Value, the principles of value, and the appraisal process
Value, price, and cost
These three words mean different things, and exam questions turn on the difference.
| Term | What it is |
|---|---|
| Cost | What it takes to create or obtain the property (land, labor, materials). |
| Price | What a buyer actually asks, offers, or pays. Once paid, it is a fact. |
| Value | An opinion of worth. It must be qualified, for example market value. |
A buyer under pressure can pay a price well above value, and a builder can spend more on a house than the market will pay. Neither price nor cost automatically equals value.
Market value
Lender appraisals use the federal definition in 12 CFR 34.42(h): the most probable price a property should bring in a competitive and open market, with buyer and seller each acting prudently and knowledgeably and the price not affected by undue stimulus. It assumes:
- Buyer and seller are typically motivated.
- Both are well informed or well advised and acting in their own best interests.
- A reasonable time is allowed for exposure in the open market.
- Payment is in cash or comparable financing.
- The price is not distorted by special or creative financing or sales concessions.
The four elements of value (DUST)
Property has value only when all four are present:
- Demand, backed by the purchasing power to buy.
- Utility, the ability to satisfy a need or use.
- Scarcity, a limited supply relative to demand.
- Transferability, meaning title can actually change hands.
Cost is not one of the four. Spending money on a property does not create value by itself.
Principles of value
- Highest and best use: the use that is legally permissible, physically possible, financially feasible, and maximally productive. A use must pass the first three tests before you ask which one produces the highest value.
- Substitution: a buyer won't pay more than the cost of an equally desirable substitute. It underlies all three approaches.
- Conformity: value is highest when nearby properties are reasonably similar in use and style.
- Contribution: a component is worth what it adds to market value, not what it cost. A $40,000 pool that raises the price by $15,000 contributes $15,000.
- Anticipation: value is the present worth of expected future benefits. This is the basis of the income approach.
- Regression: a higher-value property loses value when surrounded by lower-value ones.
- Progression: a lower-value property gains value when surrounded by higher-value ones.
- Change: market conditions keep shifting, so a value opinion is good only as of its effective date.
The appraisal process
Appraisers follow a standard sequence drawn from USPAP:
- Define the problem: client and intended users, intended use, type of value, effective date, the property, and assignment conditions.
- Determine the scope of work.
- Collect and analyze data, including market analysis and highest and best use.
- Apply the approaches to value: sales comparison, cost, and income.
- Reconcile the indications into a final opinion of value.
- Report the conclusion to the client.
If a question asks for the first step, the answer is defining the problem, not gathering data.