ch 19

ex for income formulas

$72,000 income ÷ 9% capitalization rate = $800,000 value, or $72,000 income ÷ 8% capitalization rate = $900,000 value Note the relationship between rate and value: As the rate goes down, the value increases.

anticipation,

According to the principle of anticipation, value is created by the expectation that certain events will occur. Value can increase or decrease in anticipation of some future benefit or detriment. For example, the value of a house may be affected if rumors circulate that an adjacent property may be converted to commercial use in the near future.

progression

Conversely, under the principle of progression, the value of a modest home would be higher if it were located among larger, fancier properties.

cost approach ex

Current cost of construction = $185,000 Accrued depreciation = $30,000 Value of the land = $55,000 $185,000 - $30,000 + 55,000 = $210,000 In this example, the total property value is $210,000.

gross income multiplier (GIM

If the buyer is interested in purchasing five or more units, a commercial gross income multiplier (GIM) is often used in the appraisal process.

regression

In general, the worth of a better-quality property is adversely affected by the presence of a lesser-quality property; this is called the principle of regression. Thus, in a neighborhood of modest homes, a structure that is larger, better maintained, or more luxurious would tend to be valued in the same range as the less-lavish homes.

income formulas

Income ÷ rate = value Income ÷ value = rate Value × rate = income

how do you find estimated market value?

Rental income × GRM = estimated market value

gross income multiplier (GIM formula

Sales price ÷ gross annual income = gross income multiplier (GIM)

gross income multiplier (GIM

Sales price ÷ gross monthly rent = gross rent multiplier (GRM) image

A building was purchased five years ago for $240,000. It currently has an estimated remaining useful life of 60 years. What is the property's total depreciation to date? A) $18,462 B) $20,000 C) $14,364 D) $54,000

The answer is $18,462. $240,000 ÷ 65 × 5 = $18,462.

The effective gross annual income from a property is $112,000. Total expenses for this year are $53,700. What capitalization rate was used to obtain a valuation of $542,325? A) 10.5% B) 10.75% C) 9.75% D) 10.25%

The answer is 10.75%. $112,000 ‒ $53,700 ÷ $542,000 = 10.75%.

For appraisal purposes, depreciation is NOT caused by A) external obsolescence. B) physical deterioration. C) accelerated capitalization. D) functional obsolescence.

The answer is accelerated capitalization. For appraisal purposes, depreciation is divided into three classes, according to its cause: physical deterioration, functional obsolescence, and external obsolescence.

Certain figures must be determined by an appraiser before value can be computed by the income approach. Which of these is NOT used by an appraiser applying the income approach to value? A) Annual gross income B) Capitalization rate C) Annual net operating income D) Accrued depreciation

The answer is accrued depreciation. The income approach is based on the present value of the right to future income and uses annual potential gross income, vacancy and rent loss, annual net operating income, and capitalization rate to arrive at value.

he 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. The market value of real estate is the most probable price that a property should bring in a fair sale.

An individual wants to be an appraiser in the northwest suburbs of Chicago. While she is willing to appraise residential properties, her real interest is in appraising commercial properties. If she wants to be qualified to conduct appraisals under FIRREA, this individual must A) become a certified general real estate appraiser. B) become an associate real estate trainee appraiser. C) do nothing, because individuals who wish to conduct appraisals under FIRREA must receive federal appraisal certification rather than state licensing. D) become a certified residential real estate appraiser.

The answer is become a certified general real estate appraiser. Title XI of the federal Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) requires that most appraisals used in connection with a federally related transaction be performed by someone licensed or certified by law. A certified general real estate appraiser is qualified to appraise all types of real property without restrictions as to the scope of practice subject to USPAP requirements.

Which factor is important in comparing properties under the sales comparison approach to value? A) Depreciation B) Active listings C) Property rent roll D) Date of sale

The answer is date of sale. In the sales comparison approach, an estimate of value is obtained by comparing the property being appraised (the subject property) with recently sold comparable properties.

Capitalization is the process by which annual net operating income is used to A) determine potential tax value. B) establish depreciation. C) determine cost. D) estimate value.

The answer is estimate value. The capitalization rate is determined by comparing the relationship of net operating income to the sales prices of similar properties that have sold in the current market. Apply the capitalization rate to the property's annual net operating income to arrive at the estimate of the property's value.

The appraised value of a residence with four bedrooms and one bathroom would probably be reduced because of A) incurable physical deterioration. B) curable physical deterioration. C) external obsolescence. D) functional obsolescence.

The answer is functional obsolescence. Functional obsolescence means a loss in value from the market's response to the item. Outmoded or unacceptable physical or design features that are no longer considered desirable by purchasers are considered curable. Such features could be replaced or redesigned at a cost that would be offset by the anticipated increase in ultimate value.

An appraiser who is asked to determine the value of an existing strip shopping center would probably give the MOST weight to which approach to value? A) Cost approach B) Income approach C) Index method D) Sales comparison approach

The answer is income approach. The income approach is used for valuation of income-producing properties such as apartment buildings, office buildings, and shopping centers.

Which of these appraisal methods uses a rate of investment return? A) Sales comparison approach B) Gross income multiplier method C) Cost approach D) Income approach

The answer is income approach. The income approach to value is based on the present value of the rights to future income. One of the steps in estimating value is to estimate the price a typical investor would pay for the income produced by this particular type and class of property. This is done by estimating the rate of return (or yield) that an investor will demand for the investment of capital in this type of building.

From the reproduction or replacement cost of a building, the appraiser deducts depreciation, which represents A) loss of value due to any cause. B) the remaining economic life of the building. C) costs to modernize the building. D) remodeling costs to increase rentals.

The answer is loss of value due to any cause. In a real estate appraisal, depreciation is a loss in value due to any cause compared with today's cost of replacement.

The amount of money a property commands in the marketplace is its A) market value. B) book value. C) subjective value. D) intrinsic value.

The answer is market value. The market value of real estate is the most probable price that a property should bring in a fair sale.

Two adjacent vacant lots are each worth $50,000. However, if they are sold as a single lot, the combined parcel is worth $120,000. What principle does this illustrate? A) Plottage B) Substitution C) Progression D) Regression

The answer is plottage. The principle of plottage holds that merging or consolidating adjacent lots into a single, larger one produces a greater total land value than the sum of the two sites valued separately.

A homeowner constructs an eight-bedroom brick house with a tennis court, greenhouse, and indoor pool in a neighborhood of modest two- and three-bedroom frame houses on narrow lots. The owners of the lesser-valued houses in the neighborhood may find that the values of their homes are affected by what principle? A) Progression B) Increasing returns C) Regression D) Competition

The answer is progression. Under the principle of progression, the value of a modest home would be higher if it were located among larger, fancier properties.

Which of these is the act of analyzing and effectively weighing the findings from the three approaches to appraisal? A) Appraisal analysis B) Reintegration C) Benefit analysis D) Reconciliation

The answer is reconciliation. When the three approaches to value are applied to the same property, they normally produce three separate indications of value. Reconciliation is the act of analyzing and effectively weighing the findings from the three approaches.

A homeowner constructs an eight-bedroom brick house with a tennis court, greenhouse, and indoor pool in a neighborhood of modest two- and three-bedroom frame houses on narrow lots. The value of this house is likely to be affected by what principle? A) Assemblage B) Regression C) Progression D) Change

The answer is regression. In general, the worth of a better-quality property is adversely affected by the presence of a lesser-quality property; this is called the principle of regression.

The characteristics of value include A) anticipation. B) progression. C) balance. D) scarcity.

The answer is scarcity. To have value in the real estate market, a property must have the following four characteristics: demand, utility, scarcity, and transferability. Remember the acronym "DUST".

cost approach

The cost approach to value also is based on the principle of substitution. The cost approach consists of five steps: Estimate the value of the land as though it were vacant and available to be put to its highest and best use. Estimate the current cost of constructing the buildings and improvements. Estimate the amount of accrued depreciation resulting from the property's physical deterioration, functional obsolescence, and external depreciation. Deduct the accrued depreciation (step 3) from the current construction cost (step 2). Add the estimated land value (step 1) to the depreciated cost of the building and site improvements (step 4) to arrive at the total property value.

cost Approach, 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. This is the most common and easiest method of cost estimation. The figure on the previous page uses the square-foot method (also called the comparison method). For some properties, the cost per cubic foot of a recently built comparable structure is multiplied by the number of cubic feet in the subject structure.

conformity

The principle of conformity means that maximum value is created when a property is in harmony with its surroundings. Maximum value is realized if the use of land conforms to existing neighborhood standards. In single-family residential neighborhoods, for example, buildings should be similar in design, construction, size, and age.

The sales comparison approach to value is usually given the greatest weight in valuing single-family residences. True False

The statement is true. In appraising a home, the income approach is rarely valid, and the cost approach is of limited value unless the home is relatively new.

Reconciliation is the act of analyzing and effectively weighing the findings from the three approaches to value. True False

The statement is true. In reconciliation, an appraiser explains not only the appropriateness of each approach but also the relative reliability of the data within each approach in line with the type of value.

The Uniform Residential Appraisal Report is a form required by many governmental agencies. True False

The statement is true. The Uniform Residential Appraisal Report sets forth the types of detailed information required of an appraisal of residential property.

In the unit-in-place method, the replacement cost of a structure is estimated based on the construction cost per unit of measure of individual building components. True False

The statement is true. These building components include material, labor, overhead, and the builder's profit.

The three approaches to value are the highest and best use approach, the sales comparison approach, and the market conditions approach. True False

The statement is true. These building components include material, labor, overhead, and the builder's profit.

In the square-foot method, the cost per square foot of a recently built comparable structure is multiplied by the number of square feet in the subject building. True False

The statement is true. This is the most common and easiest method of cost estimation.

unit in place method

Unit-in-place method. In the unit-in-place method, the replacement 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. The sum of the components is the cost of the new structure.

physical deterioration,

a curable item is one in need of repair, such as painting (deferred maintenance), that is economically feasible and would result in an increase in value equal to or exceeding the cost. An item is incurable if it is a defect caused by physical wear and tear if its correction would not be economically feasible or 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 of construction costs up to the present time is applied to the original cost of the subject property. Because it fails to take into account individual property variables, this method is useful only as a check of the estimate reached by one of the other methods.

depreciation

a loss in value due to any cause compared with today's cost of replacement. It refers to a condition that adversely affects the value of an improvement to real property. Land does not depreciate—it retains its value indefinitely, except in such rare cases as downzoned urban parcels, improperly developed land, or misused farmland. Depreciation is the result of a negative condition that affects real property. Depreciation is considered curable or incurable, depending on the contribution of the expenditure to the value of the

the sales comparison approach, the cost approach, and the income approach. The three m

an estimate of value is obtained by comparing the property being appraised (the subject property) with recently sold comparable properties (properties similar to the subject, called comps).

The term reconciliation refers to A) analyzing the results obtained by the different approaches to value to determine a final estimate of value. B) loss of value due to any cause. C) the process by which an appraiser determines the highest and best use for a parcel of land. D) separating the value of the land from the total value of the property to compute depreciation.

analyzing the results obtained by the different approaches to value to determine a final estimate of value.

depreciation straight line method

e easiest but least precise way to determine depreciation is the straight-line method (also called the economic age-life method). Depreciation is assumed to occur at an even rate over a structure's economic life—the period during which it is expected to remain useful for its original intended purpose. The property's cost is divided by the number of years of its expected economic life to derive the amount of annual depreciation.

strgt line depreciastion ex

e easiest but least precise way to determine depreciation is the straight-line method (also called the economic age-life method). Depreciation is assumed to occur at an even rate over a structure's economic life—the period during which it is expected to remain useful for its original intended purpose. The property's cost is divided by the number of years of its expected economic life to derive the amount of annual depreciation.

According to the principle of conformity, value is created by the expectation that certain events will occur. True False

f

gross rent multiplier

f a buyer is interested in purchasing a one-to-four-unit residential rental property, the gross rent multiplier (GRM) would be used for the appraisal value.

Market Value Versus Cost

for example, a homeowner may install a swimming pool for a cost of $15,000, though the cost of the improvement may not add $15,000 to the value of the property.

assemblage

he process of merging two separately owned lots under one owner is called assemblage. Plottage is the amount that value is increased by successful assemblage.

quantity-survey method

he quantity and quality of all materials (e.g., lumber, brick, and plaster) and the labor are estimated on a unit cost basis. These factors are added to indirect costs (e.g., building permit, survey, payroll, taxes, and builder's profit) to arrive at the total cost of the structure. This method is detailed and time-consuming, but is the most accurate method of appraising new construction.

contribution

he value of any part of a property is measured by its effect on the value of the whole. Installing a swimming pool, greenhouse, or tennis court may not add value to the property equal to the cost, but remodeling an outdated kitchen or bathroom might.

appraisal

is an opinion of value based on supportable evidence and approved methods.An appraisal report is an opinion of market value on a property given to a lender or client with detailed and accurate information.

External obsolescence

is caused by negative factors not on the subject property, such as zoning, environmental, social, or economic forces. In this case, the depreciation is always incurable; the loss in value cannot be reversed by spending money on the property. For example, proximity to a polluting factory or a deteriorating neighborhood is a factor that could not be cured by the owner of the subject property.

Reproduction cost

is the construction cost at current prices of an exact duplicate of the subject improvement, including both the benefits and the drawbacks of the property. Replacement cost is the cost to construct an improvement similar to the subject property using current construction methods and materials, but not necessarily an exact duplicate. Replacement cost is more frequently used in appraising older structures because it eliminates obsolete features and takes advantage of current construction materials and techniques. Below shows an example of the cost approach to value, applied to the same property as in the Sales Comparison Approach.

market value

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. Third, market value depends on the price not being affected by unusual circumstances.

Functional obsolescence

means a loss in value from the market's response to the item. Outmoded or unacceptable physical or design features that are no longer considered desirable by purchasers are considered 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 example, 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. Incurable obsolescence includes 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. For example, an office building that cannot be economically air-conditioned suffers from incurable functional obsolescence if the cost of adding air-conditioning is greater than its contribution to the building's value.

Competition

n is the interaction of supply and demand. Excess profits tend to attract competition. For example, the success of a retail store may cause investors to open similar stores in the area. This tends to mean less profit for all the stores concerned unless the purchasing power in the area increases substantially.

change

no physical or economic condition remains constant—this is the principle of change. Real estate is subject to natural phenomena such as tornadoes, fires, and routine wear and tear. The real estate business is also subject to shifting market conditions. An appraiser must be knowledgeable about both the past and perhaps the predictable future effects of natural phenomena and the changeable behavior of the marketplace.

value

o have value in the real estate market—that is, to have monetary worth based on desirability—a property must have the following four characteristics: Demand. The need or desire for possession or ownership backed by the financial means to satisfy that need Utility. The property's usefulness for its intended purposes Scarcity. A finite supply Transferability. The relative ease with which ownership rights are transferred from one person to another

CMA

recently closed properties (solds), properties currently on the market (competition for the subject property), and properties that did not sell (expired listings in the area)

The principle of plottage holds that merging or consolidating adjacent lots into a single, larger one produces a greater total land value than the sum of the two sites valued separately. True False

t

If a property's annual net income is $24,000 and it is valued at $300,000, what is its capitalization rate? A) 15% B) 10.5% C) 12.5% D) 8%

the answer is 8%. $24,000 ÷ $300,000 = 0.08 or 8%.

substitution

the maximum value of a property tends to be set by how much it would cost to purchase an equally desirable and valuable substitute property. Substitution is the foundation of the sales comparison approach.

what are the 3 approches to value

the sales comparison approach, the cost approach, and the income approach.

broker's price opinion (BPO

vs a less-expensive alternative of valuating properties often used by lenders working with home equity lines, refinancing, portfolio management, loss mitigation, and collections. Both Fannie Mae and Freddie Mac provide forms that are used by real estate licensees who perform BPOs for a fee