Valuation: How Many Approaches Are Enough?
Over the last several decades, I’ve had countless debates with numerous people in the appraisal industry about how many different valuation methods, or “approaches” are appropriate for use in a single appraisal assignment of one property being used for a single purpose (such as a multi-tenant retail strip being used as such). And, I just had occasion to have a discussion about this same subject today.
First and foremost, when the purpose of an appraisal assignment is to form an opinion of the “market value” of a property, the sole purpose and goal of an appraiser is to the value that property using the same considerations and methods that would be used by the typical buyer and seller of that type of property in its market place; thus, the term “MARKET” value.
Consequently, the primary function of the appraiser in this circumstance is to understand how that “typical” market participant views the utility and value of that type of property. This is absolutely essential to be determined, understood and emulated, or the result will likely not reflect the value of that property to the market participants in its market.
A little too deep for you? Then, let me make really simple.
Value is like beauty; it’s in the eye of the beholder.
So, if you’re going report on the social preferences in a certain town, and the typical resident thinks that people with green hair and purple eyes and live on the east side of town are the most beautiful and most successful people in the world, you can’t report that they think the that people who have black hair and green eyes and live on the south side of town are the most successful people in the world.
In real property valuation (just as in the valuation of anything), it is absolutely critical to recognize the valuation method or methods used by the people who actually buy and sell that type of property in that market area.
It’s also generally true, that people who buy real estate for their personal use (an owner occupied property), aren’t particularly concerned with anything except how well the physical attributes of that property satisfy their needs; a/k/a the utility of those physical attribute. Consequently, they will look at the most similar types of real estate uses to the one they’re considering that were most recently bought by other owner-users, then compare them to the property they’re considering in order to get an idea of what they might reasonably be expected to pay to buy that property. (Not rocket science.)
But, what that owner-user buyer WOULDN’T do, is consider the net present value of the income of a property bought by an investor, because 1) the owner-user really doesn’t care since they’re not buying for cash-flow purposes, 2) they probably don’t know how to make such an analysis, and 3) if they do know how to make such an analysis, they will certainly know that using the investment valuation method (in place of the direct comparison valuation method) will give them a different value indication which will be of no use to them.
Now, there are situations where a property owner has a real estate parcel in an area that might be bought by an owner-user, yet has just as reasonable a probability of being bought by an investor. Therefore, in the case where that property owner hires an appraiser to advise how much he should ask for the property, the appraiser would best serve that property owner by providing 2 opinions of value; one opinion as if being sold to an owner-user, and the other as if being sold to an investor. Naturally, this would require the appraiser to develop two valuation methods; the direct comparison method for the owner-user value opinion, and the investment analysis method for the investor value opinion.
Getting back to when I discuss this topic with other appraisers, they say, “Well, I use the direct comparison approach as a check on the investment analysis approach,” or vice versa. To which I respond incredulously saying, “WHAT?!”
Then, I point out, that each of these methods / approaches was designed for use by people who view the use of the same property in two different ways; they have no relationship what ever to each other, so how can one be a check on the other? It’s like saying, “I compared the 0-60 mph performance of a 70 horsepower 2010 Smart Car to that of a 550 horsepower 2010 Lamborghini Gallardo.” Yes, they’re both cars. But, the Smart Car is bought for the purpose of city driving and high gas mileage (rated at 41 mpg highway), while the Lamborghini is bought for speed and sports car performance on the open road. In the end, their are no conclusions one can come to as to the value of either of these cars by comparing one to the other.
I can go on almost forever in discussing my frustrations with those who defend the indefensible use of multiple approaches to form an opinion of the value of a single property under a single use, but, I’ll leave some for future blog posts.
Your comment and/or opinion is welcomed.
