Real Estate Principles Chapter 10

Four types of physical deterioration

1) deferred maintenance 2) normal wear and tear 3) breakage 4) ageing of building materials

Property Depreciation According to the IRS

27.5 years and commercial is 39

Sales Comparison approach

One of the three major valuation methods, which compares a subject property's characteristics with those of comparable properties which have recently sold in similar transactions.

Chronological Age

The actual age of a building.

Physical Obsolescence

The loss in value due to the actual wearing out of the improvements.

Real Estate Agents use 3 approaches to determine the value of a property

1) sales comparison approach 2) cost approach 3) income approach

Principal of Contribution

A component part of a property is valued in proportion to its contribution to the value of the whole. Holds that maximum values are achiever when the improvements on a site produce the highest (net) return, commensurate with the investment.

Scarcity

A lack of supply

Economic Obsolescence

A loss in value due to factors away from the subject property but adversely affecting the value of the subject property.

Principal of Substitution

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

Cost Approach

An appraisal method whose process of estimating the value of a property by adding to the estimated land value the appraiser's estimate of the reproduction or replacement cost of the building. Used for specialty properties.

Over Improvement

An improvement which is not the highest and best use for the site on which it is placed by reason of excess size and cost.

Remaining Economic Life

Equals the economic life minus the effective age.

Principal of Supply and Demand

In appraising, a valuation principle stating that market value is affected by the intersection of supply and demand forces in the market as of the appraisal date.

Physical Deterioration

Loss in value caused by unrepaired damage or inadequate maintenance. Physical deterioration may either be curable or incurable.

Value

Present worth of future benefits arising out of ownership to typical users/investors.

Economic Life

The amount of years a building can produce an income.

Effective Age

The conditional age of a building.

Demand

The supply of willing and able buyers in the marketplace or lack thereof.

Fair Market Value (FMV)

This is the amount of money that would be paid for a property offered on the open market for a reasonable period of time with both buyer and seller knowing all the uses to which the property could be put and with neither party being under pressure to buy or sell.

Gross Income

Total income from property before any expenses are deducted.

Principal of Conformity

Value is created when properties tend to be similar in a particular neighborhood.

Principal of Change

Holds that it is the future, not the past, which is of prime importance in estimating value. Change is largely the result of cause and effect.

Functional Obsolescence

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

Straight Line Depreciation

A method of depreciation under which improvements are depreciated at a constant rate throughout the estimated useful life of the improvement.

appraisal

A written statement, independently and impartially prepared by a qualified appraiser setting forth an opinion in a federally related transaction as to the market value of an adequately described property as of a specific date. It is supported by the presentation and analysis of relevant market information. An estimate of the value of property resulting from an analysis of facts about the property. An opinion of value.

Sales Comparison Approach

An appraisal method whose process of estimating the value of a property by examining and comparing actual sales of comparable properties. used for residential properties (1-4 family).

Cost Approach

One of three methods in the appraisal process. An analysis in which a value estimate of a property is derived by estimating the replacement cost of the improvements, deducting therefrom the estimated accrued depreciation, then adding the market value of the land.

Depreciation

The ability to deduct expenses on improvements made to income producing property.

Utility

The ability to give satisfaction and/or excite desire for possession. An element of value.

Effective Gross Income

The amount of income produced by a piece of property, plus miscellaneous income, less vacancy costs and collection losses.

Federal Reserve System

The federal banking system of the United States under the control of central board of governors (Federal Reserve Board) involving a central bank in each of twelve geographical districts with broad powers in controlling credit and the amount of money in circulation.

Depreciation

The loss of value of property brought about by age. Physical deterioration of functional of economic obsolescence.

EFFECTIVE AGE OF IMPROVEMENTS

The number of years that is indicated by the condition of the building materials. Which is distinct from chronological age.

Law of Progression

The worth of a lesser valued residence tends to be enhanced by association with higher valued residences in the same area.

Objective Value

What something is worth when there is a reasonably prudent seller and a reasonably prudent, willing and able buyer, and all else remains equal without coercion and transacted at arm's length.

Subjective Value

What something is worth to an individual person without regard to market conditions.

Net Operating Income

The annual income generated by an income-producing property after taking into account all income collected from operations, and deducing all expenses incurred from operations.

Tax Depreciation

the reduction in taxable income intended to reflect the wear and tear that income properties experience over time. The homeowner can write-off the depreciation of their property as an expense. The straight-line method is commonly used in real property.

Federal Funds Rate

The rate at which member banks charge each other for borrowing short-term money.

Economic Obsolescence

A loss in value due to factors outside the subject property, such as changes in competition or surrounding land use. Also referred to as external obsolescence. (proximity to a landfill, decrease in local pop)

Appraiser

One qualified by education, training and experience who is hired to estimate the value of real and personal property based on experience, judgment, facts, and use of formal appraisal processes.

Functional Obsolescence

A loss of value due to adverse factors from within the structure which affect the utility of the structure, value and marketability.

Under improvement

An improvement which, because of its deficiency in size or cost, is not the highest and best use of the site.

Law of Regression

Where a property is "over improved" relative to other surrounding properties in the area that are of lesser value.

Highest and Best Use

An appraisal phrase meaning that use which at the time of an appraisal is most likely to produce the greatest net return to the land and/or buildings over a given period of time; that use which will produce the greatest amount of amenities or profit. This is the starting point for appraisal.

Income Approach

An appraisal used to determine the value of a property that produces income or rent - (net annual income = rate of return x market value) - also called capitalization method. Used for valuing commercial properties.

Income Approach

One of the three methods of the appraisal process generally applied to income producing property, and involves a three-step process - (1) find net annual income, (2) set an appropriate capitalization rate or "present worth" factor, and (3) capitalize the income dividing the net income by the capitalization rate.

Principal of Conformity

Holds that the maximum of value is realized when a reasonable degree of homogeneity of improvements is present. Use conformity is desirable, creating and maintaining higher values.

discount rate

The minimum interest rate set by the Federal Reserve for lending to other banks.

Capitalization Rate

The rate of interest which is considered a reasonable return on the investment, and used in the process of determining value based upon net income. Capitalization Rate = NOI / Purchase Price

Principal of anticipation

Affirms that value is created by anticipated benefits to be derived in the future.