Table of Contents
A. Data Documentation and Appraisal Reporting Standards
Part III Data Analysis and Conclusions Before Acquisition 44
A-14. Analysis of Highest and Best Use. The appraiser's determination of highest and best use is one of the most important elements of the entire appraisal process. 45 Therefore, the appraiser must apply his or her skill with great care and clearly justify the highest and best use conclusion in the appraisal report.
The highest and best use of the land, as if vacant, is first estimated. If the land is improved, the highest and best use of the property, as improved, is then estimated. In some cases, the highest and best use of property cannot be reliably estimated without extensive marketability and/or feasibility studies, which in complex cases may call for the assistance of special consultants. 46 Before it can be concluded that any use for the property is its highest and best use, that use must be physically possible, legally permissible, financially feasible, and must result in the highest value. Each of these four criteria must be addressed in the appraisal report.
If the appraiser concludes a highest and best use that will require a rezoning of the property, the probability of that rezoning must be thoroughly investigated, analyzed and reported. Likewise, if the appraiser's highest and best use conclusions will require other forms of government approval, the probability of obtaining those approvals must be investigated, analyzed, and reported. The extent of the investigation and analysis required by the appraiser to meet the requirements of this standard will be found in Section D-6.
Essential in the appraiser's conclusion of highest and best use is the determination of the larger parcel. 47 The appraiser must make a larger parcel determination in every appraisal conducted under these Standards, even in the case of a minor partial acquisition where the client agency has determined a complete before and after appraisal is not necessary. The appraiser's analysis that led to the larger parcel determination and the determination itself must both be reported. 48 Because the ultimate determination of highest and best use is the appraiser's to make, and that determination cannot be made until after considerable investigation and analysis has been completed, the appraiser's conclusion as to the larger parcel is sometimes different from the specific parcel he or she was requested to appraise by the agency. In such an instance, the appraiser shall inform the agency of his or her determination of the larger parcel and the agency shall amend the appraisal assignment accordingly.
Appraisers must bear in mind that the determination of the larger parcel is required in every appraisal assignment; irrespective of whether the agency has designated an acquisition a total acquisition or a partial acquisition. This is so because, from a practical stand-point, whether an acquisition is a total or partial acquisition cannot be determined until such time as the appraiser has made a determination of the highest and best use, and the larger parcel. By applying the rules for larger parcel determination, as described in Section B-11, it is possible that two physically separate tracts may constitute a single larger parcel, or conversely, a single physical tract may constitute multiple larger parcels. This can be important not only in consideration of damages and special benefits, but also in the appraiser's selection and comparative analysis of comparable sales. 49
In light of the discussion in Section B-11 regarding the larger parcel, it is recommended that the appraiser begin an analysis of the unity of ownership test with the premise that, in making their larger parcel determination, it is allowable to consider all lands that are under the beneficial control of a single individual or entity, even though title is not identical in all areas of the tract( s). If the appraiser then concludes that the larger parcel constitutes lands that are under the beneficial control of a single entity, but title is not identical, the appraiser's larger parcel determination, together with the facts upon which it is based, should be submitted to agency, or Department of Justice, legal counsel for review before the appraiser proceeds. Based on applicable case law and the facts of the case, legal counsel can then determine whether, as a matter of law, the unity of ownership test of the larger parcel is present, and provide written legal instructions to the appraiser accordingly.
Appraisers conducting appraisals for federal land exchanges, or in connection with inverse condemnation claims, should be aware that the tests applied in larger parcel determination may be different than that suggested above. For a discussion of those potential differences, appraisers should refer to Section D-7 regarding federal land ex-change appraisals and to Section D-8 regarding inverse condemnation appraisals.
The use to which the government will put the property after it has been acquired is, as a general rule, an improper highest and best use. 50 It is the value of the land acquired which is to be estimated, not the value of the land to the government. If it is solely the government's need that creates a market for the land, this special need must be excluded from consideration by the appraiser. 51 Only on the rare occasion that a private demand for the land exists, for the same use for which it is being acquired by the government, is it proper for the appraiser to conclude that the highest and best use of the property is that use for which it is being acquired by the government.
The appraiser's estimate of highest and best use must be an economic use. A non-economic highest and best use, such as conservation, natural lands, preservation, or any use that requires the property to be withheld from economic production in perpetuity, is not a valid use upon which to estimate market value. 52 Therefore, any appraisal based on such a non-economic highest and best use will not be approved for federal land acquisition purposes. Similarly, an appraiser's use of any definition of highest and best use that incorporates non-economic considerations (e. g., value to the public, value to the government, or community development goals) will subject the appraiser's report to disapproval for use for federal land acquisition purposes.
A-15. Land Valuation. The appraiser shall estimate the value of the land for its highest and best use, as if vacant and available for such use. In doing so, the appraiser's opinion of value shall be supported by confirmed sales of comparable or nearly comparable lands 53 having like optimum uses. Differences shall be weighed and explained to show how they indicate the value of the land being appraised. Items of comparison shall include property rights conveyed, financing terms, conditions of sale, market conditions, location, and physical characteristics. The appraiser shall provide adequate information concerning each comparable sale used and the comparative analysis to enable the reader of the report to follow the appraiser's logic. 54
When the highest and best use of a property is for subdivision purposes and comparable sales do not exist, the appraiser may resort to the development approach 55 to land value, but only if adequate market and/ or technical data are available with which to reliably estimate the property value by this approach. This method of estimating land value can also be used to test the appraiser's highest and best use conclusion and to check against the indicated value of the land developed by the use of comparable sales when the sales data is limited. However, this approach to value is complex, often requiring the assistance of other experts, 56and always requiring substantial amounts of research, analysis and supporting documentation. 57
In applying this technique, appraisers must bear in mind that a property being appraised must be valued in its as is condition. Therefore, consideration must be given to the time-lag that is typically necessary between the effective date of the appraisal and the projected date when developed lots would become marketable. This time-lag must provide for the time necessary to procure all land use permits and approvals, as well as the time necessary for the physical construction of the infrastructure that will be required to convert the land into marketable lots. One of the most critical factors in the application of this technique is, of course, selection of the appropriate discount rate to be applied to the income streams generated by the development. This discount rate should be derived from and supported by direct market data whenever possible. 58
A-16. Value Estimate by the Cost Approach. This section should be in the form of computational data, arranged in sequence, beginning with reproduction or replacement cost and should state the source (book, page, including last date of page revision, if a national service) of all figures used. Entrepreneur's profit, as an element of reproduction or replacement cost, must be considered and discussed, and if applicable, should be derived from market data whenever possible. If the appraiser will place considerable weight on this approach to value in reaching a final value estimate, consideration should be given to retaining the services of a contractor or professional cost estimator to assist in developing the reproduction or replacement cost estimate.
The dollar amount of depreciation from all causes, including physical deterioration, functional obsolescence and economic, or external, obsolescence shall be explained and deducted from reproduction or replacement cost. The preferred methods of estimating depreciation are the breakdown method 59 and the market extraction method. 60 The estimating of depreciation by the use of published tables or age-life computation is to be avoided.
Even though the cost approach is often the least reliable approach to value and is often maligned by the courts, 61 it can be a useful analytical tool in allocating the contributory value of various elements of the property in partial acquisition appraisals. Therefore, the indicated value of the property by the cost approach should be developed with care.
The cost approach may be excluded when only a salvage or scrap value is estimated or when it is clear that the improvements would never be reproduced or replaced and application of the cost approach would contribute nothing to the solution of the appraisal problem.
A-17. Value Estimate by the Sales Comparison Approach. Since any recent and unforced sale of the property under appraisal can be the best evidence of its value, 62 any such sale is treated as a comparable sale in this approach to value. It shall be analyzed like any other comparable sale and given appropriate weight by the appraiser in concluding a final estimate of value of the property. As noted in Section A-13e of these Standards, an unsupported claim that a sale of the subject property was a forced sale or not indicative of its value is unacceptable.
All comparable sales used shall be confirmed by the buyer, seller, broker or other person having knowledge of the price, terms, and conditions of sale. 63 When a comparable sale is of questionable nature and/ or admissibility (e. g., sales to a government entity) special care must be taken in the verification of the circumstances of the sale. 64 A narrative comparative analysis of each comparable sale shall be made explaining how the sale relates to the property under appraisal in respect to those features which have an effect on market value.
In selecting the comparable sales to be used in valuing a given property, it is fundamental that all sales have the same economic highest and best use as the property under appraisal and that the greatest weight be given to the properties most comparable to the property under appraisement. In this regard, appraisers must recognize that, when valuing a property with a highest and best use for some form of development that will require rezoning or extensive permitting, sales of similar properties may require extensive analysis and adjustment before they can be deemed economically comparable. The analysis and adjustment of such sales is discussed in Section D-9 of these Standards.
Each appraisal must contain a sufficient description of the comparable sales used so that it is possible for the reader to understand the conclusions drawn by the appraiser from the comparable sales data. Photographs of the comparable sales are valuable visual aids that indicate the comparability of the property recently sold with the property under appraisal. Such photographs must accompany each appraisal report not only to aid the reviewing appraiser but also for the agency's records and for later use in possible condemnation trials. In addition to the identification of the property, every photograph should show the date taken and the name of the person taking the photograph.
The preferred method of adjusting comparable sales is through the use of quantitative adjustments whenever adequate market data exists to support them: "[ q] uantitative adjustments are developed as either dollar or percentage amounts. Factors that cannot be quantified are dealt with in qualitative analysis." 65 Only when adequate market data does not exist with which to support quantitative adjustments should the appraiser resort to qualitative adjustments (i. e., inferior, superior). 66 Appraisers must bear in mind that quantitative and qualitative adjustments are not mutually exclusive methodologies. Because one factor of adjustment cannot be quantified by market data does not mean that all adjustments to a sale property must be qualitative. All factors that can be quantified should be adjusted accordingly. When quantitative and qualitative adjustments are both used in the adjustment process, all quantitative adjustments should be made first. 67 When using quantitative adjustments, appraisers must recognize that not all factors are suitable for percentage adjustments. Percentage and dollar adjustments may, and often should, be combined. 68 Each item of adjustment must carefully be analyzed to determine whether a percentage or dollar adjustment is appropriate.
When appraisers must resort to qualitative adjustments, they must recognize that this form of comparative analysis will often require more extensive discussion of the appraiser's reasoning. This methodology may also require the presentation of a greater number of comparable sales. It is essential, of course, that the appraiser specifically state whether each comparable sale is generally either overall superior or inferior to the property under appraisal. To develop a valid indication of value of the property under appraisal by the use of qualitative analysis, it is essential that the comparable sales utilized include both sales that are overall superior and overall inferior to the property being appraised. If this is not done, the appraiser will have merely demonstrated that the property is worth more than a certain amount (if all of the sales are inferior to the subject property) or less than a certain amount (if all of the sales are superior to the subject property).
In developing a final value estimate by the sales comparison approach, the appraiser shall explain the comparative weight given to each comparable sale, no matter whether quantitative or qualitative adjustments, or a combination thereof, are used. A comparative adjustment chart, or graph, is recommended and may assist the appraiser in explaining his or her analysis in this regard.
Documentation of each comparable sale shall include the name of the buyer and seller, date of sale, legal description, 69 type of sale instrument, document recording information, price, terms of sale, location, zoning, present use, highest and best use, and a brief physical description of the property. A plot plan, or sketch, of each comparable property should be included, not only to facilitate the reader's understanding of the relationship between the sale property and the subject property, but also to locate the sale property in the field. This information may be summarized for each sale on a comparable sales form and included in this section or in the addenda of the report. As noted, a photograph of each comparable sale shall also be included. A comparable sales map, showing the relative location of the comparable sales to the property under appraisal 70 shall be included, either in this section or in the addenda of the report. Inclusion of a copy of the transfer document (e. g., deed, contract) in the report is neither required nor desirable, unless there is something in the document that is unusual or particularly revealing.
The definition of market value used in these Standards requires that the estimate of value be made in terms of cash or its equivalent. 71 Therefore, the appraiser must make a diligent investigation to determine the financial terms of each comparable sale. When comparing the sale to the property being appraised, the appraiser shall analyze and make appropriate adjustments to any comparable sale that included favorable or unfavorable financing terms as of the date of sale. Such adjustment must reflect the difference between what the comparable sold for with the favorable or unfavorable financing and the price at which it would have sold for cash or its equivalent.
While cash equivalency of favorable or unfavorable financing can be estimated by discounting the contractual terms at current market or yield rates for the same type of property and loan term over the expected holding period of the property, the preferred method of estimating a proper cash equivalency adjustment is by the analysis of actual market data, if such data is available.
A-18. Value Estimate by the Income Capitalization Approach. The appraisal report shall include adequate factual data to support each figure and factor used 72 and should be arranged in detailed form to show at least (a) estimated gross economic, or market, rent or income; (b) allowance for vacancy and credit losses; (c) an itemized estimate of total expenses; and (d) an itemized estimate of the reserves for replacements, if applicable.
Capitalization of net income shall be at the rate prevailing for this type of property and location. The capitalization technique, method, and rate used should be explained in narrative form supported by a statement of sources of rates and factors. The preferred source of an applicable capitalization rate is from actual capitalization rates reflected by comparable sales. 73
As with a recent and unforced sale of the property under appraisal, 74 if the property is actually rented, its current rent is often the best evidence of its economic, or market, rent and should be given appropriate consideration by the appraiser in estimating the gross economic rent of the property. Likewise, the appraiser should attempt to obtain at least the last three years' historical income and expense statements for the property. These can generally be developed into a reliable reconstructed operating statement. If this historical income and expense information is available, it should be included in this section or in the appraisal report's addenda.
A-19. Correlation and Final Value Estimate. The appraiser shall explain the reasoning applied to arrive at the final opinion of value and how the results of each approach to value were weighed in that opinion, and the reliability of each approach to value for solving the particular appraisal problem.
The appraiser shall also state his or her final estimate of value of all of the property under appraisal as a single amount, including the contributory value of fixtures, timber, minerals, and water rights, if any. The appraiser must avoid making a summation appraisal. 75 The appraiser is solely responsible for the final estimate of value. If that value estimate includes elements of value which were based on estimates developed by others (e. g., timber cruisers, mineral appraisers), the appraiser cannot merely assume their accuracy. The reasonableness of the subsidiary estimates must be confirmed in accordance with Section D-4 of these Standards.
44. If the government's acquisition is a partial acquisition, it is imperative that the sections of the appraisal report in Part III relate only to the before situation. The appraiser should not attempt to combine the analysis and conclusions relating to the after situation with the analysis and conclusions relating to the before situation.
45. See Section B-3.
46. See Section D-4. See also Section D-3.
47. The larger parcel, for purposes of these Standards, is defined as that tract, or those tracts, of land which possess a unity of ownership and have the same, or an integrated, highest and best use. Elements of consideration by the appraiser in making a determination in this regard are contiguity, or proximity, as it bears on the highest and best use of the property, unity of ownership, and unity of highest and best use.
48. The legal basis and reasoning for this specific Standard may be found in Section B-11.
49. For instance, if an appraiser determined that the larger parcel was a ten-acre tract out of a total ownership of 200 acres, the unit (e. g., per sq. ft.; per acre) value may well be different for the smaller tract, and the appraiser would utilize comparable sales similar in size to the 10 acre larger parcel, rather than sales similar in size to the entire 200 acre ownership.
50. See Section B-3 for the legal basis of this statement.
51. Ibid.
52. See Section B-3 for the legal basis and reasoning for this standard.
53. For a discussion of what legally constitutes a comparable sale and the admissibility of comparable sales information, see Section B-4 of these Standards.
54. For a discussion of comparable sales documentation and information required and the requirements for comparison, see Section A-17 of these Standards.
55. For a discussion of the courts' view of this technique of valuation, see Section B-8 of these Standards.
56. Such as marketing and feasibility consultants, land use planners, civil engineers and contractors. However, see, Guide Note 6, "Reliance on Reports or Information Prepared by Others," Guide Notes to the Standards of Professional Appraisal Practice (Appraisal Institute, 1991, amended 1/ 16/ 93).
57. For a discussion of the various methodologies that can be used in applying this valuation technique see, American Institute of Real Estate Appraisers, Subdivision Analysis (1978); a copy of this publication may be found in Appendix B of the Appraisal Institute's and American Society of Farm Managers and Rural Appraisers' Seminar Handbook for their seminar "Federal Land Exchanges and Acquisitions: Appraisal Issues and Applications." For a discussion of the market analysis, forecasting techniques, and financial modeling used in this technique of valuation, see Douglas D. Lovell and
Robert S. Martin, Subdivision Analysis (Chicago: Appraisal Institute, 1993). See also J. D. Eaton, Real Estate Valuation in Litigation, 2nd ed. (Chicago: Appraisal Institute, 1995), 245-70.
58. For a discussion and examples of discount rate extraction from sales, see Appendix B of the Appraisal Institute's and American Society of Farm Managers and Rural Appraisers' Handbook for their seminar "Federal Land Exchanges and Acquisitions: Appraisal Issues and Applications."
59. For discussion of this method of estimating depreciation see The Appraisal of Real Estate, 11th ed. (Chicago: Appraisal Institute, 1996), 378-94.
60. Ibid., 371-74.
61. See Section B-6 of these Standards.
62. See Section B-5 of these Standards.
63. These Standards require that sales verification be conducted by competent and reliable personnel, and if the case goes into condemnation, the sale must be personally verified by the appraiser who will testify. However, appraisers should recognize that some agencies may require in their appraisal contracts that initial verification be made by the appraiser who will sign the appraisal report.
64. For a description of the verification process required by these Standards for such sales see Section D-9.
65. The Appraisal of Real Estate, 11th ed. (Chicago: Appraisal Institute, 1996), 414.
66. The decision whether to use quantitative or qualitative adjustments should be based on the question of availability of data to support quantitative adjustments. Using qualitative adjustments for the purpose of obscuring the appraiser's complete reasoning and analysis from opposing parties in litigation is an unacceptable practice and, in the view of the Department of Justice, is contrary to the intent of Rule 26( a)( 2)( B) of the Federal Rules of Civil Procedure.
67. The Appraisal of Real Estate, 11th ed. (Chicago: Appraisal Institute, 1996), 440.
68. For instance, a percentage adjustment for market conditions (time) may be appropriate, but an adjustment for the fact that the property under appraisal is 300' from a sewer connection and all of the comparable sales are connected to sewer should often be made in a lump sum dollar amount to reflect the cost to cure the subject property's comparative deficiency. If a percentage adjustment were applied to the price per unit (e. g., per acre, per sq. ft.) of each comparable, the adjustment to each of the comparables would vary, depending on the price per unit of the comparable, and might
have no relationship to the cost to cure subject's deficiency.
69. This may be abbreviated if lengthy, or reference may be made to a tax parcel number.
70. It is important that the locations of the comparable sales and the subject property are shown on the same map so that a reader of the report, not familiar with the area, can understand the relative proximity of the properties and locate them in the field.
71. See Section B-2 of these Standards.
72. For a discussion of the legal basis for this Standard see Section B-7.
73. See Section B-7 of these Standards. For discussion of derivation of capitalization rates from comparable sales, see, The Appraisal of Real Estate, 11th ed. (Chicago: Appraisal Institute, 1996), 514-16. See also, J. D. Eaton, Real Estate Valuation in Litigation, 2nd ed. (Chicago: Appraisal Institute, 1995), 184-85.
74. See Section A-17 of these Standards.
75. See Sections B-13 and D-4 of these Standards.
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