Methods of Appraising Property
This chapter covers the methods used by appraisers in appraising property for tax purposes. It is not intended to teach ARB members how to appraise property. However, it provides extensive methodology in order to give ARB members a better understanding about how property is appraised so that they may be better prepared to ask the right questions and assess the evidence presented by the parties. This part of the manual provides explanations of the law, the standards, the methods, and the language used in the appraisal of property.
The intent of this chapter is to provide ARB members with information they can use to evaluate the quality and credibility of the evidence presented in a protest hearing, not so that ARB members will be able to appraise the property under protest. It is not the ARB's duty to appraise property. An ARB member, for example, typically has no training, knowledge, or experience on how to measure, or distinguish, "20 percent good" or "50 percent depreciated" and, therefore, should not be forming opinions required of a trained and licensed appraiser. Indeed, it is illegal for someone, including an ARB member, to appraise property for taxation without first being certified by the Texas Department of Licensing and Regulation (TDLR). An individual commits a Class B misdemeanor if he or she performs an appraisal without being certified by TDLR. An owner, however, is qualified to testify about market value of his or her property, even if he or she is not certified by TDLR. The owner's qualifications to testify are limited to opinions of market value of the owner's property.
ARB members will learn the basic procedures involved in carrying out property tax appraisals for various types of properties. At the conclusion of the chapter, participants will have a better understanding on how appraised value is properly developed and have a deeper understanding of the appraisal process so that they can better weigh evidence at protest hearings.
I. What is an Appraisal?
An appraisal is an unbiased opinion of value; it is not a statement of fact. No one can forecast the exact selling price of a property. Appraisers, however, cannot randomly assign values to properties; they must base their opinion of value on market conditions. The appraiser must avoid bias at all cost; he or she must base the opinion of value on fact, not on personal opinion.
Texas law requires that the market value of property be established by using generally "accepted appraisal methods and techniques." This means that appraisal districts have a legal duty to follow a set of industry-recognized procedures to develop an estimate of market value. An appraisal is defined in the Uniform Standards of Professional Appraisal Practice (USPAP) as follows:
the act or process of developing an opinion of value; an opinion of value; of or pertaining to appraising and related functions such as appraisal practice or appraisal services.
Following industry standards eliminates the potential for appraiser bias and provides methods to independently test and objectively defend the estimate of market value. While in the end an appraisal is an opinion, it is one that is based on objective processes and data and not mere guesswork.
Basic definitions involving value, which can take different forms in the appraisal and taxation process, are as follows:
- Market value means the price at which a property would transfer for cash or its equivalent under prevailing market conditions if the following elements are present:
- exposed for sale in the open market with a reasonable time for the seller to find a purchaser;
- both the seller and the purchaser know of all the uses and purposes to which the property is adapted and for which it is capable of being used and of the enforceable restrictions on its use; and
- both the seller and purchaser seek to maximize their gains and neither is in a position to take advantage of the exigencies of the other.
- Appraised value means the value determined as provided by Chapter 23 of the Property Tax Code.
- Assessed value means, for the purposes of assessment of property for taxation, the amount determined by multiplying the appraised value by the applicable assessment ratio, but, for the purposes of determining the debt limitation by the Texas Constitution, means the market value of the property recorded by the chief appraiser.
- Taxable value is the amount determined by deducting from assessed value any applicable partial exemptions.
The Tax Code defines the following three distinct types of property:
- Real property means land; an improvement; a mine or quarry; a mineral in place; standing timber; or an estate or interest, other than a mortgage or deed of trust creating a lien on property or an interest securing payment or performance of an obligation, in a property enumerated herein. An improvement is a building, structure, fixture, or fence erected on or affixed to land; a transportable structure that is designed to be occupied for residential or business purposes, whether or not it is affixed to land, if the owner of the structure owns the land on which it is located, unless the structure is unoccupied and held for sale or normally is located at a particular place only temporarily; or subdivision of land by plat; installation of water, sewer or drainage lines; or paving of undeveloped land.
- Tangible personal property means personal property (property that is not real property) that can be seen, weighed, measured, felt, or otherwise perceived by the senses, but does not include a document or other perceptible object that constitutes evidence of a valuable interest, claim, or right and has negligible or no intrinsic value.
- Intangible personal property means a claim, interest (other than an interest in tangible property), right, or other thing that has value but cannot be seen, felt, weighed, measured, or otherwise perceived by the senses, although its existence may be evidenced by a document. It includes a stock, bond, note or account receivable, franchise, license or permit, demand or time deposit, certificate of deposit, share account, share certificate account, share deposit account, insurance policy, annuity, pension, cause of action, contract, and goodwill.
Property can change from real to personal property and from personal to real property. Minerals in place, for example, have not been removed from the ground. When they are mined, these minerals convert to personal property. A manufactured home is considered real property if the owner designates it as such on the statement of ownership and location for the home issued under Occupations Code Section 1201.207 and files a certified copy of the statement of ownership and location in the real property records in the county in which the home is located; otherwise, it is personal property.
Appraisers distinguish between improvements, including buildings, structures, fixtures, or fences, and improvements-to-land, such as sidewalks, curbs, retaining walls, and stock tanks. Improvements include such things as houses, barns, and other buildings. Appraisers usually include the value of improvements-to-land with their opinion of land value, not their opinion of improvement value. Often, they use the term site to refer to the raw land and the improvements-to-land.
Mineral leases are an example of real property that falls under the category "any other ownership interest." A person or company that purchases mineral rights in a property must pay property taxes on the value of that ownership interest. However, an ownership interest held by a mortgage lender or a contractor who has a lien on a property is not taxable. A lien enables the holder to take over ownership of property or force its sale if the owner does not pay a debt he or she owes the lien holder. The lien holders cannot be taxed on the value of the lien unless they actually use it and gain possession of the property. Borrowers are liable for the property taxes as long as they retain ownership of the property.
All property that is not real property is personal or intangible property. Tangible property includes both real and personal property. If one can feel, see, or touch personal property, it is tangible. If one cannot see the property itself, it is intangible. Stock in a corporation is intangible. Even though one can see the share of stock as a piece of paper, the corporation itself or the ownership interest in it cannot be seen.
Usually, ARBs do not have to be concerned with intangible property. In some instances, such property is taxable, such as the intangible property of insurance companies and savings and loans, but in most cases, it is exempt.
II. Uniform Standards of Professional Appraisal Practice (USPAP)
Texas law requires that the market value of property be determined as of Jan. 1 by the application of generally accepted appraisal methods and techniques. If an appraisal district uses mass appraisal methods to determine the appraised value of property–which most do-it must comply with USPAP. The Appraisal Foundation, authorized by the U.S. Congress to oversee appraisal standards and appraiser qualifications, developed USPAP for use by professional appraisers in the United States. The industry considers USPAP as the "generally accepted standards." USPAP changes every two years. The appraiser is responsible for complying with current USPAP standards when the appraisal is conducted.
The underlying purpose of USPAP is to provide the public with a level of confidence in appraisal work. By setting the standards for the work appraisers perform, as well as the qualifications for appraisers, USPAP helps ensure that appraisal work is reliable, fair, and uniform. In addition to the appraisal standards, the Appraisal Foundation sets out the ethical and competency requirements that appraisers must observe and maintain.
USPAP addresses the ethical and performance obligations of appraisers through definitions, rules, standards, and statements. The rules specifically address ethics, competency, scope of work, and jurisdictional exceptions.
USPAP provides the following 10 standards used in appraising real, personal, and business property:
- Standard 1: Real Property Appraisal, Development;
- Standard 2: Real Property Appraisal, Reporting;
- Standard 3: Appraisal Review, Development and Reporting;
- Standard 4: Real Property Appraisal Consulting, Development;
- Standard 5: Real Property Appraisal Consulting, Reporting;
- Standard 6: Mass Appraisal Development and Reporting;
- Standard 7: Personal Property Appraisal, Development;
- Standard 8: Personal Property Appraisal, Reporting;
- Standard 9: Business Appraisal, Development; and
- Standard 10: Business Appraisal, Reporting.
Most appraisal districts use mass appraisal and will be concerned with Standard 6; however, if an owner brings in an independent appraisal, it too must comply with USPAP. If it is real property (single-family, commercial, land, etc.), Standard 1 must be followed in developing the appraisal and Standard 2 in reporting the appraisal; if it is personal property, Standard 7 applies in the development and Standard 8 in the reporting; and for business property, standards 9 and 10 must be observed.
A mass appraisal includes the following elements:
- identifying the properties the appraisal district will appraise;
- defining a market area whose consistent behavior applies to all properties being appraised;
- identifying characteristics, such as supply and demand, that affect the formation of value in the defined market area;
- developing a model structure that reflects the relationship among the characteristics affecting value in the market area;
- calibrating the model structure to determine the contribution of the individual characteristics affecting value;
- applying the conclusions reflected in the model to the characteristics of the property the appraisal district is appraising; and
- reviewing the mass appraisal results.
Like any complicated process, mass appraisal is best implemented by reducing its various parts into a model. A model is simply an expression of how things work. Once the user knows how it works, he or she can use it repeatedly with essentially the same results. A mass appraisal model explains or forecasts market value by using up-to-date, real estate data based on the three approaches to value, which will be discussed later in this manual. The International Association of Assessing Officers (IAAO) points out the following:
Mass appraisal model building requires good appraisal theory, data analysis, and research methods. The best models are accurate, rational, and explainable. Models that reflect the local market are also easier to defend.
USPAP Standard 6 applies to all mass appraisals of real or personal property, whether prepared with or without computer assistance, and includes rules appraisers must consider in appraising property under this method. In mass appraisal, the following is true:
...perfection is impossible to obtain...However, an appraiser must not render appraisal services in a careless and negligent manner...This Standards Rule requires an appraiser to use due diligence and due care.179
III. Mass Appraisal
An appraisal district must estimate the value of thousands of properties. The appraisal district has neither the time nor money to repeat the full appraisal process for each individual property. Instead, it uses mass appraisal. The Appraisal Foundation defines mass appraisal as "the process of valuing a universe of properties as of a given date using standard methodology, employing common data, and allowing for statistical testing." The definition includes basic appraising elements used to appraise individual pieces of property, such as standard methodology and common data. Appraising properties in mass, however, requires an additional component–the use of statistical testing.
In general, property appraisal is made up of a set of procedures designed to ensure that appraisers base opinions of value on a disciplined interpretation of factual information. The appraiser submits information from the market to a series of examinations that enable him or her to develop an opinion of the value of a single property. The following four areas comprise the essential elements of an appraisal system:
- discovery of all taxable property;
- inspection of all taxable property;
- construction of system to record and maintain records of taxable property; and
- estimation of fair and uniform value of all taxable property.
No matter how small the appraisal district, no appraiser can carry out all of these steps for every property. Maintenance of the integrity of the system requires independent verification and methods to perform quality checks on data gathered, analyzed, and recorded. This requires involvement of more than one individual. It is the chief appraiser's responsibility to assign and coordinate these tasks to ensure the quality of the data. One staff appraiser may spend the majority of his or her time collecting ownership information, a second may concentrate on inspecting existing property, a third may focus on inspecting new property, and a clerk may enter the data into the appraisal record-keeping system.
Because mass appraisers must work with large numbers of properties, appraisers must alter their discipline accordingly. Mass appraisers attempt to find the value of a typical property of a given type and then use that typical value to estimate the value of specific properties. Since every appraisal district has a variety of different types of properties, the first step in mass appraisal is to classify properties, to figure out what kinds of properties are typical in the appraisal district.
Mass appraisers then devise a value schedule for each type of property included in the appraisal district's classification system. The set of improvement schedules, for example, include (at least) one schedule for single-family residences, one for commercial properties, and one for multi-family residences. The market in the appraisal district determines the kinds of schedules necessary, but in almost every appraisal district, the commercial category is probably too large. Subdivisions of it might arise from size, from the type of commercial business, or from the location.
The process of building a value schedule involves the following seven basic steps:
Step 1 Developing a classification system.
Step 2 Collecting information on sales.
Step 3 Posting sales to the appropriate category.
Step 4 Calculating appropriate time adjustments and applying them to sale prices.
Step 5 Adjusting sale prices of individual properties to eliminate any features that are not typical of their category.
Step 6 Selecting the value from each category that best represents the typical value per unit of measure.
Step 7 Calculating adjustments with which to tailor typical values to specific properties.
Step 5 distinguishes mass appraisal most clearly from appraisal of a single piece of property. Since mass appraisal aims to deal quickly with large numbers of properties, it devises values for categories. To find those values for categories, appraisers must eliminate all unique features of the individual properties within the group. They must then adjust their sale information so that it will reflect the market value not of the specific property sold, but of a typical property that lacks any unique features. At Step 7, appraisers produce adjustment figures which enable the schedule to work. These adjustments allow them to convert typical values back into values appropriate for specific properties.
In practice, mass appraisal does not progress as methodically as the seven-step process suggests. An appraisal district can construct a preliminary classification system, but must modify it as information on sales is collected. Obviously, sales cannot be posted until the appraisal district has perfected its classification scheme. The classification system might, for example, separate classes of single-family houses according to number of bedrooms.
All value schedules are different because all markets are different. Deciding what types of properties are typical can present tremendous difficulties, but that effort to classify properties is at the heart of mass appraisal. A value schedule cannot be any better than the classification system on which it is based.
Although it is possible to build a value schedule for land in the same way a schedule for improvements is built, those steps are not really necessary. Location, topography, and use all tend to go together. That is, one of the major ways we determine a location is by looking at the geographic features that define it. Quite often, locations are also identified by use of residential areas, central business districts, warehouse districts, industrial parks, and other categories. The appraisal district must develop adjustments to apply to properties identified as non-typical. Nonetheless, compared with the adjustments improvements require, the total number of adjustments to land prices should be small.
A. Characteristics of Mass Appraisal
What is the difference between mass appraisal and appraisal of a single piece of property? One difference is simply scale. Valuing a single property involves problems of an entirely different nature from those faced by an appraiser valuing 10,000 parcels, as a result of the difference in scale. The mass appraisal process has a number of general characteristics that distinguish it from single property appraisal.
One such characteristic is centralization of authority. While a sole and independent contractor may appraise a single property, the mass appraisal process is more than a single individual can undertake. Typically, tasks are divided among administrators and field appraisers.
A second characteristic is standardization of appraisal procedures. Not only must a large number of properties be appraised, they must be appraised in a manner that conforms to law and does not discriminate. This means that a great deal of the art of appraisal is replaced by standard operating procedures designed to minimize the difference in the treatment of properties and to make the treatment of properties routine.
A third characteristic is synchronization of tasks. When one person performs all the tasks in an appraisal, the tasks are performed in a proper order. Where, however, one person directs, a second develops valuation tools, a third collects data, a fourth uses the tools and the data to appraise, and a fifth draws on the work of the other four in producing an appraisal roll, it is essential that the work of the five be synchronized so that one does not wait on another so that the roll is produced on time.
Maximization, the fourth characteristic, is a commitment to getting the most value for the dollar spent. The mass appraisal balances cost per parcel, time involved per appraisal, and accuracy of appraisal in producing a product that meets the requirements of the jurisdiction.
A fifth characteristic is repetition. Many of the tasks performed in a mass appraisal are highly repetitive from taking measurements to collecting data to filing. The mass appraisal system typically provides for repetitive tasks to be handled in a routine manner.
Division of labor concerns all of the above characteristics. It means that rather than having each person perform all the tasks required, the appraisal district employs specialists who perform a limited range of tasks over and over. These six characteristics–centralization, standardization, synchronization, maximization, repetition, and division of labor–are essential elements of mass appraisal.
B. Jurisdictional Exceptions
USPAP provides exceptions to its general standards. The "jurisdictional exception rule" may apply to Standard 6 mass appraisal "because ad valorem tax administration is subject to various state, county, and municipal laws."
"Jurisdictional exception" is defined as an assignment condition that voids the force of a part or parts of USPAP, when compliance with part or parts of USPAP is contrary to law or public policy applicable to the assignment. If any part of USPAP is contrary to the law or public policy of any jurisdiction, only that part shall be void for that jurisdiction. The purpose of the rule is to provide a severability clause if one or more parts of USPAP is contrary to a state or local law. Law, in this context, means a body of rules with binding legal force established by a controlling governmental authority. It includes federal and state constitutions, statutes, case law, administrative rules, and local ordinances and regulations. Public policy refers to standards of conduct generally accepted by the community and recognized by law and other evidence.
There are numerous jurisdictional exceptions in the Tax Code, which require deviations from USPAP standards. Compliance with these laws is required and will not create violations of USPAP. Examples include, but are not limited to, the following special appraisal requirements found in Chapter 23 of the Tax Code:
- productivity value of agricultural land;
- productivity value of timber land;
- consideration of governmental taking of property;
- inventory appraisal of real or personal property as a unit;
- dealer inventory appraisals;
- appraisal of mineral interests not being produced;
- appraisal of oil and gas interests; and
- nominal valuation of property owned by non-profit homeowner organizations.
Other special appraisal provisions are included in Chapter 23 and other federal, state, and local laws. These provisions do not violate USPAP, but instead are jurisdictional exceptions to USPAP that must be followed regardless of generally accepted appraisal standards.
C. Mass Appraisal and the Three Approaches to Value
An appraisal district using mass appraisal cannot use the three approaches to value in the same way that a single property appraiser does because of the number of taxable properties in the appraisal district and the limited time within which the appraisal district must complete its work. Instead, appraisal districts develop property categories on the basis of market analysis and use elements of these approaches to convert market data into value schedules. The three approaches to value are incorporated into the mass appraisal process.
IV. Three Approaches to Value
The law requires that in determining the market value of property, the chief appraiser must consider the cost, income, and market data comparison methods of appraisal and use the most appropriate method. These methods, however, are not exclusive; the chief appraiser may use other methods or a combination of methods so long as they produce defensible market value.
The market data comparison approach focuses on the sale of comparable properties and requires an active market in sales of comparable properties. The cost approach estimates the cost of replacing an improvement and requires the appraiser to estimate replacement cost and accrued depreciation. Appraisers using the cost approach must also use the market or income approach to estimate land value. The income approach examines the income stream a property produces and requires that the subject property be able to produce income and that the appraiser have enough information to develop a capitalization rate. The capitalization rate expresses in numbers the relationship between a property's income potential and its present value.
In appraising single pieces of property, all three approaches are used whenever possible, checking the results of one method against the others before estimating the final value. In mass appraisal, an appraisal district combines techniques from the three separate approaches.
A. Market Data Comparison Approach
Since appraisers are aiming to determine market value, it is not surprising that they generally consider the market data comparison approach as the most accurate method of appraisal. Appraisers use this approach whenever possible because it focuses directly on the actions of buyers and sellers in the marketplace and, therefore, usually produces the best results. The market data comparison approach works best when the subject property is not so unique that few comparable properties ever sell. Oil refineries, for example, can differ widely, depending on when they were built and what kinds of refining processes they use.
The market data comparison approach has two distinct advantages over the cost and income approaches. First, the market data comparison approach can be used for any kind of property–improved or unimproved and income-producing or not. Second, because it focuses directly on buyers and sellers in the market, it is most likely to produce reasonable valuations. At the same time, the market data comparison approach cannot be used if there are not enough comparable sales. Appraisal districts can usually find enough comparable residential sales, but other types of properties do not sell frequently, and when they do there may be intangible value included in the sale.
Because the market data comparison approach derives market value from the sale prices of properties comparable to the subject, appraisers must identify and describe the subject property precisely. Appraisers must determine who owns the various legal rights to the property and discover any limitations (such as easements, covenants, or deed restrictions) on that ownership. In order to select appropriate comparables, appraisers must discover what features of the subject property add to or detract from its market value.
Comparables must resemble the subject as closely as possible. The more the appraiser knows about the subject property, the more exactly he or she is able to match comparables to it.
The appraiser should inspect the subject property and comparables because the law requires that an appraiser follow "accepted appraisal practices." Measuring and sketching the improvements rather than accepting someone else's figures is very important. Calculating the area and re-checking the math is equally important.
The market data comparison approach requires appraisers to perform the following four steps:
Step 1 Selecting properties that are similar to the property being appraised (the subject) that have recently sold.
Step 2 Listing differences between these properties (comparable properties) and the subject.
Step 3 Calculating adjustments and adjusting the comparables to the subject.
Step 4 Estimating the subject's value from the adjusted values of the comparables.
1. Selecting Comparable Properties
Appraisers do not always find sufficient comparables that closely resemble the subject. The market data comparison approach requires the same information on properties that are similar to it and which have recently sold be gathered. The subject property determines the type of sales information needed. A single-family residence, for example, does not require that information on warehouses be collected. An appraisal office should have sales and property information organized in its files according to some classification system that enables the appraiser to search the files for information on sales of properties similar to the subject by using the description of the subject.
Comparable sales should resemble the subject as closely as possible in the following six features:
- size of improvements;
- land area;
- architectural style; and
- date of sale.
Since the subject has not sold, the appraiser must consider date of sale in relation to Jan. 1. The more closely a comparable property resembles the subject, the easier to calculate and the more accurate the appraisal.
All comparables are not created equal. Good comparables require fewer adjustments and ensure a more accurate appraisal. If the appraiser cannot find good comparables, he or she will need to use more properties to ensure accurate adjustments.
2. Listing Similarities and Differences
None of the comparable sales will match the subject precisely. The appraiser must develop a way of describing, classifying, and evaluating the differences between the subject property and the comparables.Major factors distinguish subjects and comparables, including:
- property rights transferred with the sale;
- conditions of sale (motivation);
- expenditures made after the sale;
- market conditions (date of sale);
- physical characteristics;
- economic characteristics; and
- non-realty components.
The appraiser must know what transferred (property rights) in each sale. Some property sells with the price representing tangible and intangible value. A sale needs to reflect a cash transaction because the premises behind "market value" require this. The definition of "market value" requires that the buyer and seller are well-informed, not under duress and acting in their own best interest. If the sale price reflects abnormal motivation conditions, the price must be adjusted or the comparable excluded. If a property sells needing to be updated or renovated, the expenditures made after sale will adjust the comparable to market standards reflecting the money for the rehabilitation or renovation costs.
If one comparable sold in January and one in July, and if the effective date of the appraisal is Jan. 1, the appraiser has to find a way to account for the different dates. If one comparable sold with a low down payment and a high interest rate and another sold on an assumed mortgage with a low interest rate, the appraiser has to convert both sale prices into values in current dollars. Real estate agents frequently identify location as the single factor that most influences the sale price of a home; thus, if comparables from neighborhoods different from the subject's are available, the influence of location on value must be taken into account.
Physical characteristics cover a number of factors, including size of the lot, the area of the improvements, original construction quality, and condition. The appraiser must also consider special features and amenities. Garages, swimming pools, greenhouses, fences, heating and cooling systems, and custom features all influence the market value of the subject and comparables.
The remaining factors can include economic characteristics, use, and non-realty adjustment considerations. The adjustment for economic characteristics reflects differences in ability to generate income, differences in vacancy or expense structures, and even differences that could be expressed in different capitalization rates. However, appraisers must take care not to adjust in this category when they have already adjusted for the same difference in another category, such as location. Use factors could include private (deed restrictions) or public use (zoning) restriction differences. Non-realty items are sometimes included in a sale price. If the appraiser is only appraising real property, this must be excluded.
3. Adjusting the Comparables
The appraiser must assign a value to each difference between the subject and the comparables and adjust the sale price of each comparable so that it will reflect the price at which the subject should sell. Adjustments fall into one of three categories: those made as of the date of sale, a market conditions adjustment, and those that should be made as of the date of the appraisal (Jan. 1). Adjustments made at time of sale include property rights conveyed, financing, conditions of sale (motivation), and expenditures anticipated to be made at the date of sale. The next adjustment category is market conditions (time), which includes adjustments for changes in market conditions between the sale date of the comparable and Jan. 1 and for inflation or deflation. The last category of adjustments is related to differences for location, use, economic characteristics, physical differences, and non-realty components. These adjustments must always be applied to the comparable, not the subject. If the comparable's price is less than the subject, the appraiser adjusts the comparable's price upward. If the comparable's price is higher than the subject, the appraiser adjusts the comparable's price downward to reflect a value for the subject.
4. Deriving an Opinion of the Subject's Value
Comparables establish a range of possible values and a determination must be made where within that range the subject falls. Deriving this final opinion of the subject's market value requires an appraiser's judgment; it cannot be reduced to a simple mathematical process.
In general, an appraiser looks within the range established by the highest and lowest comparables to see which comparable most closely matches the subject. He or she also looks for the comparables sold on the dates closest to the effective date of the appraisal. Before making the final opinion, the appraiser must identify the comparables with the smallest number of adjustments and the comparables with the amount of total adjustments closest to zero. A decision may be required to reject the comparable with the lowest number of adjustments or with the amount of net adjustments closest to zero because another comparable more adequately reflects the subject. The comparable with the highest or lowest value may provide the best indication of the subject's value. The subject's value may also fall between the values indicated by two comparables.
Only one hard and fast rule governs the final opinion of value: the appraiser must not average the indicated values of the comparables to arrive at an opinion of the subject's value. There is no set of steps to use as a substitute for judgment and experience. The final opinion should not be arbitrary or random, but the appraisal cannot be reduced to a mechanical formula. The appraiser must rely on judgment and experience when examining comparables.
5. Appraising Land
The market data comparison approach is the preferred method of appraising any property, but it is especially critical to the appraisal of land. Since land cannot be reproduced, appraisers cannot use the cost approach in valuing it. The income approach is often inappropriate because much land does not produce income. However, the income approach to land is acceptable if the land is rented, such as with a ground lease, or if there is income-producing potential for the land. Acceptable methods of land valuation include sales comparison, allocation, extraction, ground rent capitalization, land residual, and subdivision. Ground rent capitalization is a procedure where estimated net market rent of land is capitalized with a capitalization rate. In most cases, the process of elimination dictates that appraisers employ the sales comparison approach to estimate the land value. Whether used on land, improvements, or whole properties, the basics of the market data comparison approach remain the same.
6. Appraising Improvements
Improvements present an appraiser with a set of problems different from those that land presents. Land does not depreciate, but improvements do. Therefore, an appraiser must develop a way to account for the effects of weather, neglect, changes in architectural style, and other forces that can cause a structure to lose value. Moreover, differing construction techniques and materials produce structures that differ in quality. Appraisers must recognize and evaluate differences in the construction type and construction quality of improvements. Finally, differences in size and amenities also influence the value of improvements and appraisers must know how to interpret their impact on market values.
B. Cost Approach
When using the cost approach to determine the market value, the chief appraiser must use cost data obtained from generally accepted sources; make appropriate adjustments for physical, functional, or external obsolescence; and clearly state the reason for any variation between generally accepted cost data and locally produced cost data if the data vary by more than 10 percent.
The cost approach is usually used when market sales data is not available. It works best on newer improvements. Older improvements often contain outdated materials or were constructed using outdated techniques. Estimating the replacement cost and accrued depreciation of older properties is difficult.
A focus on the estimated cost involved in constructing an improvement distinguishes the cost approach from the other approaches to value. Because of this focus, an appraiser using the cost approach must always use a second appraisal approach to determine land value, usually the sales comparison approach.
The cost approach follows the following four basic steps:
Step 1 Determining the value of the land without any improvements on it and under its highest and best use as though vacant.
Step 2 Estimating the cost of replacing or reproducing the improvements.
Step 3 Estimating and subtracting the value lost to accrued depreciation in order to arrive at the indicated value of the existing improvement.
Step 4 Adding the indicated improvement value to the land value.
Using the cost approach requires good judgment. The cost approach provides the only reasonable way to estimate the value of many special use properties–aircraft hangars, for example, or museums, convention halls, fraternal lodges, and other non-income-producing properties for which there are no comparable sales. Knowledge of the cost approach is essential to effective mass appraisal.
1. Defining Cost
An estimate of replacement cost indicates what a typical builder charges to construct a building of equal utility to the subject. Reproduction cost tells what a typical builder charges to construct an exact replica.
An estimated reproduction cost more reflects the actual improvements than an estimated replacement cost. Reproduction cost estimates are tailored to the specific subject property. To estimate reproduction cost, however, a great many details must be examined, including carpeting, bathroom fixtures, attics, ceilings, interior wall coverings, and others. These features may influence property value considerably, but property tax appraisers seldom have the opportunity to complete a detailed inspection of a house's interior. For this reason, property tax appraisers often cannot estimate reproduction cost.
The elements of cost include direct and indirect cost and entrepreneurial incentive (profit). Direct costs (hard costs) are materials and labor. Indirect costs include architect fees, attorney fees, appraiser fees, financing fees, construction interest, marketing expenses, and other related costs that are not materials or labor. Entrepreneurial incentive is the money necessary to cause the development of the property. The previous examples relate to the four agents of production land, labor, capital, and coordination.
Estimating an amount for accrued depreciation is probably the most difficult task in all appraisal work. Some elements of depreciation–a broken window, for example–can hardly escape an appraiser's notice; but other elements, such as substandard wiring, are hidden beneath a building's surface. Still others, such as the negative or positive impact of a floor plan, may influence only a few buyers. Still, cost is not the same thing as market value; an appraiser must determine the dollar amount of losses arising from problems with a building's condition, design, and surrounding environment. The total of these losses equals accrued depreciation. Subtracting accrued depreciation from the cost to build a new structure leaves the estimated market value of the improvements.
Physical depreciation is from normal wear and tear and aging of improvements. Functional obsolescence is loss from poor or substandard layout, design, appearance, etc. External obsolescence is from economic and locational sources. Economic obsolescence is from poor market conditions that cause loss in value. Locational external obsolescence is from the property being located adjacent to or near a nuisance or property that causes loss in value.
Accrued depreciation can be defined as an improvement's loss of value from all causes relating to the property itself, its use and possible uses and the uses of surrounding properties. Accrued depreciation includes all loss from replacement or reproduction cost as of Jan. 1.
3. Cost Approach in Mass Appraisal
Mass appraisers have historically relied on the cost approach more than any other method. Before computers came into widespread use, a cost table provided just about the only way to appraise a large number of properties in a uniform manner. Even now, the mass appraisal process is quite similar to an appraisal using the cost approach: classify and measure the improvement, multiply the size times the appropriate value from the table, estimate and adjust for depreciation, and add land value to arrive at total property value.
Basically, the procedures for developing a value schedule based on cost are the same as those for developing one based on market data. The values in a cost schedule reflect typical building costs; the values in a market schedule reflect typical sale prices. Appraisers compile information and build a cost schedule in much the same way that they compile sales information and build a market schedule.
Building a cost-based value schedule and the depreciation table to accompany it has the following eight steps:
Step 1 Analyzing the market to identify value factors.
Step 2 Developing profiles of benchmark properties.
Step 3 Collecting cost information.
Step 4 Posting cost information to appropriate benchmark properties.
Step 5 Deriving typical costs for benchmark properties.
Step 6 Developing field procedures for classifying properties and adjusting preliminary value estimates for specific properties.
Step 7 Using market data to develop depreciation tables.
Step 8 Testing the schedule for accuracy and uniformity.
All cost appraisals depend upon an accurate opinion of land value. Land values in the area are used to test a cost schedule.
C. Income Approach
Appraisers use the income approach only to appraise properties that generate income or have a definite and predictable prospect of producing income. The income method assumes that potential buyers will base the amount they are willing to pay for a property on the income that the property currently produces and will produce in the future.
Since a property must be capable of generating income before the income approach can be used to appraise it, the income approach is seldom the best choice for appraising single-family residences. Nonetheless, the income approach can be used on single-family residences when the rental market for such properties is active.
Income appraisals are more suitable for commercial property, even if the property is not producing income at the time of the appraisal. The income approach can be used on an unoccupied commercial building because the income that the property produces under typical ownership and management can be estimated. The income approach can also produce reliable values on industrial property.
The Tax Code requires appraisers to use the income approach on property that qualifies for special valuation, such as agricultural, timber, and open-space land.
The income approach follows three basic steps:
Step 1 Determining the subject property's net annual income.
Step 2 Determining the capitalization rate.
Step 3 Dividing net annual income by the capitalization rate in order to arrive at property value.
Using the income approach requires a considerable amount of information about property sales, interest rates, buyers' expectations, financing terms, and property income. In essence, the income approach requires estimating the future benefits of ownership and converting them into an indication of present worth.
The fundamental process involved in any income approach is the conversion of anticipated net income into an estimated value. The traditional income approaches use a single year's income to determine value. The expectation of change and even a future sale of the property are built into the capitalization rate used to convert the single year's income to value.
Expenses required for maintaining the property's income stream must be subtracted from effective gross income. However, only certain expenses are deducted. Fixed expenses of property taxes and insurance are appropriate deductions from effective gross income. Variable expenses of management, utilities, landscaping, janitorial, and other expenses directly related to operating the property are also deducted. The total of these expenses should be consistent with the ratio of like properties in the market.
Inappropriate expenses for the income approach that are not deducted include income taxes, entity expenses (from choice of ownership vehicle), capital improvements, and other non-operating expenses. To find property value, net operating income is divided by the capitalization rate. This returns the property's net operating income, which is what is capitalized into value.
V. Capitalization Rate
After estimating income, appraisers use a capitalization rate to determine value. The simplest method of deriving a market capitalization rate is to divide the net operating income from a comparable property sale by its adjusted sale price. Expressed in a formula, this would read as follows:
R = I ÷ V
In the equation, R is the capitalization rate, I is the net operating income, and V is the sale price. The net operating income would have to reflect only those expenses normally used by appraisers and recognized in the market. The appraiser must also consider how the subject property compares with the comparable property to ensure the sale price of the comparable property meets the conditions of the subject property's market.
Using a capitalization rate derived from highly comparable sales is generally regarded as the most accurate form of income capitalization. If an income-producing property sells and if the net operating income is available, the net operating income can be divided by the sale price to arrive at an overall capitalization rate. The appraiser then estimates a capitalization rate that best represents the subject property.
A capitalization rate in its simplest form is the conversion of net operating income into an opinion of value. How this is done can have adverse consequences if miscalculated, as may be seen from the following passage taken from the IAAO's Property Appraisal and Assessment Administration:
Small errors in estimating the capitalization rate will have a pronounced effect on the estimate of property value. For example, estimating the capitalization rate at 9 or 11 percent instead of 10 percent will change the estimated value by approximately 10 percent. For this reason, capitalization rates should be derived with care and supported with market data.
VI. Appraisal of Business Personal Property
Items not permanently affixed to, or part of, real estate are generally considered personal property. As a general rule, an item is personal property if it can be removed without serious injury to the real estate or to the item itself.
A. Rendition of Personal Property
Except with regard to rolling stock, an individual who owns or manages tangible personal property as of Jan. 1 used for the production of income must render it for taxation. A rendition statement for property valued at $20,000 or more must include the following:
- the name and address of the property owner;
- a description of the property by type or category;
- if the property is inventory, a description of each type of inventory and a general estimate of the quantity of each type of inventory;
- the physical location or taxable situs of the property; and
- the property owner's good faith opinion of the market value of the property or, at the option of the property owner, the historical cost when new and the year of acquisition of the property.
This general rule regarding rendition of personal property is intended to give the ARB member an overview of this provision of the Tax Code. For exceptions or variations to this general provision, please consult the Tax Code or your attorney.
B. Situs of Personal Property
The appraisal of personal property is more difficult than the appraisal of real property because it is easily concealed and frequently moved. For these reasons it is often difficult to determine situs for personal property.
Generally, tangible personal property is taxable by a taxing unit if it is located in the unit on Jan. 1 for more than a temporary period; if it normally is located in the unit, even though it is outside the unit on Jan. 1, if it is outside the unit only temporarily; or, if it normally is returned to the unit between uses elsewhere and is not located in any one place for more than a temporary period. It also has situs if the owner resides or maintains a principal place of business in the unit and the property is taxable in Texas but the property is not located in the unit on Jan. 1 or is not located in any one place for more than a temporary period but is normally returned to the unit between uses.
C. Valuation of Personal Property
In appraising tangible personal property, the appraiser gives recognition to the trade level at which property is situated and to the principle that property normally increases in value as it progresses through production and distribution channels. Such property normally attains its maximum value as it reaches the consumer level.
D. Inventory Valuation
The Tax Code provides, with certain particular exceptions, that the market value of inventory is the price for which it would sell as a unit to a purchaser who would continue the business. An inventory includes residential real property that has never been occupied as a residence and is held for sale in the ordinary course of a trade or business, provided that the residential real property remains unoccupied, is not leased or rented, and produces no income.
E. Special Problems in Inventory Appraisal
Some larger stores do not operate the entire store themselves, but lease certain sections to separate concerns. For example, many automotive departments in discount stores are leased. As these stores render their inventory, there is no guarantee either that leased departments are included or that the inventory of leased departments will be rendered separately. It is a good practice to ask the management of a large store if such leased departments exist. Once their existence is established, the inventories of such departments are treated as small stores of a particular type. When the larger store's inventory valuation is developed for the entire store, this figure is reduced by the leased departments' inventory value. This amounts to valuing the leased departments separately and allocating the residual inventory to the main store.
Consigned goods, like all other personal property, are taxable to the owner or consignor. Since the property is found in the hands of the consignee, an assessment is sometimes made against the consignee. This assessment is properly made against the owner, the consignor, since the consignee has no title to the goods. If the owner is unknown, the holder or consignee is responsible until the owner can be identified. Such property is taxable and should be appraised.
F. Valuation of Commercial and Industrial Personal Property
In the absence of specific market data, replacement cost of a new item, less depreciation, is considered a logical approach to the valuation of commercial and industrial personal property. An appraiser may estimate replacement cost either by indexing known historical costs or by using a standard valuation guide. Next, the appraiser must estimate the actual physical depreciation that has accrued.
Commercial and industrial inventories, supplies, and spare parts are valued at the lower of cost or market. Special equipment items such as computers are given special consideration because of a short economic life due to advances in technology. Appraisal of mobile machinery and tools, such as switch engines, gantry cranes, and forklifts depends on their size. The larger items are valued individually using current market prices for similar, used equipment as a guide. The smaller items are grouped into an average service life and treated in the same manner as furniture and fixtures.
Often the cost figures on leased equipment are not available to the appraisal district. Since manufacturers, in this case, are essentially final users, the retail level of trade rather than manufacturer's level is the proper level at which to value the property. The lack of retail selling prices necessitates the use of another approach to value in these situations.