What is MAI?

MAI is a professional designation for real estate appraisers who are experienced in the valuation and evaluation of commercial, industrial, residential, and other types of properties, and who advise clients on real estate nvestment decisions. Originally, the name of the organization was the American Institute of Real Estate Appraisers (AIREA) until it merged with the Society of Real Estate Appraisers (SREA) in the 1980s.

 

 

The current requirements that an appraiser must fulfill to receive the MAI designation are as follows:

• Education:

• Receive a passing grade on 11 examinations that reflect 380 hours of classroom instruction and that test the appraiser’s knowledge of basic and advanced appraisal principles, procedures and applications; report writing; valuation analysis and standards of professional practice
• Receive a passing grade on a four-module, two-day comprehensive examination
• Hold an undergraduate degree from a four-year accredited educational institution

• Experience: Receive credit for 4,500 hours of experience, all of which must meet strict criteria.

• Demonstration Report: Receive credit for a demonstration appraisal report relating to income-producing property that demonstrates the ability to present a properly supported value estimate or opinion evaluating the nature, quality or utility of a parcel of real estate or any interest in, or aspect of, real property, including handling physical incurable depreciation, or fulfill an approved comparable alternative.

 

 

USPAP

The profession of Appraisal has uniform standards to be followed by all practitioners.  The main guiding doctrine for appraisers is USPAP.  

 

What is USPAP?: The Uniform Standards of Professional Appraisal Practice, (USPAP), is considered the quality control standards applicable for real property, personal property, intangibles, and business valuation appraisal analysis and reports in the United States. USPAP was first developed in the 1980s by a joint committee representing the major U.S. and Canadian appraisal organizations. As a result of the savings and loan crisis, the Appraisal Foundation (TAF) was formed by these same groups, along with support and input from major industry and educational groups, and TAF took over administration of USPAP.

 

USPAP Standards: While USPAP provides a minimum set of quality control standards for the conduct of appraisal in the U.S., it does not attempt to prescribe specific methods to be used. Rather, USPAP simply requires that appraisers be familiar with and correctly utilize those methods which would be acceptable to other appraisers familiar with the assignment at hand and acceptable to the intended users of the appraisal. USPAP directs this through what is called the Scope of Work rule.

 

 

At the onset of an assignment, an appraiser is obligated to gather certain specified preliminary data about the project, such as the nature of the property to be appraised, the basis of value (e.g. market, investment, impaired, unimpaired), the interests appraised (e.g. fee, partial), important assumptions or hypothetical conditions, and the effective date of the valuation. Based on this and other key information, the appraiser relies on peer-reviewed methodology to formulate an acceptable workplan.

 

USPAP Updates:  Since 2006, USPAP has been updated in a 2 year cycle, which begins on January 1 of even number years. The current version of USPAP is available at www.appraisalfoundation.org and has an effective date of January 1, 2010.

 

 

Deriving Cap Rates

There are several acceptable methods for deriving capitalization rates for use in the income approach to property appraisal.  The following explains some of the more commonly used approached to cap rate derivation.

 

 

Direct Market Extraction: This approach simply obtains cap rates by examing the cap rates for sales comps.  It assumes that there is current, readily available net operating income and sale price information on comparable income-generating properties. The advantage with the market-extraction method is that the capitalization rate makes the direct income capitalization more meaningful.  The cap rates for the most recent and similar properties are given the most weight in this process.  Market cap rates may also be obtainined through interviews of appraisal professionals, brokers and investors.

 

 

Summation Technique: This approach combines market risk and reward measurements to obtain a cap rate.  For example, to obtain a cap rate, the following may be added together:

1) Expected Inflation Rate;

2) Real Rate of Return;

3) Risk Premium Rate; and,

4) Recapture Premium Rate. 

 

General Constant Growth Formula: Simply derives a capitalization rate by subtracting the growth rate of the economy from the IRR on equity.

 

(M x Rm) + (E x Re) = Ro

 

Band of Investment (Borrowing Cost & Rate of Return): This method presumes that a capitalization rate equates to a composite of debt and equity funds. This overall rate is extracted by deriving the weighted average of the mortgage capitalization rate and the equity capitalization rate. Market data components in this equation are the proportions of debt and equity in a typical deal and surveys of mortgage interest and equity return rates as well as actual market data for these components where available. The reliability of this method depends on the accuracy of the analyst's research and the disparity of rates between surveys and actual transactions.  The method derives an overall cap rate as follows: [(LTV x Mortgage Constant) + (ETV x required rate of return)]. 

 

Band of Investment (Land & Building): The band of investment calculation can be modified to incorporate land and building valuation metrics.  In so doing, the cap rate is derived as follows: [(Ratio of land value to total property value x Land Cap Rate) + (Ration of building value to total property value x Building Cap Rate)].

 

 

Discount Rate v. Cap Rate

Both the discount rate and the capitalization rate are applied in the appraisal process.  It is important that the difference between these rates be understood so that they are not incorrectly applied.

 

Discount Rate: Rate used to convert a specified future income stream for a given period + sales proceeds into a present value. It is the equivalent of the yield rate or IRR.

 

Captialization Rate: Determined by dividing the property's NOI by its sales price.  This rate incorporates the anticipation of income increasing or decreasing and the appreciation / depreciation of the subject property.

 

 

 

 

 

Discounted Cash Flow Model of Income Valuation

The discounted cash flow (DCF) model determines a properties value by discounting the following values to a present value:         

 

     1) NOI for all years through the end of the projected holding period for the property; and,

 

     2)  Sales proceeds for the property at the end of the projected holding period for the property.

 

 

     To properly apply this approach, the appraiser must develop a forecast of NOI for each year in the expected holding period.  If this information os not available from the property owner, it may be available for comparable properties.  Next, the appraiser will estimate the sales reversion at the end of the holding period.  The appraiser must then determine an appropriate discount rate -- this is typically done through an investor survey.  Finally, the appraiser will set up a T-Bar and solve for the present value of the differential NOI cash flows and reversion value of the property. 

Functional & External Obsolesence in the Cost Approach

Step 3 of the cost approach to valuation is to estimate the structure's accumulated depreciation. There are five forms of depreciation and value adjustments that should be considered.  Three of these adjustments involve functional and external obsolescence related to the subject property.

 

Curable Functional Obsolescence: Essentially this value adjustment acknowledges that design defects or obsolete components can create a loss of value.  For example, materials once considered acceptable when the structure was built may be considered sub-standard today.  The cost of bringing the obsolete components up to current standards should be calculated and subtracted from the building's replacement cost.  The follwoing example of adding an elevator to a building is instructive:

 

Cost of Widening Halls:                                     $15,000

Cost of Elevator:

             To install Today               $50,000

             To install at orig constr    $30,000

             Value Loss                                           $20,000

 

Total Curable Functional Obsolescence:         $35,000

 

 

Incurable Functional Obsolescence: Assume that a property needs a parking lot to compete in its marketplace.  If that property does not have the physical space to build a parking lot, obviously the condition cannot be cured. The resulting loss in value counts as incurable functional obsolescence.  To value incurable functional obsolescence, estimate the loss of net operating income (NOI) from the lack of the parking lot and divide the estimated NOI by properties capitalization rate to obtain lost value.

 

 

External Obsolescence: This value impairment is a function of forces beyond the property owner's control. For example, if an entire area where the subject property is located deteriorates due to lack of maintenance of common areas and roads, that is external obsolescence.  Likewise, if a new mall is built near a property and traffic congestion significantly increases to the point of impairing access to the property, this obsolescence is external to the property.  Any loss in value from external obsolescence is divided proportionally between the land and the improvements because both are affected by the outside influence.  

 

Curable & Incurable Physical Deterioration in the Cost Approach

Step 3 of the cost approach to valuation is to estimate the structure's accumulated depreciation.  There are five forms of depreciation and value adjustments that should be considered.  Two of these adjustments involve the calculation of curable and incurable physical deterioration of a structure.

 

Curable Physical Deterioration: Estimating the value to assign this component simply involves taking inventory of what needs repaired, such as weather stripping, painting, window replacement, etc., and assigning it a market cost to remedy.  This should only include items if the gain in value resulting from the repair will offset the cost of repair.

 

 

 

Incurable Physical Deterioration: The loss resulting from wear and tear for which the cost of repair would outweigh the increase in value from repair.  This includes ALL physical deterioration not included in the "curable" category.  Incurable physical deterioration is categorized into short-term and long-term.  Shoert term includes items with an expected life shorter than that of the building.  Long-term includes those items that have an expected life equal to or longer than the expected remaining life of the building.