ABOUT APPRAISING
Cost, Value and Fractional Appraisals"What use is it to know the cost of everything and the value of nothing?"
Often the distinction between cost and value is lost in the appraisal of personal property. Value is a measure of the future utility of property. Cost is the monetary equivalent of that property for the purposes of an exchange. Sometimes the two terms are numerically equal, more often they are not.(1)
The concepts that separate cost from value are familiar to any layman who has had to assemble a knocked down piece of furniture, watched a celebrity's property being auctioned off, or was surprised by the bottom line in the contract for sale of an automobile.
Overheard at the Café Boeuf: "Garçon, there must be some mistake? Costco sells ..."
The most important tool the personal property appraiser has is the market approach to value.(2). The value of the subject property is based on the selling prices of comparable items. Unfortunately, reported selling prices of comparables often do not include many of the costs that may be associated with the item being appraised. Specifically they usually do not include sales tax, delivery, installation, commissions, decorator fees, engineering or the effort and time that it may take to simply locate and buy something. Often much of the value in property is added after its acquisition. Picasso's canvas was enhanced by his judicious application of paint. A business' most valuable tangible assets may be property like jigs, molds, and computer software made by employees with most costs expensed and having little or no resale value except as part of the business.
"10-Cents on the dollar"
Appraisal results can be very different depending on the purpose of the appraisal. In liquidation, the subject's relationship with property not being valued is usually not important. On the other hand, replacement value includes all the costs necessary to bring the property into use, often in conjunction with other property.
The difference between liquidation value and replacement cost for property not in use is reduced to costs of sale. Instances can include the assets of a defunct business awaiting liquidation, the stock-in-trade of a retail store, out of service machinery and equipment, and stuff in your attic waiting for a use or a garage sale.
Very rarely do items of personal property exist apart from other property that may or may not be the subject of valuation. A glove is usually part of a pair and the pair of gloves part of wardrobe. Drapes are part of the furnishings of home. A computer may be part of a network. Conversely, each of these items can exist alone, abandoned on the sidewalk or sitting on a loading dock, with no relationship to any other objects. Whether the property is to be considered with or without regard to its ownership and relationship to other property, is fundamental to the appraisal process. For example drapes may have significant value as part of a home, but little value once removed.
"A bird in the hand is worth two in the bush."
Often a significant effort can be required to replace a subject property. A machine in service as part of a production line may have significantly greater value than a comparable one that might take months to acquire and put into service. Similarly the furnishings of a residence make it habitable and the time and effort required to furnish a home significantly adds to the value of the contents.
"A rose by any other name "
In the preceding I have italicized the word "part" because it has a special meaning here. It is used to signify that the item being appraised is being considered as part of an integrated whole property, taking into account its ownership and relationship with other property not being appraised. When valuing an item independent of its ownership, use, and relationship to the integrated whole property, the item is described as afraction rather than a part; and the appraisal as a fractional appraisal. Fractional appraisals are often misleading. It is recommended appraisal practice that fractional appraisals should be clearly identified as such.(3). In practice, often they are not. Fractional appraisals have limited application. With regard to personal property, their use may be appropriate for valuing loan collateral, bankruptcy and estate tax applications. In real estate they may be used for the insurance valuation of buildings without consideration of the land. They are not appropriate for general application to items in use except where they may be jurisdictionally mandated.
Following are common terms identified with respect to the concepts ofparts and fractions
In addition to the market approach to value, appraisers often rely on thecost approach. In the cost approach the value is based on the historical cost first trended to accommodate the effects of inflation and then adjusted for obsolescence. Historical cost is usually taken from the owner's records. The cost approach is often utilized when comparable sales data is not available and for mass appraisals where the cost ofmarket approach appraisals would be prohibitive.
Cost records usually include sales tax, delivery, installation, commissions, decorator fees and engineering. When the cost approach is used, these elements of value are consequently included in the valuation. A fractional appraisal utilizing the market approach would likely not include the preceding. In general, market approach appraisals yield results significantly less than the value indicated by the cost approach. The differences are often argued as being the result of flaws in the cost approach. However, it is as likely the result of the appraiser's neglect of value elements built into historical cost, and not included in his analysis. Compounding the differences, the costs of locating and bringing used property into service may be greater than that of new property.
How do you get there from here?
i - Market Approach
On rare occasions personal property can be valued by the income approach. It is required that the property generate income that can be segregated from other elements of a business. This usually occurs where the property is owned specifically for rent. Property valued by the income approach will yield value based on part of an integrated whole property. In the event that the capitalized income is less than the value as a fraction separated from the whole property, the fractional value becomes the lower limit of value.
Summary
In valuing personal property, except in the case of fractional appraisals, consideration has to be made for all the costs required to bring the object into its existing use, and for any other special considerations attendant to its ownership. In the market approach, the appraiser's job only starts with the location of a comparable sales records. The difference between cost and value is quantifiable and its measure is what makes appraising an art.
References
1. Babcock, Henry A., Appraisal Principles and Procedures, ASA Washington DC 1980, p-95.
2. State of Florida, Manual of Instructions for Ad Valorem Taxation,Standard Measures of Value Pertaining to the Assessment of Tangible Personal Property and Inventory, Tallahassee FL.
3. Code of Ethics, ASA Washington DC, Revised January 1994, 6.3 and 8.3.
© Copyright by Harris J. Samuels
Cost, Value and Fractional Appraisals"What use is it to know the cost of everything and the value of nothing?"
Often the distinction between cost and value is lost in the appraisal of personal property. Value is a measure of the future utility of property. Cost is the monetary equivalent of that property for the purposes of an exchange. Sometimes the two terms are numerically equal, more often they are not.(1)
The concepts that separate cost from value are familiar to any layman who has had to assemble a knocked down piece of furniture, watched a celebrity's property being auctioned off, or was surprised by the bottom line in the contract for sale of an automobile.
Overheard at the Café Boeuf: "Garçon, there must be some mistake? Costco sells ..."
The most important tool the personal property appraiser has is the market approach to value.(2). The value of the subject property is based on the selling prices of comparable items. Unfortunately, reported selling prices of comparables often do not include many of the costs that may be associated with the item being appraised. Specifically they usually do not include sales tax, delivery, installation, commissions, decorator fees, engineering or the effort and time that it may take to simply locate and buy something. Often much of the value in property is added after its acquisition. Picasso's canvas was enhanced by his judicious application of paint. A business' most valuable tangible assets may be property like jigs, molds, and computer software made by employees with most costs expensed and having little or no resale value except as part of the business.
"10-Cents on the dollar"
Appraisal results can be very different depending on the purpose of the appraisal. In liquidation, the subject's relationship with property not being valued is usually not important. On the other hand, replacement value includes all the costs necessary to bring the property into use, often in conjunction with other property.
The difference between liquidation value and replacement cost for property not in use is reduced to costs of sale. Instances can include the assets of a defunct business awaiting liquidation, the stock-in-trade of a retail store, out of service machinery and equipment, and stuff in your attic waiting for a use or a garage sale.
Very rarely do items of personal property exist apart from other property that may or may not be the subject of valuation. A glove is usually part of a pair and the pair of gloves part of wardrobe. Drapes are part of the furnishings of home. A computer may be part of a network. Conversely, each of these items can exist alone, abandoned on the sidewalk or sitting on a loading dock, with no relationship to any other objects. Whether the property is to be considered with or without regard to its ownership and relationship to other property, is fundamental to the appraisal process. For example drapes may have significant value as part of a home, but little value once removed.
"A bird in the hand is worth two in the bush."
Often a significant effort can be required to replace a subject property. A machine in service as part of a production line may have significantly greater value than a comparable one that might take months to acquire and put into service. Similarly the furnishings of a residence make it habitable and the time and effort required to furnish a home significantly adds to the value of the contents.
"A rose by any other name "
In the preceding I have italicized the word "part" because it has a special meaning here. It is used to signify that the item being appraised is being considered as part of an integrated whole property, taking into account its ownership and relationship with other property not being appraised. When valuing an item independent of its ownership, use, and relationship to the integrated whole property, the item is described as afraction rather than a part; and the appraisal as a fractional appraisal. Fractional appraisals are often misleading. It is recommended appraisal practice that fractional appraisals should be clearly identified as such.(3). In practice, often they are not. Fractional appraisals have limited application. With regard to personal property, their use may be appropriate for valuing loan collateral, bankruptcy and estate tax applications. In real estate they may be used for the insurance valuation of buildings without consideration of the land. They are not appropriate for general application to items in use except where they may be jurisdictionally mandated.
Following are common terms identified with respect to the concepts ofparts and fractions
- 1. Fair Market Value - Value as a part of an integrated whole property.
2. Fair Market Value-in-place - Value as a part of an integrated whole property.
3. Fair Market Value-in-exchange - Fractional value.
4. Fair Market Value - Estate Tax Purposes - Fractional value.
5. Fair Market Value - Tangible Personal Property Tax Purposes - Value as a part of an integrated whole property.
6. Liquidation Value - Fractional value adjusted for costs of sale.
7. Salvage Value - Fractional value of component parts adjusted for costs of sale.
8. Actual Cash Value - Value as a part of an integrated whole property by the cost approach.
9. Highest and Best Use - Incorporation into the integrated whole property that maximizes the value of the subject property.
In addition to the market approach to value, appraisers often rely on thecost approach. In the cost approach the value is based on the historical cost first trended to accommodate the effects of inflation and then adjusted for obsolescence. Historical cost is usually taken from the owner's records. The cost approach is often utilized when comparable sales data is not available and for mass appraisals where the cost ofmarket approach appraisals would be prohibitive.
Cost records usually include sales tax, delivery, installation, commissions, decorator fees and engineering. When the cost approach is used, these elements of value are consequently included in the valuation. A fractional appraisal utilizing the market approach would likely not include the preceding. In general, market approach appraisals yield results significantly less than the value indicated by the cost approach. The differences are often argued as being the result of flaws in the cost approach. However, it is as likely the result of the appraiser's neglect of value elements built into historical cost, and not included in his analysis. Compounding the differences, the costs of locating and bringing used property into service may be greater than that of new property.
How do you get there from here?
i - Market Approach
- Develop the basic or raw cost from an analysis of data on comparables.
- Adjust the raw cost for factors that might not be included in the data including buyers' premiums and sales tax.
- Add the following to the adjusted comparable data:
- Delivery and Installation,
- Engineering and design,
- Brokers' commissions,
- Cost of repairs (many sources of comparable cost data do not include condition in their property descriptions), and
- Allowance for in-house purchasing costs
- Develop the depreciated replacement cost new from historical cost or replacement cost new.
- Adjust for expensed factors including delivery, installation, engineering, design and purchasing costs. Custom manufactured property such as computer software, manufacturing dies, molds and jigs are often, in large part, expensed. Their reported costs may only be a small fraction of their value
On rare occasions personal property can be valued by the income approach. It is required that the property generate income that can be segregated from other elements of a business. This usually occurs where the property is owned specifically for rent. Property valued by the income approach will yield value based on part of an integrated whole property. In the event that the capitalized income is less than the value as a fraction separated from the whole property, the fractional value becomes the lower limit of value.
Summary
In valuing personal property, except in the case of fractional appraisals, consideration has to be made for all the costs required to bring the object into its existing use, and for any other special considerations attendant to its ownership. In the market approach, the appraiser's job only starts with the location of a comparable sales records. The difference between cost and value is quantifiable and its measure is what makes appraising an art.
References
1. Babcock, Henry A., Appraisal Principles and Procedures, ASA Washington DC 1980, p-95.
2. State of Florida, Manual of Instructions for Ad Valorem Taxation,Standard Measures of Value Pertaining to the Assessment of Tangible Personal Property and Inventory, Tallahassee FL.
3. Code of Ethics, ASA Washington DC, Revised January 1994, 6.3 and 8.3.
© Copyright by Harris J. Samuels