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Updated: Dec 10, 2021

To a layperson, the terms value, price, and cost may seem to mean pretty much the same thing. However, to the professional appraiser, the terms each have a specific meaning. And the meanings are most certainly not the same thing.


Market Value is the focus of many appraisals. Market Value is an opinion. In simplest terms, it is most probable sale price in an “arm’s length” transaction. However, simple terms rarely suffice. The definition is usually modified with certain assumed conditions. In a definition often used by professional appraisers in the United States (from the Comptroller of the Currency), the conditions assumed are very specific. Market Value is defined as the most probable sale price when the buyer and seller are typically motivated and reasonably well informed. Further, it is reflective of a typical marketing period and payment in terms of U.S. dollars with no influence from sales concessions or special financing.


There are many variations of the definition. The sources include the California Civil Code, the California State Board of Equalization, U.S. Treasury, Civil Jury Instructions, Internal Revenue Service, International Valuation Standards, and many more. As an example, the market value definition for reporting federal estate taxes is not exactly the same as the definition for local property tax assessment. In most cases, the definitions are intended to mean the same thing (or very nearly the same thing) as the definition referenced above. However, there are exceptions. In eminent domain actions (State of California rules), damage assessment in litigation, and a few other instances, the market value definition specifies “highest” price rather than “most probable” price. The intent is clear; the benefit of the doubt is intentionally extended to the property owner.


Finally, no discussion of Market Value would be complete without reference to the term “Fair Market Value”. The term is often encountered when dealing with legal matters. The various definitions of Fair Market Value do not suggest that the meaning is any different from simply Market Value. In fact, the U.S Supreme Court, in an eminent domain case (United Stated States vs. Miller), observed, “the term ‘fair’ hardly adds anything to the phrase ‘market value.’“ Most appraisers do not use the term. It has been observed that the term “Fair Market Value” suggests that there could be an “Unfair Market Value.”


Sale Price is a fact. Sale price is the agreed upon consideration upon which a buyer and seller agree to a transfer of property. Sale prices can be reflective of value but are not necessarily so. In a situation where a seller is under pressure, the price accepted might be lower than market value. Similarly, a buyer under pressure or motivated by other considerations (e.g. owning adjacent property) might pay more than market value. A property that has to be sold quickly might sell at below market value. There are any number of things that could impact sale price.


When undertaking Data Comparison Approach valuation analyses, professional appraisers survey markets for evidence of sales of “comparable” properties. The sale price for each property needs to be analyzed to determine if it was impacted by any influence that could cause the price to be something other than market value. It is as a group that the analyzed sales data help point to an indication of market value for the subject property.


Construction Cost is the cost to build a structure or other improvement. If Construction Cost refers to numbers compiled prior to actual construction, it is an estimate. It is often prepared by a contractor or cost estimator. If Construction Cost refers to numbers put together reflecting actual costs of construction which has been completed, it is factual. In either case, it is a unique number to a specific project and prepared by a particular person. Anyone familiar with construction knows that costs can vary depending on the project and the preparer.


Replacement Cost is most often used by appraisers when performing a Cost Approach valuation analysis. As such, it is an opinion. It is an estimate of costs to construct a structure comparable to the subject using current standards, materials, and practices. The Cost Approach valuation analysis is based on the premise that the cost to acquire a comparable site and construct similar improvements should be suggestive of value. However, an often quoted mantra amongst appraisers is “cost does not equal value.” Generally, people expect that the value will exceed the estimated cost. If it were not so, things would rarely get built.

Reproduction Cost is the estimated cost to build an exact replica of the subject. It is used by appraisers when a structure has unique components that are not reflective of current materials or practices but are considered desirable and therefore could add value. It also might be appropriate when a cost evaluation is being prepared for insurance purposes.

Professional appraisers regularly deal with value, price, and cost. The concepts overlap and influence one-another but the terms are not synonymous.



Mr. Arnold is a principal at Hammock, Arnold, Smith & Company. They are a general practice appraisal firm providing valuation and evaluation services to a variety of clients including corporations, government agencies, the legal community, financial institutions, private individuals, and others.









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Updated: Dec 10, 2021

In my years as an appraiser, I have often heard it said that property valuation is a blend of art and science. I don’t think it has necessarily been said as a complement but I embrace the description. The work we do as appraisers is a combination of careful observation, data collection & confirmation, statistical analysis, and mathematical calculations coupled with professional judgement that is reflective of years of experience with various property markets. The science side of the work is the research and calculation; the art side is the professional judgement. While both are always evident, the balance can swing from one side to the other depending on the property type.

Real estate valuation is heavily weighted to the art side with properties such as high end residential estates. The buyers of these properties are often making very emotional decisions. Comparable sales data can establish broad value ranges but the ultimate value of a specific property is reflective of highly subjective perceptions and decision-making processes on the part of typical market participants. It takes the seasoned judgement of an experienced professional to understand how a typical buyer would react to a specific high end residence.

At the other end of the spectrum could be, for example, a commercial property leased long term to a quality tenant. The typical buyer for these properties tends to be more dispassionate. At the end of the day, decisions to buy are based on pretty objective assessments of the quantity, quality, and durability of projected incomes and what constitutes a reasonable rate of return. Generally, market activity provides clear indications as to what is market rent and what capitalization rate ranges are appropriate. While there is some art involved in selecting the various factors, the ultimate value calculation is a mathematical application of the overall capitalization rate to the net operating income – pretty cut and dry.

Of course, I have over simplified. Even in the most straight forward commercial valuations, judgments are made at every turn. For example, if contract rent appears to be below market rent, the appraiser must decide how typical market participants would react. Would they make value decisions based on market rent? Would they apply some sort of discount for lost rental income opportunity? Would they use the contract rent and adjust the overall capitalization rate to reflect that there is better than typical potential to increase rental income when the lease expires? And each of these judgements is made in concert with various other judgments. I have often said that the valuation process can be likened to fitting together the pieces of a Chinese puzzle.

Appraisal text books tend to focus on the science side of valuation.This is not surprising; it would be difficult to write a book about professional judgement.However, the text books do not tell the whole story.It is foolhardy for an appraiser, or a user of appraisals, to think of property valuation as simply a scientific exercise.I will never forget the advice of a teacher I had early in my appraisal education.He was a Columbia grad school educated Texan.He had a sharp analytical mind clothed in good old boy veneer.He told us, “after you’ve done all your research, your analyses, and your calculations, go sit on the curb across the street from the property and ask yourself, ‘What’ll it fetch?’ ”




Mr. Arnold is a principal at Hammock, Arnold, Smith & Company. They are a general practice appraisal firm providing valuation and evaluation services to a variety of clients including corporations, government agencies, the legal community, financial institutions, private individuals and others.













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Updated: Dec 10, 2021

Cap rates are used by market participants, brokers, and appraisers in estimating value of income producing properties. In professional valuation, the cap rate is formally referred to as the Overall Capitalization Rate (OAR). The Overall Capitalization Rate is an expression of the relationship between value and income. The “IRV” diagram is sometimes used to illustrate all the relationships that exist between income, rate and value.

To summarize; I (income) divided by R (rate) equals V (value). I divided by V equals R. And finally, R times V equals I. Therefore, to develop an indication of the OAR, the net operating income (NOI) of a property is divided by the sale price.

The best source of general cap rate information is the market. Appraisers and commercial brokers keep track of sales and their indicated capitalization rates. Different property types tend to have different cap rate ranges. At the time of this writing, cap rates in the Santa Barbara area generally fall in the range of 4.0% to 7.0%

The overall capitalization rate is not a property rating. Rather, the OAR is a rating of the perceived quantity, quality, and durability of the projected income. When considering the projected income, the valuer takes into account the balance between the exposure to risk and the potential for gain. The exposure to risk is an assessment of the likelihood that the projections will not be met. The potential for gain is an assessment of the likelihood that the projections will be exceeded. The perception of lower potential risk and/or higher potential for gain results in downward pressure on the rate.

In an all cash transaction, the OAR is a direct reflection of the return to the property owner. However, the market is dominated by situations where the potential return must be allocated between the buyer (equity position) and the lender (mortgage position). Therefore, looking at the return requirements of the two positions can be helpful in estimating an appropriate capitalization rate. This is called the “Band of Investment” method of evaluation of an overall capitalization rate.

Currently, mortgage interest rates are in the area of 4.0% to 4.5%. For a typical commercial property, the mortgage ratio is often in the area of 70%. Investors have two sources of potential return. They are the annual “cash-on-cash” return and the potential for equity growth through mortgage pay down and property appreciation. The two are related; the equity dividend rate (cash-on-cash return) used in the analysis is influenced by property appreciation expectations. Currently equity dividend rates are judged to be in the area of 7.0% to 8.0%. Mathematically, the calculation is expressed as follows:


Position Ratio Rate Extension

Mortgage 70% x 4.25% = 2.98%


Equity 30% x 7.5% = 2.25%


Total 5.23%


There is no empirical method of calculating an overall capitalization rate. From the point of view of a professional valuer, the analyses undertaken are helpful in pointing in the direction of what would be an appropriate capitalization rate to use in a particular situation. But, at the end of the day, the selection is careful professional judgement.




Mr. Arnold is a principal at Hammock, Arnold, Smith & Company. They are a general practice appraisal firm providing valuation and evaluation services to a variety of clients including corporations, government agencies, the legal community, financial institutions, private individuals and others.












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