Re-printed from Ontario Industrial Magazine
In this issue we examine the various types of real estate valuation and the methods of conducting them. While most people know the term Appraisal, few words are as frequently misused.
Real estate owners will frequently assert that their property was recently appraised at such-and-such a value and while they fully believe this to be true, in most cases what they actually received was either a Letter of Opinion or most frequently a Comparative Market Analysis ( CMA).
A true Appraisal can only be conducted by a certified Appraiser who has the appropriate designation for the jurisdiction where the property is located. A certified Appraiser applies substantial research to the task and assumes a higher degree of accountability for the accuracy of the valuation therefore a formal appraisal will provide an acceptable value for purposes of Court Proceedings, for transactions under power-of-sale and for settling disputes as to value between adversaries in circumstances such as an expropriation or disputes over valuation for property tax purposes.
The Letter of Opinion, while intended to provide a true value is not appropriate for settling disputes. It is frequently used for determining value in an estate where there is no controversy, for justifying income tax submissions and in some cases for obtaining financing. However, for the latter, unless the financing is at a low ‘loan-to-value’ ratio and the property is fairly standard, the lending institution will often prefer to obtain its own Appraisal at the borrower’s expense. Beware of spending time or money on a Letter of Opinion unless the lender has previously agreed to be guided by it.
Finally, the CMA or comparative market analysis is simply a limited study by a Realtor, comparing the subject property against similar properties currently available and against other properties recently sold. It is used to assist a client in setting a listing price and negotiating a sale or lease and has no authority with courts or lending institutions.
The Real Estate Council of Ontario ( RECO) ,whose rules are binding upon all Realtors specifies that “ A member shall not give an opinion or advice about the value of a property unless the Member has the knowledge,skill and training to do so for that type of property and the member has done the necessary research”. RECO then includes within its guiding principles “Evaluations and Comparative Market Analysis are distinct from Formal Appraisals. A member should not perform a Formal Appraisal unless the member has the appropriate designation or certification”
The intent of these rules is to protect the client :
1/ By prohibiting a Realtor from giving an opinion on types of property or properties in locations that are outside of that Realtor’s sphere of expertise and
2/ By ensuring that the client receives the right type of valuation for his purpose, which is not always simply to list the property.
The method or methods of valuation used will vary according to situation and the type of property. They include the Comparative Sales Method, the Income Method and the Cost Method.
The Comparative Sales Method is an important component of any type of valuation. Essentially it is a common-sense determination of what a fully informed buyer should pay and a fully informed seller should accept, in current market conditions, with neither operating under duress. The subject property is compared to similar properties that have sold and to similar properties available for sale, with adjustments made for each positive or negative of the subject property’s features and condition in comparison to the other properties. Adjustments will also be made for timing, variations in economic conditions, changes in interest rates and developments in the neighborhood which all play an important role in comparing to properties sold previously.
The Income Method is of course used for Investment properties. Essentially it looks at the ratio of Cash Flow to Selling Price of similar properties that have recently sold and similar properties currently for sale, and then applies this ratio to the Cash Flow of the subject property. Care must be taken to compare the cash flows on an apples-to-apples basis so that items like financing and management costs and capitalization versus expensing of repairs/improvements are accounted on exactly the same basis for each property or eliminated from the equation on all. This method would rarely be used by itself but in conjunction with the Comparative Sales Method as a cross-reference. It is important to note that not all Realtors would have the accounting expertise or up-to-date knowledge of rental property to use this method with authority and would also need to be fully aware of all legislative or economic factors which might impact the future cash flows of the subject property.
The Cost Method as the name implies, establishes the total cost that would be involved in acquiring land and materials and paying for labor, design costs, permits, legal expenses and all the other ‘soft costs’ to replicate the property at today’s costs. The resulting total, minus the land costs could then be used to determine a current replacement value for Insurance purposes or as a basis for current cost depreciation .Alternately one can establish a ‘depreciated value’ for the current structure by looking at its present age versus the total ‘useful life’ and construction cost. This depreciated value can then be added to the land and soft costs as another cross-check of value.
For Residential work many Realtors will know current raw land costs, soft costs and the range of typical per-square-foot construction costs. For Commercial/Industrial work specialized assistance is recommended for anything beyond a broad preliminary estimate.
No matter what the purpose or type of valuation it is always a ‘snap-shot-in-time’ so to be of any practical use a fundamental requirement is that it be up-to-date.
Paul Graham is the owner and Broker of Record for BUYERS REALTY INC. Please direct your questions to paul@buyerscall.com or to his direct line, 905-607-4400
