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.

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Dictionary Table of Contents

A

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 and 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.

B

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.

C

CAM Common area maintenance. 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 over estimates. See our lease audit services.

Capitalization The conversion of income into value.

Capitalization Rate A rate, commonly a percentage between seven 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 to 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 time table when the engagement is commenced.

Consulting, Task-Oriented Consulting on issues or projects where a traditional, well defined deliverable or time table is targeted from the beginning of the engagement.

Cost Approach One of the primary three approaches to value, the cost approach is an analysis 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.

D

Depreciation Most people understand physical depreciation, the loss in value due to aging, physical deterioration. As real estate and other assets age they often loss value. Proper appraisals not only reflect physical depreciation, they reflect also functional and external (economic) obsolescence. Functional obsolescence (or superadequacy) 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. Further, 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.

E

External Obsolescence See Depreciation

F

Functional Obsolescence See Depreciation

G

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. Its 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 pay 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.

H

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.

I

Income There are dozens of type 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 synonyms, such as NOI, Io, EBIT, EBITDA, Im, Ie. Each is used for different purposes and are not interchangable. Consequently, appraisers take great care to ensure they’ve calculated the right income for their analysis.

Income Approach The appraisal methodology that forecast 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).

J

K

L

M

N

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 pay 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.

O

P

Q

R

 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.

S

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.  

T

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 pay 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.

U

V

W

X

Y

Z

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.