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The evolving appraisal paradigm.

During the past decade a new appraisal paradigm has been evolving. As a result of the commercial real estate boom and bust of the 1980s and the ensuing federal regulatory restrictions, the natural evolution of the appraisal process was accelerated and changed. In addition, the development and widespread use of microcomputers has facilitated the use of detailed, lease-by-lease spreadsheet analyses in appraisals. The implications of these and other factors as well as the direction of this evolutionary process are considered here.

Over the past decade or so it has become increasingly obvious that a new appraisal paradigm(1) has been evolving. The evolutionary change has occurred in fits and starts, at different rates in different settings, but with a consistent theme and direction. To a high degree, the articles listed in the Appendix are representative of that theme and direction.(2) The objective of this article is to consider this evolutionary process, its direction, and its implications.(3)


The "old" paradigm(4) was based on the direct capitalization of "stabilized" income, a simple study and projection of the "market" (if any), and emphasized market value rather than leased fee value. The fundamental assumption was, not inappropriately, stability. The almost universally assumed vacancy ratio was 5%. Income loss during lease-up was often (usually) disregarded. In proposed residential developments, what we now call "total sellout" was often reported as value, disregarding the time value of money. Risk was considered only implicitly, if at all, and the Ellwood method could satisfactorily capture the impact of some simple assumed changes if necessary. Although the principle of change was considered axiomatic, the speed of change was low, and appraisal methodology reflected its environment.

Through the late 1960s and early 1970s, inflation increased but was still relatively low and not a major factor in appraisal. With higher inflation rates, change accelerated. As the economy heated up, real estate became more popular as an inflation hedge. Corporate management became more aware that real estate holdings represent big ticket investments with long futurities needing more management attention. Inflation-hedging investment portfolios became increasingly popular, and required active management. Negative pre-tax cash flows became more acceptable (even inevitable?) in real estate investment. On the analytical side, personal microcomputers were developed and widespread ownership rapidly became economical. Spreadsheet concepts and financial techniques were imported from financial analysis, where they had been running for years on mainframe computers, and were applied using microcomputers.

In science, progress in theory (and practice) is made as simpler models are replaced by more general and more sophisticated models. Just so in the applied economic discipline of appraisal. The four basic elements of a new paradigm are in place: technology, knowledge, need, and evolving consensus. Technologically, microcomputers with spreadsheet programs as well as office and commercial lease analysis programs allow detailed, lease-by-lease analyses. The knowledge needed to apply the technology is widely available; it is almost impossible to find a graduating business student who is not conversant in the basics of computerized spreadsheet analysis. (The open literature, as indicated in the Appendix, is instructive.)

The need is being clarified (and mandated) by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) and by recent economic events that have made the risk associated with real estate investment readily evident to all. Finally, a consensus as to "quality" is being continuously refined and extended through the communications media, standards, and the educational process. In the next section the perceived need for change is discussed.


In the 1980s, what may have been the biggest boom in commercial real estate development in the history of the country occurred. The financial developments that stimulated this boom, however, also contained the seeds of the current bust. The boom began (coincidentally) with deregulation of the savings and loan industry, completed in early 1983. With the easing of limitations on savings and loan investment in commercial property, many thrift managers began to rapidly increase investmetns in commercial real estate, an investment area in which they had limited experience and expertise.(5) Simultaneously, banks, which had traditionally focused on shorter term construction loans, expanded investment in commercial real estate through tax shelter-driven syndications having otherwise negative economics. Almost simultaneously, pension fund managers, with an ever-increasing asset base under management, looked to investments in commercial real estate as a hedge against inflation. Finally, in the last half of the 1980s there was a considerable influx of foreign investment funds. These combined factors provided the basis for a huge capital investment in the real estate sector of the economy, which continued even in the face of falling effective rents caused by overbuilding and which ultimately drove yields to unprecedentedly low levels.

When the bubble burst, the search for the villains of this real estate debacle began. A predictable regulatory overreaction was instituted, causing the current credit crunch. Although the problems of the industry were systemic and largely a result of a concatenation of only loosely related events, the blame was publicly laid, in large part, on the appraisal industry--a small industry providing an easy scapegoat. The appraisal industry appears to have accepted blame unblinkingly.(6)

By the beginning of the 1990s, the thrift industry was moribund. (Some individual thrift associations survive, but they are not part of an institutionally separate group of financial organizations specifically designed to provide housing finance.) Banks, in the midst of the regulatory credit crunch, are also under competitive pressure in part because of substantial overcapacity in the industry. Federal bank regulators have correctly focused on real estate loans in general and commercial property loans in particular, as these loans form a significant portion of bank portfolios and have shown high delinquency and foreclosure rates. (Historically about half of bank real estate loans have been construction and development loans.) Unfortunately they have made up for their past failures with current overzealousness.(7)

For the evolving appraisal paradigm, the most relevant result of the real estate boom and bust cycle of the 1980s and early 1990s was federal regulation of the appraisal industry. By now FIRREA, which requires state regulation of appraisers, is widely known in the appraisal community. The principle thrust of this legislation as well as Federal Home Loan Bank Board (FHLBB) Memoranda Series R-41 was the reduction of risk to lenders, in part through the production of more thorough appraisals.


The need for a revised appraisal paradigm was driven by both economic events and federal regulation. Title XI of FIRREA requires the Federal Reserve Bank as well as other financial institutions' regulatory agencies to adopt regulations regarding real estate appraisals used by state member banks, bank holding companies, and other similar regulated depository institutions. The Federal Reserve Bank adopted such regulations in mid-1990,(8) as did the other financial institutions' regulatory agencies and the Resolution Trust Corporation (RTC), the world's biggest real estate player.

Almost simultaneously, the Uniform Standards of Professional Appraisal Practice (USPAP), based on the original Uniform Standards developed and copyrighted in 1987 by an ad hoc committee of The Appraisal Foundation, were adopted as the standard of the industry by The Appraisal Foundation. A review of USPAP Standards 1 and 4 is particularly instructive of the new paradigm's approach to reducing risks.


The natural evolution of the appraisal process was accelerated and changed by the economic events of the 1980s and subsequent government regulation.(9) With or without government intervention, however, the form of the evolving paradigm is clear: reduction of risk through the improvement of appraisal practice. Some of its aspects are outlined in the following sections.

Market studies

Appraisal practice is rapidly developing toward the inclusion (directly or by reference) of a serious market study component in every major appraisal. The importance of a market study cannot be overemphasized. As Anthony Downs notes in "Appraisal Practices Need Revision," "A final lesson from the 1980s is that there is no substitute for insightful analysis of both 1) overall market conditions and trends and 2) local market conditions and trends."(10) Richard U. Ratcliff, ahead of his time, went so far as to identify appraisal with market analysis in his article, "Appraisal is Market Analysis."(11) In summarizing this article Stephen Fanning wrote:

Ratcliff argues that "value" is essentially

an abstract term functioning in a hypo-

thetical, perfect market. A client's concern

is with the prediction of a selling "price"

which the appraiser can determine only

through an analysis of the real life real es-

tate market of the day. Ratcliff further

holds that markets and market data are in

a constant flux and "notoriously unpre-

dictable," so no single price figure is a cer-

tainty; appraisals should therefore include

a range of values in the value conclusion

as a probability qualification.(12)

The details of the basic market study are defined in Ratcliff's presentation, in the Appraisal Institute's Market Analysis course, and in a number of references in the Appendix.(13) Thus, extensive description of the technical aspects of the process of market analysis will not be provided here.

From a policy viewpoint the Appraisal Institute should take steps to encourage the inclusion of market studies in appraisals, at least for major properties. This would certainly include reinforcing and strengthening those parts of USPAP Standard 4 regarding market analysis.(14)

Spreadsheet modeling

Spreadsheet modeling, often incorrectly referred to as discounted cash flow (DCF) analysis by appraisers, is the most versatile and powerful tool in an appraiser's tool kit. Whether the spreadsheet model is used to obtain a discounted cash flow, internal rate of return, or a modified internal rate of return makes no significant difference in its usefulness. It is the single most widely used tool in investment and institutional real estate markets, and should be utilized in the valuation of any proposed income-producing real estate project.(15) The power of spreadsheet modeling as a technique for comprehensive analysis and valuation is its almost infinite richness in information theoretic terms. This should become clear when the potentialities of a spreadsheet model are compared with the estimation of value by dividing a "stabilized" net operating income by an overall capitalization rate.

Simply stated, spreadsheet modeling allows appraisers to clearly specify the quantity, variability, and duration of estimated periodic income as well as the quantity and timing of reversions. Income, expense, growth, and debt service can be quite irregular. Many complex leases can be considered simultaneously. When computerized, a spreadsheet can be used to test the effects of varying assumptions on the plausibility of implied results quickly and inexpensively. Further, a computerized spreadsheet can be used to simulate various possibilities that, when assigned probabilities, can estimate risks. (In fact, this is the best way to estimate risks.)

One of the principal problems with spreadsheet modeling (e.g., DCF analysis) is the mildly paranoid defensiveness of its Appraisal Institute proponents, and even of the Appraisal Institute's formal position. Consider the first paragraph of the Appraisal Institute's Statement on Appraisal Standard 2 (SMT-2). First, it is stated that DCF analysis is an acceptable analytical tool and method of valuation within the income capitalization approach to value, and that DCF is not a new method.(16) It is then stated that "Because DCF analysis is profit oriented and dependent on the analysis of uncertain future events, it is vulnerable to misuse." (Emphasis added.)(17) There is no doubt that spreadsheet modeling can be misused.(18) But a certain symmetry is appropriate here. Analysts from other fields smile at the naivete of a statement that begins "Because DCF is profit oriented," a statement that applies equally and identically to the direct income capitalization approach based on stabilized income and expenses.(19) This response applies equally to almost any of the other standard admonitions concerning the abuse of DCF analysis. Symmetry demands that some consideration be devoted to the abuses of direct capitalization, as William S. Harps did in 1984.(20)

It is indeed true that the seeming precision of computer-oriented projections may give the appearance of certainty to projections that are actually variable within a wide range. Standard 2 is not wrong. It is merely timidly positive in its approach and fails to make clear that any and every appraisal technique can be, has been, and no doubt will continue to be misused. Timidity does not make for industry leadership. The proper and appropriate application of spreadsheet modeling and DCF analysis, based on market-derived information, should be aggressively fostered, not just timidly accepted, for it is the centerpiece of the evolving appraisal paradigm. This does not mean that direct capitalization should not be used, only that it should be kept in its proper (limited) role, applied to small, non-complex properties in relatively stable times.

Risk and value

The idea that there is a "true market value"

of any real property that can be expressed

by a single number is a convenient myth

invented by the real estate industry. This

fiction is necessary to the industry be-

cause many of its members want to be able

to state the "current values" of their prop-

erties or property portfolios, and to gov-

ernment because it needs some basis for

calculating property taxes. In reality there

is no such thing as the "true market value"

of any piece of real estate. Even the num-

ber that appraisers call a property's "mar-

ket value" is not only a subjective judg-

mental estimate--which they freely

admit--but also a single number that really

stands for a whole set of possible val-

ues--which they do not usually admit.

"True market value" is supposed to be

what a willing buyer would pay a willing

seller under specified conditions. But fu-

ture uncertainties are always so great that

different buyers would pay a range of dif-

ferent values under different--and often


The truth of Anthony Downs's statements should be obvious to appraisers who have worked through transaction negotiations to their conclusion. What competent appraiser has not questioned himself or herself about the inherent uncertainty in the appraisal process. Downs is not the only keen observer with this opinion. In October 1989, Vincent F. Martin, Jr., managing partner of TCW Realty Advisors, stated

[That] perceptions of value differ amongst

potential buyers of a given property is to-

tally evident to anyone who has partici-

pated in a purchase or sale of a tangible

asset. Many times the value disparities are

very significant....

We must know the nature of the real

estate market we work in in order to rec-

ognize its limiting factors and, within that

context, develop policies and procedures

to produce the information we need, al-

ways utilizing such information with the

knowledge of what it represents. The ap-

praisal process is not a sufficient substi-

tute for an efficient market pricing mech-

anism.... Having said this, we must

recognize that the valuation information

being produced and disseminated today

is being misused by a large segment of the

industry. Many investors still believe that

the financial reports show the precise value

of their investment. Consultants rank

managers in order of the yields they re-

port, sometimes to the first decimal place.(22)

Martin recommends the education of all parties involved. He continues, "The [appraisal] result is a single discrete numerical value, not a range of values. This process seems inherently flawed because, as we have seen, the valuation analysis is clearly an estimation process that can produce a range of values all of which can be reasonable under the circumstances."(23)

James Gibbons speaks cogently to issues of market value and risk as follows.

It cannot be stressed too strongly that the

broad general understanding of the term

value is that it is the present worth of an-

ticipated benefits of ownership. Valuation

is forecasting such benefits and discounting them

to present worth. Among others, we have

value types commonly labeled market

value, investment value, and liquidation

value. The principal difference between

them seems to be...who is making the

forecast and under what constraints it is

made. Market value then would flow from

"the market's" forecast of benefits, as in-

ferred from its recent market actions, dis-

counted at an earnings rate it gives evi-

dence of deeming acceptable considering

the investment risks it perceives. But there

are the other value types which are im-

portant and useful in today's markets.

Certainly bank regulators are interested in

liquidation values, although they appar-

ently prefer to have them described as

market value. This is causing bumpiness

in the paradigm. Thus, these other value

types seem to be subordinated to, or folded

into, the notion of there being one grand

market value definition that has universal

appraisal usability.... The best defini-

tion of an appraisal is that it is the answer

to a question about a real property inter-

est. The number of possible questions is

myriad. Market value cannot be the key

to answering all. I have always thought a

financial institution would be best served

by picking an expert, an appraiser in whose

abilities they have full confidence, and

having him estimate investment value to

a prudent investor.(24) (Emphasis added.)

Just so. The Appraisal Institute should now take a leadership position with respect to the issue of risk in the real estate appraisal process. There are simple methods of (at least implicitly) indicating the risk associated with a point estimate. One is the specification of a range of values. The use of this technique should not merely be accepted by the Appraisal Institute, but should be recommended and ultimately required. Appraisers would be more comfortable with a range, even if assessors and banks are not. There are many other risk reduction and reporting techniques that could also be useful.(25)

Directions and implications

The appraisal paradigm, as applied in the world of real estate investment, has been changing at a rapid rate during the past decade. It has reached a new evolutionary plateau where the capitalization of income by division of a single, stabilized net operating income estimate by a market-derived overall rate is an undersirable oversimplification except for the most basic of properties; a plateau where the operationalization of an explicit, rigorous market study component is becoming de rigueur in the appraisal of major properties, existing or proposed; where it is fully expected that the assumptions of the income approach, based on market research, are spelled out in detail and modeled in an appropriate spreadsheet format; where the plausibility of assumptions are standardly tested using the power of the microcomputer; and where lease-by-lease analysis is a requirement. Finally, a plateau has been reached where the ultimate question: Does this make sense given market conditions? is asked and answered based on a healthy but controlled skepticism. Can Appraisal Institute members adapt and function effectively on this plateau or will they be relegated to small local jobs?

Further change in the paradigm is desirable and inevitable. The trap of a totally linear appraisal worldview must be broken. There is a business cycle and a real estate cycle. Yet appraisers pretend otherwise in spreadsheet modeling of projects having futurities of about the same length as the period of the cycle. Appraisers still fail to take appropriate cognizance of risks inherent in the marketplace. By producing only a single market value estimate, giving no hint of relative risks, they pretend the appraisal process may be applied with equal precision (and accuracy) to all types of properties in all types of markets. Reinforcement of risk reduction techniques, such as the use of an explicit market study embodied in a spreadsheet format and the reporting of relative risk, even in some simple form, are needed now.

In the future, techniques and concepts of financial and investment analysis will be more fully incorporated into appraisal analysis, until the differences will be difficult to perceive (this has been occurring for years in the institutional investment community). To maintain its leadership in this dynamic situation, the Appraisal Institute needs to stay in the vanguard of the industry, instigating and propagating change rather than resisting or denying it. The needed changes are not just technical, they are attitudinal. Attitudes can be changed by the exercise of leadership in ethical standards and education, and by example. Change will not be accepted and implemented without such leadership. No organization is in a better or more natural position to exercise such leadership than the Appraisal Institute. The real question, then, is obvious.


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Chernow, Ron "Political Cowardice, Financial Panic." The Wall Street Journal (January 9, 1991).

Clark, David. "Forecasting Residential Rent Cycles: A Measure of Effect on Valuation." Real Estate Finance (Summer 1989): 53--66.

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Davis, Joseph M. "Cash Flow Model Analysis: Buy the Assumptions, Not the Investments." The Appraisal Journal (April 1985): 226--236.

Downs, Anthony. "Appraisal Practices Need Revision." National Real Estate Investor (June 1990): 30--32.

Downs, Anthony. "How the Current 'Credit Crunch' is Excessively Depressing Real Estate Values." Urban Land Institute (February 4, 1991).

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(1.)Webster's Twentieth Century Dictionary defines paradigm as "a pattern, example or model."

(2.)For example, in 1981 Charles H. Peterson asked "Are capitalization rates obsolete?" It is the question, not the answer, that is indicative of change. Also in 1981, Robert S. Martin and Steven L. Noble wrote "Capitalization Rates--The Future." In their excellent 1983 article, Peter F. Korpacz and Mark I. Roth described the "Changing Emphasis in Appraisal Techniques: The Transition to Discounted Cash Flow."

(3.)The author would like to acknowledge several unofficial reviewers of this article whose suggestions were sometimes incorporated into the manuscript without citation. In particular, thanks to James E. Gibbons, Peter F. Colwell, Al Gobar, Dowell Myers, Hugh Norse, Austin Jaffe, and especially Bob Foreman. The opinions expressed are, of course, the author's, as are the errors and oversimplifications.

(4.)There is, of course, no "old" paradigm, or for that matter a "new" one either. For expository purposes, a complex, natural, evolutionary process has been simplified.

(5.)In March 1982 the Federal Home Loan Bank Board (FHLBB) issued Memorandum R-41b in response to potential and perceived risk taking and loan losses in the newly deregulated thrift industry (unfortunately this memorandum was virtually unknown to the rank and file of the appraisal industry until 1984 or later). It described revised requirements for defining market value, for using discounting in appraisals of development properties, and for using market and economic feasibility data. Compliance with the memorandum became a matter of increasing concern to both the appraisal and thrift industries after 1983, when appraisal reviews revealed deficiencies in reports submitted to institutions in support of real estate projects and increasing real estate loan losses attracted the attention of Congress. In 1986, in response to sloppy loan underwriting and decision making at all levels, a revised and extended Memorandum R-41c was promulgated. It died aborning at the hands of the thrift industry itself, by then quite hooked on the "speed" of commercial investment. R-41c was a fair set of standards, which, if implemented, would have gone far toward avoiding the unfortunate debacle of the late 1980s.

(6.)Although appraisers cooperated in the self-destruction of the savings and loan industry, and subsequently acquiesced in taking the blame, the real blame lies with Congress's and the Fed's misguided policies in the early 1980s. (Only a national political authority like Congress has the power to destroy a multibillion dollar industry so quickly. The idea that appraisers were instrumental in the debacle is absurd on its face.) Clearly, the most important of these Congressional errors was inflation of the currency. To this we can add the ill-conceived deregulation of the savings and loan associations, the creation of new tax sheltered syndications, dramatic changes in depreciation periods for real estate, and $100,000 depository insurance. What Congress had given, it then took away. Lawrence Kudlow, speaking of the 1987 stock market crash, correctly indicated that, "The foolish 1986 tax bill significantly raised capital costs and lowered investment returns because it raised the capital gains tax, lengthened depreciation schedules, eliminated the investment tax credit and crushed real estate" (Wall Street Journal, October 15, 1992). Congress's basic response was to deal only with the symptoms of the problems they had caused by creating FADA, FIRREA, and RTC while avoiding meaningful structural reforms (e.g., of the federal deposit insurance system), reforms that were (and are) obviously needed and well within the proper domain of Congress.

(7.)Fear of protracted and costly litigation, often unwarranted by the facts, has forced banks to virtually close the "loan window." Gretchen Morgenson succinctly summarized the current situation: "In part because the RTC has terrorized everyone, small businesses, which created much of the growth of the 1980s, can no longer get financing to expand their operations. According to the National Federation of Independent Business, the fraction of firms borrowing on a regular basis today has fallen to 34%, from 41% ten years ago. Says Timothy Harris, a Los Angeles lawyer, 'The FDIC's eagerness to sue has made the threat of possible litigation a silent partner in every loan decision made in the U.S.'" (Forbes, September 1992). Timothy Ryan, Director of the Office of Thrift Supervision, spoke of OTS enforcement, and of its consequences, as follows. "But now we know that our [enforcements] have had some unintended consequences that concern us. Financial institutions are finding that well-qualified directors have been hard to attract and hard to keep. Directors are inhibited in their decision making by an abiding fear of personal exposure to litigation, a fear fed by efforts of some defense lawyers to distort our law enforcement actions.... This has hurt credit availability in the U.S. We know this firsthand because we have been conducting credit availability hearings around the country. When we bring together senior bankers, senior regulators and the most important borrowers, they tell the same story--only the accents and examples change. Fear of personal exposure to liability often leads bankers to say no to credit-worthy borrowers seeking to finance credit-worthy projects. The age-old "character loan" is a thing of the past. It is increasingly difficult for a banker to give a good customer more time to work out a problem loan. This attitude hurts every community" (The Wall Street Journal, November 13, 1992). Also see Anthony Downs's paper, "Banks and Real Estate: How to Resolve the Dilemma," published in 1991 by the Urban Land Institute.

(8.)12 CFR part 225.64. Adopted by the Board of Governors of the Federal Reserve System effective August 9, 1990.

(9.)Appraisal regulation will probably prove to be a costly mixed blessing at best. The appraisal paradigm was already quite naturally evolving in the direction that regulation is now driving. Now more costly, mandated regulatory "solutions" substitute the limited judgment of professional politicians and bureaucrats for that of market participants. Worse, it will codify solutions to what was a market "problem" long after the problem has worked its way out of the market. For example, a more skeptical view of appraisal licensing was presented by John B. Major in his unpublished paper "Appraisal Mythology: A Case Against Licensing," presented at the 1992 American Real Estate Society Convention. Major summarizes his thesis as follows. "Therefore, licensing appraisers will never eliminate real estate losses. Loss experience is a function of the risk taken and the investment made. This is beyond the control of the appraiser except for his ability to educate the decision maker about the risk inherent in real estate property. This is best done by evaluation of different scenarios likely as a result of ownership. He can then reduce losses to those who decide to opt out of certain risks." (Emphasis added.) Another skeptical article appeared in the Fall 1991 ORER Letter published by the University of Illinois at Urbana--Champaign. In their article, "Impact of Regulation on Appraisal Quality," Peter F. Colwell and Joseph W. Trefzger conclude that "Those who expect the best appraisers to thrive in a competitive market place by exceeding the regulatory standards are likely to be disappointed. If minimum standards are needed because users of appraisal services cannot discern unacceptable quality from acceptable quality, then it must be conceded that clients cannot discern definitionally acceptable quality from truly good quality." (Emphasis added.) What we see today is a "fill in the blanks" review form approach on the part of often incompetent RTC and FDIC reviewers, sometimes the same people who helped bring on the debacle.

(10.)Anthony Downs, "Appraisal Practices Need Revision," National Real Estate Investor (June 1990).

(11.)Needless to say, not everyone agrees with this identification. James Graaskamp, speaking at an American Institute of Real Estate Appraisers (AIREA) Research Symposium, stated that "Market research differs from appraisal for another reason. Until R-41c identified market research as a part of the appraisal function, there was really no compelling support for it and many lenders didn't require that it be done. In fact, some clients don't want to hear about market research because the discovery of an absent or weak market could kill a "good" project. Beside that, with the scientific method you always present conclusions as alternative scenarios. I learned from the banks in New York that in financial consulting, conclusions are always presented as alternative courses of action. The final choice is that of the client, which takes the consultant off the hook. Instead of providing a fixed number, appraisers should indicate a central tendency or range of alternative outcomes that apply to a specific set of circumstances. In this way they can begin to absolve themselves of at least some degree of error." (James Graaskamp, Research Report No. 2 of the AIREA Research Series Impacts of Regulation On the Appraisal Industry [Chicago: American Inst. of Real Estate Appraisers, 1986]).

(12.)Stephen Fanning, "Defining Market Analysis for Real Estate Appraisers," Research Report No. 3 of the AIREA Research Series Real Estate Market Analysis and Appraisal (Chicago: American Inst. of Real Estate Appraisers, 1987).

(13.)See, for example, Dowell Myers and Phillip S. Mitchell, "Identifying the Well Founded Market Study," pending, Urban Land Institute.

(14.)The requirement of a market study course for every member might be appropriate.

(15.)Spreadsheet analysis is the only viable tool for modeling the development process. It is almost inconceivable that spreadsheet analysis would not be used for major properties (new or existing) in today's real estate markets. Of course, spreadsheet models should utilize the results of the market studies discussed above as well as other data developed in the course of the appraisal or analysis, and should not be done mechanically.

(16.)Far from it. Peter Colwell, in a private correspondence, indicates that DCF analysis is over 100 years old.

(17.)Appraisal Institute, Statement on Appraisal Standard 2 (SMT-2).

(18.)In an unpublished correspondence, James Gibbons cogently stated his concern that spreadsheet modeling has been "...abused. With the development of numerous software packages, the process has often become mechanical rather than thoughtful. As one example, selecting a growth rate for income, sometimes improperly referred to as inflation (today's inflation is said to be about 4% but real estate values and rents are deflating), and then compounding it across a ten-year period can produce startling numbers. In my view of history, I doubt that we have ever had ten years of such compound growth. I am aware that some practitioners suggest that the growth rate is a level equivalent of expected future variability. The process also powerfully affects the reversion estimate.... Having said all these terrible things, I still believe in DCF thoughtfully executed and I certainly don't believe we could function without the huge blessings of computerization. Sensitivity analysis is such a vital component of our functioning."

(19.)The fundamental assumption of "direct capitalization" is that the identical periodic net operating income (NOI) will repeat indefinitely (i.e., to infinity). This appears to represent a series of "uncertain future events."

(20.)See William S. Harps, "The Pitfalls of Direct Capitalization," The Appraiser (June 1984): "The process of direct capitalization can be derived directly from the market, provided that pertinent adequate data are available. Among other things, the pertinent data must include dates, amounts, and all terms of existing leases. The principle of anticipation looks forward to all expected benefits, not yet produced, but probable. In a multileased property for which the rents can lag 5 to 20 years behind economic rents, risk and anticipation control the rate. For example, physically identical, multileased office buildings with different lease structures attract investors at widely varying prices. To conclude that two identical buildings would have the same market value when they are subject to different leases is erroneous and results in unwarranted, unsubstantiated value estimates from all approaches to value. The lack of adequate pertinent data and the lack of care in analysis exacerbates the problem.

The validity of the estimated value depends on the validity, adequacy, and analysis of the data used to generate the estimate. The concept has not changed and probably never will. In my opinion, the quantity and quality of the data to be analyzed has increased, and the analysis has to be in greater depth. During periods of stable markets between the peaks and valleys of the recurring economic cycles, gross income multipliers, overall rates, and in some cases prices in dollars per square foot of rentable area could be relied upon, particularly when an adequate number of sales is available to form a recognizable pattern."

(21.)Anthony Downs, "Today's Appraisals Are Unreliable," National Real Estate Investor (February 1992).

(22.)Vincent F. Martin, Jr., "Real Estate Valuation Policy and Procedures Revisited," unpublished.


(24.)James E. Gibbons, unpublished correspondence, April 1992.

(25.)Many are described in the Appraisal Institute seminar materials for "Real Estate Risk Analysis ... A Challenge to Professionalism."
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Title Annotation:includes appendix
Author:Mitchell, Philip S.
Publication:Appraisal Journal
Date:Apr 1, 1993
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