BASIC PRINCIPLES OF REAL ESTATE APPRAISAL

APPRAISAL
❖ is a supportable or defensible estimate of value as of a
particular point in time.
❖ an act or process of estimating value
❖ An estimate expressed as a single peso amount, of the
scarcity and utility, i.e., economic nature, of a specific property
at a specified time and place, assuming a specific use.

TYPES OF APPRAISAL
1. Oral Report
2. Letter Report
3. Narrative Report
4. Form Report

PURPOSES OF APPRAISAL
1. Sale or Purchase
2. Mortgage loans/Lending
3. Insurance
4. Tax Assessment
5. Eminent Domain (Condemnation)
6. Property Disputes
7. Inheritance/Partitioning of Estate
8. Options – right to renew/ to buy
9. Urban Renewal
10. Corporate Realty – mergers, etc
11. Foreclosure
Other uses

Real Estate Valuation Principles

• 1. Anticipation
• 2. Balance
• 3. Conformity
• 4. Contribution
• 5. Increasing & Diminishing Returns
• 6. Change
• 7. Consistent Use
• 8. Substitution
• 9. Highest and Best Use
• 10. Competition
• 11. Economies of Scale
• 12. Supply & Demand
• 13. Externalities

ANTICIPATION
present worth of all present and future benefits arising from
ownership and use of real estate. The value of a property may
increase or decrease based on a potential purchaser’s belief
that some future event will benefit or detract from the value of
the property.

BALANCE
The principle of balance also relates to land use.
Under the optimum land use concept, there would be a proper
blend of single- family residences, apartments, complementary
shopping centers, nearby employment centers, and reasonably
accessible recreational facilities.
Conversely, a neighborhood that features no convenient access
to shopping, places of worship, or employment would be
considered inferior and result in lower demand and in lower
prices.
CONFORMITY
• The principle of conformity is similar to the principle of
balance, but it relates more to real estate characteristics.
• It holds that maximum value is achieved and maintained
when there is reasonable conformity and not monotonous
uniformity among properties.
• maximum value when it conforms to the surrounding land
usage.

SURPLUS PRODUCTIVITY
• The surplus productivity principle recognizes the four agents
of production. The four agents /factors of production are as
follows :
1. Labor
2. Capital
3. Entrepreneurship
4. Land
• An example of surplus productivity would be a Hotel. Income
is derived from room rents, telephone charges, restaurant
sales, and other departmental sources. All of the hotel labor is
paid first. After that, payments due on borrowed funds are
made (Capital). The entrepreneur is usually paid last.
CONTRIBUTION
• The principle of contribution holds that the value of a
component is a function of its contribution to the whole rather
than as a separate component. The cost of an item does not
necessarily equal its contributory value.
• Value of an improvement is equal to its contribution to the
added value of the property (positive contribution).

INCREASING & DIMINISHING RETURNS

• The principle of increasing and decreasing returns relates to
the principle of balance as well as to the principle of
contribution.
• This principle holds that as capital units are added, a certain
point is reached where the added units do not contribute value
commensurate with their costs.
• Decrease in Incremental (additional) output as one factor is
increased & other remained constant “Ceteris Paribus” (all else
being equal).
CHANGE Real estate condition, both physical and economic, do
not remain constant value.

Physical change may be brought by normal wear and tear

Economic change may be due to

(1) land classification and zoning changes (residential to
commercial, agricultural to residential), and
(2) tax laws changes and
(3) buyers preference. It may not be noticeable on a day-to-day
basis, but can be seen overtime.

CHANGE
• The principle of change holds that as time and market
conditions change, so does supply and demand for real estate,
and thus, the value of real estate. All elements around us are
constantly in a state of change, and a valuation represents a
photograph at a certain point in time within its constantly
changing environment.

Real estate passes through a cycle of:

a. Growth
b. Stability
c. Decline and
d. Renewal

REAL ESTATE LIFE CYCLE

• Growth • Stability • Decline • Revitalization

REAL ESTATE LIFE CYCLE

Growth
• Growth is typically the initial stage in a neighborhood or
district’s life cycle. This refers to the period in which the
neighborhood or district is expending and developing.

Stability
• After the growth stage, an area typically matures and grows
at a slower rate. The stability stage in the life cycle may occur
when it is no longer profitable to build, and/or the simply or
vacant land is depleted.
Decline
• When neighborhood can no longer compete with other
comparable neighborhoods, it usually enters the decline stage
of its life cycle. Improvements may become functionally
inadequate and lose market appeal, and maintenance levels
frequently decrease.

Revitalization
• After decline, a neighborhood or district sometimes shows
revitalization, that is, it regains momentum or sees rebirth.
Often, this occurs because of an area’s proximity to
employment or other conveniences. Many fringe areas around
older downtown business districts are being revitalized. In a
sense, a district or neighborhood such as this re-enters the
“growth” stage of the life cycle.

• Sometimes, a neighborhood or district may go through a long,

extended growth stage, then mature and stabilize, never going
through the decline or revitalization stages. Stability may
dominate the life cycle for many years, with the area never
declining to the point the revitalization occurs.

CONSISTENT USE
• Consistent use theory involves the concept that land cannot
be valued under one highest and best use while the
improvements are valued based on another highest and best
use. o Agri land to Agri-use o Industrial land to Industrial-use…
etc.

SUBSTITUTION
• is the process of identifying alternatives that would satisfy the
same need, want, or desire.
• the maximum value of a property is equal to the cost of
purchasing or constructing equally desirable property.
• A prudent purchaser would pay no more for a home than it
would cost him or her to build or buy another one. Substitution
keeps the market in balance.
• equally desirable property.

HIGHEST & BEST USE

• is defined as that logical, legal, and most probable use which
will yield the greatest net income to the land over a sustained
period of time.
• Each property has one best legal use that gives its greatest
value.
• The four standard tests for highest and best use
• Each property has one use that gives its greatest value.
1. Legally Permissible
2. Financially Sustainable
3. Physically Possible
4. Socially Feasible

COMPETITION
• The principle of competition holds that profits tend to spur
competition.
• The more profitable a venture may appear, the more
competition will be created. In other words, success breeds
competition, and extremely high success breeds excess
competition.
• Better Quality (Value) and a more competitive Price.
• Profit attracts competition, while competition favors the
consumer, too much of it will ruins profit.

ECONOMICS OF SCALE
• This theory, economies of scale, is based on the idea that the
greater the volume of an item, the less each incremental
volume should cost.
• For instance, which would cost less: a single can of cola or
each can in a case of colas? Probably the latter, due to the
quantity discount. The same holds true for real estate. Which is
more expensive per square meter or per hectare?

SUPPLY & DEMAND

• When demand is equal to supply, price is normal;
• When demand is greater than the supply, price rises;
• When supply is greater than demand, price falls. Value (Price)
increases if few supply and high demand Value (Price)
decreases if abundant supply and few demand
Types of Real Estate Properties
• Raw Land
• Subdivision Lots
• House and Lots
• Townhouses
• Condominium Units
• [Industrial] Warehouses
• Commercial & Office Space
• Memorial Lots
• Agricultural land

FORCES AFFECTING VALUE

• Social
• Economic
• Governmental
• Environmental

FORCES THAT INFLUENCE VALUE

Real Estate value fluctuates, remains stable at times on account
of certain forces within and/or outside an identified real
property. The appraiser and valuer, in his research for value,
analyzes and evaluates those forces to arrive at the right figure
on a specific date.

These forces are designated as:

1. SOCIAL – forces relate to population growth, birth control
measures and migration.
2. POLITICAL – forces are government-based. The degree of
efficiency in the maintenance of peace and order and the effort
of providing primary services such as electricity light, water,
fuel and food. Zoning and land use ordinances, antisquatting
law, rent control.
3. ECONOMIC – forces include the nature of basic industry and
business activity in the neighborhood, trend of employment
and workers and expansion of the housing program.
4. ENVIRONMENTAL (PHYSICAL) – forces refer to the location
and age of the neighborhood: size, shape and topography of
land, type of improvements and architectural trends, and street
pattern, sidewalks and underground drainage.

DEPRECIATION - Loss of value from any cause.

1. Physical Deterioration
2. Functional Obsolescence
3. Economic obsolescence

• Physical Deterioration – reflecting loss in value brought about

by wear and tear. Ex. Cracks on walls and floors, roof, skylight,
balconies are affected by heat and cold climates (action of the
sun, wind and moisture). Elevators, motors, cables & other
equipment-due to wear & tear. These can be corrected by
repairs.
• Functional Obsolescence – out of date or old model. Ex. Poor
architectural design & appearance, bad room arrangement,
inadequate light & ventilation, under/overimprovement of site,
excess construction, high ceiling, waste space.

• Economic Obsolescence – when there is rapid tempo of

neighborhood changes. Ex. Changes in zoning ordinances,
government restrictions, changes to supply & demand with
regard to land usage, decrease in population, infiltration of
squatters & lower living standards, reduced buying power,
when good companies or business move to another location,
shifting of business center to social center. (Ex. Ballroom
Dancing)

CONCEPTS OF VALUE:

Types of Value: Market value, leasehold value, insurable value,

value in use, intrinsic value, investment value, asset value,
assessed or taxable value, zonal value.

Definition of Market Value – “the estimated amount for which a

property should exchange on the date of valuation between a
willing buyer and willing seller in an arms-length transaction,
after proper marketing and both acting knowledgeably,
prudently and without compulsion.”

Disequilibrium – periods of rapid changes in market conditions

affecting prices or values.

The 3 categories for non-market valuation :

1. Benefits that an owner inherently enjoys
2. Reasonable price agreed between two specific parties only
3. Value determined by statute or contract

Other types of value:

1. Special value – an amount above the market value
2. Synergistic value – additional value created by combining
two or more interests
3. Going concern value – when a business is transferred as an
operating entity
4. Liquidation value – value following closure; includes forced
sale.
5. Salvage value – value when asset has reached the end of its
economic life; for recycling.

THE APPROACHES TO VALUE

❑ Market Data ❑ Cost Approach ❑ Income Approach

The MARKET DATA APPROACH is primarily based on the

principle of substitution which implies that no prudent
purchaser will pay more than what it will cost him to acquire an
equally desirable substitute property. It is a comparison process
which produces an estimate of value of a property by
comparing it with similar properties of the same type and class
which have been sold recently or are currently being offered for
the sale in the same or comparable areas.

1. The MARKET DATA APPROACH The process involved

judgment concerning similarity with respect to value factors
such as location, time, construction, age, and condition, layout
and equipment. When appraising vacant land alone, common
value factors are time, location, comer influence, size and
shape, and other physical attributes.

MARKET or SALES COMPARISON APPROACH

• Advantages of the Approach
1. Sales comparison approach is essential in almost every
appraisal of real estate. Theoretically, this approach is sound
because it represents the considered judgment of many buyers
in completed transactions as evidenced by market data.
2. Market data or market prices are good evidence of value
because they truly represent the reaction of typical users and
investors to a particular type of property.
3. In concept, it is widely accepted by weight of authority in
Economics, Law and Business.
4. It has a great deal of appeal, easily understood and the
method is commonly used by appraisers and the public alike.

MARKET or SALES COMPARISON APPROACH

• Advantages of the Approach
1. Sales comparison approach is essential in almost every
appraisal of real estate. Theoretically, this approach is sound
because it represents the considered judgment of many buyers
in completed transactions as evidenced by market data.
2. Market data or market prices are good evidence of value
because they truly represent the reaction of typical users and
investors to a particular type of property.
3. In concept, it is widely accepted by weight of authority in
Economics, Law and Business.
4. It has a great deal of appeal, easily understood and the
method is commonly used by appraisers and the public alike.

BASIS OF THE METHOD:

• The basic principle that underlies the market approach or
sales comparison approach is essential in almost every
appraisal of real estate. It is the single approach to value in the
sense that regardless of the approached use, the appraiser
must the market data. “A prudent man will not buy or rent a
property than what it will cost him to acquire or rent an already
substitute property of equal desirability.”

PROCEDURES INVOLVED IN SALES COMPARISON APPROACH.

1. Description and classification of the subject property. The
property under appraisal should be described as to the type or
class, location, size, shape, frontage, depth topography, width
of street and other physical attributed that are significant and
relevant to its value.
2. Establish the time period. Sales made close to the appraisal
are given the most consideration. Weight is given to the
indication of value of at least three or more sales that have
occurred within the same year. Longer periods are also
necessary to establish price trends and economic levels which
are vital to sound estimate of value increments in adjusting
time.
3. Determination of market area. The availability of sufficient
comparable sales and similarity of the immediate
neighborhoods, for comparison purposes, must have
characteristics in common.
4. Gathering of sales data. The various sources of market data
include in-house files or data bank, Registry of Deeds, Office of
City or Municipal Assessor’s Office, Revenue District Office (BIR)
where the property is located, real estate brokers and
salespersons and/or parties involved in a sale, realty boards
and appraisers associations, internet, classified ads on real
estate, buy & sell magazines, bulletins or listings of properties
for sale, multi-listings group.
5. Classification, analysis and modification of sales data
gathered. The first step is to eliminate unrepresentative sales
since the selection representative sales is critical to the market
vale estimate.

Some of sales data considered unrepresentative or invalid are:

a. Sales between relatives
b. Sales under compulsion (gov’t. expropriations)
c. Sales from income tax point
d. Foreclosure sales
e. Sale made not under ordinary terms
f. Sales influenced by special business or financial consideration
g. Certain sales transactions that by their nature usually include
an element or coercion or duress (force or threat)

THREE MAIN GROUPS OF UNREPRESENTATIVE SALES:

Government Sales:
1. Tax sales
2. Sheriff’s sale
3. Eminent domain sales
4. Sale of surplus buildings or land
5. Sales of partial interest, easements, leaseholds

Sales between interrelated parties:

1. Sales between family members
2. Sales to and from interrelated corporations; affiliates or
subsidiaries
3. Sale of partial or fractional interest

Transfer Convenience
1. Voluntary sale in lieu of foreclosure
2. Sales and executor did
3. Sales to and from charitable institutions or organizations
4. Sales executed by quit claim deeds.

VALUE FACTORS THAT INFLUENCED MARKET:

1. Frontage and width
2. Depth (Lalim)
3. Corner Influenced
4. Plottage / Synergistic Value, Shape

2. The COST APPROACH Likewise based on the principle of

substitution, is the summation of cost new existing
improvement less accrued depreciation plus the value of the
land estimated by the market data approach. Cost new may be
reproduction or replacement, depreciation may be straight-line
method, or observed condition method considering the
physical and functional inadequacies and economic
obsolescence, if existing. The cost per square meter, unit cost-
in – place, or quantity take off mar be used to estimate the cost
new. COST APPROACH: • Reproduction Cost – is the cost of
construction at current prices of an exact duplicate or replica of
a building using the same materials, construction standard,
design, layout and quality of work.

• Replacement Cost – is the cost of construction at current

prices of a building having utility equivalent to the building
being appraised but built with modern materials and according
to current standards, designs and layout. COST ESTIMATING
METHODS: 1. Quantity survey method – this is a detailed
inventory of all materials and labor that go into the finished
building. Used by architects, engineers, builders and
contractors. 2. Unit-in Place Method – a cost estimating
method in which total building cost is estimated by adding
together the unit costs for the various building components as
installed, also called the segregated method. (Ex. Cost of hollow
blocks per piece, nails, roofs, ceilings, excavation, floors,
plumbing, walls, doors, windows etc.) 3. Cost per square
method-most commonly used.

BASIC STEPS IN COST APPROACH 1. Estimate the land value as

vacant. 2. Estimate the reproduction cost of all improvements
3. Estimate the depreciation expense to arrive at depreciated
value 4. Add the land value to the depreciated cost of
improvements to obtain the value indications.

The INCOME APPROACH Based on the principle of anticipation,

is a capitalization process. It generally requires an estimate of
the actual or stabilized gross income less provisions for vacancy
and bad debts, operating expenses such as building insurance,
real estate taxes, repairs and maintenance and administrative
charges.
The erstwhile capitalization process adapted is the residual
technique such as property residual, building residual, or land
residual. In the property residual, the net income before
provision for depreciation (or recapture) (NIBR) is capitalized
into value by adapting an overall rate abstracted from the
market.

Steps in Income Approach 1. Estimates the potential annual

gross income 2. Estimate other income 3. Add gross income
estimate to other income 4. Estimate vacancy and collection
losses 5. Deduct vacancy and collection lossess estimates from
total annual gross income to get effective gross annual income
6. Estimate expense data such as taxes, insurance premiums
and operating costs. 7. Deduct the expenses estimate from
effective gross annual income to get annual operating income
8. Capitalize the net annual operating income to arrive at an
indication of value.

CAPITALIZATION RATE Net Income / Over-all Rate GROSS

INCOME MULTIPLIER [ GIM] [ Direct Capitalization ] Value of
property = Annual Gross Income x GIM Procedure: Research
comparable property on annual gross income and selling price
Gross Income Multiplier is = Sale price of comparable property
Annual Gross Income of comparable = P 7,000,000 = 7
P1,000,000 GIM = 7
Problem on GIM A property has an annual gross income of
1,200,000.00 . In his market study, an investor found that a
comparable property with an annual gross income of P 1 million
was recently sold for P 6 million.

On the basis of the gross income multiplier indicated by the

comparable property, at how much should he buy the
property? Solution: Gross Income Multiplier = Selling price of
comparable property Annual Gross Income of comparable
= P 6M P 1M GIM = 6 Value = Annual net
income of subject x GIM = P 1,200,000.00 x 6 = P
7,200,000.00 Price at which property should be bought = P
7,200,000.00