We have written in previous articles the effective way of aquiring real estate properties in Mexico, but we left out a very important aspect, the appraisal. We received comments on this regard and considering the importance of how sales prices are ususally based on appraisals, we deemed adecuate to devoque this number to this particular aspect of any real estate transaction, the apprisal.
Appraisals are used all the time, not only when it comes to determinning the value of a real estate property but basically any asset in the market, and not only for purchase-sale transactions but also for many other corporate and personal porpuses such as: Insurance, corporate reestructures, tax planning, heritages, trusts, etc.
In this current number we will specifically talk about real estate appraising, since we consider this to be the most interesting aspect of general appraising for potential foreing investors in Mexico.
In this article we will address two very important aspects of real estate apprising in Mexico, governing laws and applicable methods and thecniques.
Current applying laws and regulations.
Is very important to understand that we have in Mexico, a very well defined Federal system, and as such, we will have aplicable laws and regulations on both levels, federal as well as local.
1.- Valuation and appraisal services methodology (NMX-R-081-SCFI-2015)
This type of rules are issued by the department of economics at the federal level, there are two types of rules, the “Official” ones and the “Non official”, the “official” rules, as expected, are mandatory. The “non official” rules, are taken as guidelines, it is very common for a “non official” rule, after certain number of years to become “official”.
In Mexico we had the rule NMX-C-459-SCFI-ONNCCE-2007, this rule applied since 2007, since 2015 works have begun to put together a rule, “non official” at the beginning that resembles the International Valuation Standards (IVS).
The International Valuation Standards Council, is an independent not for profit private sector organization. The objective of the IVSC is to develop a single set of high quiality globally accepted International Valuation Standards (IVS) and to strenghthen the valuation profession by establishing codes of conduct and competency benchmarks for valuation professionals, this council is based in London, England. The last time the IVSC issued ammendments to its Standards was 2013.
The 2013 version of the IVS, were taken (not very accuretly) by the Mexican Government in order to create what we have in place today in Mexico, the afored mentioned Valuation and Appraisal Services Methodology.
2.- Institute For the Administration and Appraisal of National Assets (INDAABIN)
INDAABIN, for its name in spanish Instituto de Administracion y Avluo de Bienes Nacionales, is an agancy from the Federal Government that deals with the administration and valuation of all assets property of the government on any level, both federal and local, but this agency %%%%%, also finds within its tasks to regulate apprasing outside of government owned or managed assets in certain, very important areas such as: Hydrocarbons, agriculuture, mining, telecomunications, and radio.
3.- Correduria Publica’s Federal law and its corresponding regulations.
We have covered in recent articles the very unique and important role of the Corredor Publico in Mexico, one of the main attributions by law, based on very hevy and technichal examinations, is the abillity to perform appriasals recognized by any level of the government and any authority, therefor, in its governning law and regulations, we find important set of rules applying to this professional activity.
At the local level, we have two main regulation bodies to acknowledge, the state appraisal law, if it exists, we currently have in Mexico roughly ten states that have some sort of regulation for conducting appraisals, some of these states are Baja California, Chihuahua, Guerrero, Cuidad de Mexico, Quintana Roo, among others. The idea of these state laws or regulations is to stablish basic, minimum methods and techniques to the applied when conducting an appraisal, specially when it comes to real estate valuation or appaising.
At the municipal level there is a very unique perspective about real estate valuation, the reason is rather simple, the most important source of income for the government at this level (municipal) is Property Tax (Impuesto Predial), and the second most important income is Real Estate Acquisition Tax (Impuesto Sobre Adquisicion de Inmuebles). They are both uniquely link to the adecuate perfomrance of municipal apparisors. A few states, have even opted to set the value for real estate transactions (regarding taxes) themselves, states such as Coahuila, Sonora, Jalisco, among others, do not requiere a municipal certified appraisor to perform the apprisal for real estate transactions, the government, usually through its treasurer stablishes minimun real estate values by zone in each city, and said values are used as base for calculating both Property Tax and Real Estate Acquisition Tax.
In our experience, both systems could work, however, we have seen that when appraising relies in duly trained experts is much easier to adapt to the ever changing mood of the real estate market, than it is to do so, when the government is the one that sets its values.
As expected in a country the size of Mexico, we have sevral aplying laws and regulations when it comes to appraising, specially real estate appraising, and those who perform as proffesional appraisors have to always be aware of such regulations, (and they usually are). Eventhough there are several regulations, most of them, recognize the sama commonly used techniques and methods, same methods and techniques that are alreay recognized world wide.
Commonly used methods and techniques.
Also known as Fair Market Value (FMV), this method is defined by the International Valuation Standards as “the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion”.
This method is also known as ‘Sales comparison aproach”, based on the way it is carried out, by seeking and searhcing comparable sales, ideally the expert appaisor will search for comparables in the same zone, same area, and of course, properties with the same market impact, preferably properties with the same “market recognized variables”, these variables are: area, zone, numer of rooms, number of garage spaces, number of bathrooms, special amenities, among others speciall features regarding weather, accesability, etc.
This method usually utilizes one of the available published construction cost indexes, in Mexico there are several recognized publications such as Varela, Metros Cubicos, Intercost, and others , which break down costs by material types and region. A buyer seriously considering building a new structure may well retain a building contractor to make a complete building cost estimate.
The construction current replacement cost then needs to be adjusted to reflect the actual state (and value) of the subject property. This involves reductions to reflect the property’s physical deterioration and functional obsolescence. The physical deterioration can involve some curable “deferred maintenance” that can be repaired, but it also involves the very real effects of age and the fact that some repairs are no longer economically justifiable. Functional obsolescence refers to the impact on income of changes in building technology and consumer tastes and preferences on the property’s value.
Income Based Approach.
This commonly used method or approach is based on the future earnings that the property can produce for the owner, the principle is rather simple, the idea is to bring to a present value the future earnings that the property will produce (or has the potentiality) to produce, using a disscount or capitalization rate.
This approach is based on an economic principle known as “Best and better use”, this principle states that when valuing a real estate property, or any other asset, the appraiser will consider the best scenario of economic eficiency, which means, the appraiser will consider the hipotetical best income that the property will produce (base on its real and current circunstances), an example of this will be, a home that is currently being rented for $600.00 USD, for several different reasosns, but the market is willing to pay for said property $800.00 USD, when valuing said property the appraiser should consider as monthly income the $800.00 rather than the $600.00.
This approach requires determining the amount, certainty, and length of time of future income from the property, and then applying an appropriate capitalization rate or “cap rate” to convert the future income into a present value, this are the two variables in this method, the annual income (usually known as Net Operating Income or NOI and the cap rate.
This approach is generally used by determining the net operating income of a property and then choosing a capitalization rate suited to the property’s type, location, age, and quality of tenants.
When selecting a suitable Cap Rate appraisers usually use WACC (Weighted Average Cost of Capital), our position on this subject is that WACC can be an starting point, but it can’t be the complete basis for determining the cap rate, since it does not include any specific circunstances of the property itself, for instance, the cap rate for to neighboring homes, one is very carefuly kept, the other one is not, should be a little bit different, since you need to anticipate the larger maintenance cost for the second home, (on top of making the proper deductions on income for the same reasons). A reasonable Cap Rate in Mexico for residential Real Estate will fluctuate between 8% and 12%.
Final Comments and conclusions.
These three approaches will often provide three different values for a property, so an appraiser must reconcile the varying results. Depending on the property and the appraisal’s objective, one of the approaches may be more suitable than the others, so a simple averaging of the three results is usually not appropriate. An appraiser will need to meld the results of the three approaches in a sensible, reasoned way.
Although working at least these three approaches is ideal, is not always possible, if a buyer or a seller finds an appraisal that offers just one or two approaches, he or she should ask why, and in doing so, should find a reasonable answer, if appraiser does not (usually in the report) explain the reasons and difficulties why certain approaches were not developed or to his experience were not necessary, the report is, at the very least, incomplete.
The three primary approaches to valuation each have unique characteristics. Market data (comparables) are always beneficial in a valuation analysis, and can indicate what potential buyers are currently paying for comparable properties. Still, recently sold properties are often not truly comparable to the property being evaluated, and might not adequately reflect the property’s actual projected income. Where newer buildings are involved, the cost approach is often more reliable; it may be the only choice where market data is scarce.
In the end, an apprising report is just an opinion, but an educated opinion issued by an expert so, a very good idea for potential buyers and sellers initiating their quest into a Real Estate transaction is to always begin by retaining the services of an experienced appraiser.