Unit 16

Main economic principals that affect value of real estate

-Anticipation -Change -Competition -Conformity -Contribution

For appraisal purposes, depreciation is divided into three classes, according to cause:

-Physical deterioration. A curable item is one in need of repair, such as painting (deferred maintenance), that would result in an increase in value equal to or exceeding its cost. An item is incurable if it is a defect caused by physical wear and tear and its correction would not be economically feasible or contribute a comparable value to the building, such as an extensive crack in the foundation. The cost of a major repair may not warrant the financial investment. -Functional obsolescence. Obsolescence means a loss in value from the market's response to the item. Outmoded or unacceptable physical or design features that are no longer considered desirable by purchasers are considered curable if they can be replaced or redesigned at a cost that would be offset by the anticipated increase in ultimate value. Outmoded plumbing, for instance, is usually easily replaced. Room function may be redefined at no cost if the basic room layout allows for it. A bedroom adjacent to a kitchen, for example, may be converted to a family room. Currently undesirable physical or design features that cannot be easily remedied because the cost of the cure would be greater than its resulting increase in value are considered incurable. A four-bedroom home with only one bathroom is likely to suffer from incurable functional obsolescence. -External obsolescence. If depreciation is caused by negative factors not on the subject property, such as environmental, social, or economic forces, it is always incurable. The loss in value cannot be reversed by spending money on the property. For example, close proximity to a polluting factory is a factor that cannot be cured by the owner of the subject property.

The elements of comparison for which adjustments must be made in the sales comparison approach include the following:

-Property rights. An adjustment must be made when less than fee simple—the full legal bundle of rights—is involved. An adjustment could be made because of the presence of a land lease, ground lease, life estate, easement, deed restriction, and/or encroachment. -Financing concessions. The financing terms under which a property was sold must be considered, including mortgage loan terms and owner financing or an interest rate buydown by a builder-developer. -Market conditions. Interest rates, supply and demand, and other economic indicators must be analyzed. -Conditions of sale. Adjustments must be made for motivational factors that would affect the sale, such as foreclosure, a sale between family members, or some nonmonetary incentive. -Market conditions since the date of sale. An adjustment must be made if economic changes occur between the date of sale of the comparable property and the date of the appraisal. -Location or area preference. Similar properties might differ in price from neighborhood to neighborhood or even between locations within the same neighborhood. -Physical features and amenities. Physical features, such as the structure's age, size, and condition when compared to the subject property, may require adjustments.

Appraisal process

-identify problem -identify scope of work -gather, record, verify all data(general, specific, sales data, etc) -analyse data -form opinion on land value -form opinion on value from the 3 approaches -report

In which appraisal situations is each approach(sales comparison, income approach, cost approach) given the most weight in determining the value?

-sales comparison approach is given the most weight in the appraisal of single family homes -the income approach is given the most weight in the appraisal of income property -the cost approach is given the most weight in the appraisal of churches, libraries, museams, schools, where little income or sales are generated

determination of market value thus requires that

-the buyer and the seller are unrelated and acting without undue pressure; -both the buyer and the seller are well informed of the property's use and potential, including both its defects and its advantages; -a reasonable time is allowed for exposure of the property in the open market; -payment is made in cash or its equivalent; and -the price paid for the property is a normal market price, unaffected by special financing amounts or terms, services, fees, costs, or credits incurred in the market transaction.

Data used by appraiser's two main categories with explanations of each

1) General data, which covers the nation, region, city, and neighborhood. The appraiser researches the physical, economic, social, and political influences that affect the value and potential of the subject property. 2) Specific data, which covers the type and features of improvements to the subject property as well as comparable properties that are similar to and competitive with the subject property.

In estimating value using the income approach, an appraiser must take the following five steps:

1. Estimate the property's annual potential gross income. An estimate of economic rental income must be made based on market studies. Current rental income may not reflect the current market rental rates, especially in the case of short-term leases or leases about to terminate. Potential income also includes income to the property from such sources as vending machines, parking fees, and laundry machines. 2. Deduct an appropriate allowance for vacancy and rent loss, based on the appraiser's experience, and arrive at the effective gross income. 3. Deduct the annual operating expenses from the effective gross income to arrive at the annual net operating income (NOI). Management costs are always included, even if the current owner manages the property. Mortgage payments (principal and interest) are debt service and are not considered operating expenses. Capital expenditures are not considered expenses; however, an allowance can be calculated representing the annual usage of each major capital item. 4. Estimate the price a typical investor would pay for the income produced by this particular type and class of property. This is done by estimating the rate of return (or yield) that an investor will demand for the investment of capital in this type of building. This rate of return is called the capitalization rate (or "cap" rate) and is determined by comparing the relationship of net operating income with the sales prices of similar properties that have sold in the current market. For example, a comparable property that is producing an annual net income of $15,000 is sold for $187,500. The capitalization rate is $15,000 divided by $187,500, or 8%. If other comparable properties sold at prices that yielded substantially the same rate, it may be concluded that 8% is the rate that the appraiser should apply to the subject property. 5. Apply the capitalization rate to the property's annual net operating income to arrive at the estimate of the property's value.

Five steps of Cost Apprach

1. Estimate the value of the land as though it were vacant and available to be put to its highest and best use. 2. Estimate the current cost of constructing buildings and improvements. 3. Estimate the amount of accrued depreciation (loss in value) resulting from the property's physical deterioration, external depreciation, and functional obsolescence. 4. Deduct the accrued depreciation estimated in Step 3 from the construction cost estimated in Step 2. 5. Add the estimated land value from Step 1 to the depreciated cost of the building and site improvements derived in Step 4 to arrive at the total property value.

To arrive at an accurate determination of value, appraisers typically use 3 valuation approaches. For each example, select the most appropriate approach. 1. Based on investment potential 2. depreciated reproduction cost 3. comparable properties used 4. replacement cost

1. Income Approach 2. Cost approach 3. Market Approach 4. Cost approach

Gross Income Multiplier(GIM)

A figure used as a multiplier of the gross annual income of a property to produce an estimate of the property's value; usually used for commercial property or for residential rental properties with five or more units

Uniform Standards of Professional Appraisal Practice

A set of standards developed by the Appraisal Foundation that details information required for a property appraisal.

Which of the following would be included in operating expenses? -Management costs -Mortgage payments -capital expenditures -real estate taxes -insurance -heat -maintenance -utilities, electricity, water, gas -repairs -decorating -replacement of equipment -legal and accounting -advertising

All except mortgage payments and capital expenditures

Numerous trade associations are available for appraisers and are valuable sources of education, legal updates, and networking opportunities. Some of the largest are the following:

American Society of Appraiserswww.appraisers.org American Society of Farm Managers and Rural Appraisers, Inc.www.asfmra.org Appraisal Institutewww.appraisalinstitute.org International Association of Assessing Officerswww.www.iaao.org International Right of Way Associationwww.irwaonline.org National Association of Independent Fee Appraiserswww.naifa.com

Substitution

An appraisal principle that the maximum value of a property tends to be set by the cost of purchasing an equally desirable and valuable substitute property, assuming that no costly delay is encountered in making the substitution.

Regression

An appraisal principle that the value of a better-quality property is affected adversely by the presence of a lesser-quality property. Thus, in a neighborhood of modest homes, a structure that is larger, better maintained, or more luxurious would tend to be valued in the same range as the less lavish homes.

Progression

An appraisal principle that the value of a lesser-quality property is favorably affected by the presence of a better-quality property.

Appraisal

An estimate of the quantity, quality, or value of something. The process through which conclusions of property value are obtained; also refers to the report that sets forth the process of estimation and conclusion of value.

Law of increasing returns

Applies as long as money being spent on property improvements produces an increase in the property's income or value.

An opinion of value based on supportable evidence and approved methods

Appraisal

Extensive report prepared by the real estate proffesional including info on the neighborhood and a list of comparable properties

BPO

Report based on sales, current listings, and expired listings

CMA

To have value in the real estate market—that is, monetary worth based on desirability—a property must have the following characteristics

DUST! -Demand—the need or desire for possession or ownership backed by the financial means to satisfy that need -Utility—the property's usefulness for its intended purposes -Scarcity—a finite supply -Transferability—the relative ease with which ownership rights are transferred from one person to another

Value in real estate is based on four characteristic. Match the definition with the characteristic. Need or desire for possession or ownership backed by the financial means to satisfy it

Demand

T or F: According to the principle of change, value is created by the expectation that certain events will occur.

False

T or F: An appraiser using the cost approach method computes the reproduction or replacement cost of a building and would NOT employ the quantity survey method.

False

NOI formula

NOI=Gross income-operating expenses

Law of diminishing returns

Point at which additional property improvements do not increase the property's income or value.

Appraiser Independence Requirements (AIR)

Regulations issued by Fannie Mae that must be followed by appraisers to ensure accurate and objective appraisals.

To establish an accurate GRM, an appraiser must have recent sales and rental data from at least four properties that are similar to the subject property. The resulting GRM can then be applied to the estimated fair market rental of the subject property to arrive at its market value. The formula would be as follows:

Rental income × GRM = Estimated market value

Value in real estate is based on four characteristic. Match the definition with the characteristic. A finite supply

Scarcity

Conformity

The appraisal principle holding that the greater the similarity among properties in an area, the better they will hold their value. It means that maximum value is created when a property is in harmony with its surroundings.

Anticipation

The appraisal principle holding that value can increase or decrease based on the expectation of some future benefit or detriment produced by the property. Ex. rumors of a major employer going out of business

Competition

The appraisal principle stating that excess profits generate competition. Profitable businesses tend to attract competition. For example, the success of a retail store may cause investors to open similar stores in the area. This tends to mean less profit for all stores concerned unless the purchasing power in the area substantially increases.

Contribution

The appraisal principle stating that the value of any component of a property is what it gives to the value of the whole or what its absence detracts from that value. The appraisal principle stating that the value of any component of a property is what it gives to the value of the whole or what its absence detracts from that value.

Supply and demand

The appraisal principle that follows the interrelationship of the supply of and demand for real estate. Because appraising is based on economic concepts, this principle recognizes that real property is subject to the influences of the marketplace as with any other commodity.

Change

The appraisal principle that holds that no physical or economic condition remains constant. Real estate is subject to natural phenomena such as tornadoes, fires, and routine wear and tear. The real estate business is subject to market demands, like any other business. An appraiser must be knowledgeable about both the past and the predictable future effects of natural phenomena and the behavior of the marketplace.

Assemblage

The combining of two or more adjoining lots into one larger tract to increase their total value.

Gross Rent Multiplier(GRM)

The figure used as a multiplier of the gross monthly income of a property to produce an estimate of the property's value; usually used for single-family residential property or for residential rental properties with one to four units

Net Operating income(NOI)

The income projected for an income-producing property after deducting anticipated vacancy and collection losses and operating expenses.

Plottage

The increase in value or utility resulting from the consolidation (assemblage) of two or more adjacent lots into one larger lot. For example, two adjacent lots valued at $35,000 each might have a combined value of $90,000 if consolidated.

Highest and Best Use

The legally permitted and physically possible use of a property that would produce the greatest net income and, thereby, develop the highest value. The use must be physically possible, legally permitted, economically or financially feasible, and the most profitable or maximally productive.

Economic life

The number of years during which an improvement will add value to land.

Cost Approach

The process of estimating the value of a property by adding to the estimated land value the appraiser's estimate of the reproduction or replacement cost of the building, less depreciation.

Sales Comparison Approach/Market data approach

The process of estimating the value of a property by examining and comparing sales and listings of comparable properties. Considered the most reliable approach in appraising single family homes

Income Approach

The process of estimating the value of an income-producing property through capitalization of the annual net income expected to be produced by the property during its remaining useful life. is used for valuation of income-producing properties such as apartment buildings, office buildings, retail stores, and shopping centers and is based on anticipation.

Capitalization rate

The rate of return a property will produce on the owner's investment.

Value in real estate is based on four characteristic. Match the definition with the characteristic. Ease in which ownership can be conveyed

Transferability

T or F: Maximum value is created when a property is in harmony with its surroundings under the principle of conformity.

True

T or F: The sales comparison approach is also called the market data approach.

True

Value in real estate is based on four characteristic. Match the definition with the characteristic. Property's usefulness for its intended purpose

Utility

An appraisal is based on

a detailed analysis of market conditions, the features of the subject property and comparable properties in the neighborhood, recent sales and listings, land value and current construction cost—all the elements that a lender wants to consider in determining whether or not to make a loan and accept the property as security for the debt.

Broker's Price Opinion(BPO)

a less-expensive alternative of evaluating property that is often used by lenders working with home equity lines, refinancing, portfolio management, loss mitigation, and collections. Can't be used in federally related transactions

Market Price

a property's asking, offer, or sales price.

Sales Comparison to Value

an abbreviated version of the information that an appraiser will provide a client, but it illustrates the kind of comparisons and value adjustments that are made.

How to calculate capitalization rate

comparing the relationship of net operating income with the sales price of similar properties that have sold in the current market Comp's annual net income/ comp sell price=capitalization rate Ex. A comp that produces annual net income of $15,000 was sold for $187,500. The capitalization rate is $15,000/$187,500 or 8%

Appraisal report should

identify the real estate and real property interest being appraised; state the purpose and intended use of the appraisal; define the value sought; state the effective date of the value and the date of the report; state the extent of the process of collecting, confirming, and reporting the data; list all assumptions and limiting conditions that affect the analysis, opinion, and conclusions of value; describe the information considered, the appraisal approaches used, and the reasoning that supports the report's conclusions (if an approach was excluded, the report should explain why); describe the appraiser's opinion of the highest and best use of the real estate; describe any additional information that may be appropriate to show compliance with the specific guidelines established in USPAP or to clearly identify and explain any departures from those guidelines; and include a signed certification, as required by USPAP.

Most appraisers work as

independent contractors

Depreciation

is a loss in value for any reason. It refers to a condition that adversely affects the value of an improvement to real property. Land is not considered a depreciating asset; it retains its value indefinitely, Depreciation for appraisal purposes represents the actual loss in value caused by property deterioration, damage, or obsolescence. Depreciation for tax purposes is an annual deduction from taxable income for a term of years, as permitted by IRS regulations, which may even allow the term of years to be shortened so that accelerated depreciation can be taken.

Reconciliation

is the act of analyzing and effectively weighing the findings from the three approaches. The final step in the appraisal process, in which the appraiser considers the estimates of value received from the sales comparison, cost, and income approaches to arrive at a final opinion of market value for the subject property.

Formula for calculating value when dealing with income properties

net operating income/cap rate=value income/value=rate value*rate=income

A CMA is based on

properties similar to the subject property in size, location, and amenities for the purpose of deriving a likely listing price or offering price. -recently closed properties (solds), -properties currently on the market (competition for the subject property), and -properties that did not sell (expired listings in the area).

GIM formula

sales price/annual gross income=GIM If a commercial property recently sold for $155,000 and its annual rental income was $15,000, the GIM for the property would be $155,000 ÷ $15000 = 10.33 GIM

GRM formula

sales price/monthly gross rent=GRM For example, if a home recently sold for $155,000 and its monthly rental income was $1,250, the GRM for the property would be $155,000 ÷ $1,250 = 124 GRM

Sales price

the amount paid to the seller for the product sold

Uniform Residential Appraisal Report

the form required by many government agencies. It illustrates the types of detailed information required of an appraisal of residential property. It also highlights the extensive list of certifications required of the appraiser and is accompanied by a page of instructions.

Market Value

the most probable price that a property should bring in a competitive and open market under all conditions requisite to a fair sale.

The three approaches to value

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

As the cap rate decreases,

the value increases