RE FINAL
A comparable property sold 10 months ago for $100,000. This sale price is adjusted to a normal sale price of $98,500. If the appropriate adjustment for market conditions is 0.30% per month, what would be the market-adjusted normal sale price of the comparable property?
$101,495
A comparable property sold six moths ago for $150,000. The adjustments for the various elements of comparison have been calculated as follows: Location: -5 percent Market conditions: +8 percent Physical characteristics: +$12,500 Financing terms: -$2,600 Conditions of sale: 0 Legal characteristics: 0 Use: 0 Nonrealty items: -$3,000 What is the comparable's final adjusted sale price? a. $160,732
$160,732 Transaction price $150,000 Financing terms Minus $2,600 Normal sale price $147,400 Market conditions Plus 8% $11,792 Mkt-adj normal sale price $159,192 Location Minus 5% $7,960 $151,232 Physical characteristics Plus $12,500 $163,732 Nonrealty minus $3,000 $160,732
An appraiser estimates that a property will produce NOI of $25,000, the Yo is 11 percent, and the growth rate is 2.0 percent. What is the total property value (unrounded)?
$277,778
You find two properties that have sold twice within the last two years. Property A sold 22 months ago for $98,500; it sold last week for $108,000. Property B sold 20 months ago for $105,000; it sold two weeks ago for $113,500. What is the average monthly compound rate of change in sale prices?
0.42%
If a comparable property sells for $1,200,000 and the effective gross income of the property is $12,000 per month, the gross income multiplier is
8.33
Transactional adjustments
Adjustments to comparable property transaction prices that concern the nature and terms of the deal
Appraisal
An unbiased written estimate of the fair market value of a property
Selling expenses (SE)
Costs associated with the disposition of a property
Repeat-sale analysis
Estimation of the rate of property appreciation through statistical examination of the properties that have sold twice during the sample period. Normally the analysis is by statistical regression
The final price for each comparable property reached after all adjustments have been made is termed the:
Final Adjusted Sale Price
The final price after reconciliation of the answers obtained from two or more approaches is termed the
Final Estimate of Value
What is meant by functional obsolescence? Could a new building suffer from functional obsolescence?
Functional obsolescence refers to a building's loss in value resulting from changes in tastes, technical innovations, or market standards. Typically, functional obsolescence is associated with a building's decline in utility through the passage of time, but it is possible for a newer building to suffer from functional obsolescence. For example, costumer preferences and demands may change soon after a relatively new building is completed.
The cost approach to market valuation does not work well in markets that are overbuilt. Explain.
In an overbuilt market, the market value of an existing property is frequently less than the construction cost of the property. The estimated value calculated using reproduction cost of the property is likely significantly different from the value obtained from the sales comparison approach and the income approach.
A new house in good condition that has a poor floor plan would suffer from which type of accrued depreciation?
Incurable functional obsolescence
The final price from each appraisal approach is termed the:
Indicated Value
To reflect a change in market conditions between the date on which a comparable property sold and the date of appraisal of a subject property, which type of adjustment is made?
Market conditions
Comparable properties
Properties similar to the subject property used in the sales comparison approach to calculate a single indicated value for the subject property
Which of the following types of properties probably would not be appropriate for income capitalization
Public school
Why is the market value of real estate determined partly by the lender's requirements and partly by the requirements of equity investors?
Real estate investments are frequently financed using a combination of equity and mortgage debt. A real estate investment can be viewed as a joint investment made by both the lender and equity investor, and therefore, both parties' required rates of return are relevant. Consequently, the investor's minimum required rate of return is heavily influenced by the availability and terms of financing provided by lenders, as well by evaluating the required returns on alternative investments of similar risk. In general, a levered investment has greater risk than an unlevered investment, which increases the investor's required rate of return
Reversion
The cash proceeds from the sale
What main difficulty would you foresee in attempting to estimate the value of a 30- year old property by means of the cost approach?
The cost approach assumes that the market value of a new building is similar to that of constructing the building today. Of the two methods available for estimating cost, appraisers normally use the reproduction cost of a building for appraisal purposes. A 30- year old building likely possesses many characteristics that render it obsolete. Therefore, calculating an accurate reproduction cost for an older building is difficult because outdated features, such as room arrangement, decorative features, and materials, are included in the reproduction costs. Estimating these costs can be problematic because reproducing the cost of a 30-year old building requires significant effort and assumptions of accrued deprecation.
Appraisal report
The document the appraiser submits to the client and contains the appraiser's final estimate of the market value, the data upon which the estimate is based, and the calculations used to arrive at the estimate
Net sale proceeds (NSP)
The expected selling price less selling expenses
Operating expense (OE)
The expenses that are necessary to operate and maintain an income producing property
Accrued depreciation
The identification and measurement of reductions in the current market value of a property from today's production cost
Going-in cap rate
The overall capitalization rate; the ratio of the first year net operating income to the overall value or purchase price of the property
Market value
The price a property should sell for in a competitive market when there has been a normal offering time, no coercion, arm's-length bargaining, typical financing, and informed buyers and sellers
Transaction price
The prices observed on sold properties
Income capitalization
The process of converting periodic items into a value estimate
Direct capitalization
The process of estimating the value of a property by dividing a property's annual net operating income by an overall capitalization rate
Reconciliation
The process of forming a single point estimate from two or more numbers. It is used widely in the appraisal process.
Subject property
The property for which an appraisal of fair market value is produced
Internal rate of return (IRR)
The rate of interest (discount) that equates the present value of the cash inflows to the present value of the cash outflows; that is, the rate of discount that makes the net present value equal to zero
Elements of comparison
The relevant characteristics used to compare and adjust the sales price of the comparable properties in the sales comparison approach
Contract rent
The rent specified in the lease contract
Distinguish between levered and unlevered cash flows. In what sense does the equity investor have a residual claim on the property's cash flow stream if mortgage financing is employed?
The use of mortgage debt to finance the acquisition of a real estate investment property is referred to as leverage. Levered cash flows measure a property's income stream after deducting debt service payments. The amount of cash flow available for distribution to an equity investor is reduced by the amount paid to the lender. Therefore, the equity investor has a residual claim, known as the before- tax cash flow, which is simply NOI less debt service.
Investment value
The value of the property to a particular investor, based on his or her specific requirements, discount rate, expectation, and so on.
Summary appraisal report
This report summarizes the conclusions of the appraisal. Most use forms reporting option, meaning much shorter than narrative reports and are generally required by mortgage lenders when selling or refinancing. Their standardization creates efficiency and convenience
What is the theoretical basis for the direct sales comparison approach to the market valuation?
The direct sales comparison approach to the market valuation relies on value judgments made by willing buyers and sellers. Therefore, this method uses market- driven information. The sales comparison approach involves comparing a subject property with recently sold comparable properties.
Direct market extraction
Method of estimating the appropriate capitalization rate from comparable property sales
Which of the following expenses is not an operating expense?
Mortgage payment
Replacement cost
The cost to build a new building of equal utility to an existing building that is not an exact physical replica of the existing building
Reproduction cost
The cost to build a new building that is exactly like an existing building in every physical detail
Market conditions
The relationship between supply and demand for a particular type of real estate in a local market at a specified point in time
Market rent
The rent that could be obtained by renting the property on the open market
Terminal value
The sale price at the end of the expected holding period
Reconstructed operating statement
A statement of property income and expenses formatted for the purposes of appraisal and investment analysis. Differs from typical management operating statement in the treatment of certain expenses, including management fees, mortgage payments, and vacancy and collection losses
Arm's length transaction
A transaction between two parties that have no relationship with each other and who are negotiating on behalf of their own best interests. A fairly negotiated transaction and reasonably representative of market value
Potential gross income (PGI)
The total annual income the property would produce if it were fully rented and had no collection losses
Effective gross income (EFG)
The total annual income the rental property produces after subtracting vacancy losses and adding miscellaneous income
Overall capitalization rate
The type of capitalization rate used in direct capitalization, calculated by dividing comparable properties' net operating incomes by their selling prices
Net operating income (NOI)
The type of income to a property used in direct capitalization, calculated by deducting from potential gross income vacancy and collection losses and adding the other income to obtain effective gross income. From this amount all operating expenses are subtracted, including management expense and a reserve fro replacements, or capital expenditures, and other nonrecurring expenses
Highest and best use
The use of a property found to be 1 legally permissible, 2 physically possible, 3 financially feasible, and 4 maximally productive
Pro forma
A cash flow forecast prepared to facilitate discounted cash flow analysis
What is the difference between a fee simple estate and a leased fee estate?
A fee simple estate is the highest form of property ownership. It is complete ownership of a property without regard to leases. A leased fee estate is ownership of a property subject to leases on the property. When acquiring existing commercial real estate, investors are most often acquiring a leased fee estate because they are acquiring the property subject to the existing leases
Adjustments
Additions or subtractions from a comparable sale price or cost which are required to make the comparable property more directly comparable to the subject property
What is an appraisal report?
An appraisal report is the document prepared by the appraiser. This report contains the appraiser's final estimate of value, the data forming the foundation of this estimate, and the calculations supporting the estimate
Capital expenditures
Expenditures for replacements and alterations to a building (or improvement) that materially prolong its life and increase its value
What is the difference between contract rent and market rent? Why is this distinction more important for investors purchasing existing office buildings than for investors purchasing existing apartment complexes?
Contract rent refers to the actual rent paid under existing lease contracts executed between owners and tenants. Market rent refers to the potential rental income a property could receive on the open market as of the effective date of an appraisal. The distinction is particularly important for investors in office buildings because commercial leases tend to be for multiple years, unlike apartment leases. Existing leases at below market rates will be included in the calculation of potential gross income, which will depress the appraised value of the property relative to the appraised value assuming market rental rates.
In what situations or for which types of properties might discounted cash flow analysis be preferred to direct capitalization?
Direct capitalization is dependent on information obtained from sales of properties that are deemed to be comparable to the subject property. Identifying comparable properties is particularly difficult with commercial real estate investments. Discounted cash flow analysis is useful for valuing income-producing properties because the unique expected cash flows for a particular property are evaluated using the appropriate required internal rate of return. DCF is especially useful when valuing multi-tenant office buildings and shopping centers were lease terms can vary widely across even otherwise similar properties.
Why is an estimate of the developer's fair market profit included in the costs estimate?
In practice, developers and contractors frequently include their profit in the calculated cost amount because a fair and reasonable profit amount is considered a cost of the project.
Self-contained appraisal report
Includes all the detail and information that were relevant to deriving market value or the other conclusions within the report. Most use narrative reporting option, meaning the longest and most formal format which uses step by step descriptions of facts and methods used to determine value
The final value estimate produced by one approach is called
Indicated Value
Nonrealty items
Items of personal property
Physical deterioration
Loss of value of a building from its reproduction cost, resulting from wear and tear over time
Functional obsolescence
Losses in value of a building relative to its reproduction cost because the building is not consistent with modern standards or with current tastes of the market
External obsolescence
Losses of property value caused by forces or conditions beyond the borders of the property. The losses are deducted form a building's reproduction cost in the cost approach to estimating market value
In appraising a single-family home, you find a comparable property very similar to the subject property. One important difference, however, concerns the financing. The comparable property sold one month ago for $120,000 and was financed with an 80 percent, 30-year mortgage at 5.0 percent interest. Current market financing terms are 80 percent, 30-year mortgage at 7 percent interest. The monthly payments on the market financing would be $638.69, while the monthly payments on the special 5.0 percent financing are $515.35. Assume the borrower's opportunity cost rate is 7 percent. The approximate present value of the present savings on the non-market financing is ______, and this amount should be _______ to the transaction price of the comparable. The present value of the payment savings is
N= 360 I/YR = 7/12 PV = 0 PMT = 123.34 FV = 0 This $18,538.94 should be subtracted from the sale price of the comparable property. d. $18,539, subtracted
An overall capitalization rate (Ro) is divided into which type of income or cash flow to obtain an indicated value?
Net operating income (NOI)
The methodology of appraisal differs from that of investment analysis primarily regarding
Point of view and types of data used
Restricted appraisal report
Provides a minimal discussion of the appraisal with large numbers of references to internal file documentation. If the client just wants to know what the property is worth and does not intend to provide the appraisal to anyone for use or reference, a restricted report may be sufficient
Terminal capitalization rate
Rate used to convert annual net cash at the end of an expected holding period into an estimate of future sale price
You are estimating the value of a small office building. Suppose the estimated NOI for the first year of operations is $100,000. If you expect the initial $100,000 NOI will grow forever at a 3% annual rate, what is the value of the building assuming a 12.2% discount rate? If you pay this amount, what is the indicated initial cap rate?
The capitalization rate consists of a required IRR on equity and a growth rate. Applying the general constant-growth formula and assuming that the growth rate is 3%, the indicated capitalization rate is equal to 9.2% (12.2% - 3.0%.). Therefore, using a cap rate of 9.2%, the indicated value of the building is $100,000/0.092, or $1,086,957
Fee simple estate
The complete ownership of a property; may be either absolute or conditional
Given the following owner's income and expense estimates for an apartment property, formulate a reconstructed operating statement. The building consists of 10 units that could rent for $550 per month each. Owner's Income Statement Rental income (last year) $60,600 Less: Expenses Power $2,200 Heat 1,700 Janitor 4,600 Water 3,700 Maintenance 4,800 Reserves 2,800 Management 3,000 Depreciation 5,000 Mortgage payments 6,300 34,100 Net income $26,500 Estimating vacancy and collection losses at 5 percent of potential gross income, reconstruct the operating statement to obtain an estimate of NOI. Remember, there may be items in the owner's statement that should not be included in the reconstructed operating statement. Using the NOI and a Ro of 11.0 percent, calculate the property's indicated market value. Round your answer to the nearest $500.
Reconstructed Operating Statement PGI: (10 units x $550 x 12) $66,000 Less: Vacancy Loss (at 5 percent) (3,300) EGI: 62,700 Less: Operating Expenses Power $2,200 Heat 1,700 Janitor 4,600 Water 3,700 Maintenance 4,800 Reserves 2,800 Management 3,000 = 22,800 Net Operating Income $39,900 Note: Mortgage payments and depreciation are not included in the calculation of the property's NOI. The indicated value of the property is $362,727 ($39,900 / 0.11), which rounds to $363,000.
Reproduction cost has been estimated as $350,000 for a property with a 70-year economic life. The current effective age of the property is 15 years. The value of the land is estimated to be $55,000. What is the estimated market value of the property using the cost approach, assuming no external or functional obsolescence?
Reproduction cost 350,000 Less: Depreciation (75,000) [$350,000 x 15/70] Depreciable Cost of Building Improvements 275,000 Add: Estimated Value of Site 55,000 Indicated Value by the Cost Approach 330,000
Uniform Standards of Professional Appraisal Practice (USPAP)
Rules governing the appraisal process and reporting of appraisals that are developed by the Appraisal Standards Board of the Appraisal Foundation. Appraisers are obligated by law to follow these rules and guidelines
You have been asked to estimate the market value of an apartment complex that is producing annual net operating income of $44,500. Four highly similar and competitive apartment properties within two blocks of the subject property have sold in the past three months. All four offer essentially the same amenities and services as the subject. All were open-market transactions with similar terms of sale. All were financed with 30-year fixed-rate mortgages using 70 percent debt and 30 percent equity. The sale prices and estimated first-year net operating incomes were as follows: Comparable 1: Sale price $500,000; NOI $55,000 Comparable 2: Sale price $420,000; NOI $50,400 Comparable 3: Sale price $475,000; NOI $53,400 Comparable 4: Sale price $600,000; NOI $69,000 What is the indicated value of the property using direct capitalization?
The abstracted going-in capitalization rates from the four properties are listed below: Comparable 1: 0.110 Comparable 2: 0.120 Comparable 3: 0.112 Comparable 4: 0.115 Simple Ave. 0.114 The simple average of the four comparable cap rates is 0.114. Thus, the indicated value of the subject property is $390, 351, ($44,500 / 0.114), which rounds to $390,000
Reserves for replacement and other nonrecurring expenses are allowances that reflect:
The annual depreciation of the short-lived components of the building and expenses that occur only occasionally
The cap rate on mortgage financing is 7.5 percent for properties similar to the subject. The typical loan-to-value ratio is 75 percent of value. What would be the indicated Ro by simple equity analysis, if equity dividend rates (RES are running at about 11 percent?
The appropriate going-in cap rate, or RO,is simply a weighted average of the equity dividend rate and the mortgage capitalization rate. Therefore, RO is 0.75(.075) + 0.25(.11), or 8.38%
Leased fee estate
The bundle of rights possessed by the landlord in a leased property, made up primarily of the right to receive rental payments during the lease term and ultimately to repossess the property at the end of the lease term
Estimate the market value of the following small office building. The property has 10,500 square feet of leasable space that was leased to a single tenant on January 1, four years ago. Terms of the lease call for rent payments of $9,525 per month for the first five years, and rent payments of $11,325 per month for the next five years. The tenant must pay all operating expenses. During the remaining term of the lease, there will be no vacancy and collection losses; however, upon termination of the lease it is expected that the property will be vacant for three months. When the property is released under short-term leases, with tenants paying all operating expenses, a vacancy and collection loss allowance of 8 percent per year is anticipated. The current market rental for properties of this type under triple net leases is $11 per square foot, and this rate has been increasing at a rate of 3 percent per year. The market discount rate for similar properties is about 11 percent, the "going-in" cap rate is about 9 percent, and terminal cap rates are typically 1 percentage point above going-in cap rates. Prepare a spreadsheet showing the rental income, expense reimbursements, NOIs, and the net proceeds from the sale of the property at the end of an 8-year holding period. Then use the information provided to estimate the market value of the property.
The fifth year of the 10-year lease is the first year of analysis. The problem calls for an 8-year analysis--one for the last year of the 1st 5-year period, five for the second 5-year period, one to allow the vacancy and collection loss to achieve a normal level, and one at the normal level for calculating the property's value (sale price) at that time. Assume vacancy and collections losses in year 7 are 25 percent, which reflects 100 percent vacancy for three months and no vacancy for 9 months. Assume the "normal" vacancy rate of 8 percent will apply in year 8 of the analysis and beyond. Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5 Yr. 6 Yr. 7 Yr. 8 Yr. 9 Contract Rent 114,300 135,900 135,900 135,900 135,900 135,900 Market Rent 115,500 118,965 122,534 126,210 129,996 133,896 137,913 142,050 146,311 Less: VC 0 0 0 0 0 0 34,478 11,364 11,705 Effective Gross Inc. 114,300 135,900 135,900 135,900 135,900 135,900 103,435 130,686 134,606 Less: Operating Exps 0 0 0 0 0 0 0 0 0 Net Operating Inc. 114,300 135,900 135,900 135,900 135,900 135,900 103,435 130,686 134,606 Sale price at the end of Yr. 8: = [NOI (yr9) / Terminal cap rate] = $134,606 / 0.10 = $1,346,060 Cash Flows: CF1 = 114,300 CF2 = 135,900 CF3 = 135,900 CF4 = 135,900 CF5 = 135,900 CF6 = 135,900 CF7 = 103,435 CF8 = 1,476,746 (130,686+1,346,060) PV of Cash Flows @ 11 percent = $1,246,090
Indicated value
The final value estimate for the subject property resulting from application of one of the major approaches in the appraisal process
Data for five comparable income properties that sold recently are shown below: Property NOI Sale Price Overall Rate A 57,800 566,600 ~ 0.1020 B 49,200 496,900 ~ 0.0990 C 63,000 630,000 ~ 0.1000 D 56,000 538,500 ~ 0.1040 E 58,500 600,000 ~ 0.0975 What is the indicated overall rate (RO)?
The indicated overall cap rate of 10.05 percent is the simple average of the overall rates for the five comparable properties.
You are estimating the value of a small office building. Suppose the estimated NOI for the first year of operations is $100,000. a. If you expect that NOI will remain constant at $100,000 over the next 50 years and that the office building will have no value at the end of 50 years, what is the present value of the building assuming a 12.2% discount rate? If you pay this amount, what is the indicated initial cap rate?
The present value, using a financial calculator, is $817,078. N = 50 I = 12.2 PV = ? PMT = 100,000 FV = 0 The initial (going-in) cap rate is $100,000/$817,078 = 12.24%
Natural vacancy rate
The proportion of potential gross income not collected when the use (rental) market is in equilibrium
Effect gross income multiplier (EFGM)
The ratio of the sales prices to the annual effective gross income of the income-producing property
Describe the conditions under which the use of gross income multipliers to value the subject property is appropriate
The use of gross income multipliers is predicated on two primary assumptions. First, it is assumed that the operating expense percentage of the subject property and the comparable properties are equal. Second, this approach assumes that the subject property and comparable properties are collecting market rents. In practice, gross income multipliers are most appropriate for valuing apartment buildings.
You are estimating the value of a small office building. Suppose the estimated NOI for the first year of operations is $100,000. If you expect that NOI will remain constant at $100,000 forever, what is the value of the building assuming a 12.2% discount rate? If you pay this amount, what is the indicated initial cap rate?
The value of the building with NOI remaining constant at $100,000 is calculated using the formula for a perpetuity, which is $100,000/0.122, or $819,672. If you pay $819,672 for the property, the initial (going-in) cap rate is 12.2% ($100,000 / $819,672)
You are asked to appraise a vacant parcel of land. Your analysis shows that if apartments were constructed, the portion of the NOI attributable to the land would be $30,000 per year. If offices were constructed, the portion attributable to land would be $25,000, and the portion contributed by a small neighborhood shopping center would be $27,500. All of these uses would be legal. If the appropriate RL is 0.105 (10.5%), what is the value of the site?
Using the land income that provides the highest and best use, Land Value = Land Income / Land Cap Rate (RL) = $30,000 / 0.105. == $285,714.29, or rounded $285,700
Going-out cap rate
the ratio of the estimated net operating income in the year following sale to the overall value of the property at the time of the sale
