WEBVTT 00:00:00.000 --> 00:00:02.200 Welcome back to the Deep Dive. It is great to 00:00:02.200 --> 00:00:04.080 be back. You know, I was sitting at my desk this 00:00:04.080 --> 00:00:07.139 morning just staring at this massive stack of 00:00:07.139 --> 00:00:09.320 research we've pulled together for today. It's 00:00:09.320 --> 00:00:11.740 a big one. It really is. We've got articles on 00:00:11.740 --> 00:00:15.640 global standards. We've got these dense PDFs 00:00:15.640 --> 00:00:18.539 about regulations coming in 2025. We've got Wikipedia 00:00:18.539 --> 00:00:21.059 entries on methodologies from Germany and the 00:00:21.059 --> 00:00:25.449 UK. And I had a bit of a realization. Oh. What 00:00:25.449 --> 00:00:27.489 kind of realization? Well, think about how we 00:00:27.489 --> 00:00:30.510 spend our lives. We work, we save, and then eventually 00:00:30.510 --> 00:00:32.729 we try to buy assets. You know, we buy a house, 00:00:32.770 --> 00:00:34.530 maybe a little rental property if we're lucky, 00:00:34.630 --> 00:00:36.490 or we invest in a company that owns buildings. 00:00:36.689 --> 00:00:40.009 We spend our entire lives chasing these things 00:00:40.009 --> 00:00:42.350 because we think they have this solid, concrete 00:00:42.350 --> 00:00:45.210 worth. It's the scorecard of modern life in a 00:00:45.210 --> 00:00:48.450 way. Net worth. Exactly. But here is the thing 00:00:48.450 --> 00:00:50.429 that hit me while reading through this stack. 00:00:51.549 --> 00:00:54.969 That scorecard. It relies almost entirely on 00:00:54.969 --> 00:00:57.649 an opinion. We walk around thinking the value 00:00:57.649 --> 00:01:00.890 of our house is a hard fact. Like, I bought it 00:01:00.890 --> 00:01:04.010 for $500 ,000, therefore it is worth $500 ,000. 00:01:04.209 --> 00:01:07.209 It feels like physics. But today's material proves 00:01:07.209 --> 00:01:10.310 that is actually a complete illusion. It is an 00:01:10.310 --> 00:01:12.170 illusion. Yeah. And frankly, it's an illusion 00:01:12.170 --> 00:01:14.790 that keeps the entire global economy from collapsing. 00:01:15.030 --> 00:01:17.769 No pressure, right? Just the weight of the global 00:01:17.769 --> 00:01:20.489 economy resting on an opinion. It sounds dramatic, 00:01:20.689 --> 00:01:24.260 but it's true. Today, we are talking about real 00:01:24.260 --> 00:01:27.620 estate appraisal or property valuation, depending 00:01:27.620 --> 00:01:29.379 on where you are in the world. And for everyone 00:01:29.379 --> 00:01:31.400 listening, if you are tuning out because you 00:01:31.400 --> 00:01:34.560 think this is just about that annoying $500 fee 00:01:34.560 --> 00:01:37.480 you paid to get a mortgage, you are missing the 00:01:37.480 --> 00:01:39.519 massive picture. That's what I want to stress 00:01:39.519 --> 00:01:41.540 right off the bat. The hook here isn't just buying 00:01:41.540 --> 00:01:43.400 a home. This plays into divorce settlements. 00:01:43.680 --> 00:01:45.879 It dictates how much tax you pay to your local 00:01:45.879 --> 00:01:47.840 government every single year. Oh, absolutely. 00:01:48.000 --> 00:01:51.060 It affects bankruptcy proceedings. It is the 00:01:51.060 --> 00:01:54.079 hidden engine behind massive corporate mergers. 00:01:54.299 --> 00:01:56.379 It really is the bedrock of financial security. 00:01:56.640 --> 00:01:59.019 Think about it. If we don't have an agreed upon 00:01:59.019 --> 00:02:01.359 way to look at a pile of bricks and say this 00:02:01.359 --> 00:02:05.480 is worth X dollars, lending stops. Right. Banks 00:02:05.480 --> 00:02:08.919 close. The stock market freezes. Without valuation, 00:02:09.199 --> 00:02:13.060 the gears of finance just grind to a halt. So 00:02:13.060 --> 00:02:15.199 our mission today is to move beyond the number 00:02:15.199 --> 00:02:18.020 on the price tag. We want to understand the science 00:02:18.020 --> 00:02:20.280 and the art of value. We're going to figure out 00:02:20.280 --> 00:02:23.139 why the price you pay is rarely what the property 00:02:23.139 --> 00:02:25.300 is actually worth. And we're going to answer 00:02:25.300 --> 00:02:27.520 the question. How on earth does someone walk 00:02:27.520 --> 00:02:29.580 into a house, look around for 40 minutes, and 00:02:29.580 --> 00:02:33.180 decide it is worth exactly $452 ,000? And we're 00:02:33.180 --> 00:02:34.979 going to look at the future, too. Because the 00:02:34.979 --> 00:02:38.039 rules are changing in 2025, artificial intelligence 00:02:38.039 --> 00:02:39.879 is entering the chat, and it might completely 00:02:39.879 --> 00:02:43.000 overhaul how we define worth. It's a huge shift. 00:02:43.139 --> 00:02:46.000 But let's start with the basics, the core definition. 00:02:46.159 --> 00:02:48.719 What exactly is an appraisal? Because before 00:02:48.719 --> 00:02:50.199 I read this, I just thought it was a price check, 00:02:50.280 --> 00:02:52.419 like standing a barcode at the grocery store. 00:02:52.729 --> 00:02:55.169 Yeah, and that's the common perception. It's 00:02:55.169 --> 00:02:58.469 definitely not a barcode scan. Technically, an 00:02:58.469 --> 00:03:02.330 appraisal is defined as the act or process of 00:03:02.330 --> 00:03:05.849 developing an opinion of value for real property. 00:03:06.090 --> 00:03:09.250 Now, pay attention to that word. Opinion. Opinion. 00:03:09.250 --> 00:03:11.689 That feels a little subjective, a little squishy. 00:03:11.990 --> 00:03:14.509 It is, but it's a professional opinion. It's 00:03:14.509 --> 00:03:17.289 not just a guess. It's a defensible argument. 00:03:17.590 --> 00:03:19.969 The appraiser isn't just finding a number. They're 00:03:19.969 --> 00:03:23.659 building a case. They have to prove to a lender, 00:03:23.840 --> 00:03:27.599 a judge or a tax board why this number is the 00:03:27.599 --> 00:03:29.539 right number. And this explains something that 00:03:29.539 --> 00:03:31.500 always confuses people. I've had friends tell 00:03:31.500 --> 00:03:33.500 me. The appraiser came over. They were there 00:03:33.500 --> 00:03:35.460 for maybe 30 minutes, took some photos of the 00:03:35.460 --> 00:03:37.500 water heater, measured the living room and left. 00:03:37.639 --> 00:03:40.280 And I paid $600 for that. That is the classic 00:03:40.280 --> 00:03:43.080 misconception, that visit. That is just the inspection. 00:03:43.180 --> 00:03:46.460 That is the visible tip of the iceberg. But the 00:03:46.460 --> 00:03:48.219 sources highlight that the average turnaround 00:03:48.219 --> 00:03:51.139 time for an appraisal is anywhere from 5 to 15 00:03:51.139 --> 00:03:53.560 days. 5 to 15 days. So what are they doing for 00:03:53.560 --> 00:03:55.340 those other 14 days if they aren't at the house? 00:03:55.770 --> 00:03:58.229 They are in the lab, so to speak. They are doing 00:03:58.229 --> 00:04:00.789 intense research. They aren't just looking at 00:04:00.789 --> 00:04:03.750 your house. They are analyzing market trends. 00:04:04.289 --> 00:04:06.969 They are verifying public records to make sure 00:04:06.969 --> 00:04:09.229 the person selling the house actually owns it. 00:04:09.349 --> 00:04:11.189 That's a big one. Right. You have to make sure 00:04:11.189 --> 00:04:13.930 the title is clean. Absolutely. Yeah. They are 00:04:13.930 --> 00:04:16.649 checking zoning ordinances. Can you actually 00:04:16.649 --> 00:04:19.110 legally have that second kitchen in the basement? 00:04:19.529 --> 00:04:22.819 A lot of time. You can't. Oh, right. An illegal 00:04:22.819 --> 00:04:24.860 suite. An illegal suite. Yeah. Yeah. They are 00:04:24.860 --> 00:04:27.339 checking flood maps and they are crunching numbers 00:04:27.339 --> 00:04:30.040 on comparable sales. They have to construct that 00:04:30.040 --> 00:04:32.660 defensible argument we talked about because an 00:04:32.660 --> 00:04:35.379 appraisal isn't a fact. It's a thesis that has 00:04:35.379 --> 00:04:38.939 to hold up in court or to a grim faced bank underwriter. 00:04:39.230 --> 00:04:42.009 OK, let's unpack the core philosophy here, because 00:04:42.009 --> 00:04:43.990 the biggest takeaway I got right off the bat 00:04:43.990 --> 00:04:46.290 is this fundamental distinction between price 00:04:46.290 --> 00:04:49.089 and value. Yes. In my head, and I think for most 00:04:49.089 --> 00:04:51.310 listeners, those words are synonyms. If I pay 00:04:51.310 --> 00:04:54.209 $300 ,000 for a house, the value is $300 ,000. 00:04:54.430 --> 00:04:56.910 But you're saying that's wrong. That is often 00:04:56.910 --> 00:05:00.790 wrong, yes. In the world of valuation, price 00:05:00.790 --> 00:05:04.029 and value are two very different things. They 00:05:04.029 --> 00:05:07.250 might kiss occasionally, but they are not married. 00:05:07.430 --> 00:05:10.899 I like that image. Price is a historical fact. 00:05:10.980 --> 00:05:12.980 It is what happened. It is the number written 00:05:12.980 --> 00:05:16.000 on the check or the contract. Value, on the other 00:05:16.000 --> 00:05:18.779 hand, is an opinion of what the property should 00:05:18.779 --> 00:05:21.740 transact for under specific, typical conditions. 00:05:22.060 --> 00:05:23.980 Okay, so give me a scenario where they drift 00:05:23.980 --> 00:05:27.240 apart. When does price not equal value? Well, 00:05:27.279 --> 00:05:29.480 let's look at the uninformed scenario. This happens 00:05:29.480 --> 00:05:32.240 more than you think. Imagine a seller. Let's 00:05:32.240 --> 00:05:35.060 call him Bob. Bob inherited a house from his 00:05:35.060 --> 00:05:38.019 aunt. Bob lives three states away and hasn't 00:05:38.019 --> 00:05:39.980 visited the neighborhood in 20 years. And in 00:05:39.980 --> 00:05:42.259 his memory, Bob remembers it being a rough part 00:05:42.259 --> 00:05:44.860 of town. Exactly. But Bob doesn't know that in 00:05:44.860 --> 00:05:47.019 the last five years, it's become the trendy art 00:05:47.019 --> 00:05:49.540 district. You know, coffee shops, lofts, the 00:05:49.540 --> 00:05:52.199 works, gentrification. Right. So Bob just wants 00:05:52.199 --> 00:05:55.000 to get rid of it. He lists it for $200 ,000 because 00:05:55.000 --> 00:05:57.139 that sounds like a lot of money to him. And I 00:05:57.139 --> 00:05:59.420 assume it sells instantly. It sells in 10 minutes. 00:06:00.000 --> 00:06:02.740 The buyer's popping champagne. Now, the price 00:06:02.740 --> 00:06:06.240 of that transaction is $200 ,000. That is a fact. 00:06:06.579 --> 00:06:09.480 But was the market value $200 ,000? Absolutely 00:06:09.480 --> 00:06:12.240 not. The value might have been $350 ,000. So 00:06:12.240 --> 00:06:15.699 if an appraiser looks at that sale later when 00:06:15.699 --> 00:06:17.860 they're trying to value the house next door. 00:06:18.180 --> 00:06:20.319 The appraiser has to be the referee. They have 00:06:20.319 --> 00:06:22.660 to look at that sale and say, that play didn't 00:06:22.660 --> 00:06:25.399 count. That was a distressed or uninformed sale. 00:06:25.779 --> 00:06:29.480 If they use that $200 ,000 price as a data point 00:06:29.480 --> 00:06:31.819 to value the neighbor's house, they would be 00:06:31.819 --> 00:06:34.750 poisoning the data. They have to spot the discrepancy 00:06:34.750 --> 00:06:37.430 between the price paid and the actual value. 00:06:37.610 --> 00:06:39.949 So the appraiser's job is to filter out the noise, 00:06:40.170 --> 00:06:43.230 all the weird emotional or uninformed decisions 00:06:43.230 --> 00:06:45.569 that people make. Precisely. But then you have 00:06:45.569 --> 00:06:47.629 the second scenario, which is even more fascinating. 00:06:47.850 --> 00:06:50.509 This is the investment value or premium scenario. 00:06:50.870 --> 00:06:54.069 This is where paying too much is actually a rational 00:06:54.069 --> 00:06:57.230 decision. How can overpaying be rational? That 00:06:57.230 --> 00:06:59.230 sounds like a contradiction. Let's talk about 00:06:59.230 --> 00:07:02.230 assemblage. I loved this concept in the notes. 00:07:02.290 --> 00:07:04.069 It sounds like an Avengers movie, the assemblage. 00:07:04.269 --> 00:07:07.029 It's a little less explosive, but it can be very 00:07:07.029 --> 00:07:10.189 profitable. Imagine you own a vacant lot in the 00:07:10.189 --> 00:07:13.009 city. It's nice, but it's small. You can maybe 00:07:13.009 --> 00:07:15.550 build a small house on it. The market value of 00:07:15.550 --> 00:07:18.889 that lot is, say, $100 ,000. Okay, I've got my 00:07:18.889 --> 00:07:21.949 $100 ,000 lot. Now, right next door, there is 00:07:21.949 --> 00:07:24.879 another lot. Exactly the same size. Also worth 00:07:24.879 --> 00:07:27.860 $100 ,000 to the general public. But if you buy 00:07:27.860 --> 00:07:30.360 it, you can combine the two lots. And suddenly, 00:07:30.480 --> 00:07:32.839 because you have a larger footprint, zoning allows 00:07:32.839 --> 00:07:35.079 you to build a 10 -story apartment building. 00:07:35.360 --> 00:07:38.779 Ah, which is worth way, way more than two small 00:07:38.779 --> 00:07:41.240 houses. Exactly. This creates economies of scale. 00:07:41.600 --> 00:07:45.000 So that neighbor's lot is worth $100 ,000 to 00:07:45.000 --> 00:07:48.240 a stranger. But to you, it might be worth $200 00:07:48.240 --> 00:07:50.500 ,000. Because unlocking that apartment building 00:07:50.500 --> 00:07:53.620 project is huge. So I pay the neighbor $200 ,000 00:07:53.620 --> 00:07:56.579 for their $100 ,000 lot. I overpay. You pay a 00:07:56.579 --> 00:08:00.000 premium. That is investment value. The value 00:08:00.000 --> 00:08:02.660 to a specific individual. The act of combining 00:08:02.660 --> 00:08:05.500 the lots is called assemblage. The resulting 00:08:05.500 --> 00:08:08.879 increase in value, where 1 plus 1 equals 3, is 00:08:08.879 --> 00:08:11.120 called plottage. Plottage. That is a great word. 00:08:11.180 --> 00:08:13.319 I'm going to use that. It is. The whole is worth 00:08:13.319 --> 00:08:15.819 more than the sum of its parts. And we see this 00:08:15.819 --> 00:08:18.139 in the corporate world all the time. Think about 00:08:18.139 --> 00:08:22.040 Haskell takeovers. A company might buy shares 00:08:22.040 --> 00:08:25.480 of a rival at a massive premium. Why? For control. 00:08:25.779 --> 00:08:28.220 Because they want control. They aren't paying 00:08:28.220 --> 00:08:30.339 the market price for the stock. They are paying 00:08:30.339 --> 00:08:32.580 for the strategic value of owning the competition. 00:08:32.940 --> 00:08:35.460 Same principle. This really clarifies why the 00:08:35.460 --> 00:08:37.659 research sources listed so many different types 00:08:37.659 --> 00:08:40.559 of value. I saw a whole list. Market value, investment 00:08:40.559 --> 00:08:43.519 value, liquidation value, insurable value. It 00:08:43.519 --> 00:08:46.139 just kept going. It's not just one number. The 00:08:46.139 --> 00:08:48.019 number depends entirely on the question you are 00:08:48.019 --> 00:08:50.960 asking. The definition of value changes based 00:08:50.960 --> 00:08:52.980 on the context. Let's run through a few of those 00:08:52.980 --> 00:08:54.700 because they actually impact regular people. 00:08:54.799 --> 00:08:57.000 Market value is the standard, right? That's the 00:08:57.000 --> 00:08:59.679 one we hear about most. Yes. The international 00:08:59.679 --> 00:09:02.799 valuation standards define market value very 00:09:02.799 --> 00:09:07.039 specifically. It assumes a willing buyer and 00:09:07.039 --> 00:09:09.580 a willing seller. It assumes they are acting 00:09:09.580 --> 00:09:12.259 prudently, they are knowledgeable, and crucially, 00:09:12.340 --> 00:09:14.870 they are acting without compulsion. Meaning nobody 00:09:14.870 --> 00:09:17.250 has a gun to their head. Or a judge breathing 00:09:17.250 --> 00:09:20.269 down their neck. Which brings us to liquidation 00:09:20.269 --> 00:09:23.090 value. The fire sale. Exactly. This is common 00:09:23.090 --> 00:09:26.090 in bankruptcy proceedings or foreclosure. If 00:09:26.090 --> 00:09:28.450 a judge orders a property to be sold now, you 00:09:28.450 --> 00:09:30.409 don't have the luxury of waiting six months for 00:09:30.409 --> 00:09:32.330 the perfect buyer to come along. The exposure 00:09:32.330 --> 00:09:34.649 time is short. You have to take the first decent 00:09:34.649 --> 00:09:37.090 offer that walks in the door. Right. So liquidation 00:09:37.090 --> 00:09:39.409 value is almost always lower than market value. 00:09:39.909 --> 00:09:42.389 It answers the question, what can we get for 00:09:42.389 --> 00:09:44.559 this if we have to sell it by Friday? Then you 00:09:44.559 --> 00:09:47.139 have insurable value. This one trips homeowners 00:09:47.139 --> 00:09:48.980 up all the time. It does. I hear this complaint 00:09:48.980 --> 00:09:52.360 constantly. My house is worth $500 ,000, but 00:09:52.360 --> 00:09:54.279 the insurance company only covered me for $300 00:09:54.279 --> 00:09:56.480 ,000. They're ripping me off. But they aren't. 00:09:56.500 --> 00:09:59.299 No. Because if your house burns to the ground, 00:09:59.480 --> 00:10:02.200 what happens to the land? The land is still there. 00:10:02.399 --> 00:10:05.440 The dirt didn't burn. You still own the $200 00:10:05.440 --> 00:10:08.700 ,000 lot. The insurance company only cares about 00:10:08.700 --> 00:10:11.320 the cost to replace the structure. The wood, 00:10:11.399 --> 00:10:15.330 the concrete, the labor. So insurable value excludes 00:10:15.330 --> 00:10:17.970 the land value entirely. Which explains the gap. 00:10:18.210 --> 00:10:20.909 And finally, the one everyone loves to hate, 00:10:21.610 --> 00:10:24.789 ad valorem. Tax value. Ad valorem just means 00:10:24.789 --> 00:10:28.009 according to value in Latin. It's what your local 00:10:28.009 --> 00:10:30.190 government uses to figure out your property tax 00:10:30.190 --> 00:10:32.230 bill. And I saw something in the notes about 00:10:32.230 --> 00:10:35.110 fractional assessment. This sounded like a straight 00:10:35.110 --> 00:10:37.330 -up psychological trick being played on taxpayers. 00:10:37.789 --> 00:10:40.409 It is a bit of a mind game. It's a practice used 00:10:40.409 --> 00:10:43.200 by many tax assessors. Let's say the market value 00:10:43.200 --> 00:10:46.980 of your home is $1 million. I wish. But OK, let's 00:10:46.980 --> 00:10:49.159 say. If the tax assessor sends you a bill saying 00:10:49.159 --> 00:10:51.679 your house is valued at $1 million, you might 00:10:51.679 --> 00:10:54.159 scrutinize it. You might argue, no, no, the roof 00:10:54.159 --> 00:10:56.799 is leaking. It's only worth $950 ,000. You fight 00:10:56.799 --> 00:10:59.379 it. Right, because that's a big number. It is. 00:10:59.460 --> 00:11:02.000 So some jurisdictions use a fractional assessment. 00:11:02.360 --> 00:11:05.279 They assess the property at, say, 10 % of its 00:11:05.279 --> 00:11:08.179 value. So you get a notice in the mail saying 00:11:08.179 --> 00:11:12.000 your assessed value is $100 ,000. And I look 00:11:12.000 --> 00:11:13.720 at that and think, wow, these guys are idiots. 00:11:13.820 --> 00:11:16.200 My house is worth 10 times that. I'm getting 00:11:16.200 --> 00:11:18.399 a great deal. Exactly. You feel like you won, 00:11:18.539 --> 00:11:21.340 so you don't appeal. But the city isn't losing 00:11:21.340 --> 00:11:23.799 money. They just set the tax rate, the millage 00:11:23.799 --> 00:11:27.340 rate, much higher on that $100 ,000 to get the 00:11:27.340 --> 00:11:28.980 exact same revenue they would have gotten from 00:11:28.980 --> 00:11:31.700 the million. It's designed to keep me from complaining. 00:11:31.879 --> 00:11:33.659 It keeps the appeals down. It's purely psychological. 00:11:33.720 --> 00:11:36.139 That is sneaky. I respect it, but it's sneaky. 00:11:37.099 --> 00:11:39.759 Okay, so we've established that value is a shapeshifter. 00:11:39.860 --> 00:11:42.820 It depends on who is asking and why. But eventually 00:11:42.820 --> 00:11:45.100 the appraiser has to sit down at a desk and come 00:11:45.100 --> 00:11:47.419 up with a hard number. How do they actually do 00:11:47.419 --> 00:11:50.120 the math? This is where we get into what we call 00:11:50.120 --> 00:11:52.500 the three approaches to value. And depending 00:11:52.500 --> 00:11:54.580 on the scope of work, which is a formal part 00:11:54.580 --> 00:11:56.379 of the process defined in the US Page Standards, 00:11:56.720 --> 00:11:59.460 the appraiser will choose the method or combination 00:11:59.460 --> 00:12:03.440 of methods that best fits the property. USP being 00:12:03.440 --> 00:12:05.720 the Uniform Standards of Professional Appraisal 00:12:05.720 --> 00:12:08.139 Practice, the rulebook. Correct. That is the 00:12:08.139 --> 00:12:10.919 rulebook for the U .S. And they updated it back 00:12:10.919 --> 00:12:14.320 in 2006 to get rid of this confusing limited 00:12:14.320 --> 00:12:17.740 versus complete appraisal idea. And now it's 00:12:17.740 --> 00:12:19.620 all about the scope of work, which makes a lot 00:12:19.620 --> 00:12:21.779 more sense. So let's walk through these three 00:12:21.779 --> 00:12:24.299 pillars. The first one is the one I think most 00:12:24.299 --> 00:12:26.100 homeowners are familiar with. If you've bought 00:12:26.100 --> 00:12:28.460 a house, you've seen this, the sales comparison 00:12:28.460 --> 00:12:31.460 approach. This is the absolute standard for residential 00:12:31.460 --> 00:12:34.250 property. If you're buying a single -family home, 00:12:34.389 --> 00:12:36.870 a condo, or a townhouse, this is the method. 00:12:36.909 --> 00:12:38.629 It is based on the principle of substitution. 00:12:39.049 --> 00:12:41.529 Which basically says, I'm not going to pay $500 00:12:41.529 --> 00:12:44.149 ,000 for this house if I can buy a practically 00:12:44.149 --> 00:12:46.190 identical one down the street for $450 ,000. 00:12:46.350 --> 00:12:49.470 Precisely. A rational person won't pay more than 00:12:49.470 --> 00:12:52.700 the cost of a comparable substitute. So the appraiser's 00:12:52.700 --> 00:12:55.220 job is to find those substitutes. We call them 00:12:55.220 --> 00:12:58.500 comps or comparables. And there is a critical 00:12:58.500 --> 00:13:00.600 rule here regarding these comps, which we touched 00:13:00.600 --> 00:13:03.799 on. They must be sold properties. I can't stress 00:13:03.799 --> 00:13:06.320 this enough. I can list my house for $10 million 00:13:06.320 --> 00:13:08.940 today. That doesn't mean it's worth $10 million. 00:13:10.100 --> 00:13:13.919 Asking prices are just wishes. Sold prices are 00:13:13.919 --> 00:13:16.500 reality. So the appraiser finds three to five 00:13:16.500 --> 00:13:19.539 homes nearby that sold recently. But here's the 00:13:19.539 --> 00:13:24.080 problem. No two homes are exactly alike. Even 00:13:24.080 --> 00:13:26.460 in a cookie cutter subdivision, one might have 00:13:26.460 --> 00:13:29.220 a new deck and the other has a moldy basement. 00:13:29.799 --> 00:13:32.139 One backs up to the woods, one backs up to a 00:13:32.139 --> 00:13:33.960 highway. And this is where the art meets the 00:13:33.960 --> 00:13:36.240 math. This is the whole job right here. We call 00:13:36.240 --> 00:13:38.360 it the adjustment game. This is the part that 00:13:38.360 --> 00:13:40.919 I think confuses people the most. Walk me through 00:13:40.919 --> 00:13:42.960 the mechanics of an adjustment. How does it actually 00:13:42.960 --> 00:13:46.259 work on the form? Okay. So the goal is to figure 00:13:46.259 --> 00:13:48.519 out what the subject property, that's the house 00:13:48.519 --> 00:13:51.120 you are buying, is worth. We don't know that 00:13:51.120 --> 00:13:53.100 number yet, but we know what the comp sold for. 00:13:53.559 --> 00:13:56.120 Let's say the comp down the street sold for $300 00:13:56.120 --> 00:13:59.179 ,000. Okay, $300 ,000. But the comp doesn't have 00:13:59.179 --> 00:14:02.379 a garage. Your house, the subject, does have 00:14:02.379 --> 00:14:04.860 a garage. So my house is better. It's superior 00:14:04.860 --> 00:14:08.519 in that feature. Your house is superior, but 00:14:08.519 --> 00:14:10.460 we can't change the price of your house. We don't 00:14:10.460 --> 00:14:12.500 know it yet. We have to change the price of the 00:14:12.500 --> 00:14:15.720 comp. We have to ask, what would that comp have 00:14:15.720 --> 00:14:18.580 sold for if it had a garage? We are creating 00:14:18.580 --> 00:14:21.299 a hypothetical version of the comp. We are simulating 00:14:21.299 --> 00:14:24.139 reality. If the market says a garage is worth 00:14:24.139 --> 00:14:27.740 $10 ,000, we take the comp's sales price of $300 00:14:27.740 --> 00:14:31.419 ,000 and we add $10 ,000. So the adjusted value 00:14:31.419 --> 00:14:35.250 of that comp is $310 ,000. Okay. That makes sense. 00:14:35.309 --> 00:14:37.470 You adjust the comp up to match the subject. 00:14:37.649 --> 00:14:40.169 Now do the reverse. Imagine another comp sold 00:14:40.169 --> 00:14:44.149 for $320 ,000, but it has a beautiful in -ground 00:14:44.149 --> 00:14:46.909 swimming pool. Your house, the subject, does 00:14:46.909 --> 00:14:49.610 not. So in that case, that comp is superior to 00:14:49.610 --> 00:14:52.029 my house. Right. So we have to strip that value 00:14:52.029 --> 00:14:54.529 away to make it a fair comparison. We have to 00:14:54.529 --> 00:14:56.929 subtract the value of the pool from the comp's 00:14:56.929 --> 00:14:59.549 price. So we take that $320 ,000 and knock it 00:14:59.549 --> 00:15:02.500 down to match my non -pool house. Exactly. You 00:15:02.500 --> 00:15:05.100 are leveling the playing field across all the 00:15:05.100 --> 00:15:07.500 comps. You do this for square footage, for the 00:15:07.500 --> 00:15:10.639 date of sale, for location, for amenities. And 00:15:10.639 --> 00:15:13.580 ideally, after all the adjustments, your three 00:15:13.580 --> 00:15:15.980 or four comps will point to a very narrow range 00:15:15.980 --> 00:15:18.580 of value for your subject property. That seems 00:15:18.580 --> 00:15:20.820 straightforward in theory, but I bet figuring 00:15:20.820 --> 00:15:23.120 out exactly what a pool or a garage is worth 00:15:23.120 --> 00:15:25.519 in dollar terms is the hard part. It is the hardest 00:15:25.519 --> 00:15:27.980 part of the job. It's not just the cost to build 00:15:27.980 --> 00:15:31.779 it. A pool might cost $50 ,000 to install. But 00:15:31.779 --> 00:15:34.240 in a cold climate like Minnesota, it might only 00:15:34.240 --> 00:15:37.940 add $5 ,000 to the market value. Or in some markets, 00:15:38.019 --> 00:15:40.580 it might even be a liability and drag the value 00:15:40.580 --> 00:15:42.799 down because of maintenance costs. Right. I could 00:15:42.799 --> 00:15:45.080 see that. Speaking of random value factors, I 00:15:45.080 --> 00:15:47.120 saw a stat in the notes that blew my mind. Tree 00:15:47.120 --> 00:15:49.580 value. Ah, yes. The tree value contribution. 00:15:50.299 --> 00:15:52.519 It's a real thing. The notes say tree value can 00:15:52.519 --> 00:15:55.120 contribute up to 27 % of a property's value. 00:15:55.460 --> 00:15:58.620 That seems huge. Is that really possible? In 00:15:58.620 --> 00:16:01.679 some specific analyses, yes. But think about 00:16:01.679 --> 00:16:04.860 it. Imagine a street lined with mature, 100 -year 00:16:04.860 --> 00:16:08.340 -old oak trees that create a canopy. It feels 00:16:08.340 --> 00:16:11.399 established, cool, private. It's beautiful. Of 00:16:11.399 --> 00:16:13.759 course. Now imagine the next street over was 00:16:13.759 --> 00:16:16.500 clear -cut for development. It's hot, dusty, 00:16:16.679 --> 00:16:19.759 exposed. All the houses are identical. But one 00:16:19.759 --> 00:16:22.779 street just feels better. I'd pay way more for 00:16:22.779 --> 00:16:25.179 the oak trees, no question. The market reacts 00:16:25.179 --> 00:16:28.519 to curb appeal. Trees also provide shade, which 00:16:28.519 --> 00:16:32.299 lowers energy costs. But trying to quantify that, 00:16:32.360 --> 00:16:35.139 trying to say this tree is worth exactly $4 ,000 00:16:35.139 --> 00:16:38.480 is incredibly difficult. That is where the appraiser's 00:16:38.480 --> 00:16:40.700 experience and local knowledge come in. Before 00:16:40.700 --> 00:16:42.580 we move off sales comparison, we have to talk 00:16:42.580 --> 00:16:45.019 about shop talk. I saw the term pencil appraisal. 00:16:45.019 --> 00:16:47.259 What is that? Oh, boy. Can you give me a pencil 00:16:47.259 --> 00:16:49.500 appraisal? That sounds shady. It's a slang term 00:16:49.500 --> 00:16:52.240 you hear from loan officers or real estate agents. 00:16:52.539 --> 00:16:54.340 They call up the appraiser and say, hey, I've 00:16:54.340 --> 00:16:56.259 got this deal. Can you just pencil it out for 00:16:56.259 --> 00:16:58.220 me? Just give me a quick look to see if the value 00:16:58.220 --> 00:17:00.120 is there before we order the full report. Like 00:17:00.120 --> 00:17:02.440 a back of the napkin guess? A pre -approval. 00:17:02.799 --> 00:17:05.180 Exactly. They want a pre -check. But strictly 00:17:05.180 --> 00:17:08.180 speaking, under USPAP, if an appraiser gives 00:17:08.180 --> 00:17:12.059 an opinion of value, any opinion, it is an appraisal. 00:17:12.359 --> 00:17:14.799 There is no such thing as a pencil search that 00:17:14.799 --> 00:17:17.440 avoids the ethical requirements. If they give 00:17:17.440 --> 00:17:19.380 you a number, they are on the hook for it. They 00:17:19.380 --> 00:17:21.380 need a work file. They need to follow the standards. 00:17:21.680 --> 00:17:23.579 So if you ask for a pencil appraisal, you're 00:17:23.579 --> 00:17:25.759 basically asking them to work for free or break 00:17:25.759 --> 00:17:27.900 the rules. Pretty much. It's a dangerous game 00:17:27.900 --> 00:17:29.799 for the appraiser. Good to know. Okay. Moving 00:17:29.799 --> 00:17:33.160 to method number two, the cost approach. This 00:17:33.160 --> 00:17:36.259 feels less like shopping and more like construction. 00:17:36.740 --> 00:17:38.460 That is the best way to think about it. This 00:17:38.460 --> 00:17:41.019 is the builder's perspective. The formula is 00:17:41.019 --> 00:17:44.490 simple math. At least on the surface. Value equals 00:17:44.490 --> 00:17:47.390 the value of the land. As if it were vacant. 00:17:47.630 --> 00:17:50.430 Plus the cost to build the structure new, minus 00:17:50.430 --> 00:17:54.809 depreciation. RCNLD. I saw that acronym. Reproduction 00:17:54.809 --> 00:17:56.849 costs new, less depreciation. You're getting 00:17:56.849 --> 00:17:59.309 the lingo down. I'm trying. But there's a subtle 00:17:59.309 --> 00:18:01.190 distinction here in the notes between reproduction 00:18:01.190 --> 00:18:05.509 and replacement. Huge difference. Reproduction 00:18:05.509 --> 00:18:09.539 means an exact replica. Imagine you are appraising 00:18:09.539 --> 00:18:13.450 a historic Victorian home built in 1890. It has 00:18:13.450 --> 00:18:16.309 hand -carved gargoyles, plaster lathe walls, 00:18:16.589 --> 00:18:18.890 lead glass windows. To build that today, you 00:18:18.890 --> 00:18:20.609 couldn't even find the craftsman. You'd have 00:18:20.609 --> 00:18:22.849 to hire artisans. The cost would be astronomical. 00:18:23.190 --> 00:18:25.529 It might cost $5 million to reproduce it exactly. 00:18:25.849 --> 00:18:27.890 That is reproduction cost. It's mostly used for 00:18:27.890 --> 00:18:30.029 insurance on historic buildings. But the house 00:18:30.029 --> 00:18:31.690 probably isn't worth $5 million on the market. 00:18:31.890 --> 00:18:35.230 Probably not. So usually appraisers use replacement 00:18:35.230 --> 00:18:37.589 cost. This means building a house with the same 00:18:37.589 --> 00:18:40.970 utility but using modern materials. So drywall 00:18:40.970 --> 00:18:43.650 instead of plaster. Fiberglass shingles instead 00:18:43.650 --> 00:18:46.450 of slate. Standard windows. It's much more practical. 00:18:46.630 --> 00:18:49.650 Okay. But then comes the big subtraction. Depreciation. 00:18:49.650 --> 00:18:51.190 And this isn't just about peeling paint. The 00:18:51.190 --> 00:18:53.690 notes talk about obsolescence. Yes. There are 00:18:53.690 --> 00:18:55.930 three kinds of decay. Three forms of depreciation. 00:18:56.869 --> 00:18:59.549 Physical obsolescence is the easy one. The roof 00:18:59.549 --> 00:19:01.890 is leaking. The carpet is worn out. It's just 00:19:01.890 --> 00:19:04.750 stuff wearing out. But functional obsolescence 00:19:04.750 --> 00:19:06.569 is where the stories are. This is my favorite 00:19:06.569 --> 00:19:09.490 part of the notes. Functional obsolescence means 00:19:09.490 --> 00:19:13.569 the design itself is stupid. Right. Or just bad. 00:19:13.769 --> 00:19:15.890 Or just outdated. It doesn't match what the modern 00:19:15.890 --> 00:19:18.170 market wants. Like the super adequacy example. 00:19:18.470 --> 00:19:21.170 The house with nine bathrooms. That is a classic 00:19:21.170 --> 00:19:23.809 super adequacy. Imagine someone builds their 00:19:23.809 --> 00:19:26.730 dream home. It has two bedrooms. But for some 00:19:26.730 --> 00:19:29.170 reason, they put in nine bathrooms. They spent 00:19:29.170 --> 00:19:31.730 the money. The cost is there. But nobody wants 00:19:31.730 --> 00:19:34.269 that. It's a cleaning nightmare. A buyer with 00:19:34.269 --> 00:19:36.710 a family looks at that and says, I have two bedrooms. 00:19:36.869 --> 00:19:39.799 Why do I want to clean nine toilets? the market 00:19:39.799 --> 00:19:41.980 will not pay for those extra bathrooms. So the 00:19:41.980 --> 00:19:45.200 appraiser has to penalize that value. The cost 00:19:45.200 --> 00:19:48.099 was high, but the value is low. That's a super 00:19:48.099 --> 00:19:50.759 adequacy. Or the opposite, inadequacy. Right. 00:19:50.859 --> 00:19:53.299 Think about a luxury mansion in Phoenix, Arizona. 00:19:53.559 --> 00:19:56.640 In that market, at that price point, buyers expect 00:19:56.640 --> 00:19:58.930 a pool. It's a given. If you build a mansion 00:19:58.930 --> 00:20:01.509 without a pool, you have an inadequacy. And the 00:20:01.509 --> 00:20:03.829 value gets dinged. The value is dragged down, 00:20:03.930 --> 00:20:06.089 often by more than the cost of the pool itself, 00:20:06.170 --> 00:20:08.470 because now the buyer has to go through the hassle 00:20:08.470 --> 00:20:10.809 of hiring contractors and digging up the yard 00:20:10.809 --> 00:20:13.269 for a year. It's a pain. And then there's the 00:20:13.269 --> 00:20:16.710 third one, the tragic one, external obsolescence. 00:20:16.750 --> 00:20:19.230 The unfixable one. This is when the problem isn't 00:20:19.230 --> 00:20:21.390 the house, it's the world around it. Your house 00:20:21.390 --> 00:20:24.390 could be perfect. Exactly. A paper mill opens 00:20:24.390 --> 00:20:27.150 up next door and it smells like sulfur 24 -7. 00:20:27.690 --> 00:20:30.410 A busy highway gets rerouted through your front 00:20:30.410 --> 00:20:34.309 yard. Or the entire local economy crashes because 00:20:34.309 --> 00:20:36.849 the main factory in town closed. You can fix 00:20:36.849 --> 00:20:39.309 a roof. You can remodel a bathroom. You can't 00:20:39.309 --> 00:20:42.150 fix a paper mill. You cannot. External obsolescence 00:20:42.150 --> 00:20:44.609 is usually considered incurable. It's a permanent 00:20:44.609 --> 00:20:47.029 loss of value that you, the homeowner, can do 00:20:47.029 --> 00:20:49.920 absolutely nothing about. So when is this cost 00:20:49.920 --> 00:20:52.619 approach actually used? It seems like a lot of 00:20:52.619 --> 00:20:54.480 work to calculate bricks and mortar and then 00:20:54.480 --> 00:20:57.279 subtract all this theoretical decay. It is used 00:20:57.279 --> 00:20:59.859 mostly for new construction where depreciation 00:20:59.859 --> 00:21:02.660 is minimal or for special use properties. Think 00:21:02.660 --> 00:21:05.960 about a church or a marina or a public library. 00:21:06.180 --> 00:21:09.180 Right. You can't use the sales comparison approach 00:21:09.180 --> 00:21:12.240 for a library. Exactly. What did the library 00:21:12.240 --> 00:21:14.599 down the street sell for? It didn't. There are 00:21:14.599 --> 00:21:17.720 no comps. And you can't use the income approach 00:21:17.720 --> 00:21:19.940 because a library isn't designed to make a profit. 00:21:20.220 --> 00:21:23.539 So the only way to value it is, what is the land 00:21:23.539 --> 00:21:26.279 worth and what would it cost to build this building 00:21:26.279 --> 00:21:29.039 from scratch? That makes perfect sense. Okay, 00:21:29.119 --> 00:21:31.660 let's go to the final pillar, method number three. 00:21:32.200 --> 00:21:35.059 The income approach. This is for the tycoons, 00:21:35.059 --> 00:21:38.400 the investors. The investor's mindset. If you 00:21:38.400 --> 00:21:40.579 are buying an office building, a shopping center, 00:21:40.599 --> 00:21:42.900 or an apartment complex, you generally don't 00:21:42.900 --> 00:21:45.200 care about the wallpaper or the crown molding. 00:21:45.240 --> 00:21:47.339 You care about the cash flow. The property is 00:21:47.339 --> 00:21:49.380 a machine that prints money. That's all it is. 00:21:49.539 --> 00:21:52.180 Exactly. And the fuel for that machine is NOI 00:21:52.180 --> 00:21:54.900 net operating income. This seems to be the holy 00:21:54.900 --> 00:21:57.230 grail metric for commercial real estate. Every 00:21:57.230 --> 00:22:00.049 investor talks about NOI. It is. You calculate 00:22:00.049 --> 00:22:02.390 it by taking the gross potential income. That's 00:22:02.390 --> 00:22:04.849 if every unit was full at market rent. Then you 00:22:04.849 --> 00:22:07.869 subtract vacancy because you're never 100 % full 00:22:07.869 --> 00:22:10.430 forever. And then you subtract all the operating 00:22:10.430 --> 00:22:14.369 expenses. Taxes, insurance, maintenance, management 00:22:14.369 --> 00:22:17.910 fees, utilities. Everything it costs to keep 00:22:17.910 --> 00:22:19.789 the lights on and the place from falling apart. 00:22:20.009 --> 00:22:22.690 And notice what's not in there. The mortgage 00:22:22.690 --> 00:22:27.200 payment. Debt service. Critical point. Debt service 00:22:27.200 --> 00:22:31.140 is excluded from the NOI calculation. NOI is 00:22:31.140 --> 00:22:34.539 debt -free. Why is that? Because the value of 00:22:34.539 --> 00:22:36.279 the property shouldn't depend on whether you 00:22:36.279 --> 00:22:39.859 paid cash or took out a massive risky loan. If 00:22:39.859 --> 00:22:42.160 I buy a building with cash and you buy the same 00:22:42.160 --> 00:22:44.420 building with a high -interest loan, the building 00:22:44.420 --> 00:22:46.859 is the same. The NOI is the same. The financing 00:22:46.859 --> 00:22:49.299 is a personal problem, not a property problem. 00:22:49.640 --> 00:22:52.059 Okay, so once we have this NOI number, say the 00:22:52.059 --> 00:22:55.420 building clears $100 ,000 a year, how do we turn 00:22:55.420 --> 00:22:57.779 that annual income into a total property value? 00:22:58.180 --> 00:23:00.579 We use a magic wand called capitalization, or 00:23:00.579 --> 00:23:02.559 more commonly, the cap rate. Break this down 00:23:02.559 --> 00:23:04.259 for me. The cap rate is always talked about, 00:23:04.359 --> 00:23:06.599 but it's a little abstract. The cap rate is essentially 00:23:06.599 --> 00:23:08.940 a rate of return. It measures risk. Think of 00:23:08.940 --> 00:23:11.089 it like a seesaw. If investors in the market 00:23:11.089 --> 00:23:13.750 think a property is very safe, like a brand new 00:23:13.750 --> 00:23:15.970 apartment building in a great city with long 00:23:15.970 --> 00:23:18.589 -term leases, they might be happy with a low 00:23:18.589 --> 00:23:23.670 return, say 5%. So you divide the NOI, $100 ,000, 00:23:23.890 --> 00:23:27.329 by the cap rate, 0 .05. That gives you value 00:23:27.329 --> 00:23:30.650 of $2 million. Right. But what if the building 00:23:30.650 --> 00:23:33.130 is risky? It's in a bad neighborhood. Tenants 00:23:33.130 --> 00:23:36.109 are shaky. The roof is old. Investors will demand 00:23:36.109 --> 00:23:38.819 a higher return to take that risk. Maybe 10%. 00:23:38.819 --> 00:23:43.039 So you divide 100 ,000 by 0 .10. And the value 00:23:43.039 --> 00:23:46.079 drops to $1 million. So higher cap rate equals 00:23:46.079 --> 00:23:49.539 lower value. Exactly. High risk, low price. Low 00:23:49.539 --> 00:23:52.099 risk, high price. It's the fundamental logic 00:23:52.099 --> 00:23:54.380 of investing applied to a building. And for the 00:23:54.380 --> 00:23:57.099 really big stuff shopping malls, skyscrapers, 00:23:57.099 --> 00:24:00.000 they use something called DCF, discounted cash 00:24:00.000 --> 00:24:02.519 flow. That is the advanced version. that projects 00:24:02.519 --> 00:24:04.640 the income out for five or ten years, guesses 00:24:04.640 --> 00:24:06.880 what the property will sell for at the end, they 00:24:06.880 --> 00:24:09.599 call that the reversion, and uses complex math 00:24:09.599 --> 00:24:12.279 to discount all that future money back to today's 00:24:12.279 --> 00:24:14.519 dollars. It's essentially predicting the future 00:24:14.519 --> 00:24:16.460 of the money machine. It's wild to think that 00:24:16.460 --> 00:24:18.680 a single -family home in a neighborhood of rentals 00:24:18.680 --> 00:24:21.559 might actually be valued this way instead of 00:24:21.559 --> 00:24:24.640 by comparing it to other sales. It happens. If 00:24:24.640 --> 00:24:26.799 the only reason anyone buys in that neighborhood 00:24:26.799 --> 00:24:29.259 is to rent the house out, the income approach 00:24:29.259 --> 00:24:32.660 becomes the primary indicator of value. The appraiser 00:24:32.660 --> 00:24:35.180 has to follow the market. If the market's thinking 00:24:35.180 --> 00:24:37.660 like an investor, the appraiser has to as well. 00:24:37.920 --> 00:24:40.599 So we've got our three pillars. But the world 00:24:40.599 --> 00:24:42.880 is a big place, and apparently we don't all agree 00:24:42.880 --> 00:24:45.440 on how to value dirt. Let's hop on a plane and 00:24:45.440 --> 00:24:47.799 look at international variations. This is where 00:24:47.799 --> 00:24:49.940 cultural and legal history really shapes the 00:24:49.940 --> 00:24:52.579 profession. Real estate is local, but valuation 00:24:52.579 --> 00:24:55.339 principles are global, with some fascinating 00:24:55.339 --> 00:24:57.720 twists. Let's start in the United Kingdom. They 00:24:57.720 --> 00:25:00.359 have the RICS, the Royal Institution of Chartered 00:25:00.359 --> 00:25:03.180 Surveyors. That sounds very official. RICS is 00:25:03.180 --> 00:25:05.730 huge. Their red book is the Bible evaluation 00:25:05.730 --> 00:25:08.170 there. It's respected globally. Yeah. And they 00:25:08.170 --> 00:25:09.849 have a few methods we don't use as much, like 00:25:09.849 --> 00:25:12.009 the residual method for development sites and 00:25:12.009 --> 00:25:14.490 the profit method for valuing businesses like 00:25:14.490 --> 00:25:17.009 pubs and hotels. I was really jealous of the 00:25:17.009 --> 00:25:19.690 consumer reports they have in the U .K. In the 00:25:19.690 --> 00:25:22.549 U .S., you get this dense PDF inspection report 00:25:22.549 --> 00:25:24.809 that looks like a tax form. It's impossible to 00:25:24.809 --> 00:25:26.970 read. In the U .K., they have a traffic light 00:25:26.970 --> 00:25:29.349 system. It is very consumer friendly. It's called 00:25:29.349 --> 00:25:32.029 the Homebuyer Report. It rates every element 00:25:32.029 --> 00:25:34.619 of the house. Yeah. Come on. Two or three. Green, 00:25:34.859 --> 00:25:37.660 amber, red. One, green means it's good. No worries. 00:25:38.059 --> 00:25:40.960 Two, amber means defects that need repairing 00:25:40.960 --> 00:25:44.579 but aren't critical. Three, red means serious 00:25:44.579 --> 00:25:47.779 impediments, needs attention and now. That is 00:25:47.779 --> 00:25:50.240 so much clearer. Red light means stop. There's 00:25:50.240 --> 00:25:52.180 a problem here. It creates clarity. And they 00:25:52.180 --> 00:25:54.380 have some great vocabulary, too. The notes mention 00:25:54.380 --> 00:25:57.400 the term froth. Froth. I've heard Alan Greenspan 00:25:57.400 --> 00:25:59.980 talk about market froth like a bubble. In the 00:25:59.980 --> 00:26:01.799 U .S., it usually just means a bubble is forming. 00:26:02.440 --> 00:26:05.220 But in the UK valuation context, it's more specific. 00:26:05.440 --> 00:26:08.299 It implies that the current capital value, the 00:26:08.299 --> 00:26:11.279 price, is unsupported by the rental income. The 00:26:11.279 --> 00:26:13.700 math doesn't work. The income can't justify the 00:26:13.700 --> 00:26:16.660 price. The price is just air. It's frothy. I 00:26:16.660 --> 00:26:18.779 like that. And we also have to mention the disclaimer. 00:26:18.900 --> 00:26:21.480 In the UK, the mortgage valuation is explicitly 00:26:21.480 --> 00:26:24.460 for the lender, not the borrower. That's true 00:26:24.460 --> 00:26:26.819 in the US, too, legally speaking. But the UK 00:26:26.819 --> 00:26:29.660 makes it very stark. They basically say, we are 00:26:29.660 --> 00:26:32.160 doing this for the bank. If we miss a defect, 00:26:32.400 --> 00:26:35.500 don't come crying to us. That's why they strongly 00:26:35.500 --> 00:26:37.819 recommend the buyer gets their own private building 00:26:37.819 --> 00:26:40.480 survey. Now let's move to Germany. This felt, 00:26:40.579 --> 00:26:44.119 well, it felt exactly how I expected Germany 00:26:44.119 --> 00:26:46.799 to be. Very orderly, very precise. Incredibly 00:26:46.799 --> 00:26:49.819 structured. They have the committee. The Gutachterrausches. 00:26:50.000 --> 00:26:53.039 The committee evaluation experts. Every municipality 00:26:53.039 --> 00:26:55.980 has one. And here is the superpower of the German 00:26:55.980 --> 00:27:00.359 system. Data transparency. How so? In the U .S., 00:27:00.359 --> 00:27:03.819 in non -disclosure states like Texas, we sometimes 00:27:03.819 --> 00:27:06.180 have to guess what a house sold for. It's not 00:27:06.180 --> 00:27:08.519 public record. In Germany, every single real 00:27:08.519 --> 00:27:10.319 estate contract must be sent to the committee. 00:27:10.539 --> 00:27:12.640 They collect everything in a database called 00:27:12.640 --> 00:27:14.819 the Kaufpreisamlung. The collection of purchase 00:27:14.819 --> 00:27:17.509 prices. So they have perfect data. But the philosophical 00:27:17.509 --> 00:27:19.750 difference is what caught my eye. In Germany, 00:27:19.769 --> 00:27:21.690 they treat land and improvements as completely 00:27:21.690 --> 00:27:23.769 separate things. We talked about this with the 00:27:23.769 --> 00:27:25.890 cost approach, but they take it to another level. 00:27:26.069 --> 00:27:28.769 In the U .S., we value the property as a unit. 00:27:28.990 --> 00:27:31.509 In Germany, they view land value as permanent. 00:27:31.650 --> 00:27:35.630 It never dies. But the building, it decays. It 00:27:35.630 --> 00:27:38.109 has a finite life. So they calculate them separately. 00:27:38.450 --> 00:27:40.890 They even have a specific interest rate for land 00:27:40.890 --> 00:27:43.670 use called the Liegenschaftsins. Lessee. Thank 00:27:43.670 --> 00:27:46.220 you. It connects the land value to the income 00:27:46.220 --> 00:27:48.839 it generates. It's a very precise, very analytical 00:27:48.839 --> 00:27:51.500 way of looking at property. And another key difference, 00:27:51.839 --> 00:27:55.259 German tenant laws, they're much stronger. Very 00:27:55.259 --> 00:27:57.599 strong. Landlords bear much higher maintenance 00:27:57.599 --> 00:28:00.920 costs there than in the U .S. or U .K. That lowers 00:28:00.920 --> 00:28:03.359 the net income, which changes the valuation model 00:28:03.359 --> 00:28:06.400 entirely. It's a huge factor. Fascinating. Now 00:28:06.400 --> 00:28:09.039 let's go east to Russia. The history here is 00:28:09.039 --> 00:28:12.099 wild because prior to 1990, there was no private 00:28:12.099 --> 00:28:13.859 real estate market. Exactly. You can't have an 00:28:13.859 --> 00:28:15.259 appraisal profession if you don't have private 00:28:15.259 --> 00:28:17.599 property. Yeah. So when the Soviet Union fell, 00:28:17.839 --> 00:28:19.900 the industry had to be invented from scratch 00:28:19.900 --> 00:28:22.599 in the 90s. And for a while, it was the Wild 00:28:22.599 --> 00:28:26.200 West. And then came the shock of 2017. The Great 00:28:26.200 --> 00:28:28.579 Exam Crisis. The government decided to regulate 00:28:28.579 --> 00:28:31.019 the industry in a very abrupt way. They introduced 00:28:31.019 --> 00:28:34.579 a mandatory state exam for appraisers. But it 00:28:34.579 --> 00:28:37.240 was incredibly difficult. The sources suggest 00:28:37.240 --> 00:28:40.039 it was predicted to decimate 80 % of the profession. 00:28:40.259 --> 00:28:42.500 80 %? That's not regulation. That's a purge. 00:28:42.660 --> 00:28:45.160 Imagine if 80 % of doctors suddenly lost their 00:28:45.160 --> 00:28:48.140 license because a board exam got harder. It created 00:28:48.140 --> 00:28:50.700 a massive bottleneck, dropping the number of 00:28:50.700 --> 00:28:52.940 valuers to just a few thousand for the whole 00:28:52.940 --> 00:28:55.500 country. That is a shock therapy approach to 00:28:55.500 --> 00:28:59.240 regulation. And finally, New Zealand. They seem 00:28:59.240 --> 00:29:02.200 to be fighting a battle over words. The name 00:29:02.200 --> 00:29:05.289 game. In the U .S., we use appraisal for the 00:29:05.289 --> 00:29:08.970 formal legal document. In NZ, an appraisal is 00:29:08.970 --> 00:29:10.890 just a marketing estimate given by a real estate 00:29:10.890 --> 00:29:14.089 agent. It has no legal standing. It's what we 00:29:14.089 --> 00:29:16.809 might call a CMA, a comparative market analysis. 00:29:17.170 --> 00:29:18.869 So if a professional does it, what's it called? 00:29:19.029 --> 00:29:21.470 A valuation. And it's done by a registered valuer. 00:29:21.569 --> 00:29:23.190 They're very, very strict about the distinction. 00:29:23.430 --> 00:29:25.609 And the market dynamic there has shifted, too. 00:29:25.869 --> 00:29:28.869 Banks now use clearinghouses to order valuations. 00:29:29.069 --> 00:29:31.359 Explain that. What's a clearinghouse? It used 00:29:31.359 --> 00:29:33.359 to be if you were buying a house, you could call 00:29:33.359 --> 00:29:36.319 up your local valuer, Joe, who knows the neighborhood 00:29:36.319 --> 00:29:39.000 inside and out. But that created a risk of bias. 00:29:40.119 --> 00:29:42.119 Joe might want to help you get the loan, keep 00:29:42.119 --> 00:29:45.079 the local real estate agents happy. Now the request 00:29:45.079 --> 00:29:47.400 goes through a random assignment system, a third 00:29:47.400 --> 00:29:49.700 -party platform. You might get a valuer from 00:29:49.700 --> 00:29:52.299 three towns over who was never set foot in that 00:29:52.299 --> 00:29:54.730 neighborhood. It kills the bias. But it also 00:29:54.730 --> 00:29:56.990 kills the local knowledge. That is the tradeoff. 00:29:57.289 --> 00:30:00.829 Can a stranger understand the nuance of a specific 00:30:00.829 --> 00:30:03.789 street? The good side versus the bad side of 00:30:03.789 --> 00:30:06.089 the tracks. It's a huge debate. Which brings 00:30:06.089 --> 00:30:08.849 us perfectly to the present and the future. Technology. 00:30:08.990 --> 00:30:12.450 The sources mention a lot of acronyms. AVMs. 00:30:13.430 --> 00:30:16.430 Gamma. Gamma. This is the rise of the machines. 00:30:17.269 --> 00:30:20.170 AVM stands for automated valuation model. If 00:30:20.170 --> 00:30:22.150 you've ever looked at a Zestimate or a similar 00:30:22.150 --> 00:30:24.789 online home value estimate, you've used an AVM. 00:30:24.930 --> 00:30:26.950 So how do they work? What's under the hood? It's 00:30:26.950 --> 00:30:29.470 pure math, regression analysis and machine learning. 00:30:29.650 --> 00:30:31.789 They look at thousands of data points, sales, 00:30:32.009 --> 00:30:34.710 square footage, bedrooms, tax records, and spit 00:30:34.710 --> 00:30:36.650 out a number. And the pros and cons seem pretty 00:30:36.650 --> 00:30:38.990 obvious. They are great for homogenous neighborhoods. 00:30:39.589 --> 00:30:42.190 If you live in a subdivision where every house 00:30:42.190 --> 00:30:44.869 was built in 1990 by the same builder, same model, 00:30:44.910 --> 00:30:49.339 same materials. The AVM is probably 95 % accurate. 00:30:49.619 --> 00:30:52.519 But if I live in a converted barn on a hillside 00:30:52.519 --> 00:30:55.740 with a unique view? The AVM fails miserably. 00:30:56.019 --> 00:30:58.799 It can't see the view. It doesn't understand 00:30:58.799 --> 00:31:01.740 the charm of a 200 -year -old beam. It just sees 00:31:01.740 --> 00:31:04.700 old structure, weird shape. It might value your 00:31:04.700 --> 00:31:07.000 luxury barn as a teardown shack. And governments 00:31:07.000 --> 00:31:09.720 use this too, right, for property taxes? Yes, 00:31:09.759 --> 00:31:11.900 that's comma computer -assisted mass appraisal. 00:31:11.980 --> 00:31:14.920 It's how the tax assessor values 50 ,000 homes 00:31:14.920 --> 00:31:17.900 in one county. without visiting the mall. They 00:31:17.900 --> 00:31:19.880 run the algorithm. JAMA just adds a geographic 00:31:19.880 --> 00:31:23.299 layer to it. But the big news is 2025. The notes 00:31:23.299 --> 00:31:26.920 mention the UA and UR overhaul. What does that 00:31:26.920 --> 00:31:29.319 mean for a regular person? This is inside baseball, 00:31:29.440 --> 00:31:32.220 but it's huge. The Uniform Residential Appraisal 00:31:32.220 --> 00:31:34.759 Report, the UR, the form every appraiser has 00:31:34.759 --> 00:31:38.079 used for decades, is dying. The static PDF is 00:31:38.079 --> 00:31:41.099 going away. Right. It's being replaced by a dynamic 00:31:41.099 --> 00:31:43.460 cloud -based data set. Instead of just checking 00:31:43.460 --> 00:31:46.279 boxes on a form, the report can adapt to the 00:31:46.279 --> 00:31:49.440 specific property. And it's integrating AI. The 00:31:49.440 --> 00:31:52.019 sources mention AI handling the data crunching. 00:31:52.079 --> 00:31:54.680 Right. The vision for 2025 and beyond is that 00:31:54.680 --> 00:31:58.140 AI handles the science. The AI scrapes the MLS, 00:31:58.359 --> 00:32:01.099 cleans the data, runs a regression analysis on 00:32:01.099 --> 00:32:03.200 the comps. It does the heavy lifting on the math. 00:32:03.380 --> 00:32:06.359 Leaving the human to do what? The art. The judgment. 00:32:06.480 --> 00:32:09.079 The appraiser verifies the data. There are the 00:32:09.079 --> 00:32:11.180 boots on the ground. Does the basement smell 00:32:11.180 --> 00:32:13.839 damp? Is the traffic noise louder than the map 00:32:13.839 --> 00:32:16.720 suggests? Does the floor slope? Things an algorithm 00:32:16.720 --> 00:32:19.420 can't detect. The goal is faster turnaround and 00:32:19.420 --> 00:32:22.900 better consistency. Ideally, yes. But it raises 00:32:22.900 --> 00:32:25.259 questions about the human element, which leads 00:32:25.259 --> 00:32:27.980 us to the darker side of valuation, ethics and 00:32:27.980 --> 00:32:30.339 bias. Yeah, we have to talk about the gap. This 00:32:30.339 --> 00:32:32.920 is a critical issue facing the industry. Major 00:32:32.920 --> 00:32:35.440 studies, including data from Freddie Mac, have 00:32:35.440 --> 00:32:37.539 shown a persistent valuation gap for minority 00:32:37.539 --> 00:32:39.539 -owned homes. And this isn't just an issue of 00:32:39.539 --> 00:32:42.819 income disparity or something. No. The studies 00:32:42.819 --> 00:32:45.579 control for credit score, income, and house size. 00:32:45.859 --> 00:32:48.420 Even when you compare apples to apples, the valuation 00:32:48.420 --> 00:32:51.140 often comes in lower for homes in minority neighborhoods 00:32:51.140 --> 00:32:54.400 or owned by minorities. So where is the disconnect? 00:32:54.720 --> 00:32:57.480 What's causing that? That is the fierce debate. 00:32:58.000 --> 00:33:00.140 Some in the industry argue it's neighborhood 00:33:00.140 --> 00:33:02.759 quality, which is really a byproduct of historical 00:33:02.759 --> 00:33:05.799 redlining and systemic underinvestment. They 00:33:05.799 --> 00:33:07.940 argue the appraiser is just reflecting the market 00:33:07.940 --> 00:33:10.759 and the market itself is biased. But others say 00:33:10.759 --> 00:33:13.619 it's the appraiser's subjectivity, the art part 00:33:13.619 --> 00:33:16.440 we just praised. Correct. Implicit bias. Remember 00:33:16.440 --> 00:33:18.759 those adjustments we talked about? Or the quality 00:33:18.759 --> 00:33:21.039 ratings. If an appraiser marks a neighborhood 00:33:21.039 --> 00:33:24.240 as declining instead of stable, that tanks the 00:33:24.240 --> 00:33:27.460 value. Is that choice based on hard data? Or 00:33:27.460 --> 00:33:30.019 a feeling. If it's a feeling, bias can creep 00:33:30.019 --> 00:33:32.119 in. It's a massive challenge for the profession 00:33:32.119 --> 00:33:34.400 to solve. And we also have the conflict of interest 00:33:34.400 --> 00:33:36.660 issue. This goes way back to the savings and 00:33:36.660 --> 00:33:39.640 loan crisis in the 80s. The Wild West of valuation. 00:33:40.079 --> 00:33:42.200 Back then, banks would just hire their buddies 00:33:42.200 --> 00:33:44.160 to appraise properties. They called Jerry and 00:33:44.160 --> 00:33:47.240 say, make the deal happen, Jerry. And Jerry would 00:33:47.240 --> 00:33:49.339 write whatever number was needed to make the 00:33:49.339 --> 00:33:51.599 loan go through. Exactly. And when the market 00:33:51.599 --> 00:33:54.539 turned, the banks realized they held collateral 00:33:54.539 --> 00:33:57.079 that was worth half. of what the paper said it 00:33:57.079 --> 00:33:59.779 was worth. That collapse led to the creation 00:33:59.779 --> 00:34:03.000 of the Appraisal Foundation and USPAP. It created 00:34:03.000 --> 00:34:05.900 the ethical wall between the loan officer and 00:34:05.900 --> 00:34:08.320 the appraiser. A loan officer today isn't even 00:34:08.320 --> 00:34:10.380 allowed to call the appraiser and talk numbers, 00:34:10.519 --> 00:34:12.639 right? It all has to go through a third party. 00:34:12.820 --> 00:34:15.559 They have to be very, very careful. They certainly 00:34:15.559 --> 00:34:18.119 can't say, we need this to hit 400K. That is 00:34:18.119 --> 00:34:20.719 a massive violation now. So we've covered a lot 00:34:20.719 --> 00:34:22.760 of ground. We've unpacked the three approaches, 00:34:23.019 --> 00:34:26.039 sales comparison, cost, and income. We've seen 00:34:26.039 --> 00:34:27.860 how a nine -bathroom house might actually be 00:34:27.860 --> 00:34:30.000 worth less than you think. We've traveled from 00:34:30.000 --> 00:34:32.199 the traffic lights of UK surveys to the strict 00:34:32.199 --> 00:34:34.219 committees of Germany. And we've looked at the 00:34:34.219 --> 00:34:36.639 future of AI and how it's changing the game. 00:34:36.840 --> 00:34:38.940 So what does this all mean for the listener? 00:34:39.059 --> 00:34:41.880 What's the final takeaway? It means you need 00:34:41.880 --> 00:34:44.500 to stop looking at an appraisal as just a hurdle 00:34:44.500 --> 00:34:48.440 to get a loan. It's not an obstacle. It's a protection 00:34:48.440 --> 00:34:51.119 mechanism. It protects you from yourself, from 00:34:51.119 --> 00:34:52.900 your own emotions when you fall in love with 00:34:52.900 --> 00:34:54.639 a house. It protects you from paying market price, 00:34:54.840 --> 00:34:57.639 an emotional number, for something that doesn't 00:34:57.639 --> 00:35:00.179 have the market value to back it up. Whether 00:35:00.179 --> 00:35:03.099 you are a buyer, a seller, or just a homeowner 00:35:03.099 --> 00:35:05.840 paying taxes, understanding how that number is 00:35:05.840 --> 00:35:08.940 built gives you power. You can appeal a tax assessment 00:35:08.940 --> 00:35:11.940 if you understand the cost approach. You can 00:35:11.940 --> 00:35:14.239 negotiate a better purchase price if you understand 00:35:14.239 --> 00:35:16.619 the sales comparison. Knowledge is leverage. 00:35:16.880 --> 00:35:19.280 Always. So here is a provocative thought to leave 00:35:19.280 --> 00:35:22.280 you with. As we move into this world of 2025 00:35:22.280 --> 00:35:27.659 where AI takes over the math of valuation, will 00:35:27.659 --> 00:35:30.360 the art, the human judgment, become more valuable? 00:35:30.719 --> 00:35:34.360 That is the billion -dollar question. Algorithms 00:35:34.360 --> 00:35:37.460 can crunch data better than any human. But can 00:35:37.460 --> 00:35:39.719 an algorithm walk into a house and feel that 00:35:39.719 --> 00:35:42.489 the layout is awkward? Can it smell the dampness 00:35:42.489 --> 00:35:44.829 in the basement? Can it sense that the neighborhood 00:35:44.829 --> 00:35:47.110 vibe is shifting because a cool coffee shop just 00:35:47.110 --> 00:35:49.210 opened up down the street? Or will the algorithms 00:35:49.210 --> 00:35:51.389 eventually get so good that they decide what 00:35:51.389 --> 00:35:53.289 our homes are worth without ever stepping inside? 00:35:53.610 --> 00:35:57.230 If that happens, we lose the nuance of human 00:35:57.230 --> 00:36:00.230 life that is built into our homes. I hope we 00:36:00.230 --> 00:36:02.750 keep the human element. The art is what makes 00:36:02.750 --> 00:36:04.730 a house a home, and I think it's what makes a 00:36:04.730 --> 00:36:07.929 valuation truly accurate. Something to mull over 00:36:07.929 --> 00:36:10.110 the next time you look at your property tax bill. 00:36:10.349 --> 00:36:12.469 Go check your assessment method. You might just 00:36:12.469 --> 00:36:14.730 save yourself some money. Indeed. Thanks for 00:36:14.730 --> 00:36:16.269 diving deep with us. We'll see you on the next 00:36:16.269 --> 00:36:16.429 one.