his communication by the Appraisal Standards Board (ASB) does not establish new standards or interpret existing standards. Advisory Opinions are issued to illustrate the applicability of appraisal standards in specific situations and to offer advice from the ASB for the resolution of appraisal issues and problems.
SUBJECT: Appraisals of Real Property with Proposed Improvements
APPLICATION: Real Property
THE ISSUE:
Can either a current or a prospective value opinion for a property subject to completion of proposed improvements be provided in compliance with the Uniform Standards of Professional Appraisal Practice (USPAP)?
BACKGROUND:
An appraisal of real property with proposed improvements presents complex analysis and reporting issues because some portion of the property appraised does not exist at the time of the appraisal. Consequently, an appraiser must use particular care when performing an appraisal of such property to ensure that the results are credible and the appraisal report is not misleading.
A client may have a legitimate need for either a current or a prospective opinion of value (or both) concerning proposed improvements to real property. This kind of appraisal may be performed for a variety of client types, such as lenders, developers, private investors, trusts, attorneys, government agencies, or insurance companies. Further, such an appraisal may be for purposes other than providing an opinion of market value.
Many real property appraisers have been uncertain whether a current value opinion, rather than a prospective value opinion, may be provided in compliance with USPAP for a property subject to completion of proposed improvements and, if so, which portions of USPAP are most relevant to the assignment.
Statement on Appraisal Standards No. 4 (SMT-4) addresses how an appraiser may provide a prospective value opinion in a manner that is not misleading. This Advisory Opinion provides guidance in performing an assignment involving proposed improvements to real property, whether the purpose of the assignment is to develop a current value opinion or to develop a prospective value opinion.
The value opinion in an appraisal assignment involving proposed improvements is developed on the basis of one or more extraordinary assumptions. Using an extraordinary assumption always requires specific reporting steps. An appraiser must properly address the requirements set forth in Standards Rule 1-2(f) related to use of an extraordinary assumption in developing an appraisal and must address Standards Rules 2-2(a)(x), (b)(x), and (c)(x) in reporting the appraisal opinions and conclusions so as to ensure that the results are credible and not misleading.
ADVICE FROM THE ASB ON THE ISSUE:
Relevant USPAP & Advisory References
The following USPAP references are applicable when completing an assignment involving proposed improvements to real property:
COMPETENCY RULE, as it relates to the complexity of an appraisal assignment involving proposed improvements;
SUPPLEMENTAL STANDARDS RULE, particularly as to which describes when and under what conditions a client’s requirements may augment USPAP;
STANDARD 1, particularly Standards Rules 1-1(a), 1-2(d), 1-2(e), 1-2(h), 1-3(a), and
STANDARD 2, particularly Standards Rules 2-1(a), 2-1(c), and Standards Rule 2-2.
Additional standards information is provided in these Statements on Appraisal Standards:
No. 2 (SMT-2), addressing discounted cash flow analysis;
No. 4 (SMT-4), explaining that three categories of effective appraisal dates may be used—retrospective, current, or prospective—according to the intended use of the appraisal assignment, and addressing how an appraisal can be prepared and presented in a manner that will not be misleading when a prospective value opinion is required;
No. 6 (SMT-6), addressing reasonable exposure time in market value opinions.
Both current and prospective value appraisals subject to completion of proposed improvements to real property are permitted under USPAP. As noted in Statement on Appraisal Standards No. 4 SMT-4), a current value appraisal occurs when the effective date of appraisal is contemporaneous with the date of the report, and a prospective value appraisal occurs when the effective date of appraisal is after the date of the report.
Development of a value opinion(s) for a subject property with proposed improvements in a current value appraisal involves at least one hypothetical condition, specifically that the described improvements have been completed as of the date of value. The use of a hypothetical condition, in turn, imposes additional reporting requirements as set forth in Standards Rule 1-2(g) and Standards Rules 2-2(a)(x), (b)(x), and (c)(x). The additional reporting requirements are to ensure that an intended user understands that:
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(a) |
the improved subject property does not yet, in fact, exist as of the date of appraisal; |
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(b) |
the analyses performed to develop the opinion of value are based on a hypothesis, specifically that the improved subject property is assumed to exist when in fact it does not exist; |
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(c) |
certain events need to occur, as disclosed in the report, before the property appraised with the proposed improvements will in fact exist; and |
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(d) |
the appraisal does not address unforeseeable events that could alter the proposed property improvements and/or the market conditions reflected in the analyses. |
Development of a value opinion based on a hypothetical condition is addressed in Standards Rule 1-2(g). Use of a hypothetical condition is permitted when it is clearly required for legal purposes, for purposes of reasonable analysis, or for purposes of comparison. An analysis based on a hypothetical condition must not result in an appraisal, appraisal review, or appraisal consulting report that is misleading. The hypothetical condition must be clearly and conspicuously disclosed in the report with a description of the hypothetical condition and a statement that its use might have affected the assignment results.
There may be supplemental standards that affect how and when a hypothetical condition may be used in an appraisal assignment. An appraiser should consider supplemental standards, but he or she must make certain that developing and reporting a current value opinion under a hypothetical condition in accordance with supplemental standards still results in an appraisal that complies with USPAP.
The SUPPLEMENTAL STANDARDS RULE may apply in assignments when a value opinion based on a hypothetical condition is required by applicable law or public policy.
An appraiser asked to complete an assignment involving proposed improvements to real property should consider and discuss with the client:
the intended use of the appraisal report;
the effective date of the appraisal and the date when the proposed improvements are expected to be complete;
the physical and economic changes to the existing property and changes in the market for the property that may result from completion of the proposed improvement; and
the possible change in market competition from other properties over the time frame of the improvement project.
It is important for an appraiser to ensure that the client knows that the differences in the information considered in the two types of analyses can result in significant differences between a current and a prospective value opinion concerning the same subject property.
Taken together, these factors and the client’s needs determine whether it is most appropriate to develop:
a current value opinion on the basis of a hypothetical condition that the proposed improvements already have been completed, or
a prospective value opinion on the basis of an extraordinary assumption that the property will be improved as of a future date, as proposed.
If a prospective value opinion is the most appropriate, the appraiser must ensure that the requirements set forth in Statement on Appraisal Standards No. 4(SMT-4) are properly met in the course of completing the assignment.
As stated in “General Comments” above, an appraisal of a property subject to completion of proposed improvements with a current date of value always involves use of at least one hypothetical condition (i.e., the proposed improvements have been completed as of the date of value), and this always requires reporting that the proposed improvements are appraised as if completed as described in the report, as of the date of value.
In an appraisal with a prospective date of value, the extraordinary assumption that the proposed improvements are complete as of that future date must be disclosed clearly and conspicuously. The appraiser also should report that the extraordinary assumption might have affected the assignment results.
An appraiser should carefully review Standards Rule 1-2(e) and determine whether the information available for analysis is sufficient to identify the extent and character of the proposed improvements. If sufficient information is not available, an appraiser may use an extraordinary assumption about the extent and character of the proposed improvements, if credible assignment results can still be developed. In an appraisal with a prospective date of value, the extraordinary assumption about the extent and character of the improvements is in addition to the extraordinary assumption about those improvements being completed on the future date of value.
A current value opinion assignment does not require an appraiser to provide a prospective value opinion. However, so as to not be misleading the appraisal report should clearly indicate the fact that the value of the property that actually exists as of the date of the report would be different from the value concluded for the property with the proposed improvements completed as described in the hypothetical condition(s) used in the appraisal.
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1. |
A client is considering financing the construction of a single-family residence. Construction is expected to be complete in six to eight months from the date of the appraisal report. No significant changes in market conditions are foreseeable during the construction period. The client requests a current value opinion based on the hypothetical condition that the improvements are complete as of the current date. Can such an appraisal be provided in compliance with USPAP? |
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Yes, provided sufficient information about the extent and character of the proposed improvements is available or can be reasonably assumed under a hypothetical condition used for purposes of reasonable analysis in this case. Given the intended use of the appraisal (construction financing) and the lack of significant change in the market conditions during the construction period, in this case, a current value appraisal would not be misleading solely on the basis of the hypothetical condition that the improvements are complete as of a current date.
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A client requests an appraisal to assist in establishing contract rent in a build-to-suit agreement. The agreement stipulates that contract rent will be based on a stated percentage of the market value of the property as if it were completed as of a current date. The client requests a current value opinion based on the hypothetical condition that the improvements are complete as of the current date. Can such an appraisal be provided in compliance with USPAP? |
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Yes. Given the intended use of the appraisal, the use of the hypothetical condition is necessary for purposes of reasonable analysis and would not in itself result in a misleading appraisal.
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A client is considering financing a proposed office tower with a loan commitment based on the value of the property as though the improvements were complete and occupancy is at stabilized market level. Because of the amount of vacant office space available in the subject’s market area, it is anticipated that the subject property will take five years to reach stabilized occupancy. The client requests a current value opinion that assumes the property is complete and at stabilized occupancy. Can such an appraisal be provided in compliance with USPAP? |
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No. Because of the combination of the intended use of the appraisal and the market conditions that are expected to affect the subject property, the resulting appraisal would most likely be misleading. A prospective value opinion could be provided, with an effective date of appraisal as of the date when stabilized occupancy is expected to be achieved. This would more realistically reflect the market conditions affecting the subject, when completed.
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A client is considering construction of a large apartment complex. The client expects construction to be complete in about two years. Currently, demand for similar apartment units is strong, but because of the amount of new construction under way or planned in the near future, vacancy levels are expected to rise from the current level (below 1 percent) to about 20 percent in two years. |
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A. |
The client requests an appraisal with a current value opinion for use in obtaining financing from a nonregulated financial institution, based on the hypothetical condition that the apartment complex is complete and at stabilized occupancy. Can such an appraisal be provided in compliance with USPAP?
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No, because given the intended use and the foreseeable changes in market competition during the course of construction, a current value opinion for the property, as if complete, would most likely be misleading. A prospective value opinion, with an effective value date as of the expected completion date, would more realistically reflect market conditions affecting the subject property as proposed.
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The client requests an appraisal with a current value opinion for use in testing project feasibility or investment alternatives, based on the hypothetical condition that the apartment complex is complete and at stabilized occupancy. Can such an appraisal be provided in compliance with USPAP?
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Yes, because the intended use of the appraisal and the hypothesis, in this type of assignment, is for purposes of reasonable analysis and comparison. However, so as not to be misleading, the appraisal analyses should reflect the market risk resulting from the foreseeable trend in vacancy and its probable impact on cash flow and market competition, and the appraisal report must clearly indicate the intended use of the appraisal. | ||
Additional guidance appears in Advisory Opinion 7 (AO-7), which addresses marketing time opinions.
This Advisory Opinion is based on presumed conditions without investigation or verification of actual circumstances. There is no assurance that this Advisory Opinion represents the only possible solution to the problems discussed or that it applies equally to seemingly similar situations.
Approved July 26, 1996
Last Revised October 28, 2005
© Copyright 2006 - The Appraisal Foundation