---|
| Publication: | Appraisal Journal |
| Date: | Apr 1, 2002 |
| Words: | 2288 |
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