Value: appraisal, the three approaches, CMA, BPO, AVM

Bottom line: price, cost, and value are three different things. A broker lives on estimating value, but only a licensed or certified appraiser may call a value opinion an "appraisal," and brokers cannot use their own opinions for loans.

Price, cost, value

• Price: what was actually paid.
• Cost: what it takes to build or replace.
• Value: what a typical buyer would pay on the open market.

Market value is the most likely price in an open, fair sale where buyer and seller both know the facts, neither is forced, and the property was exposed to the market for a reasonable time.

What an appraisal is, and who may do one

An appraisal is a written opinion of value made by a trained, state-credentialed appraiser. Colorado defines a "real estate appraiser" as a person who provides "an estimate of the nature, quality, value, or utility of an interest in, or aspect of, identified real estate." (C.R.S. 12-10-602(9)(a))

Federal law (FIRREA) requires a state-licensed or certified appraiser for many loans backed by federal banks. Lenders order the appraisal; the buyer usually pays the fee. A buyer's loan officer uses it to be sure the house is worth the loan.

The broker rule: never call it an appraisal

The definition of appraiser carves out a broker "who provides an opinion of value that is not represented as an appraisal and is not used for purposes of obtaining financing." (C.R.S. 12-10-602(9)(b)(II)) So a broker may give an opinion of value only if two things are true: it is not called an appraisal, and it is not used to get a loan.

The Commission's rule backs this up. When a broker prepares a CMA or BPO for any reason other than an anticipated sale or purchase, the broker must include this notice: "This evaluation was prepared by a licensed real estate broker and is not an appraisal. This evaluation cannot be used for the purposes of obtaining financing." (4 CCR 725-1 Rule 6.12) Brokers are prohibited from completing CMAs or BPOs used to obtain financing. Pay for such work outside of sales is not brokerage compensation that the firm must share unless the office policy says so.

CMA, BPO, AVM

• CMA (competitive or comparative market analysis): a broker's comparison of the subject house to recently sold similar houses (comps), plus active and pending listings, to set a list price. Usually free to the seller.
• BPO (broker price opinion): a broker's value opinion, usually for a bank or investor, often after a drive-by look. It is not an appraisal.
• AVM (automated valuation model): a computer estimate from public records and sales data. Fast and cheap, but it cannot see condition or upgrades. Online "estimates" are AVMs.

The three approaches to value

1. Sales comparison approach. Best for houses. Find recent sales of similar homes nearby (comparables, or "comps"). Then adjust the comp, never the subject. If the comp has something better, subtract its value; if it lacks something the subject has, add.

2. Cost approach. Best for new or unusual buildings (schools, churches). Value = land value + cost to rebuild the building new - depreciation. Depreciation is loss of value from physical wear, outdated design (functional), or outside factors like a nearby highway (external).

3. Income approach. Best for rentals and commercial. Formula: Value = Net operating income / Cap rate. Net operating income (NOI) is yearly rent minus vacancy and operating costs (taxes, insurance, repairs), before loan payments. The capitalization rate (cap rate) is the yearly return a buyer expects, as a percent of price. A gross rent multiplier (GRM) is a quicker shortcut: price / gross rent.

Principles of value

• Highest and best use: the legal, physically possible, financially workable use that produces the highest value.
• Substitution: a buyer will not pay more for a property than for an equally good substitute.
• Conformity: value is highest when a property fits its neighborhood. The worst house on the block is often worth the most to improve.
• Contribution: an improvement is worth what it adds to value, not what it cost.
• Also: supply and demand, change, anticipation (value comes from expected future benefits), and progression (a weaker house gains next to better ones) / regression (a better house loses value beside weaker ones).

Why the three approaches matter: each looks at value from a different angle, and an appraiser weighs them by how well the data fits the property. A house with many nearby sales leans on sales comparison. A building with no sales but steady rent leans on income. When the approaches disagree by a lot, that gap is a signal to check the data, not to average blindly. A broker can use the same thinking in a CMA, as long as the paper never calls itself an appraisal.

Example with real numbers

Income: a four-plex rents for $3,500 a month. Gross yearly = $3,500 x 12 = $42,000. Vacancy 5% = $2,100. Operating costs (tax, insurance, repairs) = $9,900. NOI = $42,000 - $2,100 - $9,900 = $30,000. At a 6% cap rate: $30,000 / 0.06 = $500,000.

Cost: land $150,000. Rebuilding 2,000 sq ft at $200 = $400,000. Depreciation $40,000. Value = $150,000 + $400,000 - $40,000 = $510,000.

Sales comparison: a comp just sold for $520,000, but it has a garage worth $15,000 that the subject lacks. Adjusted comp = $520,000 - $15,000 = $505,000. The three approaches land from $500,000 to $510,000, so an appraiser would favor the sales comparison for a house.