Real estate appraisal involves developing an opinion of a property’s value. The objective of an appraisal is to provide an unbiased estimate. Appraisals facilitate property transactions, whether buying or selling, help mortgage lenders assess the value of the collateral, and serve other purposes such as taxation, litigation, estate planning, financial reporting, and insurance.
Today, let’s explore some key terminologies in real estate appraisal.
Real Estate Property
Real estate refers to land and all structures and resources attached to it, including any improvements such as buildings, fences, water, minerals, and more.
Real Property
Real property includes the real estate along with the bundle of rights associated with it. These rights include the right of possession, the right of control, the right of exclusion, the right of enjoyment, and the right of disposition.
Commercial Real Estate
Properties that house businesses and generate profits are classified as commercial real estate. Commercial properties include retail, office, industrial, multifamily, and hospitality properties.
Residential Real Estate
Properties used for residential purposes are classified as residential real estate. These include single-family homes, condos, and townhouses.
Appraisal Report
An appraisal report, according to the Uniform Standards of Professional Appraisal Practice (USPAP), is “any communication, written or oral, of an appraisal or appraisal review that is transmitted to the client or a party authorized by the client upon completion of an assignment.”
Appraisal Methodologies
The three most internationally accepted appraisal methodologies are the sales comparison approach, the cost approach, and the income approach.
Escrow
Escrow acts as a safety net for both the buyer and the seller in a transaction. Escrow accounts are third-party accounts where assets are held until the terms of an agreement are met. Once the terms are fulfilled and agreed upon by both the buyer and the seller, the escrow provider finalizes the transaction by transferring the funds to the seller.
Eminent Domain
The right of the government to acquire private property for public use, provided that fair compensation is given to the property owner.
Highest and Best Use
The highest and best use is a detailed analysis to identify the most valuable use of a property. The property is evaluated for its physical possibility, legal permissibility, financial feasibility, and productivity.
Fair Market Value
Fair market value is the price at which a property would sell between a knowledgeable buyer and a knowledgeable seller, each acting without undue influence, under current market conditions.
Gross Building Area
The gross building area is the total area enclosed by the exterior walls of a building. This includes the area of structured parking but excludes the area of unenclosed spaces.
Net Rentable Area
The net rentable area is the portion of a building available for lease to tenants. It does not include vertical penetrations such as elevator shafts and service shafts. However, it may include an allocation of common areas that directly benefit the tenant, such as lobbies, tenant space common corridors, and restrooms.
Assessed Value
The assessed value of a property is used to determine property taxes. A municipal or county tax assessor conducts a property value assessment, which is then used to estimate the property’s tax value.
Fair Market Value
Fair Market Value is the price at which a property would sell in an open market where both the seller and the buyer act prudently, are willing, and are well-informed. The fair market value of a property depends on various factors.
Date of Value
The date of value in valuation reports refers to the specific date at which the opinion of value applies. This date can be current, a future date, or a date in the past.
Retrospective Appraisal
A retrospective appraisal provides an opinion of value as of a specific past date. Retrospective appraisals are conducted in cases such as estate planning, divorce settlements, litigation, and property assessments.
Prospective Appraisal
A prospective appraisal provides an opinion of value as of a specific future date. Prospective appraisals are conducted for properties that are proposed, under construction, or have not yet achieved stabilized occupancy.
Lease Agreement
A lease agreement is a contract between the lessor (landlord) and the lessee (tenant) that outlines the terms and conditions for leasing a premises at a specified rate for a stipulated period.
Lease Rate
The lease rate is the rental amount agreed upon by the lessor (landlord) and the lessee (tenant) that the lessee will pay during the lease term.
Market Rent
Market rent refers to the rent that similar properties in a given market command, making it the potential rent for a property. It depends on various factors such as location, amenities, size, and other property features.
Contract Rent
Contract rent is the agreed-upon rent that the tenant pays to the landlord based on the lease agreement. It is not determined by current market conditions but by the terms of the existing lease.
Gross Lease
A gross lease is a type of lease agreement in which the landlord is responsible for all expenses, and the tenant agrees to pay a flat rent.
Modified Gross Lease
A Modified Gross Lease is a lease arrangement in which both the tenant and landlord share the responsibility for property expenses. The tenant pays a base rent along with a portion of operating costs, such as property taxes, insurance, or maintenance, while the landlord covers the remaining costs.
Triple Net Lease
A lease agreement in which the lessee agrees to pay all expenses, including property taxes, insurance, and common area maintenance, in addition to rent and utilities.
Expenses
Expenses are the day-to-day costs incurred in operating a commercial property. These can include property taxes, property insurance, operating expenses such as management fees, maintenance and repairs, utilities like water, sewer, electricity, gas, and internet, as well as capital expenses for major renovations and common area maintenance.
Net Operating Income
Net Operating Income (NOI) is the income remaining after all operating expenses have been deducted from the total revenue generated by the property.
Cap Rate
A cap rate (capitalization rate) is the rate of return expected from a real estate investment. Often, cap rates are associated with risk, meaning that the higher the cap rate, the greater the risk. The cap rate is calculated by dividing the Net Operating Income (NOI) by the property’s market value.
Leasing commission
A leasing commission (LC) is a commission paid by a landlord to a real estate broker for leasing a vacant space. It is typically a percentage of the total rent that a tenant will pay over the lease term.
Tenant Improvements
Tenant Improvements (TIs) are allowances provided by the landlord to cover the costs of customizing the space to meet the tenant’s requirements.
Hypothetical Condition
A hypothetical condition is an assumption used in an appraisal that is contrary to the facts known to the appraiser.
Extraordinary Assumption
An extraordinary assumption is an assumption regarding an uncertain or unknown condition or fact, which, if proven false, could affect the resulting opinion or conclusion.
Exposure Time
Exposure time is the time the property is on market. Exposure time ends on the effective date of the value.
Marketing Time
The amount of time it might take to sell a property interest at the concluded market value. Marketing time begins on the effective date of the appraisal.
Replacement Cost New
Replacement Cost New (RCN) is the estimated cost to replace an existing asset with one of similar characteristics and value, based on current market prices.
Depreciation
The value of an asset tends to decrease over time due to physical wear and tear, functional limitations, or economic obsolescence. This reduction in value is known as depreciation.