Unit 21
If a commercial property recently sold for $155,000 and its annual rental income was $15,000, the GIM for the property would be computed as follows:
$155,000 ÷ $15000 = 10.33 GIM
Depreciation
(1) In appraisal, a loss of value in property due to any cause, including physical deterioration, functional obsolescence, and external obsolescence. (2) In real estate investment, an expense deduction for tax purposes taken over the period of ownership of income property.
Physical deterioration.
A curable item is one that can be repaired (such as painting walls), is economically feasible, and would result in an increase in value equal to or exceeding the cost. An item is incurable if its correction is not economically feasible or would not contribute a comparable value to the building (such as a crack in the foundation). The cost of a major repair may not warrant the financial investment.
Index method.
A factor representing the percentage increase to the present time of construction costs is applied to the original cost of the subject property. Because this method fails to take into account individual property variables, it is useful only as a check of the estimate reached by one of the other methods.
Gross Income Multiplier (GIM)
A figure used as a multiplier of the gross annual income of a property to produce an estimate of the property's value. for five or more units
Broker/appraiser
A real estate broker who is licensed by the Certified Appraisers Act in Pennsylvania to perform appraisals on properties for nonfederally related transactions under $250,000.
Uniform Standards Of Professional Appraisal Practice (USPAP)
A set of standards that details information required of an appraisal of residential property. The Uniform Residential Appraisal Report is required by many government agencies.
Regression
An appraisal principle stating that, between dissimilar properties, the value of the betterquality property is affected adversely by the presence of the lesser-quality property.
progression
An appraisal principle that states that, between dissimilar properties, the value of the lesser-quality property is favorably affected by the presence of the better-quality property.
Appraisal
An estimate of the quantity, quality, or value of something. The process through which conclusions of property value are obtained; also refers to the report that sets forth the process of estimation and conclusion of value.
In the sales comparison approach (also known as the market data approach)
An estimate of value obtained by comparing property being appraised with recently sold comparable properties; also known as the sale comparison approach.
Certified General Real Estate Appraiser
An individual who is certified under the state Certified Appraisers Act to perform appraisals of any type or value of property for federally related real estate transactions.
Certified Residential Real Estate Appraiser
An individual who is certified under the state Certified Appraisers Act to perform residential (one- to four-unit dwellings) appraisals for federally related real estate transactions.
To have value in the real estate market (i.e., to have monetary worth based on desirability), a property must have the following characteristics:
Demand Utility Scarcity Transferability
External depreciation.
Depreciation is always incurable if caused by negative factors not on the subject property, such as environmental, social, or economic forces. For example, close proximity to a polluting factory or a deteriorating neighborhood are factors that could not be cured by the owner of the subject property.
In estimating value using the income approach, an appraiser must take the following five steps:
Estimate annual potential gross income. Deduct an appropriate allowance for vacancy and rent loss, based on the appraiser's experience, and arrive at effective gross income. Deduct the annual operating expenses, detailed in Income Capitalization Approach to Value, from the effective gross income to arrive at the annual net operating income. Estimate the price a typical investor would pay for the income produced by this particular type and class of property. Apply the capitalization rate to the property's annual net operating income to arrive at the estimate of the property's value.
The cost approach consists of five steps:
Estimate the value of the land as if it were vacant and available for its highest and best use. Estimate the current cost of constructing buildings and site improvements. Estimate the amount of accrued depreciation (loss in value) resulting from physical deterioration, functional obsolescence, and external depreciation. Deduct the accrued depreciation (Step 3) from the construction cost (Step 2). Add the estimated land value (Step 1) to the depreciated cost of the building(s) and site improvements (Step 4) to arrive at the total property value.
cost does not equal market value
For example, while a homeowner may install a swimming pool for $20,000, the cost of the improvement may not add $20,000 to the value of the property.
example of straight line method
For instance, a $420,000 property may have a land value of $240,000 and an improvement value of $180,000. If the improvements are expected to last 60 years, the annual straight-line depreciation would be $3,000 ($180,000 ÷ 60 years). Such depreciation can be calculated as an annual dollar amount or as a percentage of the improvement's replacement cost.
The data of an appraisal are divided into two basic classes:
General data Specific data
Unit-in-place method.
In the unit-in-place method, the cost of a structure is estimated based on the construction cost per unit of measure of individual building components, including material, labor, overhead, and builder's profit. Most components are measured in square feet, although items such as plumbing fixtures are estimated by cost
With the appropriate capitalization rate and the projected annual net operating income, the appraiser can obtain an indication of value by the income approach.
Net operating income ÷ Capitalization rate = Value Example: $18,000 income ÷ 9% cap rate = $200,000 value or $18,000 income ÷ 8% cap rate = $225,000 value Note the inverse relationship between the rate and value. As the rate goes down, the value estimate increases. This formula and its variations are important in dealing with income property. Income ÷ Rate = Value Income ÷ Value = Rate Value × Rate = Income
Functional obsolescence.
Obsolescence means a loss in value from the market's response to the item. Outmoded or undesirable physical or design features are curable. Such features could be replaced or redesigned at a cost that would be offset by the anticipated increase in ultimate value. Outmoded plumbing, for instance, is usually easily replaced. Room function may be redefined at no cost if the basic room layout allows for it. A bedroom adjacent to a kitchen, for example, may be converted to a family room. However, currently undesirable physical or design features that cannot be easily remedied because the cost of the cure would be greater than its resulting increase in value are considered incurable. An office building that cannot be air-conditioned, for example, suffers from incurable functional obsolescence if the cost outweighs its contribution to the value.
For appraisal purposes (as opposed to depreciation for tax purposes), depreciation is divided into three classes, according to its cause:
Physical deterioration. Functional obsolescence. External depreciation.
The elements of the sales comparison for which adjustments must be made include the following:
Property rights Financing concessions. Market conditions. Conditions of sale. Market conditions since the date of sale. Location, or area preference. Physical features and amenities.
For one to four residential units:
Sales price ÷ Monthly gross rent = Gross rent multiplier (GRM) For five or more units and commercial: Sales price ÷ Annual gross income = Gross income multiplier (GIM) For example, if a home recently sold for $155,000 and its monthly rental income was $1,250, the GRM for the property would be computed as follows: $155,000 ÷ $1,250 = 124 GRM
An appraiser using the cost approach computes the reproduction or replacement cost of a building using one of the following four methods:
Square-foot method. Unit-in-place method. Quantity-survey method. Index method.
If a property's annual net income is $24,000 and it is valued at $300,000, what is its capitalization rate? A) 12% B) 8% C) 15% D) 10½%
The answer is 8%. $24,000 divided by $300,000 equals an 8% cap rate.
A written analysis or opinion drawn up relating to the probable sales price of a property is A) an independent valuation. B) an assessment analysis. C) a comparative market analysis (CMA). D) a broker's price opinion (BPO).
The answer is a comparative market analysis (CMA). As defined by the Pennsylvania Real Estate Commission rules, a comparative market analysis (CMA) is a written analysis or opinion relating to the probable sales price of a specific property often prepared by a real estate licensee to assist a seller is determining a competitive asking price.
The market value of a parcel of real estate is A) its value without improvements. B) an estimate of the most probable price it should bring. C) an estimate of its future benefits. D) the amount of money paid for the property.
The answer is an estimate of the most probable price it should bring. Market value is an estimate of the most probable price a property will bring in a fair sale. Price is the actual money paid. Neither cost nor price necessarily equals value.
Who is permitted to draw up an appraisal? A) Appraiser B) Any of these professionals, so long as they are licensed C) Broker of record D) Salesperson
The answer is appraiser. A properly licensed appraiser is the only one in Pennsylvania who is permitted to provide an unbiased estimate of value, according the appraisal process.
Which principle of value indicates that a developer's profitable real estate project will attract others to engage in similar activity in the same area and thus drive down profits? A) Value B) Anticipation C) Progression D) Competition
The answer is competition. Competition, the interaction of supply and demand, assumes that excess profits tend to attract competition. Competition drives down prices.
One of the most important steps in making an appraisal is that of A) estimating the cost of the land, raw. B) establishing a base line from which to increase value. C) determining the highest and best use of the property. D) verifying the original cost to build.
The answer is determining the highest and best use of the property. The appraiser's opinion of the highest and best use of the property may or may not be its current use.
Capitalization is the process by which annual net income is used as the basis to A) establish depreciation. B) determine potential tax value. C) determine cost. D) estimate value.
The answer is estimate value. The capitalization rate (cap rate) represents the rate of return that an investor will demand for the investment of capital in this type of building.
An appraiser is responsible for A) determining value. B) finding value. C) estimating value. D) computing value.
The answer is estimating value. An appraiser is an independent professional trained to provide an unbiased estimate of value in an impartial and objective manner, according to the appraisal process.
The appraised value of a residence with four bedrooms and one bathroom would probably be reduced because of A) incurable physical deterioration. B) external obsolescence. C) curable physical deterioration. D) functional obsolescence.
The answer is functional obsolescence. Deductions for functional obsolescence are intended to adjust for physical or design features that are no longer considered desirable. The proportion of one bathroom to four bedrooms by today's standards would generally be considered obsolete. Only functional obsolescence is considered either curable or incurable. Physical deterioration, by its very nature, is considered curable; external obsolescence is considered incurable because corrective measures are beyond the owner's control.
The principle of anticipation is the basis of the A) market data approach. B) cost approach. C) sales comparison approach. D) income approach.
The answer is income approach. According to the principle of anticipation, value is created by the expectation that certain benefits will be realized in the future, and it is the foundation on which the income approach to value is based.
Which approach to value makes use of a rate of investment return? A) Income approach B) Sales comparison approach C) Cost approach D) Gross income multiplier
The answer is income approach. The rate of investment return or the capitalization rate is used in the income approach to value, which in turn is based on the present value of the rights to future income.
Who, or what, determines value? A) What the buyer wants to pay B) Indicated by the market C) What the real estate licensee recommends D) What the seller wants to get
The answer is indicated by the market. While the appraiser does not determine value, neither is it determined by the seller, buyer, or real estate licensee. Instead, the appraiser develops a supportable and objective report that verifies the value indicated by the market.
From the reproduction or replacement cost of the building, an appraiser deducts depreciation, which represents A) the remaining economic life of the building. B) costs to modernize the building. C) loss of value due to any cause. D) remodeling costs to increase rentals.
The answer is loss of value due to any cause. The reproduction or replacement cost reflects new construction, but the value has to reflect the actual condition of the property, due to whatever cause, and is captured after deductions for depreciation.
In the appraisal of an office building, which of the following would be classified as external depreciation? A) A poor architectural design resulting in a cluttered floor plan B) Termite damage to the structural components of the building C) Antiquated restroom facilities D) Next door to a closed factory
The answer is next door to a closed factory. Depreciation is always incurable if caused by negative factors not on the subject property, such as environmental, social, or economic forces; including close proximity to a polluting or closed factory.
There are two vacant adjacent lots, each worth approximately $50,000. If their owner sells them as a single lot, however, the combined parcel will be worth $120,000. What principle does this illustrate? A) Progression B) Plottage C) Regression D) Substitution
The answer is plottage. Plottage is the principle that states that the value of a large parcel is greater than the sum value of individual smaller parcels. The process of merging parcels is assemblage.
The early houses that a developer built in a neighborhood were smaller than the homes built later when demand for the homes increased. The early homes have a higher value than their square footage would expect due to the principal of A) progression. B) highest and best use. C) substitution. D) increasing returns.
The answer is progression. Under the principle of progression, the value of a small, modest home is higher if it is located among larger, fancier properties.
The characteristics of value include which of the following? A) Competition B) Scarcity C) Anticipation D) Balance
The answer is scarcity. Scarcity is an element of value. Competition, anticipation, and balance are economic principles.
Who is permitted to appraise any property for any reason? A) State-certified general real estate appraiser B) State-certified residential real estate appraiser C) County tax assessors D) Broker appraiser who applied for the privilege prior to September 3, 1998
The answer is state-certified general real estate appraiser. Only state-certified general real estate appraiser may appraise any residential or nonresidential property, including commercial property valued over $1 million.
Conformity
The appraisal principle that holds that the greater the similarity among properties in an area, the better they will hold their value.
Anticipation
The appraisal principle that holds that value can increase or decrease based on the expectation of some future benefit or detriment produced by the property.
Competition
The appraisal principle that states that excess profits generate competition. It is the interaction of supply and demand.
Contribution
The appraisal principle that states that the value of any component of a property is what it gives to the value of the whole or what its absence detracts from that value. Installing a swimming pool, greenhouse, or private bowling alley may not add value to the property equal to the cost, but remodeling an outdated kitchen or bathroom might.
Replacement Cost New
The construction cost at current prices of a property that is not necessarily an exact duplicate of the subject property but serves the same purpose or function as the original.
Reproduction Cost
The construction cost at current prices of an exact duplicate of the subject property.
Square-foot method.
The cost per square foot of a recently built comparable structure is multiplied by the number of square feet (using exterior dimensions) in the subject building. The square-foot method is the most common and easiest method of cost estimation.
Gross Rent Multiplier (GRM)
The figure used as a multiplier of the gross monthly income of a property to produce an estimate of the property's value. One-to four units.
Reconciliation
The final step in the appraisal process, in which the appraiser combines the estimates of value received from the sales comparison, cost, and income approaches to arrive at a final estimate of market value for the subject property.
Plottage
The increase in value or utility resulting from the consolidation (assemblage) of two or more adjacent lots into one larger lot.
Market Value
The most probable price property would bring in an arm's-length transaction under normal conditions on the open market.
Sales Comparison Approach
The process of estimating the value of a property by examining and comparing actual sales of comparable properties.
Income Approach
The process of estimating the value of an income-producing property through capitalization of the annual net income expected to be produced by the property during its remaining useful life.
assemblage
The process of merging the two lots under one owner is known
Quantity-survey method.
The quantity and quality of all materials (such as lumber, brick, and plaster) and the labor are estimated on a unit-cost basis. These factors are added to indirect costs (building permit, survey, payroll, taxes, builder's profit, etc.) to arrive at the total cost of the structure. Because it is so detailed and time-consuming, the quantity-survey method is usually used only when appraising historic properties.
Capitalization Rate
The rate of return a property will produce on the owner's investment.
The income capitalization approach is MOST helpful in the appraisal of newer buildings or special-purpose buildings such as schools. True or False?
The statement is false. The cost approach is most helpful in the appraisal of newer buildings or special-purpose buildings such as schools, churches, and public buildings. Some properties are difficult to appraise using other methods because there are seldom enough local sales to use as comparables and because the properties do not ordinarily generate income.
To arrive at an accurate estimate of value, appraisers traditionally use the cost approach. True or False?
The statement is false. To arrive at an accurate estimate of value, appraisers traditionally use three basic valuation techniques: the sales comparison approach, the cost approach, and the income capitalization approach. The three methods serve as checks against each other. Using them narrows the range within which the final estimate of value falls. Each method is generally considered most reliable for specific types of property.
For appraisers performing appraisals for federally related transactions, all states are required to establish uniform certification procedures. True or False?
The statement is true. All states are required to establish uniform certification procedures for appraisers performing appraisals for federally related transactions. The Board of Certified Real Estate Appraisers has been created and the Real Estate Appraisers Certification Act has been adopted in Pennsylvania. Today, this board governs all appraisal activities (not just those for federally related financial transactions), and activities of appraisers and real estate licensees are separate and independently regulated.
Generally, the purpose of an appraisal is to estimate market value. True or False?
The statement is true. Generally, the purpose of an appraisal is to estimate market value. The market value of real estate is the most probable price that a property should bring in a fair sale. This definition makes three assumptions. First, it presumes a competitive and open market. Second, the buyer and the seller are both assumed to be acting prudently and knowledgeably. Finally, market value depends on the price not being affected by unusual circumstances.
County assessors who value properties are certified by the Appraisers Certification Act for ad valorem tax purposes in Pennsylvania. True or False?
The statement is true. The Appraisers Certification Act certifies county assessors who value properties for ad valorem tax purposes in Pennsylvania. Certified Pennsylvania Evaluator (CPE) certificates are issued to individuals who meet certain education requirements and pass an exam.
Highest and best use is the MOST profitable single use to which the property may be adapted or the use that is likely to be in demand in the near future. True or False?
The statement is true. The most profitable single use to which the property may be adapted or the use that is likely to be in demand in the near future is the property's highest and best use. The use must be legally permitted, financially feasible, physically possible, and maximally productive.
Example of cost approach
Value of the land = $50,000 Current cost of construction = $180,000 Accrued depreciation = $20,000 $180,000 - $20,000 = $160,000 $50,000 + $160,000 = $210,000 In this example, the total property value is $210,000
The principle of substitution holds that
a property's maximum value tends to be set by how much it would cost to purchase an equally desirable and valuable substitute property.
The cost approach to value is
also based on the principle of substitution. It is most useful in the appraisal of newer or special-purpose buildings such as schools, churches, and public buildings. Such properties are difficult to appraise using other methods because there are seldom enough local sales to use as comparables and because the properties do not ordinarily generate income.
A broker's price opinion (BPO)
is a less-expensive alternative of valuating property often used by lenders working with home equity lines, refinancing, portfolio management, loss mitigation, and collections.
Market price
is what a property actually sells for—its sales price.
The highest and best use of a property is
its most profitable single use that is legal and feasible and will bring the most money over time.
The principle of change states that
o physical or economic condition remains constant.
There are two ways to look at the construction cost of a building for appraisal purposes:
reproduction cost and replacement cost
The easiest but least precise way to determine depreciation is the
straight-line method (also called the economic age-life method).
The market value of real estate is
the most probable price that a property should bring in a fair sale.
To arrive at an accurate estimate of value, appraisers traditionally use three basic valuation techniques:
the sales comparison approach, the cost approach, and the income approach.
Specific data
which covers details of the subject property, as well as comparative data relating to costs, sales, income, and expenses of properties similar to and competitive with the subject property.
General data
which covers the nation, region, city, and neighborhood. Of particular importance is the neighborhood, where an appraiser finds the physical, economic, social, and political influences that directly affect the value and potential of the subject property.
