Section 5: Valuation and Market Analysis

Curable depreciation

refers to an item that can be repaired or replaced, and where the cost to cure the item is less than or the same as the anticipated increase in the property's value after the item is cured. This includes items of deferred maintenance such a painting or repair of faucets. The cost to cure should be reasonable and economically feasible.

Principles of Value

- Anticipation -Competition - Conformity -Highest and Best Use -Plottage -Regression -Progression

What steps does an appraiser follow when conducting a sales comparison approach?

1. Analyze the subject property to identify its characteristics, particularly those that are in demand in the current market. 2. Identify comparable properties that have been recently sold. Compare the comparables to the subject property and make adjustments to the sales price of the comparables where they are different. 3. Use the data to arrive at an opinion of value for the subject property on the date of appraisal..

Applying Elements of Comparison - To be able to make valid computations of adjustments, the elements of comparison must be applied in this order:

1. Financing terms and cash equivalency: This is often offered by builders for new construction or as seller concessions in resale transactions. 2. Conditions of sale: Was it an arm's length transaction? Were personal items included, or fixtures excluded? 3. Market conditions at time of contract and closing. 4. Location: Underwriters assume appraisers understand the local marketplace, and will accept comparables that exceed distance, time, or other guidelines, if the appraiser supports the decision with written, detailed explanation that demonstrates that local expertise. 5. Physical characteristics: This includes the site, view, construction quality, amenities, size, etc...

What are the three types of depreciation considered when appraising a property with the cost approach?

1. Physical depreciation is a loss in value caused by deterioration in physical condition. 2. Functional obsolescence is a loss in value caused by defects in design, such as a poor floor plan or atypical or inconvenient sizes/types of rooms. Examples include houses where there are bedrooms on a level without a bath(s), or where the only access to a bedroom is through another bedroom. 3. External depreciation or "economic obsolescence" is a loss in value caused by an undesirable or hazardous influence offsite. Examples are heavily trafficked areas, industrial odors, or airport noise

Steps of Valuation Process

1. State the Problem 2. List the Data Needed and Where to Find It 3. Gather the Data 4.Determine the Property's Highest and Best Use 5. Estimate the Value of the Land 6. Estimate Property Value Using Three Approaches to Value 7. Reconcile the Data 8. Report the Appraised Value

Where do appraisers get their replacement and reproduction costs?

1. Use published indexes and tables to source the data, such as Marshall & Swift Tables™. 2. The cost is then adjusted by its loss in value due to depreciation from all causes. 3. Accurate site value is required as a separate figure. (The sales comparison approach is used most commonly to estimate this value.)

What time frame is best when conducting CMA?

3-6 months.

Contribution

A change in a property impacts the value as a whole. Does converting a garage into a family room contribute to or detract from value? That would be in the eyes of the buyer.

Comparative Market Analysis (CMA)

A comparison of the prices of recently sold homes that are similar to a listing seller's home in terms of location, style, and amenities.

Substitution

A property's value is determined by what it would cost to purchase a similar substitute property. If someone offered you a car that is an exact replica of another car but was $3,000 less, it would impact your perceived value of the other car.

broker's price opinion (BPO)

An opinion of real estate value commissioned by a bank or an attorney and provided by a broker. Usually needed in foreclosure situation. Much cheaper.

The value principle of ______ is the basis of the income approach to appraisal.

Anticipation. Income approaches to appraisal are based on defining the present value of future income.

Why is it important to do a "Drive-by"

Appraisers must at least drive by comparables, partially to uncover information not found in the records (such as MLS history) that will necessitate adjustment to the comparables. A drive-by can identify a new circular drive, evidence of foundation shifting, a worn-out roof, superior or inferior view, and traffic or other nuisances such as airport noise. Adjustments must be made to comparables for items like these. Another reason for driving by potentially comparable properties (after the subject site visit) is that it gives the appraiser the chance to place the subject property and comparables within the context of the neighborhood and the larger market. Often, a drive-by causes the appraiser to redefine subject neighborhood boundaries to capture properties more similar to the subject, or to choose more suitable comparables.

When is direct capitalization used?

Appropriate for small to medium sized properties and those with stable forecast net income

Who hires an appraiser?

Buyer or lender, sometimes a seller for a re-fi, or maybe even prior to putting it on the market as a FSBO.

What should you bring to a Listing Presentation?

CMA, MLS Listing Sheets for Comparable Properties, Marketing Plan, Listing Contracts

The Hendersons were hoping to list their home for $400,000; however, four other comparable homes in the neighborhood just went up for sale, and they now must list their property at $380,000 to sell quickly. Which economic principle is at work here?

Competition

What properties would not use the cost approach?

Condominium and cooperative properties and isn't used as often with older properties because accurately estimating depreciation is difficult.

4 Factors that influence value (DUST)

Demand Utility Scarcity Transferability

Two categories of comparison

Elements of comparison: Analyze comparables' locational/physical property characteristics and transaction differences. They explain why different prices are paid for comparables. Units of comparison: Allow the comparison to be standardized. Units may be price per square foot, per apartment unit, per acre, etc.

Gross income multiplier (GIM)

Essentially the same as GRM, but it uses all sources of income from the property rather than only rent. The multiplier is found by dividing the sales price by annual gross income from all sources. You can then apply the multiplier to the subject property's income to determine value.

The income approach AKA income capitalization approach

Estimates the present value of any future benefits of owning a particular property. It's based on the value principle of anticipation. There are a few different techniques that fall under the umbrella of income approach, but they're all similar in that they use data about the income from the property and then apply some form of adjustment to translate future cash flows to a current property value.

FIRREA

Financial institutions Reform, Recovery and Enforcement Act of 1989.

How do you find the capitalization rate?

Found by analyzing the sales price and income of comparable properties.

Demand

How attractive and move in ready is a property ? What's the market like? More buyers than sellers?

What must be included on CMA?

Identification of the subject property Date prepared Defined value or price Limiting conditions, including statements of purpose(s) and intended user(s) Any present or contemplated interest, including the possibility of representing the seller/landlord or buyers/tenants Basis for the opinion, including applicable market data If the opinion is not an appraisal, a statement to that effect

Site Value

In residential appraisals, the assessed value of the site is frequently used. The site value is added to the depreciated value of the improvements to estimate the value by the cost approach. Example The appraiser determines the site value of the subject is $25,000, and the cost of the improvements is $100,000. The incurable depreciation (due to age of the improvements) is $10,000. The curable depreciation estimate is $2,000 (say, for replacing fencing and broken gutters). No functional obsolescence was noted. The value estimated by the cost approach is $113,000. $25,000 (site value) + 100,000 (replacement cost) - 10,000 (incurable depreciation) - 2,000 (curable depreciation) = $113,000 (estimated value)

Incurable depreciation

Includes items not practical to correct. Examples are a furnace or a roof that hasn't reached the end of its economic life.

Utility

Is it habitable in it's current condition does it need repairs? Updating? Does the current zoning match the intended use? Scarcity - Demand/Supply Transferability - Major clean up issues/cloud on a title are a big issue.

What are some questions that an appraiser will use to test comparability?

Is the subject property held in fee simple interest? Will the transaction be for the fee simple estate? Are the comparables also fee simple? Is the subject property or comparable sale subject to easements (e.g., ingress/egress access) or encroachments (e.g., a neighbor's fence overlaps the property boundary)? Are there any deed, easement, or leasehold restrictions? Was the comparable sold with advantageous financing or as distressed property? Was the comparable sale executed at arm's length? Or was the sale between relatives or transacted under any duress such as a forced sale before bankruptcy? Was any personal property included in the sale price (e.g., a detached spa, a boat included with lakefront property)?

Bracketing

Lenders like to see the subject property "bracketed" in several ways. Bracketing is a process in which an appraiser determines a probable range of values for a property by comparing a group of comparable sales to the subject. The appraiser attempts to include both superior and inferior units of comparison such as age, transaction price, etc. For example, comparables that are five and 15 years old bracket a subject that is 10 years old.

What properties would use the cost approach?

New construction of both residential and commercial property Unique properties, such as highly energy-efficient houses, residential acreage with excess land, historic houses, and high-dollar houses with many amenities Special-purpose commercial uses, such as hospitals, some manufacturing plants, hotels, and other single-purpose properties

Who requires a cost approach appraisal?

Not Fannie Mae, but many lenders do, especially when appraising high-value properties

Valuation

Process of forming an opinion of a property's value

What's the formula to calculate cap rate? R=I/V

R (Cap Rate) = I (NOI, Net Operating Income) / V (Property value, The Sales Price of a comparable).

What properties are exempt from Federally related transactions?

Residential Properties in federally related transactions valued at $400,000 or less are exempt from federal appraisal requirements

Evaluation

Study of a property, potentially for land use or marketability

Who regulates appraisers and appraisal companies?

The Real Estate Appraiser Board. You can get your licensing or certification through the Virginia Real Estate Appraiser Board

What's USPAP?

The Uniform Standards of Professional Appraisal Practice

How many properties "comparables" to use in a sales comparison approach?

The appraiser identifies at least three comparables to use, then makes adjustments to the sales price of comparable properties to estimate the value of the subject property. EXAMPLES: If the subject property has a superior amenity (a two-car garage while the comparable property has a one-car garage, for example), the sales price of the comparable property is increased by an appropriate amount or factor. If the subject property is inferior in an area (for example, the yard is not well-maintained, while the comparable property is beautifully landscaped), the sales price of the comparable property is decreased. The amount of the adjustment is based on the value of the item in the market. For example, if the comparable home has a fireplace and the subject property doesn't, and homes with fireplaces sell on average for $1,000 more, then the comparable property's sales price is adjusted down by $1,000.

Determining Indicated Value with Cost Approach

The cost approach determines the indicated value by estimating the reproduction cost of the new improvement and subtracting the amount of depreciation from all causes described above. Then, the appraiser adds an estimate of the site value as if it were vacant and available to be developed to its highest and best use.

What's the Cost Approach? (Appraisals)

The cost approach to finding appraised value measures value as a cost of production, including the acquisition of the land and the construction costs. Its reliability depends on valid reproduction cost estimates (i.e., the cost of rebuilding) and appropriate depreciation estimates.

To make valid computations of adjustments for the sales comparison approach to value, elements of comparison must be applied in a specific order.

The elements appraisers consider in the sales comparison approach are applied in a specific order: financing terms and cash equivalency, conditions of sale, market conditions at the time of contract and closing, location, and physical characteristics.

Plottage

The joining or assemblage of two neighboring land parcels increases the property value. In such a case, 1+ 1 often equals 3 or even 5. So two parcels worth $40,000 separately might be worth $120,000 when joined.

What is a federally related transaction?

The loan won't be sold on the secondary market and isn't guaranteed or insured by the federal government.

Competition

The more similar properties on the market, the lower the price will be. Greater competition (Supply) the lower the demand (and price)

Market Value

The price at which a buyer/seller would agree to, under the USUAL market conditions.

What principle does the sales comparison approach rely on?

The sales comparison approach relies on the value principle of substitution, which says that the value of a property is equal to the value of an equivalent substitute property. However, since every property is different, appraisers follow a process of adjustment to comparable properties (the substitutes) when estimating the value of a subject property. Think of it as a way to compare apples to apples when you're starting out with Granny Smith, Honeycrisp, and Gala apples.

Sales Comparison Approach

The sales comparison approach uses a process of comparison with similar properties that have a known sale price to determine a subject property's market value. This is the most reliable of the three approaches when appraising single-family homes for market value.

After you've made a professional listing presentation and the seller has declined to use you as a listing agent, what's the best practice?

The seller's decision may have nothing to do with you. It's appropriate to ask the seller what you could have done differently to earn their business, however. This can help you with your next listing presentation.

Highest and Best Use

This is the most profitable use that is both legal (conforms to zoning) and economically feasible (won't cost more than the increase in value).

Regression

This is the value a higher-quality property loses by being near a lower-quality property.

Progression

This is the value a lower-quality property gains by being near a higher-quality property. For example, if your neighbor builds on a second story in a quality remodel, the bump in value that your property receives is progression. Progression and regression are based in the economic belief that it's better to have the cheapest house in the nicest neighborhood than the nicest house in the cheapest neighborhood.

Direct Capitalization

This method calculates a net operating income (NOI) for a property over the next year, then applies a capitalization rate to that income to derive a market value for the property.

Yield Capitalization

This method is similar to direct capitalization but projects father into the future than one year. It also considers the potential value of the property upon resale. An expected rate of return is applied to income from the entire holding period to find the current property value.

Appraisal

Unbiased estimate value of a specific property on a specific date

Gross Rent Multiplier (Used for 1-4 Family Units)

Use the gross rent multiplier (GRM) by dividing the sale price of a comparable property by that property's monthly or annual gross rent to arrive at a single number, which is your GRM. That number is then multiplied by the subject property's anticipated monthly or annual gross rent to arrive at a property value. GRM doesn't take into account any operating costs; it's a rough estimate of how income relates to value and is best used for one- to four-family units where the primary use is as a rental property. Because it's a rough estimate, it's used in conjunction with comparable sales in the area to arrive at a property value.

Conformity

Value is created and maintained when the characteristics of a property conform to the demands of the market. For example, a house built in a commerical zone would be valued differently than a house in the middle of a neighborhood made up of similar houses.

Value in Use

What a property is worth to the person using it

Assessed Value

What the local taxting authority thinks it's worth

What are some questions you should ask sellers?

Why do you want to sell? What do you owe on the property? Have you done any recent upgrades? What can you tell me about the property? Will all decision makers be at the meeting? Have you done any recent remodeling that won't how up on your tax report?

To calculate the value of a house by the income approach, if you know the GRM derived from the comparables is 110, you would:

You would multiply the gross monthly rent by 110.