Appraisal Principles USPAP Perspective Determining Fair Market Value

Appraisal Principles USPAP Perspective

Determining Fair Market Value Appraisal is an estimate of fair market value Ø Fair market value is known with certainty only at time of sale Appraisal is an art However, the science of appraisal is its methodology for turning subjective reasoning into objective reasoning which minimizes valuation differences among professional appraisers

Definition of Fair Market Value “The price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. ” Ø Internal Revenue Section 1. 170 A-1(c)(2)

Methods for Determining Fair Market Value Sales Comparison Approach Income (Net Present Value) Approach Cost-of-Replacement (Production) Approach

Sales Comparison Approach Similar or comparable properties that have been recently sold in an arms-lengthtransaction and in a relevant market give an indication of probable value of the subject property to which they are being compared when proper adjustments are made that minimize the differences in characteristics between the subject property and comparable properties.

Sales Comparison Approach Subject Property: The property for which value is being determined Comparable Property: Has similar characteristics of the subject property for which a transaction (sale) price is known Ø Also, similar use v Registered beef cow used to produce feeder steers should be valued as brood cow v 4 -H club calve & lamb sales and 4 -H fair sales are not the same as commercial sales Being able to adequately judge the quality of the subject property and find good comparables is at the heart of the sales comparison approach

Sales Comparison Approach Arms-Length-Transaction: A sale conducted in an open market between a willing buyer and a willing seller and both have reasonable knowledge about the property ØDon’t use quick forced sale data ØAdvertized liquidation sales are OK

Sales Comparison Approach Relevant Market: The market or place where the subject property is most commonly sold at the level of value being sought. Ø High value replacement breeding stock are often sold in special disposal sales or specialized breeding sales, e. g. v Whitetail Extravaganza Top 30 Breeder Sale & Show v Pride of Washington and Best of the Northwest (dairy) Ø If an owner is claiming high value, then should be able to document previous sales at an elite breeding sale v Being registered doesn’t mean superior genetics; it just means pure genetics, can have “poor” pure genetics v Being breed registered is not sufficient documentation for higher prices, it must be demonstrated in actual sale data or documentation of breeding merchandising

Sales Comparison Approach Adjustment-in-Value: The characteristics of comparables will not always be the same as the subject property and consequently the value of the comparables are adjusted so that the comparables have the same characteristics as the subject property. Ø Making proper adjustments is also at the heart of generating good appraisal value

Income Approach The Income Approach estimates the present (discounted) worth of anticipated future stream of net income from owning income producing assets.

Income Approach Basic Methodology ØDetermine retained earnings for each time period v. Retained Earnings = Gross Revenue – Operating Expenses – Depreciation – Income Taxes – Payments to Owners (Dividends) v. Generally involves developing enterprise budgets Ø Determine number of years the asset will be productive Ø Select discount rate (cost of capital, i. e. interest rate) ØValue = ∑ (retained earningst) / (1 + i)t

Income Approach Appropriate Use ØGeneral v Businesses, real estate with rental leases, financial investments ØAgriculture v. Breeding animals § Method used for poultry calculators

Cost-of-Replacement Approach Valuation with the Cost Approach equals the cost of replacing a subject property with an exact replica, or with an acceptable, similar, new or used property.

Cost-of-Replacement Approach Uses in Agricultural Appraisals ØReplacement stock v. Value equals cost associated with raising the animal v. Can be combined with Sales Comparison Approach § value of young dairy replacement heifer equals the market price of 2 year old springer heifer minus the costs associated with raising the heifer from current age to a 2 year old springer

Cost-of-Replacement Approach Uses in Agricultural Appraisals ØBuildings, fences v. Sometimes sheds or chicken coops are destroyed as part of cleaning and disinfection v. Value can be cost of replacing destroyed item adjusted for remaining useful age § Assume backyard chicken coop has 10 year economic life and one destroyed has 2 years left, value would be two-tenths of cost of replacement

Sales Comparison Approach in Detail

Sales Comparison Approach Know the subject property Ø What are the key characteristics that will be used to determine value, i. e. adjust comparables v Breed, sex, age, body condition, productivity v Maybe limited by what is reported in relevant markets Find relevant markets for comparables Ø Market in which the subject property would normally sell v Maybe located in another state v If using an exclusive (elite) breeding sale as relevant market, then must document that the animal has the quality characteristics to be sold at such a market

Sales Comparison Approach Have multiple comparables Ø Prefer to have at least 3 Make adjustments of comparables to match subject property Ø ALWAYS adjust comparables to subject v If comparable is better than subject, then subtract value v If poorer than subject add value Ø Make adjustments to each comparable first, then average the comparables Ø If a comparable appears to be an outlier, then you may exclude it, especially if it is more different from the subject property than the other comparables

Sales Comparison Approach Adjustment Example (with made up numbers) ØSubject Animal v. Angus Beef Cow, 4 years old, 6 months pregnant, 1200 pounds ØComparable Animals v. Angus Beef Cow, 5 years old, 5 months pregnant, 1100 pounds, $700 selling price v. Herford Beef Cow, 3 years old, 7 months pregnant, 1100 pounds, $750 selling price v. Angus-Herford cross Cow, 2 years old, 3 months pregnant, 1000 pounds, $750 v. Angus Beef Cow, 9 years old, 4 months pregnant, 1400 pounds, $600 selling price

Appraisal Adjustment Table Breed Age Pregnancy Weight Sales Price ($/head) Subject Angus 4 yrs 6 mo 1200 lbs Comp 1 Angus 5 yrs 5 mo 1100 lbs $700 Comp 2 Herford 3 yrs 7 mo 1100 lbs $750 Comp 3 A–Hx 2 yrs 3 mo 1000 lbs $750 Comp 4 Angus 9 yrs 4 mo 1400 lbs $600

Adjustment for Breed Can be difficult, try to find market value for the breed in question, especially if the herd is being used to produce replacement stock Can account for breed size differential through weight adjustment & milk production (dairy) Most popular cattle breeds: Ø beef – Angus, dairy – Holstein In swine and poultry have specialized composite breeds from genetic breeding companies Foundation breeding stock for these companies can be very valuable Ø Traditional breeds are becoming heirloom breeds being raised by serious hobbyist v Body confirmation becomes very important in value

Adjustment for Age As breeding & milk animals age, they decline in value (depreciate) as offspring are born and milk is produced The average Holstein upon the birth of her first calf has a remaining life expectancy of less than three full lactations Ø (based upon DHIA data)

Adjustment for Age adjustment for our beef cow example Ø Method 1 v Heiferettes: $65/cwt; cull cows: $45/cwt v Assume 1000 lb animal and 8 calvings § [10 cwt x ($65/cwt - $45/cwt)] / 8 = $25 per year Ø Method 2 v 2 yr old bred heifer: $1200; 8 yr old bred cow: $600 § ($1200 - $600) / (8 yrs – 2 yrs) = $100 per year Ø Method 3 v Statistical analysis of USDA-AMS beef cows auction prices § Beef cows depreciate in value by approximately $30/year Ø Differences between the three methods demonstrate part of the “art” of appraisal

Adjustment for Pregnancy Status Most breeding animals are either pregnant or are nursing young (i. e. cow-calf pairs) Ø Breeding animal that don’t get pregnant are usually culled Ø Thus, breeding females are normally traded when they are pregnant (or cowcalf pairs) and consequently market prices for breeding females are for pregnant females Discount if not pregnant – not a premium for being pregnant

Adjustment for Pregnancy Status Pregnancy adjustment for our beef cow example Ø Method 1 v 70 lb calf @ $135/cwt x 95% chance of a live calf after 24 hours = $90 calf in the womb ÷ 9 months gestation = $10 per month pregnant Ø Method 2 v Cost of insemination plus variable (cash) cost associated with caring for the breeding animal Ø Method 3 v Statistical analysis of USD-AMS auction prices § Approximately $20/month

Adjustment for Weight Ø Use relevant market prices for cull values of breeding animals Ø USDA-NASS national cow price v Nov ’ 08: $43. 10/cwt v Dec ’ 08: $40. 40/cwt v Jan ’ 09: $42. 20/cwt Ø Statistical analysis of USDA-AMS beef cow auction prices v Cows: approximately $43/cwt v Heifers: approximately $71/cwt Ø $45/cwt for our beef cow example

Adjustment for Breed Registration Being breed registered doesn’t automatically add value Could increase value at little by the cost of registering due to owner prejudice Must have evidence of merchandizing breeding stock to have breeding premium Ø If a herd or flock of registered animals is used primarily to produce meat animals or milk, then it is a commercial herd and the breeding stock is of commercial value Owner must provide documentation of additional value being realized for his/her animals It’s performance, not pedigree that counts

Appraisal Adjustment Table Breed Age Pregnancy Weight Sales Price ($/head) Adjustment ($50 if not Angus) ($25/yr) ($10/mo) ($45/cwt) Subject Angus 4 yrs 6 mo 1200 lbs Comp 1 Angus $0 5 yrs +$25 5 mo +$10 1100 lbs +$45 $700 +$80 $780 Comp 2 Herford +$50 3 yrs -$25 7 mo -$10 1100 lbs +$45 $750 +$60 $810 Comp 3 A–Hx $0 2 yrs -$50 3 mo +$30 1000 lbs +$90 $750 +$70 $820 Comp 4 Angus $0 9 yrs +$125 4 mo +$20 1400 lbs -$90 $600 +$55 $655

Appraisal Adjustment Table Breed Age Pregnancy Weight Adjustment ($50 if not Angus) ($25/yr) ($10/mo) ($45/cwt) Subject Angus 4 yrs 6 mo 1200 lbs Comp 1 Angus 5 yrs 5 mo 1100 lbs $780 Comp 2 Herford 3 yrs 7 mo 1100 lbs $810 Comp 3 A–Hx 2 yrs 3 mo 1000 lbs $820 Comp 4 Angus 9 yrs 4 mo 1400 lbs $655 Subject value: ($780 + $810 + $820 + $655) ÷ 4 = $766. 25 ► $750 Subject value: ($780 + $810 + $820) ÷ 3 = $803. 33 ► $800 If no breed adjustment: Subject value: ($780 + $760 + $820) ÷ 3 = $786. 67 ► $800 Adjusted Value ($/head)

Additional Appraisal Exercises

Summary Sales Comparison Adjustments are at the heart of any appraisal, must be done right Need data to determine & support adjustments Requires constant surveillance of the market and data collection efforts Questions?

Appraisal Principles APHIS Perspective

Animal Health Protection Act of 2002 “…compensation shall be based on the fair market value, as determined by the Secretary, of the destroyed animal, article, facility, or means of conveyance. ”

Animal Health Protection Act of 2002 “…the amount to be paid under this subsection shall be final and not subject to judicial review or review of longer than 60 days by any officer or employee of the Federal Government other than the Secretary or the designee of the Secretary. ”

Factors Affecting Fair Market Value Animal characteristics Ø Breed, Age, Weight, Use Animal Profitability Ø Breeding, Milk, Egg Production v Breeding, milk or egg producing animals depreciate with age

Factors Affecting Fair Market Value Health Status Ø Free of disease, exposed to disease or infected with disease v USDA assumes healthy animals, i. e. as if they are not diseased or exposed to the disease in question v Thus, APHIS appraisal value may be greater than true fair market value

Factors Affecting Fair Market Value What others are willing to pay Ø Demand & supply situation v Rare/unique breeds: valuable because few suppliers or worthless because nobody wants them. v Be careful of minor breed hype v Sometimes for minor breeds add a slight premium (or don’t discount) to satisfy owner prejudice Ø Often expressed in auction markets

Factors Not Included in Fair Market Value The animals are family Family financial needs Bonus for cooperation Ø Need appraisal objectivity Ø Not allowed Ø Can lead to domino affect where future owners won’t cooperate without bonus

Modified Sales Comparison Approach Use of auction market reports and auctioneer (expert) opinion ØAre not true comparables and thus don’t qualify for a true sales comparison approach ØHowever, they provide useful information that can allow us to determine value

Using Auction Market Reports to Determine Value Auction market reports often limited to summary information Ø e. g. fresh Holstein cows v Sometimes will report very general body condition, e. g. “good” v Usually don’t report milk production Ø May not report how many were sold in any one category v Sale of a few animals may not be representative of fair market value Ø May not report average value for any category v Range can be miss leading as an outlier can greatly widen the range

Using Auction Market Reports to Determine Value Livestock producers claim that auctions under represent value as lower quality animals populate auction sales Ø Somebody is purchasing these animals and taking them back to their operation Ø Auction Reports sometime don’t report animals that sold at lower prices

Basing Appraisal Value on Auction Market Reports Reported prices will usually be a range of value Ø If subject property matches up with reported quality characteristics, then select midpoint (50 th percentile or median) value v Auction prices of fresh cows, 2 - 3 years old: $1500 - $2500 § Midpoint is $2000 v Subject: 3 yr old fresh dairy cow with milk production near state average: value = $2000 Ø If have data on each lot sold, then take average or if have an outlier use median (middle) value v If lots are of multiple animals then calculate a weighted average § Sum total sales value and divide by total number of animals

Basing Appraisal Value on Auction Market Reports If have prices from multiple auctions can Ø Average their midpoints $900 ($700 - $1100) + $1000 ($800 - $1200) + $1200 ($1000 - $1400) + $900 ($600 - $1200) = $4000 ÷ 4 = $1000 Ø Take the midpoint of highest minimum value and lowest maximum value v ($1000 + $1100) ÷ 2 = $1050 Minimum Value Maximum Value Auction 1 $700 $1100 Auction 2 $800 $1200 Auction 3 $1000 $1400 Auction 4 $600 $1200

Basing Appraisal Value on Auction Market Reports When auctions list average value for top 1, top 5, top 10, top 50, top 100, etc. Ø Can calculate average value for 2 -5 top head, 6 -10 top head, 11 -50 top head, 51 -100 top head, etc v Example: Top, $1600; Top 5, $1500; Top 10, $1450 Ø Determine total value for top 5, subtract value of top 1, divide by 4 (5 1) to obtain average value of top 2 -5 head. v ($1500 x 5 - $1600) ÷ (5 -1) = $5900 ÷ 4 = $1475 Ø Determine total value for top 10, subtract total value for top 5, divide by 5 (10 - 5) to obtain average value of top 6 -10 head v ($1450 x 10 - $1500 x 5) ÷ (10 -5) = $7000 ÷ 5 = $1400 Ø Repeat process Ø For average quality I use the average value for the bottom category as it generally has the most head and often there are other animals sold at a lower price that are not reported

Making Adjustments to Auction Market Reports Making adjustment for an unreported characteristic (e. g. milk production in dairy cows) What to do when subject animal doesn’t match up to reported characteristics Ø Example v Auction prices of fresh cows, 2 - 3 years old: $1500 - $2500 v Subject cow 1: fresh cow 3 years old milking 3000 pounds above state average v Subject cow 2: fresh cow 6 years old milking 3000 pounds above state average

Adjustments for Unreported Characteristics Assuming subject property matches up with reported quality characteristics, can move towards either the bottom or top of the reported price Ø One option is to select the 25 th / 75 th percentile (midpoint between 50 th percentile and bottom/top) for poorer/better quality animals v Midpoint (50 th percentile) of $1500 - $2500 is $2000 v 25 th percentile: midpoint between $1500 & $2000 or $1750 v 75 th percentile: midpoint between $2000 & $2500 or $2250 v Subject dairy cow 1: $2250 Ø If extremely better/poorer, then could select top/bottom of price range

Adjustments for Characteristics that Don’t Match Market Reports Determine value of a base animal and then make adjustments based upon other information you have Ø Subject cow 2: 6 yrs old, 3000 lbs above state milk average Ø Base animal: select 75% percentile to account for superior milk production: $2250 Ø Based upon assumed previous analysis depreciation is $200 per year of age v 6 yrs – 3 yrs @ $200/yr = $900 adjustment v Appraisal value: $2250 - $900 = $1350 Remember: You can move within the price range to adjust for a characteristic not reported, but must make an adjustment for a characteristic that is different from what is reported

Obtaining Expert Opinion Describe the subject animal in detail ØExample: 3 -4 year old Angus cow, commercial grade, confirmed 5 -6 months pregnant, good body condition ØDon’t simply ask, “What are beef cows selling for? ” ØOnce a base animal has been describe, then can ask how age, weight, breed, body condition, breed registration, pregnancy status, etc impact value

Reporting Expert Opinion Expert’s response will become part of the appraisal report, example: Ø Joe Doe, Top Value Livestock Auction Market, October 9, 2008 Ø Values for bred Angus cow, 3 -4 years of age, commercial grade, good body condition v Young cows: $900 to $1300, very top quality $1500 v Sold mouth cows: $800 to $1000 v Broken mouth cows: $100 over cull value v Cull price: $45 - $50 per cwt v Registered: up to $100 extra v Fair body condition: discount $100 - $200 v Poor body condition: $100 above cull value v Other breeds: generally bring a little less v Market is generally down $100 to $200 due to poor pasture conditions / hay shortage resulting from summer drought

Using Auction Reports & Expert Opinion Can combine information from both Ø Start with expert opinion v Generally a range of value Ø Use auction prices as supporting evidence and for adjustment to final appraisal value v i. e. specific value within the expert opinion range Remember to include copies of the auction reports as part of your appraisal report as well as the information gained from the expert

Appraising in Groups When appraising a herd one can appraise groups of animals as long as they have similar value Ø Develop a few categories to place all the animals v e. g. for dairy cows have 4 levels of lactation and 3 levels of milk production to have 4 x 3 grid of values with a 13 th value for animals to be culled due to reproductive, body condition, mammary problems, poor production etc. v Categories should be relevant and have reasonable percentage of the herd § e. g. in the above example may eliminate the low milk production category as such animals would culled by end of lactation

Appraising in Groups Develop a few categories to place all the animals Ø Determine value for each category then place the animals into the categories Ø Alternatively could have base animal with predetermined adjustments for a few key parameters v e. g. base milk cow: 1 st lactation, milking 18, 000 lbs, open & no breed registry with adjustments for higher lactation levels, milking above 21, 000 lbs, above 24, 000 lbs; pregnant; bred registered v Assumes adjustments are independent of one another § Should there be a breed registration premium for an older animal?

Accounting for Differences in Time Sometimes have very good price information, but it may be dated Ø Indexing using an established price series can be an option for updating prices v Example: Have November price information for Telemark cattle & subject cow would be worth $1000, however, it is now June v In November, Drovers reported average bred cow worth $700 and in June, $800 v Indexing: (current series value / past series value) x value of interest § ($800/$700) x $1000 = $1143 ►$1150 Ø Major assumption: that subject animal has changed in value the same percentage as animals in the price series v If true, then a viable option; if not then don’t index

Questions?