REE Exam Two Chapters 5,7,8,9

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Land value depend on quality of their

"Access" to other sites, or the "linkage"

Given the following information, calculate the effective gross income: property: 4 office units, contract rents per unit: $2,500 per month; vacancy and collection losses: 15%; operating expenses: $42,000; capital expenditures: 10%.

$102,000

Suppose that an income-producing property is expected to yield cash flows for the owner of $150,000 in each of the next five years, with cash flows being received at the end of each period. If the opportunity cost of investment is 8% annually and the property can be sold for $1,250,000 at the end of the fifth year, determine the value of the property today.

$1,449,635.50

Financing terms

ex,., below rate financing

Using the following information, determine the location quotient for this industry: percentage of employment in financial services industry within the local community: 15%; percentage of employment in financial services industry for the entire United States: 4.4%.

3.4

Given the following information, calculate the effective gross income multiplier: sale price: $950,000; potential gross income: $250,000; vacancy and collection losses: 15%; and miscellaneous income: $50,000.

3.6

Suppose that you are attempting to value an income-producing property using the direct capitalization approach. Using data from comparable properties, you have determined the overall capitalization rate to be 11.44%. If the projected first-year net operating income (NOI) for the subject property is $44,500, what is the indicated value of the subject using direct capitalization?

$388,986.00

Market conditions

i.e., changes in values since sale of comparable

Market knowledge is

key!!!

Stick analyst's

- Are not concerned about the current value, but future price trend - Simon Property Group (SPG) example in the book

Three Observed Patterns of Urban Form

- Burgess Concentric Circle Model, 1923 - Hoty Sector Model, 1939 - Harris and Ullman Multinuclei model, 1945

Who Uses Market Value Appraisals?

- Buyers - Sellers - Corporate acquisitions, mergers or dissolutions - Courts - Divorces - Eminent domain cases - Settlement of estates - Bankruptcy - Mortgage Lenders (purchase of re-finance)

Idealized Location Pattern of Convenience Goods and Services

- Circles are max market perimeter for each provider - Straight lines demarcate access "ridges" between providers

In a competitive marke

- Close substitutes should sell for similar prices - Properties are different but can share similar characteristics

Transactional Adjustments

- Concern the nature & terms of the deal - Property rights conveyed - If buyer of comparable purchased a different legal estate, should be dropped

Promissory Notes (or just Notes)

- Describes the nature of the Debt - Major elements Amount, term, type of amortization Rate of interest Payments, due dates, and late charges Rights to prepay Demand clause (reference to mortgage paper): Acceleration Due-on-sale

First thing first

- Estimating Net Operating Income To estimate NOI is to construct the operating statement

Bid-rent analysis

- Explains how urban land uses are determined. - Assumes households or firms have one demand for access (single "linkage")

Elements of the Note- Interest Rates

- Fixed rate - Adjustable rate

But real estates are in the private markets...

- Infrequent trade - Expensive trade - high search cost - Slow and frictional trade search cost - Private information - informational inefficiency and asymmetry. - Decentralized, local market trade

Four production factors:

- Labor - Material and energy - Physical capital (machines) - Land (a place to produce)

Must be paid first before they "run away"

- Labor - Material and energy - Physical capital (machines)

The first three are mobile- they can be moved to anywhere the price is the highest

- Labor - Material and energy - Physical capital (machines)

Quality of life

- Leadership - Financial support - Government support (subsides, land use regulation)

Property Adjustments

- Location - Physical characteristics - Economic characteristics (not applied to residences) - Important economic characteristics of income producing properties: operating expenses, lease terms, tenant mix

Structure is

- Modernized - Renovated - Abandoned - Demolished

Market value:

- Most probable selling price, assuming "normal" sale conditions - Buyer and seller are typically motivated and reasonably well informed - Open, fair, competitive trading environment

Multinuceli City: Changing Urban Form

- Multinuceli pattern observed by Harris and Ullman by 1945 - CBD no longer the single center of activity

Selecting Comparable Sales

- Must be properties that prospective buyers would consider substitutes for subject property - Should be arms-length transactions - Fairly negotiated prices that occurred under "normal" conditions

Public market

- No need for buyers & sellers to search for "true" market value of an asset; - It is continuously revealed by transaction prices of perfect substitutes

Accrued Depreciation

- Not tax depreciation - Difference between replacement cost & market value of improvements

Transaction price:

- Price actually paid for a specific property, a function of - market value + negotiation + random noise

Export activities

- Products or services provided to the outside world (most manufacturing; higher education and research, advance health care) - Activities that attract money (retirement, tourism, education) - As goes the base, so goes the city.

Data sources:

- Public record (e.g. county property tax assessor) - Multiple listing service (MLS) - Private vendors (title companies, others) --CoStar for commercial properties - Importance of personal relationships - Fee appraisers are research!

Methods to estimate replacement cost

- Quantity survey method - Cost per square foot or cubic foot - Unit in place

Sequence of adjustments

- Transactional adjustments - Property adjustments

Sequence of Adjustments

- Transactional adjustments 1 st ...in order listed above - Property adjustments 2nd...in no particular order - Caution: mixing dollar & percentage adjustment

Investment value:

- Value to a particular individual (investor) based on real circumstances, skills, reputation, tax status, etc. - Primarily depend on investor's ability to generate income from the property

Urban Real Estate Markets Derive from the Urban Economy:

5 - 6% of US land is in urban areas, but 90% of real estate value is in urban areas. Therefore, real estate is essentially an urban phenomenon.

An apple farmer can produce $1200 worth of apple per acre per year. His production cost (exclusive of transportation) is $800. Given transportation cost being $50/mile, what is the farthest distance he is willing to locate from the CBD?

8 miles

Example: If a property currently value = $100,000 and it is expected to produce NOI= 8,000 by the end of the year, then its cap rate

8,000/100,000 = 8%

The Economic Base Multiplier

1. "Exports" bring dollars into the community 2. Most is respent on local goods and services 3. Some "leaks" through outside expenditures 4. Some "leaks" into savings 5. Total community income is the sum of export dollars plus respent dollars

Location quotient example

1. Compute the percentage of total local employment in a given industry. Example: Suppose education employment is 20% 2. Compute the same percentage for the national economy Suppose education in the national economy is 9% 3. Compute the ratio of location to national percentage Location quotient= 20%/9% - 2.22 >1

What housing attributes seem to matter most?

1. Lot size 2. House size 3. Age 4. Location

Steps in Direct Capitalization

1. Obtain estimates of cap rates, Ro, from market using "direct market extraction" Ro= NOI1/Selling Price 2. Estimate the expected first-year NOI. 3. Divide subject' NOI by a weighted average of the cap rate abstracted from the market to obtain an estimate of value for the subject property

There are mainly two income approaches

1. The direct capitalization approach 2. The Discount Cash Flow (DCF) approach Both approaches require an estimate of the property's expected net operating income (NOI).

So to use the Direct Capitalization approach, we need two pieces of information.

1. The expected first-year NOI, which can be estimated based on the building's current operating data 2. The cap rate -which depends on the investor and the market

Types of accrued depreciation that must be considered:

1.Physical deterioration 2.Functional obsolescence 3.External (economic) obsolescence

Given the following information, determine the value of having an additional bathroom. Assume that the comparable properties are similar in all other attributes besides those listed in the table below.

10,000

Urban hierarchy

A ranking of cities based on their size and functional complexity

Several techniques can be used to obtain an indication of property value. The cost approach to valuation would most likely be used for which of the following properties?

A religious facility

An early model of land use is the concentric ring model of urban form developed by E.W. Burgess. Of the following land uses, which would be closest to the downtown area of the central business district (CBD) according to Burgess's model?

A zone of transition that contains warehousing and other industrial land uses between the downtown area and the residential area

Cities with industry economies may be...

more resistant to downturns due to cost advantage

Non-amortized, interest-only loans;

sometimes called a "bullet" loan

Economic Base

Activities that bring income into a city

Secondary (Local) Activities

Activities that recirculate income in a city (local government, local merchants and services)

Loans with right of prepayment

All "conforming" and FHA/VA loans Home equity credit lines

In markets with perfect competition & investment value revelation,

All transactions take place at true market value

Using Repeat Sales to Adjust for Market Conditions

Application: Derive monthly rates of change from most relevant series, & apply to comparables Use: If comparable use is different from best use of subject, better not use as a comparable

The expected costs to make replacements, alterations, or improvements to a building that materially prolong its life and increase its value is referred to as

Capital expenditures.

CBD

Central Business District

Adjustment to Comparable Sale Prices

Convert characters of each comparable to approximation subject

Reproduction cost:

Cost of an exact physical replica Complication in application?

Replacement cost:

Cost to create something of equal utility (functionality)

Competition for locations with better linkage

Creates the patterns of urban land uses and values.

How Does DCF Differ from Direct Capitalization?

DCF valuation models require: 1. estimate of typical buyer's expected holding period 2. estimates of net (annual) CFs over expected holding period, including net income from expected sale of property 3. appraiser to select discount rate (required IRR)

Effective Gross Income Multiplier

EGIM = sales price / effective gross income Quick indicator of value for smaller rental properties

A city's potential for growth or its susceptibility to decline is determined by a set of economic activities that the city provides for the world beyond its boundaries. Economists refer to this set of activities as a city's

Economic Base

Agglomeration economies:

Efficiencies in production due to multiple local industries - Airport service - Financial services and banking - Communications and media

Industry economies of scale:

Efficiencies of production due to scale of local industry

Cost Approach Procedure

Estimated reproduction cost of improvements − Estimated accrued depreciation = Depreciated cost of building improvements + Estimated value of site = Indicated value by the cost approach Major Assumption?: Cost of creating a property is related to its market value

Fixed:

Expenses that do not vary with occupancy (at least in the short run) Hazard insurance Local property taxes

Variable:

Expenses that tend to vary with occupancy Utilities Maintenance & supplies

The sequence of adjustments to the transaction price of a comparable property would make no difference if all adjustments were dollar adjustments. However, if percentage adjustments are involved then the sequence does matter. In making adjustments to a comparable property to arrive at a final adjusted sales price, the proper sequence for the following adjustments would be

Financing terms, market conditions, location

But the land is...

Fixed

Accrued depreciation is the difference between the current market value of a building and the total cost to reproduce it new. One reason for this difference is related to changes in tastes, preferences, technical innovations, or market standards. This is commonly referred to as

Functional obsolescence

Note: market value may not be

Fundamental value

Cities with agglomeration economies may...

Have long-term advantages: - Incubator for new businesses - Cost advantage for emerging industries

Bid-rent indicates the...

Highest rent the land user is willing to bid (can afford to pay)

Fixed rate

Home loans: monthly charge is 1/12 of stated annual rate Many income property loans: 360-actual interest-daily rate is 1/360 of annual rate; multiplied by the actual days in the month

Which of the following would be categorized as a cause of external obsolescence?

Increased traffic flow due to more intensive use in the local area

Adjustable rate

Index rate: Market-determined rate beyond control of either borrower or lender - U.S Treasury Constant Maturity Rate - Thrift institution Cost of Funds Index - LIBOR - Home mortgage rate index

The growth of the motion picture industry in Los Angeles, the petrochemical industry in Houston, and the software industry in Silicon Valley are all examples of how the growth of an industry within a city can create cost advantages for future growth. Economists refer to this phenomenon as

Industry economies of scale

Teaser rate:

Initial, temporarily reduced interest rate could be below market rate

When calculating the net operating income of a property, it is important to identify any expenses that will be incurred in attempts to maintain the property. All of the following would be considered operating expenses except

Interest expense on mortgage

Land uses are not....

Isolate, they interact

Real estate appraisers generally distinguish among the concepts of market value, investment value, and transaction value. Which of the following statements best describes the concept of market value?

It is an estimate of the most probable selling price of a property in a competitive market.

Land use can only pay with what is...

Leftover (residual) income. The land owner has no choice but to accept what the land user can afford to pay.

Households and firms have many...

Linkages

The demand for access between land uses is considered the gravity that holds a city together. These relationships between land uses are commonly referred to as

Linkages

Interpretation:

Local economy has 2.22 times the normal education employment; excess is presumed to be export employment.

Operating expenses can be divided into two categories: variable and fixed expenses. Which of the following best exemplifies a fixed expense?

Local property taxes

Physical deterioration:

Loss in market value due to aging, decay & ordinary use

External (Economic) obsolescence

Loss in value due to changes beyond property boundaries (neighborhood effects) Increased traffic congestion in area Conversion of residential neighborhood from owner-occupied to rental Environmental issues Decline in desirability/demand from neighborhood Is it hard to estimate accrued depreciation? Yes

Functional obsolescence:

Loss in value due to changes in tastes, preferences, technological innovations, or market standards Examples - Florida homes have low ceilings, older homes no hurricane shutters, older homes have not a lot of bathrooms or storage or closet space

In contrast to base activities, local economic activities (or secondary activities) serve the local business and households that are recirculating the income derived through the city's economic base. In other words, we can distinguish local economic activities from export activities by thinking about whether or not the activity brings money into the city from outside sources. Which of the following activities is not an example of land use for local economic activity?

Manufacturing center

Estimating the market value of real estate is complicated by the unique characteristics of real estate markets. In contrast to stock markets, real estate markets are characterized by all of the following except

Market prices are revealed almost instantaneously to prospective buyers.

In real estate markets, a transaction occurs only when the investment value of the buyer exceeds the investment value of the seller. The buyer's investment value is the ________ that he or she would be willing to pay for a particular property, while the seller's investment value is the ________ that he or she would be willing to accept.

Maximum, Minimum

Effective Gross Income Examples

Miscellaneous income Garage rentals & parking fees Laundry & vending machines Clubhouse rentals

Discount cash Flow (DCF)

Most reliable approach A more sophisticated approach. Objective: to estimate the President value of all expected future cash flows (including CF from sales) based on the investor's required rate of return (the discount rate) Project net CFs for a standard holding period (say, 10 yrs) Discount all expected future cash flows at required return (IRR) Appraiser trying to think like a typical investor!

Net Operating Income

NOI is property's "dividend" Why is it not investor's dividend Projected stream of NOI is fundamental determinant of property's value

For DCF approach

NOI is required for every years

CapRate Ro =

NOI1/Vo

Which of the following measures is considered the fundamental determinant of market value for income-producing properties?

Net Operating Income

Appraisal Assignments Where Cost Approach is Heavily Weighted?

New buildings Insurance appraisals Specialty buildings

In the public market

No need to Estimate Market Value

Traditional common law:

No right of prepayment unless explicitly provided

Capital Expenditures (CAPX)

Non-recurring expenditures that increase value of structure/prolong its useful life: Roof replacement Additions HVAC Replacement Resurfacing of parking areas

For direct capitalization approach

Only first year NOI is necessary

Conditions of sale (arm's length or not?)

Parents sell to daughter

Can result in negative amortization:

Payment short-fall is added to the balance, causing it to be more than initial loan amount

Given the following information, calculate the overall capitalization rate: sale price: $950,000; potential gross income: $250,000; vacancy and collection losses: $50,000; and operating expenses: $50,000.

15.8%

Suppose that an appraiser has just completed her analysis using the cost approach to valuation. She has determined that the market value of the subject property is $400,000. If the added value of the site was $80,000 and accrued depreciation amounted to $50,000, what was the reproduction cost of the building?

270,000

Prepayment penalties

Percentage of outstanding balance Yield maintenance - makeup the "lost return" for the lender Defeasance - replace lost cashflow with equivalent T-bonds

Bankruptcy

Possible threat to lender's ability to foreclose Three forms of bankruptcy Chapter 7: Liquidation Chapter 11: Court supervised "workout" Chapter 13: Wage-earner's proceeding No form of bankruptcy can set aside a mortgage lien Chapter 11 and 13 can result in delays

PGI

Potential gross income - VC- Vacancy & collection loss + MI- Miscellaneous income = EGI - Effective gross income - OE- Operating Expenses - CAPX - Capital expenditures = NOI - Net operating income

The starting point in calculating net operating income is the total annual income the property would produce assuming 100% occupancy and no collection losses. This is commonly referred to as

Potential gross income.

The main difference between mortgage and Deed of Trust is the

Power of Sale (which implies different foreclosure procedure)

The following two documents always go together

Promissory Note (or Note): Details the exact terms of the financial obligation Mortgage (or Deed of Trust): Pledges the property as security for the note Legal paper

Valuation calculations are required when a:

Property acquisition is considered

Private markets

Real estates - Unique properties - no two buildings are identical - Unique locations - Many & varied attributes

Modern statutory case:

Right of prepayment unless explicitly prohibited

While there are several conventional approaches used to estimate the market value of residential real estate (i.e. houses), which of the following is typically considered the most reliable approach?

Sales comparison approach

NOI must be sufficient to

Service the mortgage debt and Provide equity investor with an acceptable return on equity Be careful of NOI versus NCF (net cash flow)

Uniform Standards of Professional Appraisal Practice (USPAP) Steps

Step 1: Identify the Appraisal Problem Step 2: Determine the Required Scope of Work Step 3: Collect Data and Describe Property Step 4: Perform Data Analysis Step 5: Determine Value of Land Step 6: Apply Three Approaches to Valuation Step 7: Reconcile Indicated Values from Three Approaches Step 8: Report Final Value Estimate

Loans with restricted right of prepayment:

Subprime home loans "Jumbo" home loans Most income property mortgage loans

When economists say the land value is of a residual nature, they mean

That the value of location is determined by how much the land users can afford to pay

The magnitude of an economic base multiplier depends upon the amount of money that "leaks" out through expenditures outside of the city limits. All else equal, the economic multiplier tends to be smaller when

The city is less isolated from other cities

Bid-rent curve

The concept that the concentric circles in Burgess's concentric zone model are based on the amount people are willing to pay for land in each zone

Investment decision criteria: A good investment is one that

The investment value > = translation price (or market value)

How does location determine land value?

The residual nature of land value

Estimate value of the site

The value of the site is its Highest and Best Use: Legally permissible, Physically possible, Financially feasible, Maximally productive, i.e, yielding the greatest benefit to an owner

Urban growth is not uniform

There are both emerging and declining nuclei

Even the few transactions of comparable properties that we do observed may not be indicative of value of the "subject" property

Thus... we need an army of "Free appraisers" to estimate the market value of RE assets

A fundamental principle of income approach:

Value = present value of anticipated income

Sales Comparison Approach

Value of RE can be determined by analyzing the sale prices of similar properties

Conversely, if we are looking to buy a property, and expect a property to produce $8,000 net operating income by the end of the first year of our ownership, AND we know other similar buildings in this market all getting 8% cap rates, how much should our building be worth?

Vo = 8,000/8% = 100,000

Bid-rent curve calculation Sale Price 1200 Production 600 TC 60

B-RW=(1200-600)-dx60 (1500-800)-80xd =700-80d (100-700)-20d =300-20d d=300/20 = 15 miles

Better linkage means

Better location and higher value

Recourse loan: Nonrecourse loan:

Borrower is personally liable No personal liability

Expenditures made immediately after purchase

Buyer probably received price concession


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