Market Analysis for Valuation Appraisals

by Stephen Fanning, MAI, Terry Grissom, MAI, Ph.D., and Thomas Pearson, MAI, Ph.D.
Published by Appraisal Institute, Chicago, 1994

Review by Stephen Traub, ASA

[Bookcover] ALTHOUGH APPRAISERS HAVE had a wealth of literature available to them to answer the age-old appraisal question, what's it worth, until recently there has not been much literature available to help them answer the questions: How did it become worth that, and is the present value sustainable?

The first step in any real estate appraisal is to define the problem. When all or part of the problem is to determine how the area, city, and neighborhood trends affect the anticipated benefits, therefore, the value of a piece of real estate, this book can show you how.

You are shown how to answer the "why" of value. To accomplish this, the authors present practical, step-by-step, hands-on methods using the tools and techniques of market analysis. They first present a conceptual view of the market analysis process by way of a standard six-step approach. Later, examples of its application are provided through a variety of in-depth, case studies.

Inferred vs. Fundamental Analysis

The most insightful point in the book is the distinction between the more-prevalent, yet less comprehensive inferred analysis method, and the less-prevalent, but more comprehensive fundamental analysis method. One of the questions appraisers constantly face when estimating the cost of an appraisal and/or performing an appraisal is: How much data, supporting information, and analysis is enough? The authors attempt to answer this question, by providing a practical checklist to help appraisers evaluate the type and level of analysis the appraisal requires given the nature of the appraisal assignment.

The general criterion for making this determination are the following:

Regulatory requirements;
Client or user needs;
Stability (or instability) of market conditions; and
Complexity of the property.

According to the authors, the major distinctions between the inferred method and the fundamental method are the following:

Inferred analysis is based on general trends which the appraiser uses to derive general inferences and to make general projections about the future. Fundamental analysis is explicitly quantified in detail to derive a specific conclusion about the present and/or an educated forecast about the future.
Inferred analysis principally is performed using the studies and surveys of others (secondary information sources). Fundamental analysis primarily relies upon one's own, problem-specific, data searches and surveys (primary data).

As the depth of analysis increases, an analysis will contain more layers and have more sophistication. If compared with clothing, the least sophisticated method, the Level A inferred method, might be compared with shorts and a tee-shirt, while the most formal and detailed fundamental analysis Level D, might be compared with the full regalia of black-tie attire. Depending on the circumstances, the authors indicate, however, that each of these levels of analysis has an appropriate place in property appraisal.

Supply and Demand

Moreover, they provide examples how market analysis can be directly integrated into the appraisal process. One example is the case in which they show the relationship between the well known, four factors of real estate value: 1) utility, 2) scarcity, 3) desire, and 4) purchasing power, and that of the basic building blocks of economics, supply and demand. They show how utility and scarcity are value components of the supply side, and desire and purchasing power are value components of the demand side.

They go on to say:

Through supply and demand analysis, the appraiser can identify and test the level of market support, which is critical in the analysis of highest and best use. Attributes of the property are identified and analyzed in a process called productivity analysis, [which allow an appraiser] to determine the marketability of a property in terms of the specific services it provides and the specific needs it satisfies.

Market analysis links the property's attributes to market preferences. Although real estate is physically fixed, [its attributes] can support a variety of uses. Therefore, [it] is said to be economically flexible.

Real Estate Cycles

They also examine the cyclical nature of the real estate market. They depict the normal cycle as follows:

Expansion
Slowdown
Contraction
Slowed contraction

They then provide techniques that will allow an appraiser to identify the current phase of the market cycle. More specifically, these techniques can help an appraiser determine whether the current market is in a position of excess demand, excess supply, or equilibrium. Models to determine space absorption (marginal demand) also are presented, finally, leading to techniques to determine a specific property's most likely capture rate (percentage of market absorption or market share).

Although this work contains an enormous amount of useful material of depth and breadth, I have two criticisms: 1) Redundancy of material exists among the case studies. 2) In a few cases, readers without prior exposure to or knowledge of economics, would not easily be able to grasp some of the concepts presented.

Still, to my knowledge, there has not yet been written, a more focused and/or comprehensive work on this crucial topic.

Additional information you will find within this work includes:

How to determine locational market boundaries, growth rates and directions of growth;
Understanding the varying motivations and decision criteria of lessees vs. owner-occupants vs. investors vs. speculators;
Case studies of the following property types: existing shopping center, existing office building, existing apartment complex, vacant land, and a proposed retail center; and
NCREIF's suggested market analysis outline for appraisals of investment-grade real estate.

Although the book, to some extent, goes beyond what is necessary for analysis of many existing properties, particularly in stable markets, still bits and pieces of these advanced techniques can enhance an appraiser's arsenal, even when analyzing less-sophisticated properties. On the other hand, this work is comprehensive enough to enable a seasoned appraiser to undertake the most complex viability or feasibility analysis even on a high-risk, proposed-development, or large ticket project.

In conclusion, if you need to know how a particular piece of property will perform in a particular location, now, and/or over time, this book -- as the authors intended -- can in fact show you how to make those determinations.

The book above is available on-line at Amazon Books.

Stephen Traub, ASA, the reviewer, is chief commercial appraiser for Property Valuation Advisors, 63 Hill St., Newburyport, MA 01950. He is a certified general appraiser in NH, ME and MA.

To contact the author of this review, e-mail to: straub@shore.net or contact him at the address above, or call 978-462-4347.

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