REAL ESTATE APPRAISAL: ART OR SCIENCE?
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.
Michael Neal Arnold, MAI, MRICS