Chapter 7 Three Approaches to Value

The three approaches to value

(1) The Sales Comparison Approach, (2) The Cost Approach, (3) The Income Approach.

Functional Obsolescence

A loss of value to an improvement to real estate arising from functional problems, often caused by age or poor design.

Sales Comparison Approach

A method for estimating the market value of a property by comparing similar properties to the subject property.

Economic Age-Life Method

A method of estimating accrued depreciation in which the ratio between the effective age of a building and its total economic life is applied to the current cost of the improvements to obtain a lump sum deduction.

Under the cost approach, an appraiser has calculated the current replacement cost (new) for a structure that is 15 years old. What is the next factor an appraiser will consider in completing the approach?

Accrued depreciation

Reserves for Replacement

An amount of money set aside for future replacement of major items, such as the roof or heating system. Also called reserves

Incurable functional obsolescence

An element of accrued depreciation; a defect caused by a deficiency or superadequacy in the structure, materials, or design, which cannot be practically or economically corrected.

Curable Functional Obsolescence

An element of depreciation; a curable defect caused by a flaw in the structure, materials, or design, which can be practically and economically corrected.

Cost approach to value

An estimate of value based on current construction costs, less depreciation, plus land value. Contrast with the income approach to value and the sales comparison approach to value. Used for schools, courthouses, jails, churches and civic centers

CIA

Comparable Inferior Add

If the comparable property is inferior in lot size, compared with the subject property, the price of the:

Comparable is adjusted downward

What is the most suitable appraisal method for a vacant lot in a subdivision?

Comparable sales approach

CBS

Comparison Better Subtract if sales price is more desirable than that of the comp, subtract the value of that feature from the sale price of the comp

An apartment building in a college town rents rooms to some students below the current market rate. What is the below market rate called?

Contract rent

operating expenses

Costs involved in operating a business, such as rent, utilities, and salaries.

fixed expenses

Costs that do not change from month to month

Which method estimates all accrued depreciation in a lump sum by estimating the effective age of the structure dividing by its total economic life and multiplying by the replacement cost?

Economic age-life method

Five steps of income approach

Estimate annual future potential gross income, Estimate the effective gross income, Estimate net operating income, Select a capitalization rate and Apply capitalization rate

Quantity Survey Method

Estimate based on the quantities of raw materials needed to replace the subject structure as well as of the current price of such materials & their installation costs.

Six Steps of Cost Approach

Estimate the replacement cost, Estimate the accrued depreciation, Subtract accrued depreciation from current reproduction cost, Estimate land (site) value as if vacant, Depreciate site improvements and Derive a final estimate of value

If a rural subdivision loses the benefit of fire protection form a nearby city, which of the following forms of depreciation best describes the loss of value?

External obsolescence

The income approach to value is based upon past income of the property? (T or F)

False

An appraiser is appraising a building that has an unusual design and inefficient floor plan. The building suffers from which type of depreciation?

Functional obsolescence

A lender would most likely rely on which of the following approaches to value when underwriting a mortgage on an office complex?

Income

If the net operating income remains constant, what will happen to the present value of the property if the capitalization rate decreases?

Increase

External Obsolescence

Incurable depreciation caused by factors not on the subject property, such as environmental, social, or economic factors.

A house that is over-improved in relation to its value is an example of which of the following types of depreciation?

Incurable functional obsolescence

In the comparable sales approach, appraising the value of the subject property is:

Inferred from the adjusted sale prices of the comparable properties

Physical Deterioration

Loss of value of a building from its reproduction cost, resulting from wear and tear over time.

Which of the following is not subtracted from the potential gross income to obtain the net operating income?

Mortgage payments

The cost approach is not normally used to appraise which of the following?

Older residential buildings

What is the cost estimating technique used by architects and contractors more often than by appraisers to estimate the reproduction cost of a building?

Quantity survey method

Which combination of property type and appraisal method is most appropriate in estimating value?

Raw land and market approach

What is the amount required to construct a new building of equal utility to the building being appraised called?

Replacement cost

Which appraisal approach is the best reflection of market value?

Sales comparison approach

The sales comparison approach is based upon which of the following appraisal principles?

Substitution

vacancy and collection losses

The amount of income lost due to empty units or tenants not paying full rent.

unit-in-place method

The appraisal method of estimating building costs by calculating the costs of all of the physical components in the structure, with the cost of each item including its proper installation, connection, etc.; also called the segregated cost method.

Reproduction Cost

The construction cost at current prices of an exact duplicate of the subject property.

Net Operating Income (NOI)

The resulting amount when all operating expenses are subtracted from effective gross income.

Effective Gross Income (EGI)

The resulting amount when vacancy and collection losses are subtracted from potential gross income. (See also Vacancy and collection losses.)

Potential Gross Income

The total annual income the property would produce if it were fully rented for and year and had no collection losses.

An appraiser is estimating the reproduction cost of a subject property by using the cost service manual. Which cost estimating method is the appraiser using?

Unit in place method

Which applies best to external obsolescence?

Usually incurable

Curable Physical Deterioration

a reduction in a property's value resulting from a decline in physical condition; repairs that are physically possible and economically feasible and will result in an increase in appraised value. Ex: Roof replacement, painting

Income Approach

appraising property based on theory the value of a property can be estimated by the amount of net income it can produce over its remaining economic life; suitable for small apartment buildings and businesses

variable expenses

expenses that change from month to month

Three steps of sales comparison approach

locate comparable sales, adjust for dissimilarities and reconcile the value

hypothecate

process of pledging something (house) as security, but retaining possession of it.

Incurable Physical Deterioration

repairs to major structural components of a building, which deteriorate at different rates, may not be economically feasible. Ex: load-bearing walls and foundations, replacing the roof or ac system