VALUATION OF THE MARITAL HOME IN DIVORCE PROCEEDINGS:
APPRAISAL TECHNIQUES AND LEGAL CONSIDERATIONS

Galen Craun

Law & Valuation
Professor Palmiter
Spring, 1999


Abstract


Abstract

During a divorce, the valuation of a marital home is very important, especially where one spouse continues to occupy the home after the divorce and the other must be reimbursed for surrendering possession of the home.  There are numerous valuation methods for real estate involved in divorce proceedings and various types of evidence allowed to determine the value.  Appraisal is the most common evidence for determining the value of a home.

ISSUES

1.  What is the best method of determining a home’s value for the purposes of equitable distribution?
2.  What methods may be used by the appraiser in determining the fair market value of the home?
RULES
1.  Appraisal of the home by a certified appraiser.
2.  3 methods are acceptable: the sales comparison approach, the cost approach, and the income approach.

ANALYSIS

North Carolina is an equitable distribution jurisdiction for divorce proceedings.  The date of separation is used as the point in time for determining the net value of all marital property.  Net value is not defined in divorce statutes, but has been interpreted to mean the fair market value of the marital property less any encumbrances. Thus, the fair market value of a home is often an important issue in divorce proceedings.  If one spouse continues to occupy the home, the FMV cannot be determined through a sale of the home.  Thus, each party must produce evidence of an estimate of the home’s FMV on the date of separation.  Appraisals are one common method of doing this.  However, North Carolina courts have held that real estate tax appraisals and mortgage appraisals are inappropriate, because they tend to be overly conservative. If the couple has recently purchased a home, the original price may be an indicator of the FMV, but this is not helpful in cases where the couple has been married for more than a few years.  Thus, the most common type of evidence is appraisal of the marital home by a certified appraiser.  Appraisers use many factors in order to determine the FMV of a home and the land it is on, such as location, zoning, age, construction, future income potential, etc.  The North Carolina Supreme Court has recognized three appraisal techniques that may be used in divorce proceedings: the sales comparison approach, the cost approach, and the income approach.  The method may depend on the circumstances of a particular case or all may be used together.

Under the sales comparison approach, the recent sales of property comparable to the marital home are used to estimate FMV.  This is the most common method for valuing single family dwellings.  First, appraisers must identify recent sales of comparable property, by looking at location, type, zoning, desirability, size, etc. Second, appraisers will identify the significant differences between the comparable property and the marital home and make appropriate adjustments to the comparable property’s sale price.  Adjustments may be made for time, location, and physical differences between the properties.  Time adjustments reflect differences caused by appreciation, depreciation, inflation, or deflation.  tion adjustments are made when significant differences in value are created by the location of the comparable property in relation to the marital home. Physical adjustments are made to the comparable property’s sale price to reflect differences in such tings as construction or amenities.  The final step taken by the appraiser is to correlate the adjusted price with available market data to determine the marital home’s final estimated FMV on the date of separation

Under the cost approach, appraisers determine the cost of reproducing or replacing the marital home.  This is typically used to determine the value of new or recently constructed homes.  First, appraisers estimate the FMV of the land separately from the marital home, based on its highest and best use if it were vacant.  Second, appraisers estimate the reproduction or replacement cost of the existing marital home.  Finally, accrued depreciation is estimated, which is any loss in valuation caused by physical deterioration and function or economic obsolescence.  Accrued depreciation is subtracted from the estimated reproduction price, which is then added to the estimated FMV of the vacant land.  This total represents the estimated FMV of the marital home.

The third approach is the income approach, and is typically used to determine the value of a vacation home or farmland owned by the couple that is expected to generate positive income in the future, rather than the marital home.  Typically, the yield capitalization method is used, which is where the expected rental income over a projected investment period is discounted to its present value on the date of separation using an appropriate discount rate.  The estimated value of the property at the end of the investment period is also discounted to its present value and added to the present value of the rental income stream to determine estimated FMV of the property.

Attorneys involved in divorce proceedings need to carefully select a credible and experienced appraiser.  They also need to examine the strengths and weaknesses of each method of appraisal.  As appraisers are considered expert witnesses, they attorney needs to make sure that both the appraiser and the method(s) used are competent and professional.  With regard to appraisers, attorneys can select a certified appraiser.  Each method, however, has its own strengths and weaknesses.  The sales comparison approach is usually preferred by courts because of its ability to provide an estimate of FMV directly from the market.  However, its major weakness is the possible requirement of appraisers to use their personal judgment in the comparison analysis.  The cost approach is the most appropriate when valuing a recently constructed home.  Its main flaw is that it lacks a direct connection to actual market transactions.  Thus, it is difficult to determine whether the figures used by the appraiser are reasonable.  This approach is best used alongside another method, such as the sales comparison approach.


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INTRODUCTION

A couple's personal residence is often the largest single asset they acquire during the course of their marriage. When married couples file for divorce, disputes often arise over the value of the martial home. This is especially true in situations where one spouse continues to occupy the home after the divorce and the other receives money or other property acquired during the course of marriage in return surrendering possession of the home. As a result, attorneys for both parties in divorce proceedings need to determine the value of the marital home and introduce reliable evidence to support their estimates.

This paper begins with an overview of North Carolina's requirements for valuing real estate in divorce proceedings and the various types of evidence attorney's use as estimates of current value. Attention then turns to the most often used evidence for proving the value of the martial home, an appraisal. North Carolina Courts permit three appraisal methods for estimating the value of a couple's home: the sales comparison approach, the cost approach and the income approach. The procedures appraisers use under each of these methods is discussed. Finally, legal issues concerning the use of appraisers as witnesses and the application of the sales comparison and cost appraisal approaches for valuing the martial home are discussed. From this paper it is hoped the reader will gain a better understanding of the various techniques used to value real estate and the potential for using these methods as evidence in divorce proceedings.

OVERVIEW OF VALUATION IN DIVORCE PROCEEDINGS

North Carolina law provides for the equitable distribution of all "marital property" owned by a couple involved in divorce proceedings.[1]   "Marital property" includes all real and personal property acquired during the course of marriage before the date of separation.[2]   The date of separation is very important for purposes of the divorce proceedings. In addition to serving as the date for classifying assets as martial property, it is also used as the point in time for determining the "net value" of all marital property.

 

"Net value" is not defined in the divorce statutes. The North Carolina Court of Appeals, however, has interpreted "net value" to mean the fair market value (FMV) of the marital property less any encumbrances.[3] FMV is defined as the amount by 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 the facts.[4] Under this definition, FMV would not be equivalent to the price paid for the assets, the assets' replacement value, or the amount received in recent sales of similar property. These values, however, may be used in divorce proceedings as evidence of an asset's FMV in situations where the asset is not sold, but instead, possessed by one spouse after the divorce proceedings are complete.[5]
 
 

The estimated FMV of the couples' martial home is often an issue in divorce proceedings, especially where one spouse continues to occupy the home. In these situations, the home's true FMV cannot be determined by a sale between a willing buyer and seller. As a result, the parties need to produce evidence estimating the home's FMV on the date of separation. The parties themselves may estimate the FMV of their home. However, their opinions about estimated FMV may be inaccurate due to sentimental attachment or efforts to decrease the amount of money or other martial property received by the other spouse in the proceeding. Attorneys and courts, therefore, will have to rely on other evidence to determine FMV.
 
 

Attorneys may be tempted to use the home's appraised value for real estate taxes as evidence of FMV. North Carolina Courts, however, have held that real estate tax appraisals are inadmissible as evidence of FMV because they are unreliable and in many instances bear little resemblance to the property's true FMV.[6] The North Carolina Courts' opinion of property tax appraisals appears to be accurate. A study conducted in North Carolina showed that values used to assess real estate taxes were typically equal to 75 percent of the property's true FMV.[7]
 

Another estimate occasionally offered as evidence of FMV are recent appraisals of a home by lending institutions for purposes of placing a mortgage on the property. Similar to tax appraisals, these estimates tend to be on the conservative side.[8] Lending institutions usually make loans only on a portion of the property's true FMV in an effort to protect themselves in the event of foreclosure. As a result, mortgage appraisals are usually not the best evidence of FMV.
 
 

The original price paid by the couple for their home is a good indicator of what they thought the home was worth at the time of purchase.[9] Attorneys may use this as evidence of FMV in divorce proceedings if the couple recently purchased the home or if both agree that the price paid represents the home's FMV. However, in situations where the couple has owned the home for several years prior to separation or where the home was recently purchased, but the parties disagree on its FMV, the original purchase price will not be an accurate estimate of FMV. Attorneys, therefore, need other types of evidence to prove FMV. The most common type of evidence is an appraisal of the martial home from a certified appraiser.

 
 

USING APPRAISALS TO VALUE REAL ESTATE


Appraisers consider several factors when estimating the FMV of real estate. When appraising land, several items affecting value are considered such as location, zoning, quality of soil, access and egress, adaptability for other uses, and income potential. When asked to estimate the FMV of structures, appraisers look at such factors as location, age, construction, replacement cost, adaptability for other uses, and future income potential."[10]

 
 

The North Carolina Supreme Court recognizes three appraisal techniques that may be used in divorce proceedings as evidence of real estate's FMV: the sales comparison approach, the cost approach, and the income approach.[11] All three methods may be used when estimating the FMV of the marital home. Appraisers select a particular method based on the facts and circumstances of the case. In certain situations, the methods may be combined and their results correlated to estimate FMV. When properly conducted, appraisals are usually the best evidence of the marital home's FMV on the date of separation.
 

A. The Sales Comparison Approach

Under the sales comparison approach, the recent sales of property comparable to the marital home are used to estimate FMV.[12] This approach is the most common method for valuing single-family dwellings. Appraisers under this method use a three-step procedure.
 
 

Appraisers begin the process by identifying recent sales of comparable property. The focus at this stage is on finding property similar in location, type, zoning, desirability, amenities, conditions and size to the marital home. Locating exact comparables is difficult because no two pieces of real estate are alike. For single-family dwellings, however, finding comparable property is typically easier than with other types of real estate. If the marital home is located in a homogenous neighborhood where there has been an active market with numerous sales close in time to the date of separation, appraisers usually only have to search the neighborhood for comparable homes."[13] This is especially true if homes in the neighborhood were constructed alike, are still relatively new and in similar condition, and if few changes or improvements have been made by the owners.[14] When the marital home is unique or in an isolated location, however, appraisers may have to extend their search for comparable sales by moving out from the immediate location of the property. In either case, appraisers make adjustments to the sales price of the comparable property, reflecting differences created when property exactly matching the marital home cannot be found.
After comparable property has been located, appraisers will identify significant differences between the comparable property and the marital home and make appropriate adjustments to the comparable property's sales price. The direction and magnitude of the adjustments represents the appraiser's opinion about market reaction to these differences.[15]  If an appraiser feels the comparable property is superior to the marital home he or she will make negative adjustments to the comparable's sales price, reflecting the fact potential buyers will pay more for the comparable property because it has advantages or additional features not found in the marital home. Adjustments are usually made for time, location, and physical differences between the comparable property and the marital home.[16]
 
 
Time adjustments reflect differences caused by appreciation, depreciation, inflation, or deflation. In most instances, appraisers use comparable property sold prior to the date of separation. When market prices have increased from the comparable's date of sale to the date of separation due to either appreciation or inflation; positive adjustments to sales prices are made to reflect the changes. If market prices have decreased due to depreciation or deflation, the appraiser will make corresponding negative adjustments to the comparable property's sales price. The opposite occurs when appraisers use comparable property sold after the date of separation.[17]

 
 

Location adjustments are made when significant differences in value are created by the location of the comparable property in relation to the marital home. For example, if the marital home is located in a popular neighborhood and the comparable property is not, the appraiser will make positive adjustments to the comparable property's sales price. Ideally, location adjustments are based on measurable price differentials for very similar properties in different locations. When this is not possible, appraisers rely on their judgment to determine the appropriate adjustment.[18]
 

Physical characteristic adjustments are made to the comparable property's sales price to reflect differences in such things as construction or amenities. For example, if the comparable property has a swimming pool and the marital home does not, the appraiser must take this into consideration when estimating FMV. The appraiser determines the impact the swimming pool and other features not found in the martial home have on the comparable property's sales price and deduct these amounts to estimate the martial home's FMV.
 

Once an appraiser has determined the differences between the comparable property and the marital home and made necessary adjustments to the comparable property's sales price, the adjusted price is then correlated with available market data to determine the martial home's final estimated FMV on the date of separation. During this phase of the analysis, consideration is given to market trends, the most recent comparable sales, the comparable property closest in location, and the comparable property with the most similar physical characteristics. Appraisers also look at other factors including the impact financing had on sales prices, any special motivations or circumstances surrounding the sales of the comparable property that would make them less than arm's length, and any other sales conditions that may affect prices. When completed, the sales comparison method should result in a market-oriented final estimate of FMV.[19]
 

B. The Cost Approach

Under the cost approach, appraisers determine the cost of reproducing or replacing the existing martial home. Typically, this technique is used to determine the value of new or recently constructed homes or where the sales comparison method does not yield realistic estimates of value. Appraisers use three steps to estimate FMV under this approach.
 

The process begins by estimating the FMV of the land separately from the martial home. The FMV of the land is determined based on its highest and best use assuming it is vacant.[20] The vacant land's estimated FMV is used when appraisers feel the land's highest and best use standing alone differs from its FMV with the marital home included. In some instances, the vacant land may be more valuable if used for something other than the existing marital home.[21] For example, if the marital home is situated on several acres of land near a residential development, the land's highest and best use may not be as a home site, but instead, as shopping center or school. Determining the FMV of the land separately will take this into account and provide a better estimate of its FMV. In other situations, the vacant land may support a substantially different type of improvement, even if occupied for a use similar to the present one.[22] For example, if the property is situated near a university or commercial area. It may be more suitable for use as apartments or other types of multi-family dwellings. In either situation, the vacant land's FMV will usually differ from its FMV with the marital home included, requiring appraisers to value the underlying land separately as of the date of separation.
 

Once the FMV of the vacant land is determined, appraisers estimate the reproduction or replacement cost of the existing marital home. Reproduction cost is the cost to reproduce the marital home based on an exact duplicate, using the same building materials, construction techniques, design and workmanship.[23] For many older homes, however, FMV estimates using the reproduction method are not possible because of outdated construction methods and materials. In these instances, appraisers estimate FMV by determining the home's replacement cost. Replacement cost is the cost to replace the existing marital home using current construction methods, materials and design techniques.[24] Under both cost methods, appraisers develop a unit cost per square foot and multiply it by the number of square feet in the marital home. A separate unit cost is calculated for other structures such as garages and porches and multiplied by their respective square feet. These totals are then added to arrive at the marital home's estimated reproduction/replacement FMV.
 
 

After computing the reproduction/replacement FMV, appraisers next estimate accrued depreciation. Accrued depreciation is basically any loss in value caused by physical deterioration, functional obsolescence or economic obsolescence. Appraisers use several methods to estimate accrued depreciation ranging from simple ratios of depreciation to more complex techniques. Total accrued depreciation is calculated by multiplying the total estimated reproduction/ replacement FMV by the depreciation percentage calculated under the appraisers depreciation methodology. The total accrued depreciation is then subtracted from the estimated reproduction/ replacement FMV to arrive at the total estimated FMV of the martial home. This figure is then added to the estimated FMV of the vacant land and the estimated FMVs of any property improvements or out buildings such as fences, septic tanks or storage sheds. The sum total of these elements represents the estimated FMV of the martial home on the date of separation.[25]

 

C. The Income Approach

The income approach typically is not used to determine the value of a couples' marital home. This valuation technique, however, may be appropriate in divorce situations where the couple owns a vacation home or farmland surrounding the marital home that are expected to generate positive income streams in the future.
 

The most popular technique for determining the estimated FMV of rental real estate is the yield capitalization method. Under this method, the expected rental income generated by the vacation home or farmland over a projected investment period is d counted to its present value on the date of separation using an appropriate discount rate. The estimated value of the of the property at the end of the investment period (typically 10 years) is also discounted to its present value and added to the present value of the rental income stream to determine the property's estimated FMV on the date of separation.[26] Estimates of potential future income and the value of the property at the end of the investment period are determined based on rentals and prices obtained from the lease or sale of comparable properties reasonably related in respect of location and time to the property under consideration. Selecting an appropriate discount rate to determine present value is crucial under the income approach. A low discount rate will produce a higher value for the future amounts, while a high discount rate will produce lower future amounts. As a result, attorneys will need to review with appraisers the methodology used to select the discount rate to make sure it results in the most realistic estimate of the property's FMV.
 
 

LEGAL CONSIDERATIONS WHEN USING APPRAISALS TO ESTIMATE FMV


Once attorneys have decided to use an appraisal, one of the most important decisions to be made is the selection of an appraiser. The credibility and experience of an appraiser often means the difference between winning or losing on the issue of the marital home's FMV. Once an appraiser is selected, attorneys need to consider the strengths and weakness of the appraisal techniques used. Attorneys also need to devise strategies for attacking their opponents' appraisals when their estimates of FMV differ substantially from the attorney's estimates.

 

A. Using Appraisers as Witnesses of Estimated FMV
 
 

Appraisers may be asked to provide testimony as to the FMV of the martial home in divorce proceedings. Rule 702 of the North Carolina rules of evidence permits the testimony of "experts" if their technical or other specialized knowledge will assist the court in determining a fact in issue. Appraisers fall into this category of "expert" because of their specialized training in the area of real estate assessment. Appraisers' opinions about a particular piece of real estate will often vary depending on their experience and the methods employed to estimate FMV. It is, therefore, not uncommon in divorce proceedings for the parties' appraisers to have very different opinions about the FMV of the marital home.

 
 
When selecting an appraiser, attorneys need to consider the appraiser's professional competence, integrity and professionalism. The more credible and experienced the appraiser, the better the chances his or her appraisal will be used by the court as the martial home's estimated FMV. Attorneys, therefore, should select a certified appraiser to conduct the appraisal. Many appraisers are members of the Appraisal Institute (MAI). MAI certified appraisers are required to have at least five years of appraisal experience, passed written tests, and submitted many reports demonstrating their ability to render competent appraisals.[27] In addition to certification, the appraiser selected should possess knowledge of the local residential home market and have several years experience in applying acceptable appraisal methods to residential homes in the area.

 

B. Considerations When Using the Sales Comparison Approach
 

The sales comparison approach estimates FMV based on actual transactions between willing buyers and willing sellers in the marketplace. Courts usually prefer this appraisal approach because of its ability to provide an estimate of FMV directly from the market. As long as the market is active and there are sufficient recent sales of comparable property, this method tends to be the most reliable for valuing the martial home.[28] Attorneys, therefore, should request that appraisers use the sales comparison approach when estimating the martial home's FMV in most instances.

 
The major weakness of the sales comparison approach is that it may require appraisers to use their personal judgment in the comparison analysis. This can be minimized if there are numerous recent sales with few differences requiring adjustments to sales price.[29] Where numerous differences exist sue to a lack of solid comparable property, the attorney will have to use the appraisers experience and credibility as evidence to overcome attacks on the rationale behind the judgment decisions regarding estimated FMV. This is one reason why selecting the right appraiser to begin with is so important.
When confronted with an opponent's appraisal using the sales comparison approach, attorneys may be able to attack their results by questioning the appraiser's judgment during several points in the process. For example, the attorney may question the actual similarity between the comparable property used in the appraisal and the martial home. The attorney may also question the magnitude of adjustments made by the appraiser that were based on the appraiser's opinion of the market. Finally, the attorney may be able to attack the various market factors relied on by the appraiser. If these attacks fail, the attorney may challenge the credibility and experience of the opponent's appraiser or introduce evidence of his own appraisal that contradicts the assertions made in the opponent's appraisal.

 

C. Considerations When Using the Cost Approach

The cost approach is appropriate when valuing recently constructed homes or in cases where the sales comparison approach fails to produce realistic estimates of FMV. The cost approach may also be used in conjunction with other appraisal methods by correlating the results under each method to estimate the home's FMV. In cases where the sales comparison approach yields accurate results, however, the cost approach should be avoided.
 

The major flaw of a cost approach is that it lacks a direct connection to actual market transactions. As a result, it is often difficult to determine whether the cost estimates used by appraisers are accurate, the depreciation estimates are reasonable, and the total estimated value of the home truly reflects FMV or just the cost of development.[30]  Attorneys, therefore, need to carefully review with appraisers the unit cost estimates to ascertain whether the techniques used are effectively applied and the appropriate adjustments to the unit costs are made.
 

Attorneys also must determine if the information used by appraisers under the cost approach is accurate for costing the particular marital home. Appraisers often use cost estimating services and published cost estimating manuals to create unit costs. Published cost data may be dated by time or based on information assembled nationwide. It is very important that these cost figures be adjusted for time and location to obtain an accurate estimate of FMV.[31]  Attorneys, therefore, need to question whether the cost estimates used have been adjusted to the date of separation and to the particular location of the marital home. Last, but not least, appraisers' estimates of accrued depreciation are often very difficult to evaluate because they are based on the appraiser's judgment, with little factual of market-derived support.[32]  As a result, they too are easily subject to attack by opposing counsel.
 

If the cost method is used, estimates of FMV derived under this approach should be correlated with the value estimates arrived at by other appraisal methods where possible. If an appraiser only uses the cost approach, attorneys need make sure that the final value is at least correlated with available market data to provide some reliable measure of FMV.[33]
 
 

CONCLUSION

 
In cases where the couple's home is not sold as a result of divorce, appraisals are the best indicator of the home's FMV on the date of separation. Appraisals using the sales comparison approach are generally the best evidence of FMV because they rely on market-oriented information to estimate FMV. Attorneys, therefore, should use a credible and experienced appraiser and apply this technique when estimating a home's FMV in divorce proceedings. The right appraisal and appraiser determine whether courts accept the estimate of FMV or not.
 

[1] NC GS § 50-20(a).
[2] NC GS § 50-20(b)(1).
[3] Alexander v. Alexander, 68 NC App. 548, 551, 315 SE 2d 772, 775 (1984).
[4] Black's Law Dictionary, 597 (6th ed. 1990).
[5] Horton, Clarence E., Principles of Valuation in North Carolina Equitable Distribution Actions, Inst. of Gov't., The Univ. of NC at Chapel Hill (1989), at 2.
[6] Bunn v. Harris, 216 NC 366, 5 SE 2d 149 (1939).
[7] Horton, at 14.
[8] Id. at 14.
[9] Id. at 14.
[10] Id. at 14.
[11] Redevelopment Commission v. Denny Roll and Panel Co., 273 NC 368, 159 SE 2d 861 (1968).
[12] Feder, Robert D., Valuation Strategies in Divorce, 4th ed. Vol. 1, Wiley Law Publications (1997), at 338.
[13] Id. at 341.
[14] Id. at 341.
[15] Id. at 338.
[16] Id. at 346.
[17] Id. at 346.
[18] Id. at 348.
[19] Id. at 349.
[20] Id. at 379.
[21] Id. at 382.
[22] Id. at 382.
[23] Id. at 379.
[24] Id. at 379.
[25] Id. at 380.
[26] Id. at 350.
[27] Horton, at 14.
[28] Feder, at 349.
[29] Id. at 349.
[30] Id. at 384.
[31] Id. at 384.
[32] Id. at 385.
[33] Id. at 385.