Appraisal Review Manual 2015

3.2 Basic Steps in Appraisal

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This article is a compilation of various articles from online sources and includes references to practices found in
the Uniform Standards of Professional Appraisal Practice (USPAP). The USPAP is the recognized standard
adopted in most states in the U.S. Portions about the Problem Definition were obtained from an article entitled
“ Scope of Work and Problem Identification” written by noted author Stephanie Coleman, a ranking member
of the Appraisal Institute. Supplemented with the Editor’s own insights, we present the basic steps in
performing an appraisal assignment.

There are SIX ESSENTIAL STEPS in the appraisal process, namely:

1. Problem Definition
2. Preliminary Analysis, Data Selection and Collection
3. Highest and Best Use Analysis
4. Application of the 3 Approaches
5. Reconciliation of Values
6. Report writing

The Assignment

An appraisal project is considered an “assignment.” Before proceeding with the work, appraisers are reminded
about USPAP’s definition of the term “Assignment” -- a valuation service provided as a consequence of an
agreement between an appraiser and a client.

Thinking in terms of “assignments” rather than appraisal reports is critical. Appraisers do not sell appraisal
reports. Rather, they sell their expertly developed opinions. Thus, the goal of an appraisal assignment is a
credible opinion of value—not merely the production of an appraisal report. An assignment involves a
relationship between an appraiser and a client—a relationship that carries with it significant ramifications
regarding trust, confidentiality, disclosure, and liability. Therefore the Client must disclose adequate
information needed by the Appraiser to perform the assignment. An appraiser must refuse an assignment if the
client will not reveal enough information.

Step 1 – Problem Definition

The new standard in problem definition for an appraisal assignment is known as the “Scope of Work” rule of
the Uniform Standards of Professional Appraisal Practice (USPAP) which is the common default standard in
most of the States in the U.S. In older versions of the USPAP, the concepts of limited versus complete
appraisal and the old “departure rule” caused confusion to clients and appraisers. In 2006, USPAP revised the
problem definition into what is now known as the “Scope of Work Rule.”

Scope of Work Rule: For each appraisal, appraisal review, and appraisal consulting assignment, an appraiser
must: 1) Identify the problem to be solved; 2) Determine and perform the scope of work necessary to develop
credible assignment results; and 3) Disclose the scope of work in the report.

There are seven parts of the Scope of Work: 1) Client; 2) Intended users; 3) Intended use; 4) Type of
opinion; 5) Effective date; 6) Relevant characteristics about the subject of the assignment; and 7) Assignment
conditions.

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Scope Item 1. Client

USPAP definition: CLIENT -- the party or parties who engage an appraiser (by employment or contract) in a
specific assignment. As far as USPAP is concerned, it makes no difference whether the appraiser is
compensated by the client or by another party. For example, a lender might hire an appraiser, but the borrower
might pay the appraiser. This does not make the borrower the client. From a business practice standpoint, the
client is the primary contact person. The client is the one from whom you obtain all your information about the
assignment. From a USPAP standpoint, the client is the one to whom confidentiality is owed.

Scope Item 2. Intended Users

USPAP defines “Intended Users” as -- the client and any other party as identified, by name or type, as users of
the appraisal, appraisal review, or appraisal consulting report by the appraiser on the basis of communication
with the client at the time of the assignment. The Appraiser must know the intended users because his primary
responsibility regarding the use of his value estimate is to them. They are the parties who must be able to
understand the findings clearly. Not all parties who receive a copy of the report are automatically intended
users. A party becomes an intended user only because the appraiser intends that party to use the report.

Scope Item 3. Intended Use.

USPAP’s defines “Intended Use” as - the use or uses of an appraiser’s reported appraisal, appraisal review, or
appraisal consulting assignment opinions and conclusions, as identified by the appraiser based on
communication with the client at the time of the assignment. Intended use is the appraiser’s understanding of
why the client and intended users need the service. Intended use is the most important of the scope items.
Appraisers must ask for this when requested to provide an appraisal. Without understanding the client’s
intended use, the appraiser cannot begin to make the appropriate scope of work decision. The intended use can
dictate the appraisal approach and methods.

Some possible intended uses relate to: • Financing • Litigation • Condemnation • Divorce settlement
• Buy/Sell decision • Tax reporting • Portfolio evaluation • Arbitration • Partnership value • Estate value
• Charitable donation • Valuation for financial reporting purposes (market-to-market) and others.

Scope Item 4. Type of Opinion

The results of an assignment will be some type of value. While most assignments are for opinions of “market
value,” there are many other different types of value. It is important for the appraiser and client to know and to
agree at the outset which ones will apply. The appraiser does not decide which type of value will apply; he or
she merely identifies the type needed, given the nature of the client’s problem. An assignment can specify not
just one type of value but also several other types as are needed by the intended users.

Scope Item 5. Effective Date

The effective date is important because the appraiser’s conclusions are reflected as of that date, and that date
alone. The effective date can be a current date, a prospective (future) date, or a retrospective (historical) date.
Again, the effective date is not decided by the appraiser; it is determined by the nature of the client’s problem.

Scope Item 6. Relevant Characteristics About the Subject of the Assignment

The subject of an appraisal assignment is some type of property—real property, personal property, or business
property. The subject of an appraisal review assignment is work done by another appraiser (his or her appraisal,

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appraisal review or appraisal consulting report, work file, or part thereof). In an appraisal assignment,
identifying the relevant characteristics means addressing the questions, “What is the subject property?” and
“What is its nature?”

Keep in mind that in valuing real property, appraisers do not appraise realty but interests on such realty. So the
primary question is, what real property interest is to be appraised? Some possible interests include: fee
simple, leased fee, leasehold, easement, or partial interest. Most often it is best to describe the interest
appraised, however, rather than to simply give it a label, as these terms may be defined differently by different
users.

The nature of the real estate (land and improvements) is important because the value of the interest in the real
estate depends on the utility the real estate provides. So it is important to identify, along with the interest
appraised, the relevant characteristics of the real estate.

The usual means of identifying the relevant property characteristics is to inspect the subject real estate.
When no property inspection is performed (as in the case of a “desktop appraisal”), or only a limited
inspection is performed (as in the case of a “drive by”), then the appraiser must either (1) obtain information
about the property characteristics that are relevant to the assignment from other sources, or (2)
make assumptions about what those characteristics might be.

In either of these two cases, the appraisal would be made based on the extraordinary assumption that the
information applied is indeed accurate. Such an extraordinary assumption would have to be prominently
disclosed in any appraisal report.

Scope Item 7. Assignment Conditions

Assignment conditions, as defined by USPAP, are 4 kinds: Extraordinary assumptions, Hypothetical
conditions, Supplemental standards, and Jurisdictional exceptions.

1) Extraordinary Assumptions - an assumption, directly related to a specific assignment, which, if found to

be false, could alter the appraiser’s opinions or conclusions.

Extraordinary assumptions presume as fact otherwise uncertain information about physical, legal, or economic
characteristics of the subject property; or about conditions external to the property, such as market conditions or
trends; or about the integrity of data used in an analysis. Extraordinary assumptions are sometimes necessary in
an assignment because of unknowns. To go forward with the assignment, the appraiser must presume something
to be true that might not be. And if it isn’t true, the opinions or conclusions would likely be different. For
example, in the case of a “drive-by” real property appraisal, where the appraiser doesn’t do an on-site visit to
the property to examine its features, the appraiser must make assumptions in the valuation process about those
features (such as size and condition).

These assumptions would be extraordinary assumptions because, if false, the value could be significantly
impacted. Another example of an extraordinary assumption would involve appraising proposed construction. If
the date of value is a prospective (future) date when the construction is expected to be complete as proposed, an
extraordinary assumption would be that, as of that future date, the construction would indeed be complete as
proposed. On the date the appraisal is being prepared, it is unknown whether or not the construction will indeed
be complete as of that future date.

2) Hypothetical Conditions - that which is contrary to what exists but is supposed for the purpose of analysis.
Hypothetical conditions are similar to extraordinary assumptions, but they come into play when something that
is known to be false is presumed to be true in the appraisal.

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Hypothetical conditions assume conditions contrary to known facts about physical, legal, or economic
characteristics of the subject property; or about conditions external to the property, such as market conditions or
trends; or about the integrity of data used in an analysis. A good example would be a property that is known to
be contaminated, but the assignment is to value it as though clean. Since it is known that it is contaminated,
such an appraisal would be subject to a hypothetical condition that it is not contaminated or that such
contamination will be curable.

Both extraordinary assumptions and hypothetical conditions must be clearly and accurately disclosed in any
appraisal report, written or oral.

3) Supplemental Standards - requirements issued by government agencies or other entities that establish
public policy that have a material effect on the development and reporting of assignment results. Supplemental
standards are regulations, rules, policies that apply to all properties or assignments in a particular category or
class. Contractual agreements that are unique only to a particular property or assignment are not supplemental
standards. Supplemental standards are simply additional requirements issued by a regulatory entity.

4) Jurisdictional Exceptions - an assignment condition that voids the force of a part or parts of the recognized
standard (USPAP or IVSC) because compliance will be contrary to law or public policy applicable to the
assignment. Common examples of this are found in statutes governing real property values such as in the
LGU’s SFMV or the BIR’s zonal valuation. The determination of values by these government agencies are
based on formulas and procedures which may not necessarily comply with standards of USPAP or IVSC.

A jurisdictional exception is not invoked by the appraiser. That is, it’s not a choice that the appraiser makes, it’s
a requirement. As with supplemental standards, jurisdictional exceptions need to be identified at the beginning
of the assignment, not after the fact.

Step 2. Preliminary Analysis and Data Selection and Collection.

Step 2 in the appraisal process has 3 sub-steps – Preliminary Analysis, Data Selection and Collection.
Before the appraiser can make a list of data to be gathered, he must first make a preliminary analysis of the
subject property. The type of data and the extent of data gathering will depend on this preliminary analysis.

Preliminary analysis will also allow him to decide what valuation approach will be most applicable. The
valuation approach selected will then determine the type of data to be gathered. For example, if the Market
Data Approach is chosen, then the data needed will be market transactions or offering prices of properties
similar to the subject. If a Cost Approach is chosen, then the data need will be quantity survey information and
prices of materials, etc.

Data Selection involves 3 categories of data:

1) General Data –
General data includes the “PEGS”, or Physical, Environmental, Governmental, and Social data of the
geographical area to be covered by the study. The geographical area can either be a neighborhood, a city or
even a region, depending on the scope of the assignment. The purpose of gathering general data is to create a
total picture of the locality where the subject property is situated. The information gathered are in effect
“externalities” yet they will affect value of the subject property.

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2) Property-specific data –
Property-specific data must be obtained for both the Subject and the Comparables if they exist. These will
include basic physical information about the properties -- size, location, age, features, history of ownership,
costs of improvements and renovations, use of the properties, physical condition, etc.

3) Market data –
Usually applicable to income-earning properties, it is essential to obtain data about economic conditions in the
locality - supply and demand, inventory, prices, competition, absorption rate, etc. Market data should be
obtained for both Subject and Comparables.

Step 3 – HABU: “Highest and Best Use Analysis”

Highest and Best Use is defined in the MRPAAO as – the most probable use of a property which is physically
possible, appropriately justified, legally permissible, financially feasible and which results in the highest value
of the property being valued.
The IVSC definition is similar: Highest and Best Use - The use of an asset that maximizes its potential and
that is physically possible, legally permissible and financially feasible.

The concept of HABU analysis is to make a value estimate based on “potential use.” Not the property’s current
use. Such potential use, if it meets HABU criteria, could dictate the property’s market value. A property can
have more than one significant HABU; if so, the appraiser shall submit options. A HABU can also be based on
certain hypothetical conditions if there is reasonable evidence that the said conditions will soon be availing.
During periods of volatility or disequilibrium, the HABU of a property may be a “Holding for future Use”.
This is seen in Metro Manila the last few years. If changes in zoning are anticipated, the HABU can be an
“Interim Use.” To begin with, there are two important assumptions that the appraiser must make:
1) That the land is as if vacant.
2) That the land can accept improvements (buildings, structures, crops, etc.).

Steps in determining the “Highest and Best Use”

1) Inspect the site.

2) Evaluate if it meets HABU criteria: What is the best and most productive use for the property that is –
- Physically possible
- Legally permissible
- Financially feasible
3) Analysis of options
For sure, more than one potential use can be identified, especially for urban lands. Such uses should be
evaluated individually and a value judgment reached after detailed analysis.

At this point in time, it is not absolutely necessary to prepare a full-blown project feasibility study for the
suggested HABU. A careful inspection of the vicinity, rough cost studies and estimates, will usually yield a
HABU that is defensible.

Step 4 – Valuation Stage: Applying the 3 Approaches

A typical realty appraisal assignment is comprised of valuing both land and improvements, unless otherwise
excepted. Thus, the valuation stage means looking at these two major components separately.

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4.1 Land Value Estimate

Land is usually valued using the Market Data approach. Thus, the Appraiser must have good sources of market
data. In the Philippines, we know that copies of all real estate sales transactions can be found either with the
BIR or the LGU’s tax assessment office. However, they are usually confidential and can not be divulged to the
public. So, appraisers have learned how to cultivate special connections in order to obtain information. But on
the other hand, the reliability of these data is highly questionable because it is still common practice for
transactions to be under-valued.

A better source for information would be the private sector – real estate brokers, banks, insurance companies, or
private credit investigation firms. In the absence of market data about recent sales, the alternative would be to
obtain offer prices. This is readily available from ads posted online or in newspapers.

4.2 Valuing the Improvements –

Improvements can be valued using any of the 3 approaches. However it is rare to find buildings and homes that
are similar (except in housing projects with model units). Thus, the practical approaches will either be the Cost
Approach or the Income Approach.

Cost is relatively easy to develop from market sources. Contractors and builders will be the primary sources.
Unit costs from reference books can also be used if a quantity survey for the subject property is available.
Estimates of replacement cost new should be adjusted for depreciation to arrive at a market value.

The Income Approach is suitable for income-earning property. Gross income should be adjusted for vacancy
rates or seasonality to yield a reasonable and reliable amount for net operating income. The NOI can then be
translated to value by using a well-thought out capitalization rate.

Step 5. Reconciliation of Value Indications and Final Value Estimate

After applying the three approaches to valuation, the total value of a property is obtainined as the sum of the
respective value estimates for land and improvements. If two or more approaches are used to make the
estimates, they have to be “reconciled.” The reconciliation procedure can be as simple as taking an average
value or it can be done by applying a probability weight factor on the separate values.

Reconciliation will yield the final value estimate.

Step 6. Report of defined value – Oral, Form, Narrative

The last step in the appraisal process is the preparation of the Appraisal Report. There are three kinds of
appraisal reports: Oral, Form, and Narrative.

Oral reports are rarely acceptable and requested by a Client. At best, they are considered preliminary and are
used only in very unique situations where the Client strictly prohibits the preparation of written reports.

Form reports are commonly used in both public and private institutions. At the LGU, the assessors’s offices
already have prescribed forms which are used by assessors to present an assigned appraisal project. The SFMV
(Schedule of Fair Market Value) is in effect a summary report of real property values.

The most worthwhile report is of course the Narrative. A narrative report presents the total picture of the
appraisal assignment. It contains the details of the scope of work, the data used for analysis, the valuation

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analysis and the final estimate of value. In addition to its basic content, most narrative reports will contain
numerous appendices – tables, exhibits and other supporting documents. [ ]

SAMPLE QUESTIONS

Q. The following is not part of USPAP’s “Scope of Work Rule” in the problem definition of an appraisal
assignment –
A. Identify the problem to be solved;
B. Determine the valuation approach to be used and have it approved by the Client
C. Determine and perform the scope of work necessary to develop credible assignment results;
D. Disclose the scope of work in the report.

Q. The following part of the Scope of Work identifies the type of property rights that have to be valued –
A. Type of Opinion
B. Intended Use
C. Intended Users
D. Relevant characteristics about the Subject
E. Assignment conditions

Q. A condition which is false or non-existent but which is assumed true for the purpose of an appraisal --
A. Extraordinary assumptions
B. Hypothetical conditions
C. Supplementary conditions
D. Jurisdictional exceptions

Q. A situation, characteristic or feature which has not been physically verified but is considered existing
for the purpose of the appraisal --
A. Extraordinary assumptions
B. Hypothetical conditions
C. Supplementary conditions
D. Jurisdictional exceptions

Q. Even though the appraisal assignment was stipulated to be made in accordance with the Philippine
Valuation Standards, a part of the said standards will have to be violated because of existing
laws/statutes which requires a different rule --
A. Extraordinary assumptions
B. Hypothetical conditions
C. Supplementary conditions
D. Jurisdictional exceptions

Q. The definition of the appraisal assignment does not include –

A. Identifying the property
B. Determining and specifying the approach to valuation and methodology to be used.
C. Defining the type of value desired
D. Clarifying the purpose for valuation

Q. The Boy Scouts expect a share of the development profits from their property which is being
developed by Alphaland. This is called a –
A. Real estate interest
B. Personal property
C. Business asset

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D. Financial Interest

Q. Mr. Cruz has a chopstick factory in a warehouse he leased for 25 years. has been very successful.
After 10 years, he wants to retire and hires an appraiser to value the factory as a --
A. Real Property
B. Personal Property
C. Business
D. Financial Interests

Q. Nobody wants to buy a chopsticks factory so Mr. Cruz decides to retire anyway and to dismantle the
factory and sell the remaining 10-years leasehold rights to the warehouse as --
A. Real Property
B. Personal Property
C. Businesses
D. Financial Interests

Q. Mr. Cruz dismantled his factory. The chopsticks machinery will be sold for value as –
A. Real Property
B. Personal Property
C. Businesses
D. Financial Interests

Q. Which of these assignments should the appraiser refuse to handle –

A. An assignment to undertake mass valuation of property for the BIR;
B. An assignment to justify a buyer’s counter-offer for a property offered.
C. An assignment to determine the value of an estate of a person still alive.
D. An assignment to value a failed business.

Q. Assumptions, limitations and other constraints in an appraisal assignment can be imposed by –

A. The Client’s criteria
B. The Valuer’s sound judgment
C. Government laws and regulations
D. All of the above

Q. Client requires valuation of a farm land for sale at Mamasapano but Mr. Appraiser did not wish to
visit the site because it is restricted by the military so Client agreed that he can make a report based on
an interview with the farm owner. This limitation is based on –
A. The Client’s criteria
B. The Valuer’s sound judgment
C. Government laws and regulations
D. All of the above

Q. Property to be valued is a Starbucks outlet for sale by franchisee. Valuer researched the population
of the community and its level of development as part of obtaining --
A. Personal data
B. Property-specific data
C. Market data
D. General data

Q. Property to be valued is a Starbucks outlet for sale by franchisee. Valuer counted the number of its
current customers and average amount spent. This is part of –

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A. General data
B. Property-specific data
C. Market data
D. Personal data

Q. Property to be valued is a Starbucks outlet for sale by franchisee. Valuer obtained statistics showing
the neighborhood are office buildings with about 500 offices in BPO business. This is part of –
A. General data
B. Property-specific data
C. Market data
D. Personal data

Q. The Bishop asked Mr. Appraiser to value a 70-year old dilapidated church. The following approach
is practical and more appropriate –
A. Compare the price of this property with other churches in neighboring towns;
B. Make an estimate of the cost of restoring the church.
C. Find out the current income generated from churchgoers in the parish.
D. Undertake a highest and best use analysis.

Q. Previous problem. Under the principle of “consistent use” the following must be followed during the
HABU analysis --
A. The recommended HABU must assume that the use is still a “church” ;
B. The recommended value for the land and for the building is based on same use;
C. The HABU can simply be for the land assuming it is “vacant;”
D. The HABU recommendation must be what the Bishop wants.

Q. A lot at downtown in the city was leased 25 years for use as a parking lot and it earns P500K monthly.
Value shall be based on –
A. Comparable sales of other properties used as parking lot;
B. Using income approach, capitalize the earnings for next 25 years;
C. Make a HABU analysis assuming the leasehold can be terminated.
D. It is not advisable to estimate a value.

Q. In the basic steps in appraisal, “Reconciliation” means –

A. Completing an appraisal assignment on time;
B. Reconciling the Client’s value expectation with the appraiser’s estimate;
C. Selecting the final value from various results obtained during analysis;
D. All of the above.

Q. The appraiser’s opinion of highest and best use should include:

A. The highest and best use as if vacant
B. The highest and best use as presently improved
C. Both a and b above
D. None of the above

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