Principles of Real Estate Exam 2

What two documents are created in a mortgage loan?

A note and a mortgage (or deed of trust) - the note details the financial rights and obligations between borrower and lender - the mortgage pledges the property as security for the debt

Subprime Loans

- ARMs with a very large percentage being 2-28 hybrid, I-O, or option ARM - common characteristic regardless of loan design was an initial payment that was sufficiently low to cause negative amortization and at some point a payment increase so severe as to compel the borrower to seek refinancing

Principle of Scale/Balance

- Example: don't buy a $100k lot for a mobile home but rather a $300k home instead - applies to commercial as well

Mortgage Markets

- FHA and VA: gives default protection to lenders (taxpayers pick up the loss) - subsidization of housing and housing finance: for lower income people who don't have savings; more local

Redemption Rights

- The right of the defaulted borrower to get the property back to redeem to borrowers interest in the real estate by paying all sums due

Owner/User Benefits

- Use and appreciation

Contract for Deed

- a contract for the sale of a property with the special provision that the actual delivery of a deed conveying ownership will occur well after the buyer takes possession of the property - the idea is that a seller can finance the sale through installment payments and by retaining title, have recourse in case of default; effects of default vary - the rights, obligations, and recourses for the parties in this depend significantly on the jurisdiction and the nature of the property involved - purposes in real estate: can facilitate financing in situations deemed too risky for standard mortgage financing; financing marginal housing; there are few if any protections or standards built into the arrangement; undertaken by unsophisticated buyers;

Why do borrowers default?

- affordability: the inability of the borrower to make the payments due to loss or reduction of income or increase in the payment (big problem in subprime crisis) - strategic default: borrower can afford to make the payments but choses not to because loan balance exceeds the assets value; voluntary default

The Appraisal Process

- all states and federal regulatory agencies are required to follow Uniform Standards of Professional Appraisal Practice (USPAP) - steps: 1) identify the appraisal problem; 2) determine the required scope of work; 3) collect data and describe property; 4) data analysis; 5) determine value of land; 6) apply three approaches to valuation; 7) reconcile indicated values from three approaches; 8) report final value estimate

Step 7: Reconcile Indicated Values from Three Approaches

- all three approaches may be applied - the final (single) estimate is determined by weighing the relative reliability of value indicators for the property being valued (aka reconciliation)

Option ARM

- allowed the borrower to switch among a variety of payment arrangements (typically the minimum payment option) - does more harm than good

Step 5: Determine Land Value

- appraisers often develop an opinion regarding the value of land separate from that of land with improvements - most reliable approach to this is the sales comparison

Capitalization Rate (R0)

- appraisers rely on recently completed transactions of comps to guide their selection of the cap rate used in the value of the subject property; they may also use published survey results - equation: R0 equals NOI1 (projected NOI for one year) divided by sales price (V); calculating this is called the direct market extraction; information comes from the market - three important notes on the cap rate: comp NOIs are not publicly available so appraisers need to contact buyers/sellers or broker; it is a rate that estimates market value (referred to as overall cap rate or going in cap rate); NOT a discount rate that can be used to value future CF - a measure of the relationship between a property's income stream and its price or value - analogous with dividend yield on common stocks - the higher the better - when given Income (I), Rate (R), and Value (V), use the triangle picture to know which variable to solve for: top of triangle is I, bottom left is R, bottom right is V

Bankruptcy and Foreclosure

- bankruptcy is possible with individual has fewer total assets than total liabilities - chapter 7 bankruptcy: traditional form wherein the court simply liquidates the assets of the debtor and distributes the proceeds to creditors in proportion to their share of the total claims; does not disturb liens and power to foreclose remains - chapter 11 bankruptcy: court-supervised workout for a troubled business; court is likely to forestall the possibility of foreclosure; adverse affects on lender mainly being a delay in recovery of funds - chapter 13 bankruptcy: similar to chapter 11 but applies to households; proposes a repayment plan to the court

Housing Affordability Issues

- became less affordable for two reasons: rising interest rates (I/Y) and rising house prices (PV); if either I/Y or PV go up, PMT goes up - regulators haven't been successful in fixing the problem so banks used AMIs to reduce the rate or payment and shift the risk of changing interest rates from the lender to the borrower

Mezzanine Financing

- between debt and equity; lender often has an ownership interest rather than a lien - used in commercial - usually a second mortgage and participate in the equity - offers a way to avoid down payments

Net Operating Income

- calculated by deducting from the property's estimated rental income all expenses associated with operating and maintaining the property; measures the overall income-producing ability of a property - full amount of NOI is not pocketed in every case because of possible mortgage payments to lenders and income taxes (federal and state) - fundamental determinant of market value - income and expenses are determined in terms of current market conditions; based on future operating CFs of a typical market participant - equation: potential gross income (PGI) minus vacancy and collection loss (VC) plus miscellaneous income (MI) equals effective gross income (EGI) minus operating expenses (OE) minus capital expenditures (CAPX) equals NOI

Three benefits of real estate ownership

- cash flow - use (of the property)/ possession - appreciation in value

Investor Benefits

- cash flow and appreciation

Commercial Mortgage Loans

- commercial banks, life insurance companies, real estate investment trusts, other institutional capital providers, conduit lenders

Residential Mortgage Loans

- commercial banks, savings banks, mortgage companies, life insurance companies, sellers (aka seller financing)

Adjustable Rates

- common in commercial real estate loans and in many home loans (ARM); used in virtually all home equity credit line mortgage loans - components to be defined in the note when this is used includes: index, margin, method of computing the index, adjustment period, date of change in the interest rate, and determination of any "caps" or limits on interest rate changes

Nonforeclosure Responses to Default/ Alternatives to Foreclosure

- credit counseling with possible reorganization of consumer credit obligations - temporary reduction in payments - short sale when there is mortgage distress; lender cannot force borrower to sell property) usually enables a better sales price and faster sale than foreclosure, more likely to provide lender a clean end to a case than foreclosure or deed in lieu of foreclosure, lower legal costs, less damaging to a borrowers credit - deed in lieu of foreclosure: turning in the keys; lender may allow borrower to convey the property to the lender; faster than foreclosure, less costly, creates less public attention; other financial problems as a result can generate additional liens; worst risk is bankruptcy - transferring the note: lender sells the loan and is bought by person who wants the real estate

Step 3: Collect Data and Describe Property

- data concerning the market context of the "subject" property must be gathered; info includes economic, demographic, regulatory, and geographic factors that may influence value - property specific data must also be gathered for the subject; normally includes info on physical and locational characteristics of the subject property - info on transaction prices must be collected for comp properties

Note

- defines the exact terms and conditions of the loan; explicit to prevent misunderstandings between borrower and lender - contract that is physical evidence of a loan - major elements: interest rate and interest charges, adjustable rates, payments term, right of prepayment, prepayment penalties, late fees, personal liability, and the demand clause

Principle of Contribution

- parts contribute to the whole; appraisers dissect property into characteristics - examples: best investment per dollar invested=paint, soap, and water=adds value; renovating kitchens or bathrooms=adds higher value

Brief history of residential lending

- pre-depression - FHA and other banking regulations - advent alternative mortgage investments (AMIs): interest only 5 year loans with no amortization; default insurance, FDIC, etc.; ARMs

Elements of mortgage or deed of trust/ uniform covenants

- description of the property: must be unambiguous; by the metes and bounds, by government rectangular survey, or by recorded subdivision plat lot and block number - maintenance and inspection clause: expected to keep of value; lender has right to inspect with cause - insurance clause: requires borrower/mortgagor to maintain property casualty insurance acceptance to the lender giving the lender joint control in the use of the proceeds in case of major damage to the property - escrow (impound) clause: requires a borrower to make monthly deposits into an escrow account of money to pay such obligations as property taxes, casualty insurance premiums, community associations fees, etc.; funds only used on behalf of borrower's obligations - acceleration clause: in event of borrowers default this enables the lender to declare the entire loan balance due and payable - due-on-sale clause: gives the lender the right to accelerate the loan requiring the borrower to pay it off - hazardous substances clause and preservation and maintenance clause: self explanatory - deed of trust: used in place of mortgage in >20 states; deed of trust is conveyed by borrower to trustee who holds deed on behalf of borrower and lender; if loan is paid off in accordance with note, trustee returns deed to borrower; if loan is not, trustee can exercise power of sale to dispose of property on behalf of lender (advantageous to lenders)

How is risk managed?

- due diligence: pre-transaction, appraisals, market studies, credit analysis, environmental and engineering studies, legal studies, financial analysis, contracting - risk mitigation: mostly post-transactional, insurance, options, assessment and adjustment

Internal Rate of Return (IRR) or Expected Total Rate of Return

- equation: cap rate plus growth rate - growth rate equation: (expected price minus current price) divided by current price - return is based on the property's annual NOI and annual appreciation or depreciation of property value - determines the maximum amount investors are willing to bid for a property; proof that cap rates actually only react to changes in CF projections or required returns instead of determining value themselves

Income Multiplier

- example is the EGI multiplier calculated by dividing the sales price by the EGI - assumptions: operating expense percentage and the CAPX percentage of the subject and comp property are equal; the subject and/or comp properties are subject to long-term leases at rates above or below current market rents; - appropriate valuation approach for apartments because leases are seldom more than a year

Industry Issue 11-3

- explanation of the great recession - underwriting failure as a result of relaxed lending standards - no doc loans or liar loans

Default

- failure to meet the requirements of the note or mortgage - technical default: violation of note that does not disrupt the payments on the loan; don't warrant legal action - foreclosure: serious response to default when payments are not made (typically for 90 days)

Gross Income Multiplier Approach (aka GIM or GM)

- find comps and collect gross rent and selling prices - the ratio of the adjusted selling price to annual gross rent; like a form of the PE ratio - equation: subjects gross income multiplied by the multiplier - this is a rule of thumb or quick and dirty valuation

Forms of Prime Conventional Mortgages

- fixed-rate level payment mortgage (LPM): the predominant form; increased in popularity after the introduction of the PMI - conforming: loan that meets the standards required by Fannie Mae or Freddie Mac; loan must use standard GSE documentation, including the app form, mortgage, note, and appraisal form, along with numerical limits based on income and monthly payments - nonconforming: violate a GSE requirement - jumbo loans" loans that conform but exceed the dollar limit

Adjustable Rate Mortgages (ARM)

- for LMPs to be favorable mortgage interest rates should be relatively low and stable - in the 70s and 80s these rates became volatile so a solution to make an adjustable rate became favorable and more popular

Discounted Cash Flow (DCF Analysis)

- forecasts NOIs over a specified holding period and a future selling price at the end of the holding period - used when information on comps are not available; used when lease terms are long - pro forma: CF forecast prepared to facilitate DCF analysis - requires future CFs be converted into present values (called discounting) - expensive and time consuming - advantages: offers greater detail, more analytical -disadvantages: harder to defend in court

Home Equity Loan

- form of second mortgage - banks and savings institutions dominate home equity lending but credit unions, finance companies, brokerage houses, and insurance companies also offer these loans from two forms closed-end and open-end line of credit - closed-end: fixed amount borrowed all at once and paid by monthly over set period - open-end line of credit: money borrowed as needed but is limited in amount; referred to as HELOC - amounts that can be borrowed are limited by loan-to-value (LTV) ratios; limit is amount of loan that increases total mortgage debt up to this ratio - tax advantage is that the loans are 100% tax deductible up to $100,000

Effective Gross Income (EGI)

- nearly impossible to realize full potential income; reduced by inevitable and premature vacancies by tenants - natural vacancy rate: proportion of potential gross income not collected even when supply equals demand in the rental market - vacancy and collection losses (VC): found using historical experience of the subject property, actual current vacancies, and experiences of competing properties - VC is subtracted from PGI - miscellaneous revenue (MI): should be added to PGI; examples include garage rentals, parking fees, laundry machines, and vending machines, etc. - equation: PGI minus VC plus MI equals EGI

Government Sponsored Mortgage Programs

- offering low-interest loan programs to low and moderate-income households - examples: FHA and VA - Federal Housing Administration (FHA): insures loans made by private lenders that meet FHA's property and credit risk standards; paid by borrower and protects lender; covers any lender loss; main limitations are higher insurance premiums and limits on their max size; for first time homebuyers and those with moderate income; requires the upfront mortgage insurance premium and mortgage insurance premium; increases the borrowers cost of the mortgage; created the LPM - Veteran Affairs Loans: helps veterans obtain home mortgage loans with favorable terms for which they might not otherwise qualify for

Traditional Sales Comparison Approach (aka: Market Data Approach)

- general method used for all types of properties and involves comparing the subject property with comps that have recently sold - based on the principle of substitution (substituting for similar comp properties) - if the information (which comes from the market) is available, this is the best approach - subject property value is estimated by appraisers making explicit adjustments to sales prices of comp properties (because no two properties are identical); sales prices of comps are reconciled to a single indicated value that becomes the value of the subject property - works best with frequently traded properties, such as houses, condos, and land - steps: identify elements of comparison value adjustment, select comp sales (typically 5), adjust comp sales to approximate subject, reconcile adjusted prices to obtain indicated value of subject - identifying truly comparable properties is subjective and an art more than a science - important characteristic of sales comps are the "arm's length transactions"; ensures fairly negotiation has occurred under typical market conditions (i.e. not buying property from family) - large number of comps is desirable (typically 5) - sources of info on subject and comp properties include public records, (info on deeds, sales prices, property taxes, etc.), multiple listing services, and private companies - transaction adjustments: property rights conveyed, financing terms, conditions of sale, expenditures made immediately after purchase, market conditions; applied in this order - property adjustments: location, physical and economic characteristics, use, and non-realty items (personal property); applied after transaction adjustments but in no particular order - adjustments can either be in dollars or percentages; (pg. 175) gives the sequence

Reverse Mortgage

- helps those who are "house poor" with little income and substantially illiquid wealth - offers income through loans using the home as security for the accumulating loan; payments are the equity - allows homeowners to liquify a portion of their housing equity without having to sell there home or move - mortality risk: the outstanding balance will exceed the value of the property so default is likely - aided by involvement with FHA

Effect of default on the borrower

- in most cases there is damage to the borrowers credit - default remains on borrowers record for 7 years - time to qualify for another mortgage depends on the nature of default and the type of new loan

Elements of Adjustable Rates (ARMs)

- index rate: a market determined interest rate that is the "moving part" in the adjustable interest rate and should include adjustments at the change dates; not influenced by borrower or lender; moves independently; in ARM home loans US Treasury (in eastern US and this responds to changes quickly) and cost-of-funds indexes (in western US and WACC responds to changes slowly)are commonly used; for home equity credit lines use commercial bank prime rates (don't change much); LIBOR is commonly used on income-producing property - margin: the lender's "markup" added to the index (their profit); determined by the individual lender and can vary with competitive conditions and with the risk of the loan; set y contract and is fixed after it is signed - composite rate caps: periodic (limit change in the interest rate from one change date to the next) and overall cap (limit change over the life of the loan) and the payment cap (enables lender to enjoy unconstrained interest rate adjustments while protecting borrower against shock of large pmt changes); caps are typically binding for increases and decreases in the index; ex: 2.6 ARM has a 2% annual cap and 6% lifetime cap (most common ARM) - payments: monthly, a portion towards interest and the other towards principal; may be fully or partially amortized or nonamortizing or negative amortization - term: defines term to maturity (and term to amortization if it is a balloon loan-not fully amortized) - right of prepayment: depends on state laws, self explanatory - late fees: typically around 4-5% of late monthly payment

What the cap rate is NOT

- interest rate - discount rate - internal rate of return - does not measure total investment return

Interest Rates and Interest Charges

- interest rates can be fixed or variable - actual interest charged per month is the annual stated contract interest rate divided by 12, multiplied by the beginning-of-month balance - the payment is due on the first day of the following month

Why do homebuyers borrow funds for their homes?

- lack of funds, the possibility of positive financial leverage, and a better diversified portfolio

Prepayment Penalities

- limit the borrower's ability to refinance - makes borrower worse off and lender better off - using yield maintenance tools (i.e. EIR)

Complications in Income Property Appraisals

- lots of forecasting, especially with the DCF approach - lease contract issues: leases can prevent the recipient of "market" rents (CF effects)= the numerator; lease clauses can affect value because they affect risk (discount rate effect)= denominator

Value Measures

- market value - investment value - cost - transaction price

Sources of Risk in Real Estate

- market/business risk: price and rent/income fluctuations - liquidity risk: marketability - interest rate risk: fluctuations in availability and costs, including inflation, etc. as interest rates go up value goes down - financial risk: credit risk, no leverage, no risk - management risk: if you hire a property manager - information risk: negotiation on bad information - legislative risk: laws can create or destroy value - property and liability risk: insurable risk; 3rd party protection

Direct Capitalization

- method preferred by appraisers and the most commonly used method in income property valuation - practiced in the process of estimating a property's market value by dividing a single-year NOI by a cap rate - equation: NOI of the subject divided by capitalization rate (R0) - uses either a cap rate or income multiplier - advantages: simpler, easier to defend in court - disadvantages: tends to overestimate values in declining markets (only an issue when values are going down)

Conventional Mortgage Loan

- most common type of home loan - any standard home loan that is not insured or guaranteed by an agency of the US government (so it excludes FHA and VA) - types: prime and subprime and an intermediate group called alt-a

Deficiency Judgement

- option in addition to foreclosure to sue the defaulting borrower on the note - if the foreclosure proceeds do not make the lender whole, the lender can request a legal judgement for the deficiency; legal in at least 40 states including SC; used to batter strategic default - in principle, funds not recovered through foreclosure can be recovered through this - seldom happens in practice

Primary and Secondary Mortgage Markets

- primary: loan origination market in which borrowers and lenders come together; institutions supply money to borrowers including savings and loan associations, commercial banks, credit unions, and mortgage banking companies - secondary: where mortgage originators sell their loans; largest purchasers are Fannie Mae and Freddie Mac (both government sponsored enterprises); this being efficient makes the primary more efficient

Principle of Substitution

- properties substitute for one another - similar to competition - paying more/less for a similar property

Private Mortgage Insurance (PMI)

- protects a lender against losses due to default on the loan; does not protect against legal threat to the lender's mortgage claim nor does it protect against physical hazards - indemnifies the lender but not the borrower - from lender's perspective this reduces default risk - required for loans over 80% of the value of the security property - terms: payment can be in a lump sum or monthly installments added to the mortgage interest rate - cancelation may be allowed if the borrower has a record of timely payments and the remaining loan balance is less than 80% of the current market value of the home

Principle of Supply and Demand

- recognize huge price drops - value can change rapidly

Statutory Right of Redemption

- redemption after the sale; not used in SC - state law says it can be redeemed after its been sold to someone else

Capital Expenditures

- replacements and alterations to a building that materially prolong its economic life and therefore increases its value - referred to as a reserve for replacement, replacement allowance, capital costs, or similar terms - examples: roof replacements, additions, floor coverings, kitchen equipment, costs incurred to make the space suitable for needs of particular tenants, etc. - funds can be raised using investment vehicles - generally reflects the valuation method applied - in direct capitalization these expenses are required to be in annual figures; in DCF there is more specification with timing of these funds - in commercial real estate it is subtracted in the calculation of NOI ("above-line"); investment analysts subtract it from NOI ("below-line") to obtain net CF

Step 8: Report Final Value Estimate

- report writing is one of the most important functions appraisers perform - two types: appraisal report and the restricted appraisal report; third option is form report - appraisal reports: long, detailed, narrative like, and used mainly in income-producing properties; most common report is Uniform Residential Appraisal Report Form 1004 - form reports: short, efficient, convenient, generally required by mortgage lenders when households are purchasing or refinancing single-family homes - restricted appraisal report: minimal discussion, lots of references to internal file docs

Sources of Credit

- residential mortgage loans - commercial mortgage loans

Government Sponsored Enterprises (GSE)

- sponsorship of the secondary market - Fannie Mae and Freddie Mac - cleaning house (accumulators) - get contracts from lenders and sell them to investment banks who sell to securities to pension funds, insurance companies, banks, mortgage funds, etc.

Alt-A Loans

- standard conventional loans with one or more borrower requirements relaxed - major component of the residential mortgage market (subprime) decline in the early 2000s - negative amortization is a component in many of them because of the low market initial rate

Hybrid ARM

- starts with fixed interest rates and converts to standard ARM - "3/1" means the interest rate is fixed for 3 years then adjusts each year thereafter

Income Approach

- steps: calculating NOI, converting NOI forecast into an estimate of property value (aka income capitalization) - categories of income capitalization: direct capitalization models and discounted cash flows models - direct capitalization model: estimates are based on a ratio or multiple of expected NOI over the next 12 months; analogous to PE in common stocks, basically if a comp property is selling at say 7 times the first-year NOI then a reasonable assumption would estimate the subject's market value to be the product of the subject's expected first year NOI times 7 - Discounted Cash Flow (DCF): appraiser must identify the investment holding period that is typical of investors who might purchase the subject property; appraiser must convert the expectations of typical investors into explicit forecasts of the property's NOI for each year of the expected holding period (not just a single year) (forecast must include the net income produced by a hypothetical sale of the property at the end of the expected holding period); the appraiser must select the appropriate yield rate, or required internal rate of return, at which to discount all future cash flows; criticisms are the lack of accurate CF projections

Cost Approach

- the weakest approach (used when other two approaches don't work) - When the total cost to construct a property is less than its expected market value upon completion, developers have an incentive to build additional competing properties, which tends to reduce market values. - When the cost to produce a property exceeds its expected market value, developers have the incentive to stop or slow construction, which tends to increase the market value of competing properties. - based on economic principle of substitution and assumes market value of a new building is similar to the cost of constructing it today - works best with infrequently traded properties that do not produce income (i.e. publicly/gov. owned buildings like schools, churches, libraries, etc.) - depreciation of improvements (which is subjective): economic (change in supply and demand) and functional (changes in technology) obsolescence, physical deterioration (the aging process) - equation: estimated cost to construct structure today minus estimated accrued depreciation equals depreciated cost of building improvements plus estimated value of land equals indicated market value of the cost approach; in notes: (land value plus either replacement or reproduction costs) minus accrued depreciation - two types of construction cost estimates: reproduction costs and replacement costs - reproduction costs (historical or unique): expenditure required to construct the building today, replicating it in exact detail; costs using outdated materials and processes - replacement costs (generic or tract house): expenditure needed to construct a building of equal utility to the existing building; costs of modern construction techniques, materials, etc.; most often used because its easier to obtain than reproduction cost

Principles of Change and Anticipation

- those who anticipate/forecast changes better get more value - things will change, try to look ahead

Step 6: Apply Conventional Approaches to Estimate Market Value

- three approaches: income approach, sales comparison approach, and cost approach; each approach is related to the others; different methods of seeking the same goal - sales comparison approach: applicable to almost all 1-4 family residential properties where enough comp sales are available; advantage is being easily understood by buyers and sellers; determines value from the market; actual value judgments; most preferred - income approach: dominant approach; estimates value of income-producing property; assumes value is determined by expected future cash flows; simulated judgments; second most preferred - cost approach: estimates cost of replacing the property new and then subtracting the loss in value due to accrued depreciation (physical, functional, and external obsolescence); accrued depreciation is hard to estimate; used for valuing specialty properties (i.e. education facilities, churches, gov.; last resort

Principle of Conformity

- too much is bad (ex: all houses looking the same in a neighborhood) - zoning laws is a good example of this being a good thing

Interest-Only (I-O) and Balloon Mortgages

- true I-O requires no monthly principal payment and the balance remains the original amount; borrower must pay off loan after 5 to 7 years with a "balloon" payment equal to the original balance - variations include fully and partially amortizing loans that amortize over 15 or 30 years - not supported by Fannie Mae and Freddie Mac - loans are more affordable without amortization - contributed to subprime crisis

Step 4: Data Analysis

- two components: market analysis and highest and best use analysis - market analysis: goal is to develop market-specific knowledge about the factors that affect the demand and supply of properties similar to the subject and use that knowledge to forecast how real estate values are likely to change over time - highest and best use analysis: foundation for identifying comps; legally permissible, physically possible, financially feasible, and maximally productive; market value of a property is a function of its most productive use to buyer; there can be more than one - H&B use of vacant land: valued as if land were vacant minus value of anticipated improvements (i.e. building); market analysis helps drive this analysis and highest and best use conclusions drive market value conclusions - H&B use of property as improved: determined under assumptions of whether the improvements will remain or torn down or put to another use

Judicial foreclosure vs. power of sale

- two treatments for defaulted mortgages - judicial foreclosure: sale of foreclosed property must be through a court-administered public auction - power of sale: either the mortgagee or the trustee conducts sale of the property and must abide by statutory guidelines that protect the borrower; time frames vary by state; avoids courts - power of sale advantages (to the lender): faster and cheaper, borrower has no statutory right of redemption, shorter process, etc.

Operating Expenses (OE)

- typical expenses incurred in maintaining and operating rental properties that don't add value but keep the property operating and competitive in its local market - two categories: fixed and variable expenses - fixed expenses: local property taxes and hazard and fire insurance - variable expenses: utilities, maintenance, repairs, supplies, property management, etc. - estimated based on the historical experience of the subject property in comparison with competing properties, the appraiser's knowledge of typical expenses levels, and any property-specific characteristics

Foreclosure

- ultimate recourse of the lender - court supervised process of terminating all claims of ownership by the borrower and all liens inferior to the foreclosing lien - liens have priority according to their date of creation (earlier is superior); government liens are automatically superior to any private lien; highest priority lien receives all net proceeds from the foreclosure sale until that obligation is fully satisfied - equity of redemption: right of mortgagor to stop the foreclosure process by producing the amount due and paying the costs of the foreclosure process; can get property back if it hasn't been sold to someone else; time to bring it varies among states

Cost as a value measure

- useful is something is brand new, but doesn't indicate value

Fixed Rate/Payment Mortgage (LPM)

- usually priced as a long-term Treasury rate (10 years plus a premium)

Determinants of Value

- utility: the usefulness - relative scarcity: more scarce, more value - effective demand: somebody must want it - transferability: finding out real value by selling it

Purchase-Money Mortgage

- when a mortgage is created simultaneously with the conveyance of title - usually restricted definition to a mortgage from a buyer to a seller - generally a second mortgage - used to finance all types of property - piggyback mortgages: a second mortgage created simultaneously with the first mortgage for 10% of value or more; avoids cost of PMI; harmful to lenders - land contracts (aka contract for a deed): real estate debt but no mortgage, seller financing, seller/owner holds title until contract is satisfied (aka installment contract); most common use in vacation property - construction loans: not a mortgage, starts with little to no collateral, labor intensive (lender monitoring) but short term, historically the domain of commercial banks; balance starts at zero and builds - takeout commission: forward contract to pay off loan by converting it to a permanent mortgage - mini-perm loans: "gap" financing - junior (second or subordinate) mortgage: second or third in line for foreclosures; home improvement loans (both value and debt go up preserving equity), home equity loans (debt increases, value does not, so equity decreases) and HELOCs (debt goes up for short period before paying it off)

Step 2: Determine the Scope of Work

- work performed must be consistent with the work that a typical appraiser would perform in conducting a similar assignment - must be clearly described, time and personnel requirements clearly identified, and data and procedures used to complete tasks should be provided

Step 1: Identifying the problem

Appraiser must discuss the: - intended use of the appraisal - the purpose of the assignment (type of value to be estimated) - effective date of valuation - relevant characteristics of the property - any important assumptions, conditions, or limitations of the appraisal assignment; assignments focus on estimating the current market value of a property under the assumptions the owner will hold full title to the property (i.e. fee simple)

Market Value

Its most probable selling price, assuming "normal" sale conditions; value in exchange (in economics); based on EBIT - value the typical participant would place on the property - rests on willing buyers and freely bidding sellers - result of supply and demand

Transaction Prices

Prices we observe on sold properties - related to market and investment value but different - observed only when the investment value of the buyer exceeds the investment value of the seller; used to estimate the market value

Exhibit 9-4

States having power of sale for residential mortgages - more than half do, but SC does not

Bullet Loans

Terminal balance >0 - balloon payment

Accrued Depreciation

The difference between the current market value of a building (or improvement) and the total cost to construct it new - attributed to physical deterioration (aging of a building), functional (i.e. poor external design or interior floor plan) and external obsolescence (i.e. deterioration of neighborhood due to increased traffic or noxious odors)

What is the income approach based on?

The premise that a property's market value is a function of the income it is expected to produce - value comes from net operating income

Underwriting

The process of makin good loans or avoiding bad loans - five C's: Credit (think credit score), Capacity (financial that is through income and net worth), Character (of the people that is, think reputation), Collateral (how good is the appraisal), and Conditions (of the economy)

Potential Gross Income (PGI)

Total annual rental income the property would produce assuming 100% occupancy and no collection losses (paid full rent on time) - estimated on an annual basis - estimated rent per unit (or per square foot) for each year multiplied by the number of units (or square feet) available for rent - based on either market rent or contract rent - market rent: rental income the property would most probably command if placed for lease on the open market as of the effective date of the appraisal - contract rent: actual rent being paid under contractual commitments between owners and tenants; typical in long-term leases to financially reliable tenants

Income Return

When investors trade the use of the property for cash flow

Capital Return

When owners receive return from changes in property value

Mortgage

a special contract by which the borrower conveys to the lender a security in the mortgaged property - borrower is the mortgagor or grantor of the mortgage claim - lender is the mortgagee who receives the mortgage claim - under lien theory, mortgage gives the lender the right to rely on the property as security (having a security interest) for the debt obligation defined in the note (only exercised in event of default)

Investment Value

the value a particular investor places on a property; value in use - based on unique expectations of the individual investor, not the market in general; also based on cash flow - buyers: maximum they'd be willing to pay for property - sellers: minimum they'd be willing to accept

Partially Amortized Loans

term for payment is say 30 years but term for maturity is less say 5 years

Mortgage Menu

the many types and forms of available residential loans - includes loans that lenders can profit from