Chapter 8 Sales Comparison Approach - Adjustment Procedures

Real property can be owned in different ways. A property can be owned by a single individual. Oddly enough, this is called Tenancy in Severalty. The definition is simply:

"An estate in property held by one owner." Tenancy, by the way, is defined as "1. The holding of property by any form of title. 2. The right to use and occupy property as conveyed in a lease." Individuals may own property in differing legal forms. One might own 100% of the interest in a trust or own 100% of the stock of a corporation. For many years, my appraisal company was a corporation. I was the only stockholder as well as being the President, Vice President, Secretary and Treasurer.

On page 4 of the URAR form, it states:

"This report form is designed to report an appraisal of a one-unit property or a one-unit property with an accessory unit; including a unit in a planned unit development (PUD). This report form is not designed to report an appraisal of a manufactured home or a unit in a condominium or cooperative project." The URAR provides space for the appraiser to record all basic data about a property, its improvements and its neighborhood. It also gives you space to report the results of all three valuation approaches: cost, sales comparison, and income.

Changes in a real estate market may be:

1. Cyclical - rising and falling with the fates of the local industries (aerospace, defense, etc.) that go through big hiring phases followed by layoffs 2. One-time only - related to an event, either good or bad, which is unlikely to reoccur 3. Seasonal - in a resort town, all real estate purchases might occur within a narrow three-month window of opportunity 4. Exponential- continuously increasing at a rapid rate, such as what was experienced in the early to mid-2000s in the fast-growing parts of California, Nevada or Florida

Gross Adjustment (Total)

A gross adjustment is defined as "The total adjustment to each comparable sale price calculated by adding the absolute values of all positive and negative adjustments." The total gross adjustments may be a better indicator of the comparability of a comparable sale. In the example on the previous page (positive adjustments of $20,000 and negative adjustments of $21,000) the total net adjustment was only $1,000, whereas the total gross adjustment would be $41,000. NOTE: In the previous (June 1993) version of the URAR, the fields for total net and gross adjustments did not appear. However, over time, most of the software companies added this field as an option, and many appraisers chose to display these items. When the current URAR (March 2005) was released, it included fields for net and gross adjustments, pre-printed on the form.

Life Estates

A life interest (sometimes called a life estate) is defined as "Rights of use, occupancy, and control, limited to the lifetime of a designated party, sometimes referred to as the life tenant." A typical example would be an elderly person transferring ownership of a property to another party, perhaps a relative, but retaining the right to live in the property for the rest of his or her life. Upon their death the property transfers to the person named when the life interest was created (called the remainderman). During the life of the holder of the life interest, the interest is called an Estate in Remainder.

A lot of what needs to be done in the reconciliation process is more intuitive than mathematical. There's no substitute for experience and knowledge of a particular market area.

A lot of what needs to be done in the reconciliation process is more intuitive than mathematical. There's no substitute for experience and knowledge of a particular market area. We may have two comparables that adjust to virtually the same price. However, you might have a feeling about one of them that something funny happened in that transaction, but you just can't pin it down. You may have done extra research and verification of the details, but it just doesn't feel right. You lack confidence in the result. You may want to discard such a sale if you have the luxury of an adequate quantity of other reliable sales. Usually, we weight the comparable sales according to our belief in their strength and validity. This may be a subconscious process in which we believe the two best adjusted sale price properties are on the high end of our range of values, and therefore we will finalize the value opinion on or near the top end of the value range. Some appraisers go to the extent of a more formal weighting process where they might assign, for example, 50% of the weight to Comparable 1, 30% to Comparable 2, and 20% to Comparable 3. It is possible under USPAP to produce a final opinion of value as a range of numbers; such as $190,000-$195,000. However, in most appraisals for lending intended use, the client desires a single-point estimate. The last part of the sales comparison approach in the URAR form provides 7½ lines in which to summarize the factors that we have been discussing. In the very last line of the approach we have to make that commitment and state our indicated value by sales comparison approach.

Points

A point is one percent of the amount of a mortgage loan. Discount points are defined as: "A percentage of the loan amount that a lender charges a borrower for making a loan; may represent a payment for services rendered in issuing a loan or additional interest to the lender payable in advance; also called points. Each discount point is 1% of the original loan amount." Points are another example of creative financing that originated in the 1980s. The first time I heard of points was in regard to an FHA loan. Lenders started charging points, claiming that FHA loans were much more difficult and time-consuming to process, and therefore they needed to be compensated an additional processing fee. When interest rates ballooned in the 1980s in many states, they exceeded the usury limits that were on the books. For example, a state may have decreed that it was usurious to charge more than 10% interest. When lenders felt they could no longer make a profit by loaning money at 10%, they figured another way to achieve profitability. It works out mathematically that if you charge 10% interest for a mortgage loan and then charge four points up front, it averages out to give the lender a yield in the range of 10.5% over the life of loan. So charging points became an accepted way to bump up the yield on conventional loans, above the stated or "face rate".

2. Financing Terms and Cash Equivalency

Adjustments may have to be made in certain circumstances where there are differences in the financing between a comparable sale and what is considered "typical" financing in the market. The differences may lie in the interest rate, amount of down payment, points paid, concessions given, etc. Normally, we make adjustments in the sales comparison approach to equalize the comparable property to the subject property. When we make adjustments for financing, however, we are not comparing the comparable property's financing terms to the subject property's financing terms. We are comparing the comparable property's financing to "typical" financing terms that are available in the market. Adjustments for financing are typically (but not always) made on the basis of cash equivalency. We will cover that later in the chapter.

When to Make Adjustments

Adjustments only need to be made when there is a significant, measurable difference between the subject property and a comparable sale. By measurable, we mean measurable in the marketplace, such that a typical purchaser would recognize this difference and take it into consideration in the buying decision. There are 22 lines in the sales comparison grid in the URAR appraisal form. This does not mean we are expected to make 22 adjustments. We have to understand buyers' and sellers' motivations in the particular market area in which the subject is located. If a typical buyer is not willing to pay for a particular feature in a property, then we should not make an adjustment for that feature.

Adjustment Period

Adjustments should always be calculated from the time of the comparable property's contract of sale to the effective date of the appraisal. When sales are negotiated and consummated, the resulting price is a reflection of the economic conditions, supply and demand factors, financing options available etc. at that point in time. That point is called the "meeting of the minds" of the buyer and seller. Suppose a contract was negotiated and signed in January. After all the processing of the loan, the closing and passing of title takes place in May. You come along and do an appraisal in August and use that sale as a comparable property. If market conditions have changed and an adjustment is necessary, you need to make an adjustment for market conditions that reflect the change from January (the date the buyer and seller agreed on the comparable's sale price) to August (effective date of the appraisal).

URAR Sequence

Again, the 10-item sequence on the previous page is not the only accepted sequence. But it is representative of a typical set of factors that may impact value and may require adjustment. As we know, the URAR form, created jointly by Fannie Mae and Freddie Mac, is the most commonly-used appraisal report form. It is used to report appraisals of single-family homes intended for use in mortgage lending. The use of this form is also required for FHA and VA loans. In the URAR adjustment grid, the adjustment factors are presented in a slightly different sequence: Sale or financing concessions Date of sale/time Location Property rights Physical characteristics **See picture Take a look below. If you want to adjust for any other kind of factors, you will have to add them in the blank lines at the bottom of the grid.

Market Area Boundaries

An appraiser must determine the boundaries of the area of influence, whether they be neighborhood, district, or market area, surrounding the subject property, in order to decide what other properties can be considered reasonable comparables. A market area is an area in which other properties effectively compete for the favors of a potential buyer. There are no hard and fast rules. A market area does not necessarily coincide with a town, village, subdivision, or other designated or mapped area. A market area could be as small as a block or two or as large as a county, a state, or several states. In this context we are considering residential properties. Certain commercial or industrial properties might have a market area that is nationwide or international in scope. Even some exceptional residential properties could have appeal to potential purchasers from all over the country or all over the world. Think of a mansion in Beverly Hills or a private island in the Caribbean. Because the boundaries of a market area are indeterminate, we have to brainstorm each new assignment and determine what comprises the market area for that specific property. Perhaps a residence in a suburban development is competing with all other properties within a half-hour commute from a city. A resort home might be competing with other resort properties within a two-hour circle of a main population center. On the other hand, a newly-constructed house may be competing with just a few other new homes in the same development. We start our quest by proceeding out from our subject property in all directions. If it is an area with which we are not that familiar, this may entail getting in the car and driving around. It could also entail using satellite maps or online mapping programs that give us the ability to view photos of properties from street level. If it is a familiar area, we may mentally make a journey to all four points of the compass and think about what we would pass along the way. We have to extend our search far enough to include all value-affecting influences. Remember again that some of these are social, economic, governmental, and environmental. This can include a number of different factors. Once we have satisfied ourselves that we have fulfilled our search requirements, then we can figuratively draw boundaries around the area of influence. That is the market area.

Age

Appraisers normally look for houses of approximately the same age for the sales comparison approach. Minor differences in chronological age do not usually affect value significantly. Would a typical buyer in the market pay more for a 18-year-old home as opposed to one that is 19 years old? It's possible, but highly doubtful. Keep in mind that differences in condition typically have the greater impact. New homes versus homes with a few years of wear and tear on them tend to see significant conditional differences, primarily due to the fact that none of the components have been renewed. As homes age, there tends to be an even greater chance of significant conditional differences, due to a wide variation in the amount of updating and refurbishment. Age adjustments are used to calculate differences in long-lived incurable deterioration between properties. This can be done using different criteria.

As part of the reconciliation, we need to go back and re-analyze all of the comparable sales. We need to identify which are the strongest sales and the weakest sales.

As part of the reconciliation, we need to go back and re-analyze all of the comparable sales. We need to identify which are the strongest sales and the weakest sales. One way to rank the sales is to look at the number of adjustments that were necessary. A perfect comparable would require no adjustments. A weak comparable would require many significant adjustments. One method of comparison is to look at the amount of net and gross adjustments for each comparable. Because the prices may vary, the net and gross adjustments are expressed in terms of percentages; which equalize the differences. Remember what we said previously, though, that net adjustments can be deceiving. The gross adjustments will tell the story of the real magnitude of the adjustments needed to equalize a comparable with the subject property. As stated above, another measure is the number of adjustments made to each comparable. Every adjustment represents a significant difference between the comparable and the subject property. The more adjustments needed, the less comparable the properties. That may be a general rule; however, we need to look more closely. A comparable that requires only two adjustments, but they are large, subjective adjustments that are not well-supported, may be less reliable than a comparable with four, small, well-grounded adjustments.

Valuation of Partial Interests

As we mentioned before, anytime we have something less than 100% of the fee simple rights, it becomes a partial interest. Even though many appraisers typically state that the fee simple interest in the property is being appraised, in many cases the property owner has less than a fee simple interest. Any time a property has a mortgage or is encumbered by a lien, for example, the owner no longer has a fee simple interest! Actual fee simple ownership may be the exception rather than the rule. As stated previously, we typically appraise real property as if unencumbered by mortgages and liens, so stating "fee simple" in the report may be appropriate. If we are asked to appraise a partial interest, that assignment becomes more complicated. It may prove to be that the impact of some factor that creates a partial interest is negligible. But we never know until we investigate the circumstances. It is possible that an easement can add to value, reduce value, or have no impact. Generally, however, when valuing partial interests, we discover that the value of a partial interest is less than the pro rata share of a fee simple interest. For example, the value of a 1/3 interest may be considerably less than 1/3 of the market value of the property. For example, let's look at a small chain of five pizza parlors. The properties are owned jointly by three general partners and each has a 1/3 interest. A recent appraisal of the market value of all five properties has been obtained, and the opinion of value was $3,000,000. We cannot automatically assume that the value of a 1/3 share is therefore $1,000,000. The market value of the 1/3 share would presume a typical purchaser who would be knowledgeable of the facts in the situation. Minority ownership interests have limited market appeal. It may be difficult to find a buyer willing to buy into the partnership at all. The buyer might have to come up with all cash. He or she would be in a minority ownership position and not have control. They would be subjugated to the wishes of the other two partners. Therefore, the value of the partial interest might have to be discounted in order to attract a potential purchaser. You can imagine that the value of owning 51% of the shares in a company would be a lot more valuable than owning 49%.

Reconciliation and Summary of Sales Comparison Approach

As you consider the data you have used in the sales comparison grid, ask yourself three questions: Do I have a sufficient quantity of comparables to justify a value conclusion? (With unusual properties, it's not uncommon to need six or more!) Is my data of reliable quality? (Does it reflect standardization of measurements and reputable sources of data?) Is each comparable appropriate? (Does each reflect an arm's-length sale that occurred on the open market?) Presumably you will now have at least three indications of value. Let's suppose they range from $150,000 to $160,000. NEVER AVERAGE! That doesn't mean that in this case you can never arrive at a final value of $155,000. But applying a simple arithmetic mean is not the correct procedure here. Anybody could add up the three numbers and divide by three. We were contracted to perform a professional service, in which we utilize our own professional expertise, experience, and reasoning. Also, if we were to just average the results, it implies that all three comparable sales are equally meaningful and pertinent. That is usually not the case.

Prior Sales

Below the Sales Comparison Comments field on page 2 of the URAR form, you will be asked to document how many times the subject and comparables have sold in the past year. It is required by USPAP that we report and analyze prior sales of the subject for three years prior to the effective date of the appraisal. USPAP does not require a sales history of the comparable sales, but when completing the URAR for lending purposes, the form requires a one-year sales history of each comparable sale. Please note that it is for one year prior to the date of sale of the comparable - not one year prior to the effective date of the appraisal. Completing a sales history of the comparable sales is considered an assignment condition; even though it is not required by USPAP it is required by the intended user, so you would need to do it. Some lenders may want a three-year sales history on the comparable sales also. This is something you could undertake as an additional assignment-specific requirement and is an arrangement you must make with your client. The most important reason to report and analyze a prior sale is that it may be an indication of the subject's value. If it is not an indication of current value, it then becomes imperative that the appraiser know and explain why not. Values can go up or down, and the subject property can change over three years. It may have been poorly maintained or heavily renovated. All of these factors need to be considered and explained if there is a recent prior sale within the last three years. Then there is a large field on the URAR form which has 5½ lines, in which you are expected to analyze any prior sales of the subject or comparables, if applicable.

View Adjustment

Beneath the Site field on the URAR is the View field. Here we will enter the type of view (e.g., mountain, ocean, lake, other houses etc.) Use terms that are as descriptive as possible. There are specific UAD protocols for this form field as well, which involve selecting B, N, or A (Beneficial, Neutral, or Adverse) and then selecting appropriate abbreviations from a computer-generated list. Views may vary greatly, so it is not always easy to attribute a value. Do your analysis carefully, because views may be worth a great deal. Some buyers may prefer a western view to a southern one. Or a particular city view may be worth more if it includes an extraordinary feature, such as the Golden Gate Bridge or Statue of Liberty. Of course the view from the subject property or a comparable property can be a negative factor as well. The view might be of the backside of the shopping mall or the nearby landfill. If you make a substantial adjustment, for example a $30,000 adjustment because of the panoramic hilltop view, then it deserves an explanation. In the comments of the sales comparison approach or in the addendum, go into detail about this view. Be sure to include photographs in the report as well. The same goes for the situation in which we have a negative factor attributable to a view.

Partial Interests - Other Forms of Ownership

Besides the forms of individual ownership that we previously mentioned, real property can be owned by various legal entities, including: Land trusts Partnerships Corporations Syndications

Red Flags

Certain types of sales may raise red flags and inspire you to be more diligent in your investigation and verification of the sales data. These kinds of sales may prove to have transferred at market value, but there is a higher likelihood that the sales are atypical and that the sale prices may have been influenced by factors that would require adjustment. These suspicious types of sales might include: Distressed sales (e.g., "short sales") Foreclosure sales Auctions FHA sales VA sales This does not mean that these types of sales should not be used, particularly FHA and VA sales. In some markets, FHA and VA sales make up the vast majority of sales, and it would be difficult - if not impossible - to omit them from consideration. What we are saying is that these sales often involve sale concessions made by the seller, and they warrant further research and verification when considering them for use as comparable sales.

Here is a list of some factors that can help you analyze changes in market conditions:

Changes in the area's demographics Changes in typical exposure time on the market Foreclosure rates in the area Increases or decreases in residential rents Instances of seller financing Nearby development New construction available for sale Quantity of offers received by sellers Relationships between asking prices and closing prices Terms of available financing Trends in listing prices Volume of properties available for sale Zoning changes

Heating / Cooling

Detail whether the subject and its comparables have heating and air conditioning systems, and if so, what type. Many appraisers only adjust here if the subject or a comparable has a significantly different system than what is common for this age and class of building. For example, some subdivisions were built when electric baseboard heating was common. Thirty years later, natural gas service was typically provided to neighborhoods. In many markets, the cost for natural gas is much lower than electricity, so a gas forced air system may be perceived as superior to electric radiant baseboard heaters. Newer energy-efficient heat pump systems may also need to be adjusted. Heat pumps deliver both hot and cold air and the adjustment might be significant due to this dual function. The appraiser would look for paired sales or other market data to arrive at an adjustment for this.

In the Fannie Mae Selling Guide Section B4-1.1-01, General Information on Appraisal Requirements, it lists the following as unacceptable appraisal practices:

Development of and/or reporting an opinion of market value that is not supportable by market data or is misleading Selection and use of inappropriate comparable sales Failure to use comparable sales that are the most locationally and physically similar to the subject property Use of adjustments to comparable sales that do not reflect market reaction to the differences between the subject property and the comparable sales Not supporting adjustments in the sales comparison approach Failure to make adjustments when they are clearly indicated

Do most properties sell for cash? No. Therefore, sometimes we have to try to quantify the cash equivalency of a comparable sale that did not transfer for all cash.

Do most properties sell for cash? No. Therefore, sometimes we have to try to quantify the cash equivalency of a comparable sale that did not transfer for all cash. The sale may have been consummated under one of the many scenarios that we have addressed. Perhaps it sold with an FHA mortgage or a VA mortgage. Perhaps there was an assumption of an existing mortgage, or the seller agreed to provide a private mortgage at a below-market interest rate. Maybe there was a wraparound mortgage or second mortgage financing. It is important to note that a mortgage does not automatically mean that an adjustment for financing terms is required. In most cases, the seller receives all cash at the closing, regardless of whether the sale was cash or financed with a conventional or government mortgage. So in these situations, there would be no adjustment for financing terms needed. But what if a comparable sale had atypical financing terms? What if the seller decided to finance the property for the buyer, at terms that were advantageous? All of these things could impact the sale price and lead to a price that was different from market value. At that point, the appraiser has two choices. Either discard the sale as being atypical, or use it and make an adjustment for financing terms.

7. Physical Characteristics

Each parcel of real property is unique. When initially constructed, houses vary in site, site improvements, quality, layout, and materials employed. From the moment it is occupied, a house becomes unlike any other. Owners begin customizing and decorating, turning a house into a home. Almost all of the things they do (or don't do) either add to, or detract from, value. Let's look at the most common physical characteristics of residential property improvements, and investigate how they impact an estimate of value using the sales comparison approach. Specifically, we will cover: Design and appeal How to estimate quality Condition versus age Counting rooms Square footage Basements Energy efficiencies Garages and carports Appliances Porches, decks and other structures

Other times, partial interests are created when some part of the fee simple estate is taken away by:

Easements Encroachments Transfer of subsurface rights Transfer of air rights Exercise of transferable development rights (TDRs) Private restrictions Deed restrictions Conditions, Covenants, and Restrictions (CC&Rs)

Energy Efficient Items

Energy-conservation features should be noted in a home, as they can add considerable value. These include solar panels, high R-factor insulation, double or triple-paned windows, and other elements of so-called "green design." Even passive solar features, such as more windows on the south side and fewer on the northern side, can make a difference in northern climes. A high efficiency furnace would typically be dealt with under the Heating/Cooling line, even though it does have better energy efficiency. Conversely, a home with single-pane windows and no insulation might also require an adjustment for inefficiency, which can be made on the Energy Efficient Items line or the Functional Utility line in the sales comparison grid. If the market recognizes no difference in value for energy efficient items (e.g., one house has a high-efficiency furnace and another does not, but both houses sell for the same price) then no adjustment should be made for energy-efficient items.

FHA

FHA addresses the topic of sales and financing concessions in more general terms. In HUD Handbook 4000.1, it states: "Sales or Financing Concessions. Account for and adjust for any special sale or financing terms, including sales concessions, nonmarket financing terms, points, buydowns, closing terms and swaps/exchanges. The most common scenario involves the seller paying points in the form of settlement help to the buyer. To reflect the amount, adjust the sales price of the comparable sale downwards. Typically this amount will not exceed six percent of the sales price for typical transactions." In Handbook 4000.1, it says: "Report the type of financing such as Conventional, FHA, or VA. etc. Report the type and amount of sales concessions for each comparable sale listed. If no concessions exist, the appraiser must note "none." The appraiser is required to make market-based adjustments to the comparable sales for any sales or financing concessions that may have affected the sales price The adjustments for such affected comparable sales must reflect the difference between the sales price with the concessions and what the property would have sold for without the concessions" (The BOLD type was added by the author to emphasize key points)

Let's examine the various types of property rights that can be conveyed in a real estate transaction, since these will impact the way you perform the sales comparison approach: Fee simple estate is defined as:

Fee simple estate is defined as: "Absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat." Many residential appraisals involve fee simple ownership, meaning that the current property owner holds all rights of ownership or the "full bundle" of rights. These include the rights to: Sell an interest Lease an interest Exclusively occupy the property Mortgage an interest Give an interest away (through a will or trust) The right to do any or none of the above

Sale Concessions

Financing terms typically impact the interest rate or the payment amount of the mortgage. Sale concessions usually are a one-time charge that can affect the sale price as well. For example, in a slow market or with a seller who is anxious to make a deal, various sale concessions may be employed. Perhaps the only way a buyer could afford the property would be to take an FHA loan which requires three points in addition to the down payment. The seller could agree to pay these three points for the buyer. The parties may or may not then increase the contract price accordingly. Let's assume that the negotiated price was $100,000, and the buyer and seller are both content with that price. To make the deal work, the contract could be amended to read $103,000, and the seller would agree to rebate the three points to the buyer at the closing as a sale concession. If you investigated this transaction and intended to use it as a comparable sale, you could make a $3,000 adjustment in the sales comparison grid for cash equivalency. This means that it really was a $100,000 sale plus a $3,000 sale concession. In other words, if there had been no sales concessions, theoretically this property would have sold for $100,000.

Partial Interests - Fannie Mae Forms

For many years, on the URAR appraisal form (1004) there were only two choices that could be checked for property rights; fee simple or leasehold. In the current version of the form, they added a third choice - a box labeled "other" - and a blank line for explanation. For residential properties, leasehold meant it was on leased land. This was usually not the case (except in certain parts of the country). But what if the rights appraised were something else; such as a life estate? In the previous forms, there was no place to explain another form of estate. Many appraisers just checked fee simple - because it sure wasn't leasehold - and didn't bother explaining it in the addendum. Now there is a space, but if you check "other", you need to explain it fully and address its impact on value. Most likely you will have to continue the explanation in the addendum. There is a special situation that will need to be addressed in the Small Residential Income Property Appraisal Form (Fannie Mae form 1025). The same three choices are offered for property rights appraised: fee simple, leasehold and other. However, if you are appraising a two-, three- or four-unit property and at least one unit is rented, the owner no longer has a fee simple interest. Fee simple implies that the owner retains the whole bundle of rights. One of the rights of ownership is the right to lease the property. But once you lease the property then you have given up the right of exclusive possession and no longer retain the full bundle of rights. Therefore, if you are appraising a multi-unit property where at least one unit is rented, the property rights appraised consist of a leased fee interest. You need to check the box labeled "other" and explain the situation.

Gross Living Area

GLA includes only finished living areas that are above-grade. We typically do not include rooms that are even partly below grade, although they may be fully finished and heated. Gross living area (GLA) is defined as "Total area of finished, above-grade residential space; calculated by measuring the outside perimeter of the structure and includes only finished, habitable, above-grade living space. (Finished basements and attic areas are not generally included in total gross living area. Local practices, however, may differ.)"

Fannie Mae GBA

Gross building area (GBA) is different from gross living area (GLA). GLA is used for single-family residences, while GBA is used for 2-4 family properties, as well as some other types of properties. The primary difference between GBA and GLA is that GBA can include finished below-grade area, while GLA does not. In their Selling Guide, Section B4-1.4-14, Appraisal Report Review: Layout, Floor Plans, and Gross Building and Living Areas, Fannie Mae addresses GBA, stating: "Gross building area: is the total finished area including any interior common areas, such as stairways and hallways of the improvements based on exterior measurements. is the most common comparison for two- to four-unit properties. must be consistently developed for the subject property and all comparables used in the appraisal. must include all finished above-grade and below-grade living areas, counting all interior common areas such as stairways, hallways, storage rooms, etc. cannot count exterior common areas such as open stairways."

Site Adjustment

Here we will make adjustments for any significant differences between the site of the subject property versus the sites of the comparable properties. On the site adjustment line in the sales comparison grid, we enter the area of the site for the subject and the comparable properties. This area should be stated in appropriate units of comparison, depending upon the size of the property and the typical units of comparison that would be utilized by buyers and sellers in that market area. If it is a large parcel, use acres. If it is a small parcel, then the area could be stated in terms of square feet. (If the appraisal report is prepared using the UAD, there are specific protocols for reporting site sizes in acres versus square feet.) The actual dollar amount of individual adjustments for differences in the site size needs to be determined by market comparisons. Site sales need to be researched and analyzed. We need to find sales of vacant sites that are similar as possible to the subject property in terms of value-creating forces such as topography, utilities, etc. Then, through the use of paired data analysis, we can reconcile and isolate site value per acre, or other appropriate unit. This analysis goes beyond simple arithmetic. Let us assume we've found a representative sample of sales of sites that are similar to the subject property and in the market area. These similar properties are between two and four acres and have been selling at the rate of $30,000 per acre. Our subject property has three acres. Comparable Sale 1 has two acres. The math tells us that Comparable 1 is inferior and should be adjusted +$30,000 to make it equal to the subject property. However, the real question is, "How much more would a typical purchaser be willing to pay for the subject property just because it has three acres instead of two acres?" The answer is - probably something less than a full $30,000. Remember, we're appraising a single-unit residential property, and the site value is a relatively small component of the overall value of the property (in most cases). An adjustment needs to be made to reflect the contributory value of having an additional acre of land. In some markets, this may be significant and in other markets it may make little, if any, difference in the overall value of the real property. An appraiser's analysis of the market will help him or her determine if an adjustment is necessary, and if so, how much.

Expenditures Made Immediately after Purchase

Here's an example of expenditures made immediately after purchase. Let us assume a situation in which more substantial repairs are indicated. Assume that a house has all the windows broken out, the heating pipes have burst, and there has been some obvious water damage. A buyer has a contractor's estimate of $12,000 to repair the damage. The buyer made an offer of $75,000 for the property, anticipating that it would take $12,000 to put the property in reasonable condition. He felt it was a fair deal at that price. If you use that property as a comparable sale, your adjustment of $12,000 for expenditures made immediately after purchase added to the sales price would result in an adjusted sale price of $87,000. That would be the correct procedure. What if you discovered in interviewing the owner to verify the sales information that the ultimate repairs wound up costing $18,000 instead of $12,000, due to hidden damage? Should you instead make an adjustment of $18,000? No. The buying decision was based upon the best information the buyer had at that time, which was that it would take $12,000 to put the property in good shape. What if you discovered when interviewing the owner that it only cost $10,000 instead of the anticipated $12,000? Your adjustment still should be based on a presumed knowledge that the repairs would be $12,000. The owner lucked out and was able to save a little money; but that is beside the point. An adjustment for expenditures made immediately after purchase might also be required in situations where the anticipated expenditures were for: Curing deferred maintenance Demolition and removal of any or all of the improvements Costs for filling and grading of the site Costs for attempting to change the zoning Costs for remediation of actual or perceived environmental contamination Costs for running utilities to a site Costs for gaining access to a site, such as curb cuts

USPAP - Standards Rule 1-2(c)

In Standards Rule 1-2(c), USPAP makes a clear statement as to the appraiser's responsibilities. It states that an appraiser must: "identify the type and definition of value and, if the value opinion to be developed is market value, ascertain whether the value is to be the most probable price: (i) in terms of cash; or (ii) in terms of financial arrangements equivalent to cash; or (iii) in other precisely defined terms; and (iv) if the opinion of value is to be based on non-market financing or financing with unusual conditions or incentives, the terms of such financing must be clearly identified and the appraiser's opinion of their contributions to or negative influence on value must be developed by analysis of relevant market data;"1 (The BOLD type was added by the author to emphasize key points)

In the Fannie Mae Selling Guide, Section B4-1.4-18, it states:

In the Fannie Mae Selling Guide, Section B4-1.4-18, it states: "The table below describes lender evaluation requirements for sales or financing concessions. Evaluating Sales or Financing Concessions The dollar amount of sales or financing concessions paid by the seller must be reported for the comparable sales if the information is reasonably available. Appraisers must provide the sales and financing concession information that was available and verified for the comparable sales. If information is not available because of legal restrictions or other disclosure-related problems, the appraiser must explain why the information is not available. Note: Fannie Mae will not accept an explanation that indicates that the appraiser did not make an effort to verify the information. If the appraisal report form does not provide enough space to discuss this information, the appraiser must make an adjustment for the concessions on the form and include an explanation in an addendum to the appraisal report. When a quantitative sales comparison analysis is used, the amount of the negative dollar adjustment for each comparable with sales or financing concessions should be equal to any increase in the purchase price of the comparable that the appraiser determines to be attributable to the concessions. Adjustments based on dollar-for-dollar deductions that are equal to the cost of the concessions to the seller as a strict cash equivalency approach would dictate are not appropriate. Adjustments must reflect the difference between what the comparables actually sold for with the sales concessions and what they would have sold for without the concessions so that the dollar amount of the adjustments will approximate the reaction of the market to the concessions. Positive adjustments for sales or financing concessions are not acceptable. For example, if local common practice or law results in virtually all of the property sellers in the market area paying a 1% loan origination fee for the purchaser, and a property seller in that market did not pay any loan fees or concessions for the purchaser, the sale would be considered as a cash equivalent sale in that market. The appraiser must recognize comparable sales that sold for all cash or with cash equivalent financing and use them as comparable sales if they are the best indicators of value for the subject property. Such sales also can be useful to the appraiser in determining those costs that are normally paid by sellers as the result of common practice or law in the market area. Sales or financing data for comparable sales are generally available. Sales or financing data should be obtained from parties associated with the comparable transaction, such as the broker, buyer or seller, or a reliable data source. The need to make negative dollar adjustments for sales and financing concessions and the amount of the adjustments to the comparable sales are not based on how typical the concessions might be for a segment of the market area; large sales concessions can be relatively typical in a particular segment of the market and still result in sale prices that reflect more than value of the real estate."

In the Selling Guide, Section B4-1.4-18, Appraisal Report Review: Lender Review of the Adjustment Grid, Fannie Mae says:

In the Selling Guide, Section B4-1.4-18, Appraisal Report Review: Lender Review of the Adjustment Grid, Fannie Mae says: "Only finished above-grade areas can be included in the calculation of the gross living area for a one-unit property or a unit in a condo or PUD project. Basements and other partially below-grade areas must be considered separately and the appraisal adjusted accordingly. Room count and gross living area must be similar for the subject property and all comparable sales. Large differences between the subject property and the comparable sales must be addressed since they raise doubts about the validity of the comparable sales as good indicators of value."

Quality Categories

In the URAR form, you must classify the subject and comparable properties in terms of quality. Marshall & Swift recognizes the following categories of quality in construction: Low Fair Average Good Very good Excellent For residential mortgage lending appraisals for Fannie Mae and Freddie Mac lenders, as well as HUD and VA, appraisers are required to use the protocols of the Uniform Appraisal Dataset (UAD). Quality ratings are assigned to the subject on a scale from Q1 (best) to Q6 (worst). These six ratings do not necessarily correspond with the six ratings that appear in the Marshall & Swift Residential Cost Handbook. When using the UAD protocols in reporting an appraisal, the appraiser needs to familiarize himself or herself with the UAD ratings and definitions, and apply them in a consistent manner. Caution: When judging the quality of an improvement, be careful not to let your personal biases color your valuation. The fact that you like natural wood trim should not prejudice you against painted wood trim when assessing quality. Similarly, if you have always been fonder of traditional homes than contemporary ones, you should not attribute higher quality to an old-fashioned chandelier than a chrome fixture of similar value. In other words, do not confuse style with quality or use subjective opinions that may be a personal bias. Do paired sale analysis to determine a justifiable dollar figure for any differences. If the quality of construction varies too much between the subject and the comparables, then you may need to find better comparables.

Types of Adjustments

In the last chapter we described the derivation of adjustments that may be made to comparable sales in the sales comparison approach. Adjustments that are derived with quantitative approaches can be applied to a comparable property in one of two ways: dollar amounts; or percentage amounts. Making adjustments in dollars is usually preferable, especially in residential appraisals. In non-residential appraisals, percentage adjustments are often used. The choice of method will depend upon the manner in which the adjustments are derived. For example, market conditions adjustments (sometimes called time adjustments) are typically expressed in terms of a percent change. In any case, percentage adjustments are typically converted into dollar amounts when the math is processed in the sales comparison approach grid.

In their Selling Guide, Section B4-1.4-18, Appraisal Report Review: Lender Review of the Adjustment Grid, Fannie Mae says:

In their Selling Guide, Section B4-1.4-18, Appraisal Report Review: Lender Review of the Adjustment Grid, Fannie Mae says: "For each comparable sale, the appraiser should provide the date of the sales contract and the settlement or closing date. Only the month and year of the sale need to be reported unless the exact date is necessary to understand the adjustments. If both the contract date and settlement or closing date are not reported, the reported sale date must be identified as either the 'contract date' or the 'settlement or closing date.' If only the contract date is reported, the appraisal must indicate whether the contract resulted in a settlement or closing. Time adjustments must reflect the difference in market conditions between the contract date of the comparable and the effective date of appraisal for the subject property. The adjustment may be either positive or negative."

Functional Utility

In this category of the URAR form, you note whether the home "fits" with the use for which it was constructed. Functional utility is defined as "The ability of a property or building to be useful and to perform the function for which it is intended according to current market tastes and standards; the efficiency of a building's use in terms of architectural style, design and layout, traffic patterns, and the size and type of rooms." Are the rooms big enough? Are there enough bathrooms? Do you go through a bedroom to get to another bedroom? Are the stairs too narrow to get furniture and people up and down? Is the design appealing? In other words, if it is meant to be a home, would it have inutility that would impact its value as compared to other homes? Determine whether functional utility is adequate or inadequate, or rate it fair, average or good for the subject and all comparables. Enter this information in the URAR form. If there is a difference in functional utility, do a paired sales analysis to determine a value amount for the adjustment, if possible, and enter it into the grid. The amount of an inadequacy adjustment could possibly be the estimated cost to cure the problem, particularly if the adjustment can't be directly extracted from the market.

The Uniform Appraisal Dataset

In this chapter, we will touch briefly on the sales comparison grid of the URAR form, which is the most common appraisal reporting form used in mortgage lending appraisals. It is used to report the appraisal of a single-unit residential property for a mortgage that will be sold to Fannie Mae or Freddie Mac, as well as for FHA and VA. Even mortgage lenders that do not sell loans to Fannie Mae or Freddie Mac have adopted this form for use by their appraisers. In 2011, Fannie Mae and Freddie Mac created the Uniform Appraisal Dataset (UAD) which is a set of reporting protocols that apply to the URAR form and three other forms. The purpose of the UAD was to standardize appraisal report data. For example, most dates reported on the URAR form are required to be formatted in MM/DD/YYYY format. June 22, 2018 would be reported in a UAD-compliant report as 06/22/2018. As another example, overall property condition for the subject and comparables is required to be reported on a scale from C1 (best) through C6 (worst). There are a number of UAD protocols; again, these only apply in certain residential mortgage lending appraisal assignments. The protocols for the UAD are detailed in a document entitled Appendix D: Field Specific Standardization Requirements, which can be downloaded as a PDF from Fannie Mae's website at https://www.efanniemae.com/sf/lqi/umdp/uad/index.jsp As we go through this chapter, we may touch on some UAD protocols; however an in-depth look at all the UAD instructions and requirements is beyond the scope of this course.

Information Sources

Information concerning residential sales is more easily available today than it was in the past. Sales information can be found in most areas through online multiple listing services. Virtually all MLS organizations are computerized; many have programs capable of generating extensive searches and reports. Most of them routinely generate monthly, quarterly, semiannual, and annual reports on median and/or average sale prices. These statistics can be further broken down into the median and/or average prices per designated area or section, number of bedrooms, number of baths, type of property, etc. For example, you may be able to ascertain that three-bedroom houses on the north side of town sold for a median price of $142,715 twelve months ago and that the median price of those homes for the current month is $158,420. Simple division ($158,420 divided by $142,715 equals 1.11) indicates an increase of 11%. If you are in a more remote area where there is not an active MLS or where only a small percentage of sales go through MLS, you will need to rely on other sources. There are several online subscription services whereby sales information is available to be purchased; however these may only provide limited information in remote rural areas as well. Sales information recorded in public registers such as assessor's offices is becoming increasingly available online; much of this information is provided for free as a public service. In many areas the local real estate organization and/or MLS may routinely publish statistics. Usually once a month, my local newspaper publishes statistics about the local city and county real estate sales. They nicely summarize everything and produce specifics such as the fact that the median sales price of new houses this month was "X" dollars as compared to "X" dollars for the same month a year ago. Then they state what this change is as a percentage. The same information is routinely provided for median sale prices of existing homes and usually broken down by township areas. Sometimes they even publish information about building permits and new construction starts by municipality, which makes it easy to see which are the fastest-growing and slowest-growing areas. If looking in a newspaper may seem old-fashioned, it may comfort you to know there are online sources for this information as well.

3. Conditions of Sale

Let's continue with our examination of the sequence of adjustments in the sales comparison approach. The third item in the sequence is conditions of sale. Conditions of sale is defined as: "An element of comparison in the sales comparison approach; comparable properties can be adjusted for differences in the motivations of either the buyer or a seller in a transaction." Arm's-length transaction is further defined as: "A transaction between unrelated parties who are each acting in his or her own best interest." What kinds of situations might cause duress? What might cause a transaction to be something other than arm's-length?

This list is certainly not all inclusive, but some of the causes of duress that could result in a transaction that would not be considered arm's-length include:

Job Transfer Death of a spouse or close relative Sale to a relative Sale to a friend or business partner Sale by an unknowledgeable buyer or seller Desire to buy and control an adjoining property Desire to purchase a property for an assemblage Sale prior to impending foreclosure Sale under threat of condemnation Sale prior to proposed zoning change Sale influenced by tax considerations (it may have been part of a tax-free exchange)

Leased Fee Interest

Leased fee interest is defined as "The ownership interest held by the lessor, which includes the right to receive the contract rent specified in the lease plus the reversionary right when the lease expires." A leased fee interest is the landlord's interest. The landlord still owns the property, but he or she has granted the right to occupy the property to the tenant.

Leasehold interest

Leasehold interest is defined as "The right held by the lessee to use and occupy real estate for a stated term and under the conditions specified in the lease." If a property is leased, the value of the leasehold may be calculated separately from the leased-fee ownership of the property itself. The appraiser would account for the terms and also factor in the length of time remaining on the lease. Even though the owner of a leasehold interest has no real fee interest, a leasehold interest may have value if the contract rent stipulated in a lease is less than the property's market rent.

9. Legal Characteristics

Legal characteristics also need to be considered in the sales comparison approach. Use and zoning are two examples of legal considerations. This type of adjustment also deals primarily with income-producing and commercial properties. For example, adjustments could be made for differing values indicated by differing intensities of use. A parcel that would allow 20 units per acre would be worth more than one that would allow 10 units per acre. As another example, a property that has a variance to conduct business in a way that is no longer allowed under the current zoning may have an advantage.

A completed sales comparison grid on the URAR form might look something like this. Note that this grid was not completed using the UAD protocols

Let's examine Comparable Sale #1, and the rationale behind the adjustments. **See picture This sale occurred 3 months ago, and property values are increasing at a rate of 1% per month. (We used simple interest, rather than compounding, as it would not make a meaningful difference over such a short period.) Because property values are increasing, this is a positive adjustment. This property has a river view, and is superior to the subject in that regard. A negative $10,000 adjustment is made to this comparable for view. The condition of this property is fair, as it had some deferred maintenance and needed repairs. Because the comparable is inferior to the subject, a positive adjustment is made. This property is 74 square feet smaller than the subject, and required an adjustment for gross living area. This adjustment is made based on $75 per square foot (74 x $75 = $5,550.) Because the comparable is inferior, this is a positive adjustment. This property does not have air conditioning, while the subject has air conditioning. A positive $1,500 adjustment is made to this comparable for air conditioning. This property has a small older rear deck, and is rated "fair" as a result. A positive adjustment was therefore necessary. (Typically, this feature would be specifically stated in the grid as "deck" or "covered deck" and/or "large deck" instead of being rated as "average" and "fair.") This property has two gas fireplaces, and the subject has only one fireplace. Because the comparable is superior to the subject, a negative adjustment is made. The sales indicate an adjusted range of $308,130 to $310,155. In this case, reconciliation would be relatively simple, and would likely involve the appraisal reconciling to $309,000 or $310,000, based on the relative strengths of comps 2 and 3, which are similar to the subject in view and condition.

Market Value - USPAP

Let's look at what USPAP says about the concept of market value: "A type of value, stated as an opinion, that presumes the transfer of a property (i.e., a right of ownership or a bundle of such rights), as of a certain date, under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal. Comment: Forming an opinion of market value is the purpose of many real property appraisal assignments, particularly when the client's intended use includes more than one intended user. The conditions included in market value definitions establish market perspectives for development of the opinion. These conditions may vary from definition to definition but generally fall into three categories: "1. the relationship, knowledge, and motivation of the parties (i.e., seller and buyer); 2. the terms of sale (e.g., cash, cash equivalent, or other terms); and 3. the conditions of sale (e.g., exposure in a competitive market for a reasonable time prior to sale)."1 (The BOLD type was added by the author to emphasize key points) Note that this is not a specific definition of value that would be used in an appraisal assignment, nor is it intended to be. USPAP cautions appraisers to use the specific definition of market value that would be applicable in an assignment. For example, for a mortgage appraisal that is to be purchased by Fannie Mae on the secondary market, the appraiser should use Fannie Mae's definition of market value. In another assignment for an ad valorem assessment appeal, the appraiser should use the definition of market value that is used by the local municipality or taxing authority.

Calculating a Mortgage Payment

Let's take this opportunity to calculate a mortgage payment with a financial calculator. We will be using the HP12c. Example: A two-unit property can be purchased for $400,000. Typical financing terms would require a 20% down payment, with a fully-amortized mortgage at 5.5% for a term of 30 years, with monthly payments. What is the amount of the monthly payment? We will work through this one together. Here are the keystrokes on the HP12c. f CLEAR FIN 30 g n 5.5 g i 320000 CHS PV PMT 1816.92 The monthly payment for a $320,000 loan at 5.5% interest would be $1,816.92.

Design (Style) Adjustment

List the design, or housing style of the subject property and the comparable sales. Use standard terminology such as ranch, Cape Cod, split-level, etc. If the style is unusual, make an effort to classify it as succinctly as possible. For example, it may be a New England Colonial or a Classical Revival. Appraisers make adjustments for design and style infrequently, and even then only for cases when a property is significantly different from comparables and its neighborhood. These adjustments tend to be highly subjective and hard to separate from other measures such as quality. However, sometimes it is necessary to use sales that are not of similar design, and you need to explain this in detail in the report. Remember, there is a question on Page 1 of the URAR that asks "Does the property generally conform to the neighborhood (functional utility, style, condition, use, construction, etc.)?" If you answer "no" to this question because the subject property is of a non-conforming style, then you need to address this point in more detail. Explain why or why not you made an adjustment for style, and how much of an adjustment you made.

Market Condition Factors

Making market condition adjustments is not as easy as it looks. That's because values do not always increase in a straight line. They are, in fact, impacted by numerous, interdependent forces. They can stay flat for six months, and then start to either skyrocket or plummet because of external factors like interest rates or economic recession. Never assume that a difference in sales price is due solely to time elapsed. When you are comparing dates of sale, check all of the other factors that contribute to sales price before arriving at a dollar-amount adjustment. Double-check your market condition adjustments by looking for other evidence of changes in market conditions. Although these may not give a hard-and-fast percentage to use, they will nevertheless back up your assumptions, prove that the market was in a state of flux, and indicate the direction of change. What indicators can help you determine if market conditions are changing?

Life Cycle of a Market Area

Market areas typically go through four distinct phases of their life cycle: 1. Growth - Lots of new construction and development activity, speedy sales, increasing prices, a "seller's market" 2. Stability - Slowing down of new construction, prices remain steady and high, excitement is cooling 3. Decline - Prices start to fall, new construction halts, more existing homes flood the market, creating a "buyer's market" 4. Revitalization - Prices have bottomed, sales stagnate, and hopefully the area receives new interest and renewal

Percentage Adjustments

Market conditions adjustments (and location adjustments) are generally calculated on a percentage basis. That's the way people think. We constantly see studies and analyses in which median prices or average prices are said to have appreciated 5.6% or depreciated 4.8% over the last year or some other time frame. Percentages are great equalizers. If we stick with raw numbers, sometimes it's hard to see or judge relationships. I could tell you that prices of three-bedroom houses on the average rose $20,000 over the last year. That can mean different things to different people depending upon your frame of reference. If you live in a $100,000 house, that would indicate a healthy increase. If you live in a one million-dollar house, that would amount to peanuts. But if I said that a study indicates that home values in a market increased by 12% last year, that would be meaningful to everyone in that market. So our starting point is usually to try to measure a change in market conditions in terms of a percent change. Then, in the final step, we convert that percentage into a dollar amount when making an adjustment in the sales comparison grid.

Mathematical techniques can be employed to estimate cash equivalency, although they are not the only way to make an adjustment. Let's start with a simplistic example.

Mathematical techniques can be employed to estimate cash equivalency, although they are not the only way to make an adjustment. Let's start with a simplistic example. Let's assume that a purchaser has agreed to buy a property for $125,000 and will put down $25,000. The current interest rate for mortgages is 10% and most loans are available for a 30-year period. The seller has agreed to provide a 30-year mortgage at only 8% interest. What is the cash equivalent value of the sale due to the favorable financing? Let's use the HP12c calculator again to calculate the mortgage payments. We enter in the known information and then solve for the payment (PMT). We will use a shortcut (g) to calculate the monthly payments. The g shortcut divides the interest rate you enter by 12 and multiplies the time period by 12. f CLEAR FIN 30 g n 10 g i 100000 CHS PV PMT 877.57 The monthly payment for a $100,000 loan at 10% interest would be $877.57. f CLEAR FIN 30 g n 8 g i 100000 CHS PV PMT 733.76 The monthly payment for a $100,000 loan at 8% interest would be $733.76. The buyer will be saving $143.80 each and every month. Wow - that is a total of $143.81 X 360 months, or $51,772. Is that how much we should subtract to make a cash equivalency adjustment? Remember that the cash equivalency adjustment should equate to the market's reaction to a sale or financing concession. By the market, we mean the reaction of a typical purchaser of residential property who is not particularly well-informed or not an expert in economic theory. Certainly, a buyer would recognize that it sure would be nice to save over $140 a month in mortgage payments. Therefore, they might be tempted to pay more for this property than another similar one in which they would have to get a 10% mortgage. Are they planning on living there for 30 years? Probably not. The average American family moves on the average of once every five to six years. The typical life of a mortgage is generally in the range of six to eight years. at which point the owners either move or refinance a mortgage. So even on a simplistic basis, the buyer would probably recognize that they would only be saving that $140 a month for five years or so. That certainly cuts down on the amount of the savings. $143.81 x 60 months = $8,629. Also, that savings won't occur immediately, but will be strung out over the next five years or more. Most people realize that money to be received at some point in the future is less valuable than money in hand today (a bird in the hand is worth two in the bush) even if they can exactly calculate the present value of a future dollar. Therefore, a buyer in this situation might think about it for a minute and say, "Let's make a deal - I'll give you $5,000 more if you'll hold a mortgage for 8%." We, being astute appraisers, could calculate to the penny the exact present value of the right to receive $143.81 per month for 5 years, discounted at 10%. I won't go into the exact procedure. However, the calculated answer is $6,768.47. That is correct from a mathematical standpoint. But we have heard over and over that we should not apply strict mechanical methodology, but should adopt the thinking of the marketplace. I realize it gives comfort to an appraiser to be able to point to a real number as justification. However, please do not make a cash equivalency adjustment of $6,768 in this scenario. It is more correct to interview buyers and sellers and adopt more of a layperson's standpoint. If the typical buyer would think this is a pretty good deal for $5,000, then that's the number we need to use for an adjustment.

Conventional Mortgages

Mortgages come in a seemingly infinite variety, but most common are conventional mortgages. Conventional loan is defined as: "A mortgage that is neither insured nor guaranteed by an agency of the government, although it may be privately insured." Many conventional loans do have private mortgage insurance (PMI) covering part of the loan (that exceeds 80% loan-to-value).

Simple or Compound

Most appraisers make market conditions adjustments using straight-line adjustments on a monthly basis, i.e., if the adjustment is estimated to be +6% per year (or +0.5% per month), they will multiply the monthly percentage figure by the number of months between the contract date of the comparable sale and the effective date of value for the subject property. The resulting percentage adjustment is applied to the comparable sale to provide a time-adjusted indication of value. For example, a sale that closed 18 months prior to the date of value might be adjusted by 0.5% per month times 18 months, or +9%. There is, however, an alternative method - the use of compound monthly market conditions adjustments. Consider the following example: a property sells first for $500,000 and then resells, without major changes, 18 months later for $590,000. On a straight-line basis the percent change is 18% over 18 months, or 1.0% per month, or 12% per year. However, it is also possible to extract the time adjustment on a compound monthly basis, most easily using a financial calculator. For the HP12c, the keystrokes are as follows: f CLEAR FIN 18 n 500000 CHS PV 590000 FV i (we are solving for i) 0.92 The solution produced by the calculator is 0.92%, or slightly less than 1%. This may not seem like a significant difference from 1.0% straight-line, but over longer periods and with larger rates of change, the difference between straight-line and compound time adjustments can be significant. For example, in a declining market with double-digit percentage declines in value and a necessity to adjust from sales that are two or more years old, the difference between straight-line and compound market conditions adjustments can be very large indeed. Consider the following hypothetical example. A large tract of land sells for $2,000,000 and subsequently resells 18 months later in a declining market for $1,000,000. (Swings of this magnitude are known to many students of the market for residential development land during the period 2006 to 2008.) The indicated straight-line adjustment is -2.78% per month. However, the indicated compound adjustment is -3.78% per month. Now consider the difference when a straight-line adjustment and the equivalent compound time adjustment are applied to another comparable sale that is two years old and sold for $1,500,000. Straight-line adjustment will result in an adjusted price of $499,200, but compound monthly adjustment will result in an adjusted price of $594,922, nearly $100,000 and 20% higher.

Mortgages

Most homes in the United States are financed by a long-term loan secured by a mortgage on the property. A mortgage is defined as: "A pledge of a described property interest as collateral or security for the repayment of a loan under certain terms and conditions." Lenders are eager to offer loans secured with a mortgage, because homes provide very good security, unlike boats or airplanes for example, because they stay in one location, typically appreciate in value, and have long lives compared with most other assets. Over the last decade, though, lenders, investors, and the general public have learned that despite these advantages, mortgage loans still carry a great deal of risk, especially in declining markets.

Net Adjustment (Total)

Near the bottom of the sales grid is a box called "Net Adjustment (Total)." This is where you add up all of the adjustments for each comparable, both positive and negative, and determine the total net adjustment. (Actually, appraisal software programs automatically make this calculation for you, and display the results in a box on the form.) Net adjustment is defined as: "The sum of the positive and negative adjustments made to a comparable sale price." Remember that positive and negative adjustments can offset each other when calculating net adjustments. It is also possible for the net adjustment to equal zero. Example: if you have a positive adjustment of $10,000 and a negative adjustment of $8,000, the resulting net adjustment would be +$2,000. The net adjustments between the comparable sales can be compared, but they are not an absolute measure of comparability. You could have positive adjustments totaling $20,000 and negative adjustments totaling $21,000. The resulting adjustment would be -$1,000. This relatively small net adjustment might lead a reader to conclude that it is a very good comparison to the subject property, even though that might not necessarily be the case.

Above-Grade Room Count and Gross Living Area

Next, you count the number of rooms in the house and calculate the gross living area (GLA). First, count rooms that are above grade. Generally, we count all rooms except for bathrooms, foyers, and utility rooms. A room should be an area with a specific purpose. The definition of room count is "A unit of comparison used primarily in residential appraisal. No national standard exists on what constitutes a room. The generally accepted method is to consider as separate rooms only those rooms that are effectively divided and to exclude bathrooms." Total the number of full baths (having sink, toilet and tub) plus half baths (having only a sink and toilet). A "three-quarter bath" has a sink, toilet and shower (but no tub) and is typically counted as a full bath. There are UAD protocols for counting bathrooms and reporting the bathroom count as well.

Garage/Carport

Note whether the subject and comparables have a garage or carport, and the size (one-car, two-car, etc.). If both the subject and a comparable have garages, note what type they are such as two-car attached garage, two-car detached garage, or two-car attached carport. Many new houses are being constructed today with three-car garages, though you rarely see three cars stored inside. The extra space is useful for storage and for items such as riding lawn mowers, ATVs, snowmobiles, and boats. Three-car garages may bring a premium and require a larger adjustment. In other cases, two-car garages may be the norm and a single-car garage may call for a substantial reduction.

Buydowns

Other kinds of sale concessions could involve buydowns. A buydown is defined as: "A lump-sum payment to the lender that reduces the interest payments of the borrower. The cost of the buydown is usually reflected in the price paid and can be expressed as a percentage of principal." Suppose the current prevailing interest rate for mortgages is running about 7%. In order to sell the property more quickly, a seller may be willing to pay a sale concession in which they would make a lump sum payment of $5,000 in order to buy down the interest rate from 7% to 5% for the first three years of the loan. In this example, you would need to make an adjustment for that sale concession, if you used it as a comparable sale. Assume the property sold for $200,000, but that out of that sale price the seller gave $5,000 for a buydown. You would likely subtract $5,000 to equate it to a market value sale of $195,000. Adjustments for sale concessions are not always made on a dollar-for-dollar basis. Through research and analysis, an appraiser may determine that the sale price was affected by an amount greater than, or less than, the actual cost of the concession. At that point, the appraiser should make the adjustment to the sale price that reflects what the property would have sold for without the concession. Sale concessions can also be creative and might range from paying the first year's property taxes, to leaving a new boat or car in the garage, or paying a year's HOA dues or country club membership dues for the new buyer.

Conditions of Sale Adjustment

Our goal is to figure out what the property would have sold for under normal conditions, then take what it actually sold for and adjust accordingly. Example: A property sold for $190,000, but we discover that the seller was in a hurry because of a job transfer. Hopefully, we could employ a paired data analysis technique. It's our lucky day and we are able to find another nearly identical property that sold under normal conditions for $200,000. If we decide to use that sale as a comparable sale, it would need to be adjusted upwards by $10,000 for conditions of sale. That would equate it to the other sale that occurred at $200,000 with a normal time for exposure to the market. Remember that in the most common definition it states that market value: "is the most probable price......... for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale.........." What happens if we don't stumble upon a perfect match that we can pair up and compare? At least we might be able to find some other sales that are reasonably comparable. Example: The comparable sale was listed at $190,000 and sold in two days for full price. Investigation of the market reveals five sales of similar properties that sold between $195,000 and $205,000 with a normal exposure time to the market of 90 to 120 days. The most similar of them sold for $200,000. Even though it's not an exact matched pair, we could reasonably conclude that the adjustment for conditions of sale should be $10,000. We can also build a case by interviewing participants in the transaction. It would not be conclusive evidence, but good support, if you talked with the selling agent for that comparable sale and found that in her opinion, it sold for about 5% below the market, because they were in a hurry to sell. Sometimes we can't verify the transaction information with a party to the transaction. But what if the comparable sold right before a hurricane came through the region and destroyed much of the housing stock? Clearly, values will have changed after the natural disaster. Or perhaps the comparable sold before the city's main employer announced a factory closure. Prices will no doubt have dropped since the announcement. You must take all factors like these into account. Nobody said this was going to be easy.

Net and Gross Adjustments - Fannie Mae

Regarding net and gross adjustments, the Fannie Mae Selling Guide B4-1.3-09, Adjustments to Comparable Sales states: "Fannie Mae does not have specific limitations or guidelines associated with net or gross adjustments. The number and/or amount of the dollar adjustments must not be the sole determinant in the acceptability of a comparable. Ideally, the best and most appropriate comparable would require no adjustment; however this is rarely the case as typically no two properties or transaction details are identical. The appraiser's adjustments must reflect the market's reaction (that is, market based adjustments) to the difference in the properties. For example, it would be inappropriate for an appraiser to provide a $20 per square foot adjustment for the difference in the gross living area based on a rule-of-thumb when market analysis indicates the adjustment should be $100 per square foot. The expectation is for the appraiser to analyze the market for competitive properties and provide appropriate market based adjustments without regard to arbitrary limits on the size of the adjustment. If the extent of the appraiser's adjustments to the comparable sales is great enough to indicate that the property may not conform to the neighborhood, the underwriter must determine if the opinion of value is adequately supported."

Partial interests A partial interest is defined as:

Partial interests A partial interest is defined as: "Divided or undivided rights in real estate that represent less than the whole, i.e., a fractional interest such as a tenancy in common, easement, or life interest." Fee simple is the highest and most complete form of ownership. Many texts imply that this is the most common form of ownership in residential properties. However, most properties have a mortgage and therefore are no longer held in fee simple. Nevertheless, when we appraise properties that are subject to a mortgage, we typically appraise the fee simple interest; that is, we disregard the mortgage in the appraisal and we appraise the property as if free and clear of the mortgage or any other liens. Many other properties have leases or some other form of encumbrance. If there is anything that takes away from the complete bundle of rights, an interest is no longer fee simple, but some sort of partial interest. Sometimes these are described as fractional interests. For example, rights conveyed by a quitclaim deed may or may not include the total bundle of rights to make it equivalent to a fee simple title. In a quitclaim deed the grantor, or conveyor of the rights, simply says I'm going to give you all the rights I have - if I have any rights at all, they are all yours. It is possible that such a conveyance could not be used for a valid comparison in the sales comparison approach. There are many kinds of partial interests. Some are specific forms of ownership that are created by special situations. These would include: Life interests Leased fee interests Leasehold interests

Partial Interests - Concurrent Ownership

Property may also be concurrently owned by more than one individual. Concurrent ownership includes forms of ownership such as: Tenancy in common Joint tenancy Tenancy by the entirety

Quality of Construction Adjustment

Quality of construction is one of the most comprehensive factors in terms of individual components when comparing properties. Although two houses might appear to be matched pairs from a cursory glance, upon closer investigation you may find that one was built to superior specifications. Perhaps it was built under higher quality of workmanship and can therefore be expected to last much longer. In that instance, it would be appropriate to make an adjustment. "Quality" may not be just the obvious longer-lived and superior components, but also whatever the market perceives quality to be. This is what the appraiser is actually trying to measure. Shoddy construction practices may be hard to detect. Sure, you can probably tell what grade of carpet was installed after you've been appraising for a while, and notice that the appliances are top (or bottom) of the line. But it might be impossible to see some of the shortcuts the contractor took that are hidden behind drywall or under the floor.

Basements and Finished Rooms Below Grade

Rooms that are below grade are noted separately on the URAR form, and must be finished (having ceiling, walls and floor). The Fannie Mae Selling Guide states that it is important to be consistent, and compare above-grade area to above-grade area, and below-grade area to below-grade area. Fannie Mae also states that an appraiser may deviate from this approach if the style of the subject property and/or any of the comparables does not lend itself to this type of comparison. In this case, the appraiser must explain the reason why he or she deviated from this guideline, and clearly describe the comparisons that were made. Example: In some parts of the country with steep terrain, it is very common to find multi-level homes with perhaps two or even three levels that are not fully above grade. It may be difficult to separate out what is valued as basement and what is valued equal to above-grade living area. These living areas and rooms generally add value equal to above-grade area, especially when there is a view. For this reason it is permissible for the appraiser to include the finished living area below grade with the GLA. This would require explanation, and usually you would only do this if there is a good reason - perhaps the floor areas could not easily be separated out from what would be the lowest basement level, from other levels that may also be built into the hillside. Typically, if there is a finished basement area, we would try to ascertain its contributory value per square foot or per finished room by doing a similar paired sales analysis.

Sequence of Adjustments

Sequence of adjustments is defined as "The order in which quantitative adjustments are applied to the sale prices of comparable properties." The definition says the sequence of the adjustments is determined by the market and through data analysis. However, there are generally accepted sequences that are utilized by most appraisers. These will work for you most of the time. If there are particular factors in a local market that call for emphasis of particular factors that are more important in extenuating circumstances, then you may modify the normal procedure, with detailed explanation. Here's an example of an acceptable sequence that is illustrated in The Appraisal of Real Estate, 14th Edition: Property rights conveyed Financing terms/cash equivalency Conditions of sale Expenditures made immediately after purchase Market conditions Location Physical characteristics Economic characteristics Legal characteristics Non-realty components of value The Appraisal of Real Estate states that the first five adjustments (indicated in bold type) are generally applied in sequence. The last five adjustments do not necessarily need to be applied in sequence, although they typically are. The first seven elements in the sequence apply to all kinds of properties. The last three elements apply primarily to income-producing properties. In the appraisal of residential properties, it is not common to adjust for economic or legal characteristics, or non-realty components of value.

Sometimes market conditions adjustments are relatively straightforward.

Sometimes market conditions adjustments are relatively straightforward. Example: A house sold 14 months ago in an arm's-length transaction for $160,000. The same house sold again two months ago for $176,000. Your research shows that no major improvements were made to account for the increase in value and that this was also an arm's-length sale. Because both sales were for the same piece of property, and the sales occurred at the same time of the year, you could logically conclude that values have gone up by 10 percent ($176,000 - $160,000 = $16,000 / $160,000 = 0.10). This is called a sale and re-sale comparison. It provides the best data for a market conditions adjustment. It represents the perfect paired data analysis - two sales with only one significant difference (in this case, time). If you have additional data that supports this appreciation rate, you can then use this figure to make adjustments for other comparables. The above example is an easy one. Most often, however, you will not have such a tidy set of data. Instead, you must do considerable market research to become familiar with prevailing conditions.

Sometimes, we don't get the whole story... or sometimes the buyer or seller is bending the truth a little or withholding pertinent information.

Sometimes, we don't get the whole story... or sometimes the buyer or seller is bending the truth a little or withholding pertinent information. Then we must compare the sale to sales of other similar properties. If it fits the pattern, then we can proceed. We should explain any actions we took to verify the details and motivations of the transaction, and also explain what we were unable to verify. Sometimes, even with our best intentions, we are unable to uncover certain factors that may distort a sale price. I have tried to use some sales and no matter how diligent my research and how carefully I adjust for apparent factors, that sale breaks the pattern. It just doesn't fit in with a value range indicated by other sales. It is too high - or too low. If you adjust for all other factors and there is still a substantial deviation from the norm, there probably were unusual conditions of sale. Then, it's best to discard the sale and move on. Something is causing it to result in an atypical price. If you use it, it might result in a non-credible indication of value.

Valuation of Partial Interests - USPAP

Standards Rule 1-4(e) of USPAP addresses this issue when it states: "When analyzing the assemblage of the various estates or component parts of a property, an appraiser must analyze the effect on value, if any, of the assemblage. An appraiser must refrain from valuing the whole solely by adding together the individual values of the various estates or component parts. Comment: Although the value of the whole may be equal to the sum of the separate estates or parts, it also may be greater than or less than the sum of such estates or parts. Therefore, the value of the whole must be tested by reference to appropriate data and supported by an appropriate analysis of such data. A similar procedure must be followed when the value of the whole has been established and the appraiser seeks to value a part. The value of any such part must be tested by reference to appropriate data and supported by an appropriate analysis of such data."1

Addenda

The addenda (plural of addendum) includes a collection of attachments at the end of an appraisal report where you put all the supporting materials used to arrive at your value conclusion. These might include: Contracts Covenant documents Homeowner association documents Deeds Surveys Title reports Building sketches and/or floor plans (drawn to scale) Leases Location maps showing the subject and comparables Neighborhood plans Subject photos Comparable photos Plat maps This is not to say that all of these documents must be included in every report. To the contrary, this list is merely provided as a list of items that could be included, if the appraiser chooses to do so. As we stated previously in this chapter, some intended users, such as Fannie Mae and FHA, require specific exhibits such as building sketches, location maps showing the subject and comparables, and photographs of the subject property and comparables. Make sure that any addenda items look professional and are organized in a logical manner.

Required Exhibits

The Fannie Mae Selling Guide, Section B4-1.2-06, Appraisal Forms and Report Exhibits, includes a list of required exhibits for an appraisal that includes an interior and exterior inspection: 1. A street map that shows the location of the subject property and of all comparables that the appraiser used. 2. An exterior building sketch of the improvements that indicates the dimensions. (For a unit in a condominium or cooperative project, the sketch of the unit must indicate interior perimeter unit dimensions rather than exterior building dimensions.) ... A floor plan sketch that indicates the dimensions is required instead of the exterior building or unit sketch if the floor plan is atypical or functionally obsolete, thus limiting the market appeal for the property in comparison to competitive properties in the neighborhood. 3. Clear, descriptive, original photographs that show the front, back, and a street scene of the subject property, and that are appropriately identified. (Photographs must be originals that are produced either by photography or electronic imaging.) 4. Clear, descriptive, original photographs that show the front of each comparable sale and that are appropriately identified. (Fannie Mae does not require photographs of comparable rentals and listings.) Generally, photographs should be originals that are produced by photography or electronic imaging; however, copies of photographs from a multiple listing service or from the appraiser's files are acceptable if they are clear and descriptive. 5. Interior photographs, which must, at a minimum, include the kitchen, all bathrooms, main living area, examples of physical deterioration (if present) and examples of recent updates, remodeling, and renovation (if applicable). 6. Any other data - as an attachment or addendum to the appraisal report form - that are necessary to provide an adequately supported opinion of market value.

Location Adjustment

The Location adjustment on the URAR form is part of the Value Adjustments, and comes beneath the Date of Sale/Time adjustment box. Traditionally, appraisers have rated location as: Poor Fair Average Good Very Good Excellent The above ratings could be used as descriptors for a number of the factors that appraisers measure. We have to make that call and encapsulate all the positive and negative factors that apply to our subject property. We have to think it through and adopt a word that best describes the sum total of all the location factors (as compared to other similar locations). If the subject and comparables do not have the same type of location, you must put a dollar figure on the difference. You can try to perform a paired sales analysis using market data. Example: Comparable 1 is located on an arterial highway, while the subject is not. The market recognizes a difference in desirability because of the increased traffic and noise along the arterial highway. Therefore, we must make an adjustment to equalize the properties for location. We locate another sale, Comparable 3, which is very similar to Comparable 1, except that it is not located on an arterial. Comparable 1 sold for $208,000, and 3 sold for $214,000. The adjustment we will make for the arterial location will therefore be +$6,000; because if Comp 1 was NOT on an arterial, it could be expected to sell for $214,000. Note: The Uniform Appraisal Dataset (UAD) has protocols for reporting location for the subject and comparables for appraisals prepared for Fannie Mae and Freddie Mac lenders, as well as FHA and VA lenders. Rather than rating location as "Good", "Average", "Poor", etc., the UAD requires that locations be rated as B, N, or A (Beneficial, Neutral, or Adverse) and appropriate descriptors provided. As stated previously, this course is intended to provide general procedures that apply to appraisals for a variety of different intended uses; therefore coverage of the individual protocols of the UAD is beyond the scope of this course.

Instructions for Use of the URAR

The URAR form is completed, in its entirety, by the appraiser. Once the report form is completed and transmitted to the lender/client, the appraiser must retain a copy in the workfile. This workfile copy can be an electronic copy or a paper copy, but it must be a "true" copy, i.e., an exact replica of the report that was transmitted to the client, including signature(s). The Uniform Standards of Professional Appraisal Practice (USPAP) requires appraisers to identify an appraisal report as an Appraisal Report or a Restricted Appraisal Report by prominently stating which option is used in the report. The Appraisal Standards Board of The Appraisal Foundation has expressed the opinion that the content and detail level of the URAR form is generally consistent with an Appraisal Report. The appraiser must provide his or her description and analysis of the neighborhood, site and improvements. The appraiser must provide the lender with an adequately supported opinion of market value and a complete, accurate description of the property. The sales comparison analysis should include at least three other comparable properties, and should provide specific sale or financing concession information for them. In addition, the appraiser must attach the standard required exhibits listed in the Fannie Mae Selling Guide or the Freddie Mac Seller/Servicer Guide. Remember that the URAR form is designed only for use in reporting appraisals on single-unit residential properties for mortgage lending. Appraisals for other intended uses (divorces, estates, condemnation, etc.) should not be reported on this form.

Effective Age vs. Actual Age

The URAR form specifically asks for the actual age to be entered into the sales grid. In some cases that is adequate, and we can make an adjustment based on differences in actual age, particularly with relatively young properties and ones that are similar in age. The Uniform Appraisal Dataset (UAD) requires that only the chronological age of the subject and comparables be entered into the "Age" field on the sales comparison grid. For non-UAD appraisals, effective age may be entered as well. We certainly should know the effective age of the subject property after making our appraisal inspection, but we may or may not have a clear idea as to the effective age of the comparable sales. That will have to be based upon the best information that we can obtain. For example, an entry could be made such as "A-30, E-20" to indicate that the actual age is 30 years and the effective age is 20 years. Comparing properties with actual ages of 80 years and 140 years could cause a client or intended user to ask why homes of more similar age were not used as comparables. Including estimates of their respective effective ages should narrow the range considerably.

Condition Adjustment

The condition of a home is different from its quality. Condition is determined by the maintenance and care the house has received. Of course, the better the original quality, the better you can expect the condition to be if maintained - because higher quality products tend to wear better. Wear and tear can be excessive for any quality of component, of course, so it is important for the appraiser to pay close attention to this factor. The Fannie Mae/Freddie Mac UAD protocols require an appraiser to rate the condition of the subject property and comparables using a scale from C1 (best) to C6 (worst).

5. Market Conditions

The fifth element in the sequence of possible adjustments is an adjustment for change in market conditions. This has commonly been referred to by appraisers as a "time" adjustment. The term "time adjustment" has fallen out of favor, largely because value is a result of numerous factors in the market. Just because a sale occurred two months ago or six months ago doesn't necessarily mean the values are any different simply as a result of time passing. Market conditions can change and create the need for an adjustment - time is the way we measure the adjustment. I've seen lots of properties where the values have changed in a month, and I've seen other properties where values have remained stable for 18 months. It all depends on whether market conditions such as supply and demand or interest rates have changed. Real estate markets can be extremely volatile, and prices do not remain constant. In some particularly active markets, prices change on a weekly basis. The appraiser must therefore check when each comparable sold, and assess how to adjust the sales price to reflect a current value. Example: Your subject is a three-bedroom, two-bath ranch in good condition. You find a comparable that is the same size, in similar condition, which sold six months ago for $216,000. You know that house values have gone up in the past year, but you're not sure by what percentage. How much should you adjust the sale price to arrive at your opinion of value of the subject? Like anything else, this can be quantified with a paired data analysis. If you can find two comparables that are identical except that they sold in different time frames, you can reasonably conclude that the difference in sale prices is attributable to the change in market conditions between the two dates. Or you may find a very recent sale and when you research it, you find that it had also previously sold several months ago, and no improvements have been made to the property since it was purchased. In this case, you can compare the recent sale price to the sale price several months ago, and extract an adjustment for market conditions. You may get lucky and find that a comparable was sold at a time when market conditions were almost identical to those of your subject. Better yet, the comparable may have sold just a week ago, when conditions were identical. In a case like this, no adjustment for market conditions would be necessary.

Completing the Grid

The following fields on the sales comparison grid have already been addressed: Sale or Financing Concessions Date of Sale/Time Location Leasehold/Fee Simple Site View Design (Style) Quality of Construction Actual Age Condition Above Grade Room Count & GLA Basement & Finished Rooms Below Grade Functional Utility Heating/Cooling Energy Efficient Items Garage/Carport Porch/Patio/Deck Now we will address the remaining fields on the grid, in order to arrive at an indicated value by sales comparison approach.

10. Non-Realty Components

The tenth and last adjustment item, non-realty components, refers to personal property and business assets, such as furniture in a hotel and fixtures in a restaurant. These items can make a significant difference in value and may need substantial adjustments. They may also include trade fixtures in leased space.

Partial Interests - Specialized Forms of Ownership

The traditional model for a fee simple ownership of residential property includes the dwelling and the land on which it sits. All of the rights are included within the boundaries of the property. There are some specialized forms of ownership in which you may own something in fee simple along with shared rights of certain common properties. The most common types you may encounter are: Condominiums Cooperatives PUDs Timeshares

Mathematical Precision

The trap that many appraisers fall into is that they use math to calculate a precise number and then utilize that number. We have to walk a fine line between being accurate and too precise. We cannot let the power of the math overrule our own judgment and decision making. It's easy to plug numbers into an equation or software so that the resulting answer is 100% accurate. We need to proceed logically, and math is one way to prove a point. We can apply mathematical techniques to narrow the range. Then, it's time for us to utilize our own knowledge and experience in analyzing the final opinion of value (after all, that's why it is an opinion of value). There is no substitute for our own best judgment, based on appropriate research and analysis (i.e., market-based support).

Nonconventional Mortgage

There are other types of mortgages that are either guaranteed or insured. Guaranteed mortgage: "A mortgage in which a party other than the borrower assures payment in the event of default, e.g., a VA-guaranteed mortgage or a SBA-guaranteed mortgage." For example, if the borrower of a VA-guaranteed mortgage defaults and the property cannot be sold for an amount sufficient to pay off the loan, the VA would reimburse the lender for any losses. Insured mortgage: "A mortgage in which a party other than the borrower assures payment on default by the mortgagor in return for the payment of a premium, e.g., FHA-insured mortgages, private mortgage insurance (PMI)." The most common example of an insured loan would be FHA. As we know, FHA does not actually lend money; the originating lender does. However, FHA charges the borrower an upfront fee and a monthly insurance premium (MIP) to pay for the mortgage insurance. In the event of a default on an FHA loan, the lender would be reimbursed by the FHA's insurance fund if the sale of the property does not generate an amount sufficient to pay the outstanding loan balance.

8. Economic Characteristics

These last three categories of adjustments that we are going to cover in this section of the chapter apply mainly - albeit not exclusively - to commercial or income producing properties. Economic characteristics include all the attributes that influence income. This would include such items as: Operating expenses Tenant mix Lease terms We will study operating expenses in the next chapter. However, the lower the expenses, the more net income will be left. The more the net income, the higher the property value. Tenant mix is another reflection of the quality and quantity of an income stream. Are your tenants Triple-A companies with a proven track record, or are the tenants liable to leave without notice if they have an economic downturn? The lease terms can be an important factor in income-producing properties. If there is a long-term lease in place at a below market rent, it will reduce the value of the property.

Adjusted Sale Price of Comparables

This is the last line in the sales comparison grid. Here we take the sale price of each comparable property and add to or subtract from the sale price the amount of the net adjustment. We started with the gross sales price for each comparable at the top of each column. Then we adjusted each comparable sale for any significant differences between it and the subject property. The idea is to make each comparable as similar as possible to the subject property and then see what it would have sold for under those conditions. The adjusted sale prices should form a tighter pattern than the raw, unadjusted sale prices we started with. The adjusted sale prices should form the ultimate range of value for the subject property. For example, if the three adjusted sale prices are $182,000, $180,000 and $185,000, then the indicated value of the subject property should lie somewhere between $180,000 and $185,000.

Market Area Boundaries - Fannie Mae

This is what Fannie Mae has to say in B4-1.4-16, Appraisal Report Review: Sales Comparison Approach of its Selling Guide: "The appraiser must perform a neighborhood analysis in order to identify the area that is subject to the same influences as the property being appraised (based on the actions of typical buyers in the market area). The results of a neighborhood analysis enable the appraiser not only to identify the factors that influence the value of properties in the market area, but also to define the area from which to select the market data needed to perform a sales comparison analysis."

4. Expenditures Made Immediately after Purchase

This item will not occur commonly, but may have a substantial impact on a sale price. An example might be a property which needs a new roof. The definition of expenditures made immediately after purchase is: "An element of comparison in the sales comparison approach; comparable properties can be adjusted for any additional investment (e.g., curing deferred maintenance) that the buyer needed to make immediately after purchase for the properties to have similar utility to the subject property being valued." Example: A property is listed for $95,000 and is to be sold "as is." Let's assume it will cost $5,000 to replace the roof. The purchaser might offer $90,000 for the property, knowing full well that as soon as he buys the property he will have to spend $5,000 to make it livable. In this case, an adjustment should be made for the $5,000 that the purchaser will be obliged to spend. This assumes that most comparable houses would have an adequate roof. In this case, the measure of the adjustment would be the cost to cure. This could be verified by an interview with the buyer to see if he was aware of the situation and what a new roof would cost. In actuality, the purchaser might be tempted to offer even less so as to be compensated for the time lost, aggravation involved and uncertainty of the exact costs of the needed repair. A canny purchaser might offer $10,000 less, even though he expects the cost to be only $5,000.

Porch, Patio, Deck

This section of the sales comparison grid addresses living or recreational space that is not part of the main structure, yet adds to the value of the home. Consider local preferences when making adjustments here; maybe all homes in your area have screened-in porches or decks. Features to include are: Deck Gazebo Indoor or outdoor fireplace Patio Porch Screened-in patio Enclosed porch Shed or other outbuildings Pool Tennis court Barn Boathouse Dock Extraordinary landscaping Fence Greenhouse Spa/hot tub The value of these features tends to be very market-specific. Do a paired sale analysis to determine the value of each item in your area.

Conditions of Sale

This type of situation may be hard to uncover. If we contact a party to the transaction, we can directly ask them - do you consider this to be an arms-length transaction? Were there any unusual motivations on either side? Were there mitigating circumstances? If the answer is "no", and the sale price otherwise meets normal parameters, then you move along and make no adjustment for conditions of sale. If the answer is yes, then we have two choices. Throw it out as an atypical sale and find other comparables without such a problem, or use it and adjust it for conditions of sale. Not using it is generally the best course of action, if you have the luxury of other sales. If we need to utilize it, then the sales must be adjusted to account for the influence of whatever factors were out of the norm. We need to proceed with caution. There may have been more than one condition that was atypical.

URAR Form - Sales Comparison Grid

We have already covered certain adjustments that can be made in the sales comparison grid, such as: Sale or financing concessions Date of sale/time Location Leasehold or Fee Simple Now we will concentrate on adjustments that may be made for physical characteristics. These occupy the rest of the sales grid. **See picture

Financing Terms

We have talked about financing terms, which includes the types of mortgages involved. Financing terms is the second element of comparison and possible adjustment in the sales comparison approach. Our next step is to address cash equivalency. In the vast majority of residential appraisal assignments, we are developing an opinion of market value. Part of the definition of market value addresses the fact that the transaction would take place under normal conditions. Specifically, the definition of market value says: "The most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress." [emphasis added]

site adjustment example

We may find sales of comparable properties that are very similar, except for a difference in site size, and can then extract the value attributable to difference in site size through a paired analysis. We can also start with comparable properties that have several significant differences and then make adjustments for the other items. Then if there is still a difference in the sale price we can attribute it to the difference in site. Example: Comparable 1 sold for $240,000 and Comparable 2 sold for $228,000. They were very similar except that Comparable 1 had a three-car garage and four acres of land whereas Comparable 2 had a two-car garage and three acres of land. Through a paired data analysis we are able to ascertain that the contributory value of a three-car garage versus a two-car garage is $4,000. The difference in sale price between the two properties is $12,000. If $4,000 is accounted for by the difference in garage spaces, the remaining $8,000 must be attributed to the one acre of additional land. Finally, remember the caveat that we are only supposed to make adjustments for significant differences. For example, the market may not recognize the difference between 3.6 acres and 3.8 acres. If a typical purchaser would not be willing to pay more for the slightly larger lot, then we should not make an adjustment.

Making Cash Equivalency Adjustments

What do you do if you come across a property that sold with non-market financing? Your first step will be to determine whether the financing had any impact on the price. The best way to do this, as stated previously, is by looking at other comparables to see how the market reacted. If the price paid is similar, you may not need to make any adjustments. A mathematical formula may not be the best way to derive cash equivalency values. Use your professional judgment and verify with market research. Verify with the buyers, sellers, and or agents to see whether the price was affected by the financing. Ask about any special conditions, such as the seller paying closing costs or providing some other incentive for the buyer. When doing research for adjustments, you may find out the transaction was not arm's-length. At that point, you may not be able to use it as a comparable. If you do use it, be very careful, provide plenty of data to support your conclusions, and disclose all of the financing and sale conditions in your report.

6. Location Adjustments

What is the biggest difference between real property and other major investments? Unlike a yacht, a motor home or a 10-karat diamond, real estate is fixed in location and is immovable. Location always has a great influence on the value of real property. A parcel of real property is a prisoner of its environment, so what goes on around it makes a difference. You've heard the old saying that the three most important factors in real estate are location, location, location. That saying has become a cliché, mostly because it is true. Sometimes just a matter of a few hundred feet one way or the other changes the value of a property. And clearly, a house located in a secluded community of million-dollar homes will be worth much more than the same type of house in an old, run-down neighborhood. The concept of real estate value being inextricably linked to location comes to us from the economist Alfred Marshall. In 1890 Marshall published Principles of Economics, in which he described "urban situation value," the main criteria for urban real estate value. His concepts were used as the basis for modern valuation approaches by appraisal organizations when they were formed in the 1930s.

Cash Equivalency

When we use the sales comparison approach to develop an indication of market value, we are assuming that the comparable sales were: Purchased by a "typically motivated" buyer; and Paid for in cash or its equivalent, such as financed with a conventional mortgage that was obtained on the open market If the comparable sale was not cash or its equivalent, the appraiser may need to make adjustments, or, in some situations, disregard the sale as not being indicative of typical financing terms. You can usually assume that a house would have sold for less money if special financing had not been involved. This means that you must subtract the value of the financing from the price paid. With very rare exception, adjustments for financing terms are always negative adjustments. Example: A seller determines that his/her house is worth $150,000. Market financing is running 6.5%. The buyer convinces the seller to offer private financing at 5%. In return, the buyer agrees to a sales price of $155,000. It looks like this property sold $5,000 above market on the face of it. This should be confirmed by comparison to other sales to see if this is true.

Comparable Sales

Whenever possible, your comparables should be in the same market area as your subject. If they are subject to the same market forces, it makes one less thing you have to worry about and that takes away the possibility that you might have to make an adjustment for differences in location. Obviously, staying within the market area is preferable when searching for comparable properties. You might have to make exceptions, however, when: Few sales have occurred in the neighborhood The subject is in a rural area The subject is unusual (a geodesic dome, or log cabin in a neighborhood of traditional ranches, for example) Be careful, because not all homes in a particular neighborhood or market area are appropriate comparables. A house with a beautiful view would be worth considerably more than a similar house located beneath high-voltage power lines, even if both are in the same subdivision. Another home may have a higher value due to being adjacent to a greenbelt, or a lower value because of being next to a noisy street. Two condos in the same building may be identical in size, age and layout. But they could have quite different values if one is on the first floor and the other is on the third. Also, value differences might be attributable to view or being situated overlooking the golf course instead of the dumpster.

Sources for Quality Data

You can usually expect that all homes in a subdivision will be of the same general quality. It is, therefore, generally appropriate to extrapolate that a quality inspection for one home will hold for others by the same builder in the same subdivision. Be careful, though, because this is not always the case. Another resource is published cost manuals. They will help you determine the relative cost and perhaps the value of materials used in construction. It may help you rate the quality of your subject and comparables. For example, the Marshall & Swift Residential Cost Handbook carefully separates residences into six quality categories and gives illustrations of each in text and photos. Perhaps the best source for local quality related data would be experts in the industry. You should conduct market surveys of agents, builders, building supply companies, architects and the like. This will help you to develop a database of who built what and what reputation the various builders and neighborhoods have in terms of quality of construction. Keep in mind that a builder's reputation may be all that is needed for the market to react one way or another. The actual quality may appear to be the same between the subject and comparables. Always try to measure quality by paired sales if you are using more than one builder's product for comparables.

Sale and Re-sale

You might not always be able to find sales and re-sales of similar properties in the market. However, they do occur occasionally. Keep your eyes open and look for them. Every time you find a valid sale and resale of the same property, first check to make sure that no improvements were made to the property, and then keep it on file. Maybe set up a special folder or spreadsheet so that you can easily retrieve these pairs of sales when needed. Other evidence of trends may be found in group sales. You may not be fortunate enough to find an exact sale and resale of the same property, however you may have abundant evidence that properties of a certain class, perhaps similar models in a subdivision, were selling six months ago for $300,000 and now are selling generally for $320,000. This is called group data analysis.

Cash Equivalency - Points

You must also account for points in cash equivalency considerations. If the seller has paid points for the buyer, these points must be deducted from the sales price if they resulted in an above-market sale. Remember that points are calculated as a percentage of the amount of the mortgage. Example: Here's how you might adjust in the case of a home that cost $200,000. The first mortgage was $150,000, and the seller paid 1.5 points: Selling price of home $200,000 Less value of points (0.015 x $150,000) - 2,250 Adjusted selling price $197,750 Caution: Be very careful when making cash equivalency determinations. There is a lot of discussion in the real estate industry (especially between secondary market participants and appraisers) about how cash equivalency adjustments should be made. Basically, the primary requirement is that the adjustment for favorable financing should be based on comparison to sales unaffected by favorable financing or other seller-paid concessions. So your job as an appraiser is to determine if a sale is affected and adjust based on what you are able to measure in the market. Many intended users of appraisals state that a strict mechanical cash equivalency calculation is not appropriate; rather, they want the appraiser to use market data to determine the actual effect on the sale price of the favorable financing or concession. The appraiser should look for possible influence from financing when the sale is seller-, private-, FHA- and VA-financed. Even conventionally-financed sales can have concessions, seller paid fees and costs in favor of the buyer as an incentive to realize a sale. The appraiser should always give less weight to a sale that doesn't fit with the other sales due to the potential of undisclosed or undiscoverable influences.

Entering Leasehold/Fee Simple Data - URAR

You must record the type of property rights for the subject and all comparables on the Uniform Residential Appraisal Report (URAR). There is a box for this information in the Value Adjustments section, just below the box for location information. For residences, the entry in this box may be "Fee Simple". But if it is not, note the variance and assign an appropriate value to it, based on data obtained from the market. For example, if Comparable 1 sold for $220,000 but did not include timber rights, you would search for other comparables with timber rights and compare prices. Comparable 2 was nearly identical to 1, and included timber rights. It sold for $250,000. It would be reasonable to conclude that timber rights were worth $30,000. Note this information as follows: **See picture In the report, you would explain the adjustment for the lack of timber rights on Comparable 1, and that you derived the adjustment by pairing to Comparable 2.

Steps for Evaluating the Market

You will need to be very specific when you analyze market conditions for your subject and comparables used in the sales comparison approach. Answer the following questions: What and where: Specify the geographic area and type of property you are describing. Market conditions for a retirement community may be very different from conditions for condos or single-family homes. Conditions on one side of town may be different from those on the other. The market for one-bedroom homes will probably differ from the market for three- or four-bedroom homes. Old houses may be selling more quickly than new ones; or vice versa. When: In what stage of the life cycle does your subject market area fall? Short-term is typically more important than long-term in this regard, unless your market has moved from one long-term cycle to another during the study period. Also, estimate how long the current cycle is expected to last. Supply/Demand: Determine whether there is excess supply, excess demand or a relative condition of equilibrium for your type of property in the market area. At the same time, describe how great the excess (or lack) is. A 10% excess will have a very different effect than a 50% excess. A quick way to check is to examine the number of current listings in a market area and then how many have sold in a recent time frame. If there are 20 houses on the market now and five sold in the last year, you are looking at a four-year supply of standing inventory! But if 40 houses sold in the last year, then the current 20 listings represent only a six-month supply.