Common Fallacies and Mistakes Mark Pomykacz, MAI, has compiled a list of the six most common fallacies and mistakes surrounding real estate and business appraisal and consulting. Some of these fallacies could be considered humorous if it weren’t for the fact that they cause significant problems and cost the real estate community millions of dollars. Mostly, it is laymen and novices whose succumb, but all too often experts also fall victim, while the business and appraisal communities do little to dispel these myths. Fallacy / Mistake #1Laypeople mistakenly believe that appraisers only work for banks, providing expensive, full volume appraisals for loans, and that appraisers cannot provide other services.Truth  Appraisers can and should be used for many types of services, issues, and assets. Appraisers can provide services for many valuation issues, including estimating value, income, and returns, for any asset type, for any type of client. Appraisers can report their appraisals in various formats from executive summaries to full narratives. Most importantly, since they are uniquely qualified, they should not only be utilized for appraisal reporting, but should be utilized for various consulting services, including feasibility, market analysis, due diligence, arbitration and mediation, and any other activity involving the analysis of real estate or business value, income and returns, its market, and requiring strict objectivity and high standards of professional practice. Appraisers, because of their rigorous training and professional standards, are extremely well qualified to provide numerous consulting (non-appraisal) services involving value, income, and returns. See our services pages for details on all the services available to our clients. Fallacy / Mistake #2Laypeople confuse market value for value-in-use, investment value, and others.TruthThere are many different kinds of value. Market value is the most commonly appraised. Market value is the basis for loan collateral, condemnation awards, arms-length sales, and others. But the other values must be understood in order to properly utilize the market value information. For example, consider a market value (the value in the eyes of the typical seller and buyer) for a business or real estate of $1,000,000. Further, consider one particular buyer’s investment value, based on his personal investment criteria, of $1,250,000. This particular buyer would be making sound business decisions even if he paid more than market ($1,000,000), so long as he did not pay more than $1,250,000. Federal Appraisal often provides free scoping consulting to guide the client through the value-distinction process, and to ensure the client receives the type of value and service needed. See our services pages for details on all the services available to our clients. Fallacy / Mistake #3Laypeople confuse the various estates, interests, and assets in real estate and businesses.TruthIn commercial real estate and in businesses, it is essential to understand and differentiate between the various estates, interests, and assets. Depending on the client’s need, different estates, interests, and assets may be appraised differently. Some examples include appraising the fee simple estate for property taxes, while appraising the leased fee estate for a loan, while for condemnation, appraising the leased fee and fee simple for the landlord and leasehold for the tenant. Further, consider appraising the real property at a hotel or mall, while excluding business assets for property in a property tax assessment appeal. Additionally, consider all asset values, incomes and returns for a damage estimate. Lastly consider real, personal, and intangibles in state transfer tax filing or cost segregation study for IRS depreciation. Federal Appraisal often provides free scoping consulting to guide the client through the process of distinguishing between estates, interests, and assets, and to ensure the client receives the type of value and service needed. See our services pages for details on all the services available to our clients. Fallacy / Mistake #4Laypeople mistakenly believe that assessed value is directly comparable to market value. Laypeople mistakenly believe that book value is equal to market value.TruthAssessed value is rarely directly comparable to market value. In most cases, the assessed value is percentage of market value. The percentage can be referred to the equalization rate, the assessment ratio, or others. It is simply the ratio of assessed value to market value, and should be established by the taxing jurisdiction, consistently throughout the jurisdiction, for the property class. To compare the assessed value to the market value, equalize the assessed value by dividing it by the equalization ratio, then compare the equalized assessed value to the market value. Book value is an accounting defined and derived value and need not have any relationship to market value. Market value is defined and derived by appraisers. Most often, book value does not equal market value. For some accounting purposes book value is needed. When market value is needed, do not use book value. Federal Appraisal often provides free scoping to determine if a tax appeal is needed or whether a tax assessment compares favorably to market value. See our property taxes services pages for details on the related services available to our clients. Fallacy / Mistake #5Laypeople get confused with the various building area measurements.TruthThere are numerous building area measurements. Some have official definitions and others do not. Some are calculated using engineering precision. Others are negotiated. When buying, renting, or analyzing a building or a unit within a building, be sure to determine how the advertised area is defined, and use a similar definition when comparing the area to other buildings or units. When considering a space, be sure to obtain a net usable square footage estimate. Fallacy / Mistake #6Laypeople get confused with gross and net leases.TruthSometimes the landlord pays for the operating expenses, common area maintenance, utilities, real estate taxes, insurance, advertising, and capital repairs. Sometimes the landlord pays only some of these expenses. Sometimes the tenant pays all or nearly all of these expenses. A gross lease is one where the landlord pays the expense(s). A net lease is one where the tenant pays the expense(s). A “triple net” lease is not officially defined but is generally meant to describe a lease where the tenant pays operating expenses, utilities, and taxes: however, because operating expenses is not a universally defined term and other expenses may also be included or excluded, the term “triple net” lease, is the cause of common, and costly confusion. When renting or analyzing a lease, be sure to obtain and understand the lease’s definition of gross, net, and triple net, and do not assume your definition is the same at the landlord’s. See our lease auditing services pages for details on the related services available to our clients

FAQs FAQs The Appraisal Institute has compiled a list of commonly asked questions about appraisers and appraisal: Q: What is an appraisal (real estate)? A: It is the process of valuation real property, usually to find market value. Q: What are appraisers? A: People who identify and provide values for real property, which can include real property, personal property, machinery and equipment, business valuation, and even appraisal review. Q: What is defined as real property? A: Real property is any property that is attached to the land, as well as the land itself. It not only includes buildings and improvements, but also rights and interests. It can be fee simple or leased fee. Q: Why would I need an appraisal? A: There are many needs for appraisals such as for litigation, managing planning, estate tax, and more. Please visit our Purpose & Use section of the website for more examples.

Plain Language Dictionary Mark Pomykacz, MAI, has compiled a plain language dictionary of appraisal terms that are commonly misunderstood. While technical and legal definitions abound in the real estate industry, there remains a gap between the highly technical expert’s understanding and the beginner’s understanding. The purpose of this dictionary is to bridge that gap, help prevent costly mistakes and to improve market performance. Mr. Pomykacz provides plain language definitions for these commonly misunderstood terms, along with real world examples and practical advice. Readers of this page are encouraged to also read the common fallacies and mistakes pages. Dictionary Table of Contents Allocation The division of an overall appraised value or sale price of a business or property among the various component assets of that business or property. Commonly, allocations are performed for taxing purposes: property taxes (allocated between land and building), transfer taxes (real property, personal property, and exempt property), and income taxes (real property of various classes, personal property of various classes, and intangibles of various classes). Allocations are also made for SEC/investor reporting, along real, personal, and intangible classifications. Debt, equity value, and other allocations are also made. See purchase price allocation and cost segregation studies. Appraisal An opinion of value, sometimes written, sometimes oral. Government agencies and banks often provide detailed definitions of appraisal that sometimes are not consistent with each other. For example, some allow appraisals to be written by unlicensed appraisers. While others require licensed and MAI designated appraisers. You get what you pay for. Appraisals cost thousands of dollars, sometimes tens of thousands of dollars, but given the value of the assets under appraisal, and given the costs associated with damage control should the asset prove to be non-performing or the appraisal prove to be noncompliant, appraisals should be viewed as at least an insurance policy. At best, appraisals should be viewed as an integral part of or essential complement to a company’s own due diligence process. Therefore, even though many brokers and accountants provide valuation opinions at low to no cost, the most prudent course of action is to obtain the services of the seasoned appraisal professional. Order a USPAP compliance report, whether it is required or not. Appraisal Report There are three narrative appraisal report formats; complete (full) narratives, summary narratives, and limited narratives, as defined by USPAP. Also, there are two types of appraisal scope of services: complete (full) analysis appraisals and restricted analysis appraisals, according to USPAP. See our USPAP pages. Even if a consultant reported that you need not comply with the USPAP requirements for an appraisal report, compliance is strongly recommended. Approaches to Value AKA: the Three Approaches to Value. See the individual sales, cost, and income approaches below. For income producing properties and businesses, when reliable income data is available, the income approach rules, and the other approaches play supporting roles. Assessed Value Established by the assessor, assessed value is often the statutorily established percentage of market value. One must apply the assessed value to market value ratio to the assessed value to determine the assessor’s opinion of market value. Many novices mistakenly believe that they are under assessed, because they confuse assessed value with market value. Band of Investment Analysis A Band of Investment Analysis is a weighted average of the elemental yield rates or of the elemental capitalization rates of investment, i.e., equity investment rates and debt investment rates. The mortgage equity and investment analysis is one of the most common analyses used to determine overall property capitalization rates. Book Value Book value is an accounting defined and derived value and need not have any relationship to market value. Market value is defined and derived by appraisers. Most often, book value does not equal market value. For some accounting purposes book value is needed. When market value is needed, do not use book value. Broker’s Opinion of Value or Broker Price Opinion (BPO) Not an appraisal. Remember that you get what you pay for. Business Appraisal The process of finding the economic value of an owner’s interest in a certain business. It is the appraisal of the combination of assets, real property, personal property, and business intangibles that make up a going concern or enterprise. Common Area Maintenance (CAM) The definitions of CAM vary widely. So be sure to obtain a through definition before you sign a lease. Also, regularly check your landlord’s calculations of CAM for under or overestimates. See our lease audit services. Capitalization The conversion of income into value. Capitalization Rate A rate, commonly a percentage between 7 percent and 12 percent, used to convert an estimation of next year’s net operating income into estimation of value. There are numerous ways to determine capitalization, including various mathematical formulas and market surveys. The higher the risk in a property, the higher the cap rate and the lower the value. Sometimes equivalent to the yield rate minus the inflation rate on the value and income. Great care must be exercised when determining capitalization rates so as not to confuse the capitalization rates with the various but not equivalent yield rates and other rates employed within the income approach to value, and to ensure that the proper kind of capitalization rate is matched with its proper income type. Cash Flow The periodic income, usually annual income, expected from an interest in real estate or a business. Also see “Income”. Consulting, Process-Oriented Consulting on issues or projects where there is no obvious or well-defined deliverable or timetable when the engagement is commenced. Consulting, Task-Oriented Consulting on issues or projects where a traditional, well-defined deliverable or timetable is targeted from the beginning of the engagement. Cost Approach One of the primary three approaches to value, the cost approach is an analysis of the cost to build a replacement property. A cost approach should consider part in soft costs, physical, functional, and external obsolescence, the cost to acquire the interests in the land, and entrepreneurial profit. Depreciation Most people understand physical depreciation, the loss in value due to aging and physical deterioration. As real estate and other assets age they often lose value. Proper appraisals not only reflect physical depreciation, but also functional and external (economic) obsolescence. Functional obsolescence (or super adequacy) is the loss in value (value measured as the cost to build) due to bad design. For example, multi-story warehouses suffer functional obsolescence, because today users prefer one story warehouses. External obsolescence refers to conditions occurring off site, that negatively value. For example, many power plants suffered external obsolescence immediately following deregulation, because their new lower or riskier income under deregulation no longer supports their cost of construction. Direct Capitalization Direct capitalization converts next year’s estimated net operating income into a value. While the math is simple to calculate, because of the limited number of inputs into the model, this approach can be less accurate than the DCF, especially when future income and values vary significantly from year to year. Discounted Cash Flow Analysis (DCF) A discounted cash flow analysis uses the mathematics of compounding and discounting to convert the cash flow expected from an investment in real estate or business into an estimation of market value. The cash flow is discounted using a yield rate, which is analogous to the internal rate or return. While difficult to construct and analyze (given the relatively large number of inputs), the approach is preferred for its accuracy. Furthermore, the technique is necessary when future income and value will vary significantly from year to year. Discount Rate The rate used to discount a cash flow in a DCF. AKA yield rate. Commonly between 8 and 15 percent for common real estate types. The higher the risk in a property, the higher the discount rate, and the lower the value. Sometimes equivalent to the capitalization rate plus the inflation rate on the value and income. External Obsolescence See Depreciation Functional Obsolescence See Depreciation Good Will An intangible business asset, such as company or product name, franchise or reputation, or a customer list that generate value above the value of the hard (real, machinery and equipment, and personal) assets and the soft (intangibles, such as contracts) assets. It’s often measured as the difference between the sum of the values of all other assets and the sale price. Gross Lease Sometimes the landlord pays the operating expenses, common area maintenance, utilities, real estate taxes, insurance, advertising, and capital repairs. Sometimes the landlord pays only some of these expenses. Sometimes the tenant pays all or nearly all of these expenses. A gross lease is one where the landlord pays the expense(s). A net lease is one where the tenant pays the expense(s). A “triple net” lease is not officially defined but is generally meant to describe a lease where the tenant pays operating expenses, utilities and taxes; however, because operating expenses is not a universally defined term and other expenses may also be included or excluded, the term, “triple net” lease, is the cause of common, and costly confusion. When renting or analyzing a lease, be sure to obtain and understand the lease’s definition of gross, net, and triple net, and do not assume your definition is the same as the landlord’s. See our lease auditing services pages for details on the related services available to our clients. Highest and Best Use That use which is typical, legal, physically practical, and yields the highest value and return. Assuming the highest and best use is critical to a market value appraisal. Assuming a particular investor’s/buyer’s use, when that use is not the typical, will result in an investment value or value in use that is different from market value. Income There are dozens of types of income and cash flow, including potential or effective gross income, net operating income before or after capital expenditures, cash flow before and after debt or taxes. They sometimes have acronyms, such as NOI, Io, EBIT, EBITDA, Im, Ie. Each is used for different purposes and are not interchangeable. Consequently, appraisers take great care to ensure they’ve calculated the right income for their analysis. Income Approach The appraisal methodology that forecasts future income and converts it into a value. There are two major types of Income Analysis: Direct Capitalization and Yield Capitalization (AKA Discounted Cash Flow). Net Lease Sometimes the landlord pays the operating expenses, common area maintenance, utilities, real estate taxes, insurance, advertising, and capital repairs. Sometimes the landlord pays only some of these expenses. Sometimes the tenant pays all or nearly all of these expenses. A gross lease is one where the landlord pays the expense(s). A net lease is one where the tenant pays the expense(s). A “triple net” lease is not officially defined but is generally meant to describe a lease where the tenant pays operating expenses, utilities, and taxes; however, because operating expenses is not a universally defined term and other expenses may also be included or excluded, the term, “triple net” lease, is the cause of common, and costly confusion. When renting or analyzing a lease, be sure to obtain and understand the lease’s definition of gross, net, and triple net, and do not assume your definition is the same as the landlord’s. See our lease auditing services pages for details on the related services available to our clients. Real Property Real property includes not only buildings but also any improvements as well as the land itself. It also includes the rights or interests to the property. Sales Comparison Approach One of three appraisal methodologies which compare a subject property’s characteristics to similar properties that were recently sold called comparables. Consideration (adjustments) is made for the differences in characteristics between the subject and these comparable properties. The adjusted indications of value are reconciled to come up with a final conclusion. Triple Net Lease Sometimes the landlord pays the operating expenses, common area maintenance, utilities, real estate taxes, insurance, advertising, and capital repairs. Sometimes the landlord pays only some of these expenses. Sometimes the tenant pays all or nearly all of these expenses. A gross lease is one where the landlord pays the expense(s). A net lease is one where the tenant pays the expense(s). A “triple net” lease is not officially defined but is generally meant to describe a lease where the tenant pays operating expenses, utilities, and taxes; however, because operating expenses is not a universally defined term and other expenses may also be included or excluded, the term, “triple net” lease, is the cause of common, and costly confusion. When renting or analyzing a lease, be sure to obtain and understand the lease’s definition of gross, net, and triple net, and do not assume your definition is the same as the landlord’s. See our lease auditing services pages for details on the related services available to our clients. Zero Cash Flow Net Leases (AKA: Net Zero Leases or Zeros) are an estate planning and investment strategy tool and are often used in conjunction with 1031 and 1033 exchanges. The strategy is to accept low annual equity cash flows in exchange for lower investment risk, a minimal down payment, higher tax write-offs, and a high reversionary/residual equity value. The estate acquires a property, with a low down payment (often less than 20%). Sometimes the investor pays with cash proceeds from a 1031 exchange, but then refinances thereby extracting equity without severe tax consequences. The acquired property has a lease with a high credit-rated tenant that calls for lease payments that merely cover the debt service. Thus, the net cash flow to the equity interest during the term of the lease is at or near zero. During the lease, the investor enjoys high tax write-offs for depreciation and the interest expense. The debt is paid off during the term of the lease, so the equity interest in the reversion (residual value after the lease expires) is high.

Business Improvement Ideas How to Improve Your Business by Managing Your Real Estate and Using Appraisal and Appraisal Consulting Services. Real estate represents one of the largest capital outlays for businesses. Even leased real estate, where rental payments exceed the market value of the fee simple real estate after seven to ten years, amounts to one of the largest operating expenses for businesses. Yet few businesses have professional staff dedicated to the management of their real estate. Consequently, all too often real estate assets are not maximizing their potential yield for their businesses. Not only does this impact corporate income and returns to shareholders, but it also consumes excessive capital, distracts staff from the business core focus, and it often negatively impacts business flexibility due to the lack of proper real estate for their core business operation. Federal Appraisal & Consulting LLC is dedicated to helping its clients maximize their profits and returns, which is more critical than ever in this ever-changing, fast paced, competitive business environment. Here are several actions that businesses can take to maximize their real estate investment yields and values. 1. Strategic Planning Develop and maintain a place for real estate in the company strategic plan. By integrating real estate into its strategic planning, companies can transform their real estate (owned or leased) from an isolated cost center into a strategic asset. Among other benefits, a strategic plan that includes real estate will help companies use space more efficiently, achieve greater flexibility in space utilization and core business operations, and reduce operating costs. While the strategic planning should be coordinated by a senior real estate professional, such as an MAI designated appraiser, overall, this is a team effort. Much of the support for strategic planning must come from numerous sources, including appraisers, consultants, accountants, attorneys, engineers, brokers, and property managers. Federal Appraisal & Consulting LLC provides numerous appraisal and consulting services to large corporations and small businesses, individuals, and their managers and fiduciaries for the purpose of real estate strategic planning. We also offer various issues solutions and management solutions that assist in the strategic planning for real estate. Follow the links above for more information. 2. Surplus Real Estate Eliminate surplus real estate. Surplus assets include un-utilized and under-utilized real estate and can be owned or leased or can even include real estate that does not maximize market share, distribution, or corporate goals. Largely overlooked in large corporations, often small companies fail to address this issue for lack of work force and other priorities. Once identified, a holding/disposition program should be implemented. The program should reflect the goals of the company strategic plan. The program will resolve the surplus through sales, leasing, gifting, conversion/development/restructuring to new uses and to other alternatives as discussed herein. The surplus real estate elimination program should be a team effort, and includes appraisers to identify surplus and set acceptable prices and yields. Federal Appraisal & Consulting LLC provides numerous appraisal and consulting services to large corporations and small businesses, individuals, and their managers and fiduciaries for the purpose of eliminating surplus real estate. We also offer various issues solutions and management solutions that assist in the strategic planning for real estate. 3. Alternatives to Simple Ownership and Simple Leases Employ special financing and transfer structures, such as sale-leasebacks or other structured lease transactions, 1031 exchanges, barter transfers, and securitization (monetization). Such structures help businesses move real estate assets off their books, cut costs and raise capital for new investment or other purposes. Federal Appraisal & Consulting LLC provides numerous appraisal and consulting services to attorneys and accountants for purposes such as deal and financial structuring. See our Accountants and our Attorneys pages. 4. Cost Reduction Strategies & Tactics 1. Review real estate operations, management, and administration. Analyze basic costs, such as contract services, staffing, janitorial, utilities, security, general maintenance, parking, electromechanical and plumbing, elevators and escalators, and preventive maintenance. Employ benchmarking and best practice studies to analyze the performance of a company real estate against its competitors. Review a company’s organization and management structure as it relates to its real estate operations. Federal Appraisal & Consulting LLC provides customized research and consulting services. See our issues solutions and management solutions and research services pages. 2. Conduct Lease Audits. Lease audits examine landlords pass through rents and expenses, such as operating expenses, CAM, real estate taxes, utilities, and insurance, and help companies identify errors and recover overcharges. Audit/analyze all major leases prior to execution and then every several years or as required by the lease. Lease audits should be conducted by an appraiser experienced with accounting records or accountant familiar with lease analysis. Lease analyses, because they are forward looking, should be conducted by appraisers. Federal Appraisal & Consulting LLC provides lease audit and analysis services. See our Lease Audit and Analysis page. 3. Actively manage property taxes. Such management ensures that companies pay no more than their fair share of real and personal property taxes. This should include an annual review of all real estate assets with market values over $3,000,000. Even leased real estate should be reviewed annually, since most leases give tenants rights to appeal assessments. The review should be conducted by an appraiser or a professional with real estate valuation and property tax experience. Federal Appraisal & Consulting LLC provides complete property tax management and appeals services. See our Property Tax and Property Tax Management pages. 4. Segregate costs. Cost segregation improve the depreciation of various elements of a real estate asset and can dramatically increase after-tax cash flows. Conduct a cost segregation study immediately after completing construction or after acquisition. The study should be written by an appraiser or engineer with accounting experience. Federal Appraisal & Consulting LLC provides complete segregation services. See our Cost Segregation page. 5. Manage income taxes. Actively seek out real estate tax savings ideas. We have listed many ideas in this article, but many others exist. Management should maintain relationships with accountants, attorneys, and other real estate professionals, such as appraisers, for the purpose of seeking tax saving ideas for their real estate. See our Tax Savings page for more information on this topic. 6. Maintain vigilance concerning environmental issues, legal issues, and development and use rights issues. Such issues require management activities off-site, often where and with whom managers are not accustomed to operating; however, proper vigilance can avoid non-compliance issues, damage to title and to marketability, and can ensure a proper holding/disposition strategy. Management should maintain relationships with various types or real estate professionals, in particular appraisers and brokers, for the purpose of maintaining information about the market that their real estate is in. This service is most likely to be provided by local professionas: appraisers, brokers, property managers, or attorneys. Federal Appraisal & Consulting LLC provides customized research and consulting services. See our issues solutions and management solutions and research services pages.