Fair Market Value of Real Estate

Brien Roche

Sometimes in the course of litigation there arises issues about the fair market value of real estate. When you get into fair market value questions, normally there is going to be an appraiser involved.

Appraisers Use Three Different Approaches in Terms of Valuing:

Income Approach

The income approach is premised upon the property being income-producing from an arms-length tenant. That income approach can be used to supplement the other approaches. 

Cost Approach

The cost approach is typically used in an instance where there is some improvement on the property. The improvement may be a building or something else. Under this analysis, you look at comparables for the land only. You assume there was no improvement (building) on the property. Based upon that comparative analysis, you come up with a fair market value of the land alone.  You then calculate the cost to construct the building as if new. The depreciation attributable to that building is estimated. That is deducted from the estimated replacement cost of the building. The value of the land is then added to that depreciated cost estimate. 

Comparative Approach

The comparative approach is based upon finding properties that are comparable to the subject property. In most cases you’re not able to find a property that is exactly comparable i.e., exactly the same. You try to find properties that are similar in terms of being in relatively close proximity to the subject property, having sold reasonably close to the date of sale in question, being similar as far as use and similar in terms of other characteristics i.e., signage, proximity to a major thoroughfare, access, etc.

Highest and Best Use

As part of the comparative analysis, you have to consider what is the highest and best use of the property. The highest and best use is the use that is legal, physically possible, financially feasible and that results in the highest value. The highest and best use of one property may be as a skyscraper. It cannot very well be used as a comparable for a subject property if its use is as a construction site.

Adjustments

In most cases where the comparable approach is used, you’re lucky if you find one property that is truly comparable.  Appraisers may try to find several. Perhaps as many as three (3) or sometimes more and then they will make adjustments. Those adjustments may be positive or negative. For instance a positive adjustment may be made in the comparable because it has worse access to the main thoroughfare than does the subject property. A negative adjustment may be made because the location of the property is inferior to the subject property. A positive adjustment may be made because the sale date is distant from the sale of the subject property.

Those positive and negative adjustments are then added together and that results in what is called an “indicated value” of the subject property. In other words, that indicated value is the value of the comparable with the adjustments. Indicated value is the sale price of the comparable property with the adjustments referenced above factored in.

The easy way to think of this analysis is that things that make the comparable inferior to the subject property are deemed to be positive adjustments to indicated value. Things that make the comparable property better than the subject property are deemed to be negative adjustments to indicated value.

Negative and positive adjustments are somewhat difficult to conceptualize.  A negative adjustment is one where the comparable property is better than the subject property. That means that the indicated value is going to be driven down. A positive adjustment is where the comparable property is somehow inferior to the subject property. That means that the indicated value is going to be driven up. 

Market Value Real Estate-Units of Comparison

There may be different units of comparison used in the comparative approach. If the property is land only, then the unit of comparison may be square foot. That is one square foot of dirt is the same as another square foot of dirt. There may have to be adjustments made because of the location, date of sale, size and other factors but the basic unit of comparison is simply going to be the square foot size of the property. The various adjustments as referenced above are factored in.

The problem with the square foot unit of comparison is that it operates on the premise that all properties are the same. If the subject property has a building on it, then it is probably not the same as the comparable. In instances where there is a building on the property, the square foot unit of comparison typically is not a fair one for the above reason. Instead what you have to do is do a true comparative analysis. That is, you have to compare apples to apples. That is, land with a building on it is compared with the subject property which likewise has land with a building on it. 

Learned Treatises

If the opposing appraiser attempts to use a square foot unit of comparison where there is an improvement on the property, you might consider the use of some learned treatises. Babcock’s 1932 edition of The Valuation of Real Estate is considered by some to be the “bible” of real estate appraisal. On pages 178 and 179 of that book, it says that these formula methods of comparative valuation are attempts to make it possible for assessors to place appraisals on numerous parcels in wholesale fashion. 

In The Appraisal of Real Estate 15th Edition, on pages 361, 368 and 394, the authors address that issue.

As part of the comparative analysis, some appraisers might try to drive the price down by using a large number of comparables. The more comparables that you can throw into the mix with lower indicated value, then the lower the appraiser’s valuation is going to be. Most appraisers use three (3) comparables. If you see an appraiser using more than three (3) comparables, you need to ask why.

Reach Out to an Experienced Lawyer in the DMV Area

Call, or contact us for a free consult. Also for more info on market value real estate see the Wikipedia pages. Also see the post on this site dealing with contract issues.