Real Property Appraisal

Let's walk through a scenario. Appraiser Allison used various cost manuals and regional multipliers, as well as her own experience, to determine that it would cost $72 / SF to replace the subject property. If the property's square footage is 1,775 what is the estimated cost to rebuild the house?

$127,800 (1,775 square feet multiplied by $72 equals $127,800.)

Using Allison's notations, determine the final estimate of value using the cost approach. Replacement cost= $127,8000; Deterioration = $19,170; Site-value=$25,000

$133,630 (The formula for determining value using the cost approach is Reproduction/Replacement Cost = Accrued Depreciation + Land Value = Overall Property Value: $127,800 - $19,170 + $25,000 = $133,630.)

Jack is appraising a new home and determines that the lot value is $14,000 and the replacement cost is $194,500. He finds no remarkable physical deterioration, but thinks that the lack of a garage impacts the value. Cost manuals indicate that a garage would cost $30,000 to build. Using the cost approach, what might be Jack's final estimate of value?

$178,500 (The formula for determine value the cost approach is Reproduction/Replacement cost - Accrued depreciation + Site value = Property value. The lack of a garage would be considered curable functional obsolescence, and so the $30,000 should be counted as depreciation. $194,500 - $30,000 + $14,000 = $178,500.)

If the net operating income is $40,000 and the capitalization rate is 16%, what is the value of the property?

$250,000 (Remember the IRV formula: Income / rate = Value. In this case: $40,000 / .16 = $250,000)

A property has a value of $300,000. If the capitalization rate is 12%, what is the net operating income?

$36,000 (Remember the IRV formula: Rate x Value = Income. In this case: .12 x $300,000 = $36,000. The NOI is $36,000.)

After looking at a few more comps, Luke determines that a grid rent multiplier of 150 seems to be appropriate for the area and type of property. The two tenants in the building Olivia wants to buy each pay $1,200 per month. Using the GRM, what might be an acceptable offer for Olivia to make?

$360,000 (Multiply the total monthly rent of the building Olivia wants to purchase by the GRM to find the value: $2,400 x 150 = $360,000. Olivia would likely be willing to pay $360,000 for the building.)

Ed is apprising a 60-year-old duplex. He estimates that such a structure should have an economic life of 100 years, but its condition is good, so he puts the effective age at 40. He determines the replacement cost for such a structure is $460,000 and the value of the site is $120,000. Using the cost approach formula, what is the most likely opinion of value?

$396,000 (First, determine the accrued depreciation using the age-life ratio: 40 / 100 =.40. If the cost is $460,000, the depreciation is $184,000 ($460,000 x .40). Subtract depreciation from cost to find value of the structure: $460,000 = $184,000 = $276,000. Finally, add in the site value to find the final opinion of the value: $276,000 + $120,000 = $396,000.)

Before Sam "muddles the waters," let's make sure you can calculate a simple problem using the cost approach formula. Let's say appraiser Jill determines that the value of the site is $118,000. She decides it would cost $322,000 to replace the building. She further decides that the building is exhibiting $30,000 of depreciation. What is her overall opinion of value?

$410,000 (Cost of the building ($322,000) minus depreciation ($30,000) gives us a total building value of $292,000. To that, add the value of the site, or land, to find the overall value: $292,000 + $118,000 = $410,000. Next, Sam will review some basic area calculations before continuing with the cost approach.)

After looking at other properties, Hannah decided an annual gross rent multiplier of 10 was appropriate. The building she's appraising has annual rent of $52,800, annual expenses of $21,000, and annual debt service of $10,000. Using the annual GRM, what value will Hannah most likely put on the building?

$528,000 (The VIM equation uses only income (rent) and a multiplier (gross rent multiplier) to find value. It does NOT factor in any of the building's operating expenses or debt service. The equation is: $52,800 x 10 = $528,000. You can see how simple the gross rent multiplier is, but you can probably also see how limiting it can be in determining true value.)

The rent for each unit of a 10-unit strip mall is $1,000 per month. The annual vacancy rate averages 5% (or $6,000). The expenses for the property come to $30,000 per year with depreciation of $15,000 and debt service of $10,000. What is the net operating income?

$84,000 (NOI = Annual gross income - Vacancy loss - Expenses. 10 units x $1,000 per month x 12 months in a year = $120,000 annual gross income. Subtract vacancy loss ($6,000) and expenses ($30,000) to get $84,000. Depreciation and debt service do not figure into the calculation. So once you know the NOI, what do you do with it? Let's resists IRN and see...)

Hannah is appraising a four-unit apartment building. She finds a comparable property that recently sold for $624,000. Each tenant in the comparable building pays $1,300 rent a month. What is the annual gross rent multiplier?

10 (Four tenants at $1,300 a month is $5,200 every month. We're looking for the annual multiplier, so find the annual gross rent: $5,200 x 12 = $62,400. To find the annual multiplier, divide the value (sales price) by the income (gross annual rent): $642,000 / $62,400 = 10. It's important to read the question carefully.)

What is the capitalization rate of a property that has a value of $450,000 and income of $56,250?

12.5% (Remember the IRV formula: Income / Value = Rate. In this case: $56,250 / $450,000 = 0.125, or 12.5%.)

Licensee Luke's client Olivia is interested in purchasing a two-unit residential building as an investment. Luke researches recent sales in the area and finds a similar though slightly nicer duplex in another neighborhood that just sold for $420,000 where each tenant pays $1,400/month. What would be the monthly GRM, or gross rent multiplier, for this comp?

150 (Simply divide value (sales price of the comp) by income (total monthly rent) to find the gross rent multiplier: $420,000 / $2,800 = 150.)

Sue is appraising a 20-year-old bank building. baed on her research and analysis on the quality of the construction and the local conditions, she determines that the building should have an economic life of 50 years. She also concludes the the building has not been well maintained and has effective age of 30. What is its remaining economic life?

20 years (The remaining economic life is 20 years. This is found by subtracting the effective age (30) from the expected economic life (50).)

Paul is doing an appraisal for Fannie Mae. What is the minimum number of comps he needs to consider when using the sales comparison approach?

3 comps (A minim of three comparable is required by most secondary market lenders to ensure an accurate appraisal from sufficient data.)

A building has an effective age of 20 years, an actual age of 10 years, and a total expected life of 70 years. What is the remaining economic life of the building?

50 years (To calculate remaining economic life, simply subtract the effective age (20 years) from the total expected life (70 years).)

Jake is interested in buying a property with a net operating income of $14,400. If he paid the asking price of $200,000, what is the capitalization rate?

7.2% (Income (NOI) divided by Value (sales price) is .0072 or 7.2%. This cap rate indicates the annual rate of return on the property if it was purchased for cash.)

Gross Income Multiplier

A conversion factor derived from the sales price of a comparable rental property divided by its gross monthly rent and any other miscellaneous income. This factor is multiplied by the estimated gross rent of the subject to estimate its value.

Gross Rent Multiplier

A conversion factor derived from the sales price of a comparable rental property divided by its gross monthly rent. This factor is multiplied by the estimated gross rent of the subject to estimate its value.

Unit-in-Place Method

A cost approach appraisal method for determine the cost of a building that estimates the cost of reproducing a building by looking at the unit cost of each of the component parts of the structure, and adding all of these unit costs together.

Quality Survey Method

A cost approach appraisal method where the appraiser counts the number and type of each part and material that were used to construct the building, and adds a cost for labor, profit, permits, etc.

Depreciation

A loss in value of a piece of property for any reason.

Direct Capitalization Rate

A rate of return, stated as a percent, used to derive a value opinion from the anticipated net operating income a property could generate. It is used for direct capitalization in the income approach. Also called Cap Rate or Rate.

IRV Formula

A simple calculation for finding the net operating Income, the Rate, or the Value of an investment property. When any two factors are known, the third can be determined. Also called Capitalization Rate Formula.

Amenity

A tangible or intangible feature that enhances or adds value to real estate.

Arm's Length Transaction

A transaction that occurred under typical conditions int he marketplace, with each party acting in his or her own best interest.

Improvements

Additions to real property; can be natural (eg. trees or a lot feature), but usually there are man-made; substantial fixtures, such as buildings.

Reserves for Replacement

An amount of money, considered as an operating expense, set aside for future replacement of major items, such as the roof or heating system.

Sales Comparison Approach

An appraisal method that estimates the value of real property by performing a market analysis of the area where the subject property is located. Data are collected and adjustments made for the differences.

Income Approach

An appraisal method that estimates the value of the real estate by analyzing the amount of income the property currently generates, or could generate, often comparing rents and expenses o the subject property to other similar properties.

Cost Manuals

Books, electronic media, and online sources that give estimated construction costs for various types of buildings in different areas of the country.

Reproduction

Building an exact duplicate of the original building, giving the are structure the exact same look and feel as the original.

Replacement

Building the functional equivalent of the original building, using modern materials, usually with one that is the same size, layout, quality, and utility as the original.

Indirect Cost

Costs associated with a construction project, other than labor and materials.

When a property owner sets aside a specific amount of money to replace a furnace in his duplex, it is considered a fixed expense.

False (A big ticket item such as a furnace or new roof is not part of the normal fixed expenses necessary to maintain the property. Instead, it is categorized as reserves for replacement.)

There is NO minimum number of comparable needed to ensure an accurate appraisal with the sales comparison approach.

False (A minimum of three comparable is required by most secondary market lenders to ensure an accurate appraisal from sufficient data with the sales comparison approach.)

After an appraiser makes all necessary adjustments, she can average the value of the comparable to determine the appropriate estimate of value for the subject property.

False (After all adjustments are made, an appraiser must reconcile the adjusted prices of the comparable to estimate the value of the subject property, weighted the comparable as appropriate - never averaging them. And what if you have few comparable? Let's hear from Sam again.)

Once you derive a multiplier for a particular property type, you can use it over and over again with each new property appraisal.

False (Because the one thing that's constant is change, the multiplier you use must reflect what's going on in the market currently. And even if you're looking for the value of two properties on the same day, they could have wildly different multipliers depending on the type of property, the location, etc. Let's go back to Sam...)

A property owner can expect fixed expenses to go down as the vacancy rate goes down.

False (Fixed expenses occur whether the property is vacant or fully leased, and generally do not vary in response to changing levels of occupancy.)

The gross rent multiplier is considered the more accurate application of the income approach than the capitalization rate as it considered expenses.

False (GRM is a simple calculation that does not consider expenses or vacancy/collection losses.)

The unit-in-place method of determining replacement cost is mostly rooted in market data.

False (It's the comparative unit method that uses market data from recently constructed buildings to determine replacement costs. Let's go back to Sam as he continues to illustrate the cost approach formula.)

Land CANNOT decline in value

False (Land CAN decline in value, but land never factors into the determination of depreciation. Land cannot depreciate. Let's jump into some math next as Sam walks through the factors in the cost approach formula.)

An appropriate GRM is determined to be 123.75. The subject's estimated annual rent is $11,400. The estimated value of the property is $1,410,750.

False (The GRM was derived from monthly rents, so first, divide $11,400 by 12 to find a monthly rent of the subject property of $950. Using that monthly rent, the estimated value is $117,562.50 (950 x 123.75).)

A building has an economic age of 60 years and an effective age of 48. If the cost to replace the building the building is $150,000, the building's value is $120,000.

False (The age-life ratio is 80% (48 / 60 = .80). The building has lost $120,000 of the original cost to build the building ($150,000 x .80). That means the value of the value of the current building is actually $30,000 ($150,000 - $120,000).)

When adjusting properties, the subject property is adjusted up or down depending on the features of the comps.

False (The subject property is your base and each comparable is then compared to it. The subject never changes. Sam Martin will summarize this process next.)

The color of carpet in one house compared to another is a significant feature.

False (This is unlikely to be a significant feature. The presence of carpet as opposed to other flooring materials, such as hardwood, could be significant feature, however. An experienced appraiser will have a good idea of what may be significant in the market in which he or she practices.)

When adjusting properties using the sales comparison approach, if a comparable is inferior to the subject, the appraiser subtracts from the comp to make it equal.

False (When adjusting properties, if a comparable is inferior is to the subject, the appraiser adds to the comp to make it equal.)

IRV abréviation

I (income is the net operating income of the property) R (or capitalization rate, represents the amount of return on the purchase price that a buyer expects) V (is the amount one would likely spend to buy the property)

Comparative Unit Method

Method for determining the replacement cost of a building that relies on cost manuals showing the construction costs of recently built comparable buildings. Also called: Square Foot Method.

Net Operating Income (NOI)

Net income after all operating expenses have been deducted.

Fixed Expenses

Ongoing operating expenses that do not vary based on occupancy levels of the property (eg. taxes, insurance).

Variable Expense

Operating expense necessary to the property, but dependent on the property's occupancy level.

Matched Pair Analysis

Process of determining the value of specific property characteristics or features by comparing pairs of similar properties.

Subject Property

Property for which a value estimate is sought. Also called Base.

Comparables

Recently sold properties with similar characteristics (size, room count, design, utility, etc.) that are in close proximity to the property being appraised. Also called Comps.

Economic Age

The age of structure based not eh actual wear and tear that the building shows from physical, functional or external obsolescence; not necessarily the structure's actual age.

Debt Service

The amount of money paid in regular intervals toward reducing the principal and interest owed on a debt.

Site Valuation

The value of land with the enhancements necessary to make it ready for building, such as water, were, electricity, etc.

If the gross rent multiplier is 150, Luke knows that an investor in this neighborhood looking at this type of property is willing to pay 150 times the monthly gross rent to purchase a property.

True (As Sam indicated, what the gross rent multiplier is really telling you is how much an investor is willing to spend to purchase the property. Value = Income x Multiplier. Sam will share another example next.)

The cost approach is the best method for determining the value of unique properties.

True (As Sam mentioned earlier, when there are no comparable properties and when the property is not income-generating, you can always use the cost approach. Next Is the terminology review and unit quiz.)

Allison has determined that the economic life of the building is 60 years, and that its effective age is 9. The total depreciation is $19,170.

True (Divide effective age by economic life to find the age-life ratio: 9 / 60 = .15 or 15%. Multiply that by the building cost ($127,800) to find a depreciation of $19,170.)

When using the age-life ratio to determine depreciation, the actual age of a building is irrelevant.

True (Here, we're looking at its effective age and its remaining economic life.)

The sales comparison approach is considered the most common and useful of the three appraisal methods for residential property.

True (If adequate comps are available, the sales comparison approach is considered the most useful and accurate for residential property since it's rooted in actual market activity.)

In general, when evaluating a property using the cost approach, replacement (rather than reproduction) cost estimates are done for most residential appraisal assignments.

True (In most residential appraisal assignments, cost estimates are done for replacing a building with one that is of similar size and function.)

After the value of a structure is determined, site value is the last element to be considered before arriving at a final opinion of value.

True (Once the value of the structure is determined, the last element to consider is the site value, which must be added to arrive at a final opinion of value for the property.)

Replacement cost per square foot would generally be significant less than reproduction cost per square foot.

True (Replacement cost is more likely to be used for new properties, while reproduction cost is more likely to be used when an exact replica of the building needs to be constructed, such as a historic home. Reproduction costs could be significantly higher and much more difficult to estimate.)

Ideally, comparable properties should be part of an arm's length transaction.

True (The comparable use das the basis for comparisons should be part of an arm's length transaction that occurred under typical conditions in the marketplace, with each party acting in his or her own best interests.)

For a home that has few comparable, the cost approach should carry the most weight in final reconciliation.

True (The cost approach is best for appraising unique properties. We'll look at the next unit, but for now, it's time for the terminology review and the unit quiz.)

The GRM considered only rental income, whereas the GIM considers all sources of potential income.

True (The gross multiplier considers potential income from rent only. The gross income multiplier also considers other sources of income.)

As the capitalization rate goes up, an investor is likely to pay less for the property.

True (The higher the cap rate, the greater risk. Therefore, investors are likely to pay less for a property as the cap rate increases. Sam will walk through another example from beginning to end next.)

Fewer adjustments indicate that the comp is similar to the subject property.

True (The object is to find comparable that are already as close as possible to the base to reduce the number of adjustments that have to be made.)

The cost of the building minus depreciation of the building equals the value of the building.

True (The value of the building its depreciation cost) takes into consideration any depreciation. Then when you add the value of the building to the value of the land, you can find the overall value.)

Homeowner Steve was forced to sell his house quickly because of a lost job, lowering the selling price considerably. Appraiser Andy should take this fact into consideration if using this transaction as a comparable to arrive at an estimate of value on the subject property.

True (This is NOT an arm's-length transaction because the conditions were not typical. A good appraiser makes a serious effort to determine the impact of all significant features and conditions when rendering an opinion of value.)

If appraiser Andy decided to use Steve's property as a comp, he would make the adjustment based on terms of sale first.

True (When making adjustments to this comp, assuming that there is nothing different about the property rights being conveyed, ie. both are fee simple, terms of sale is the first feature/condition that Andy would address.)

If appraiser Gerry has an assignment to estimate the value of an A-frame in a neighborhood of ranches and split levels, the cost approach would be very useful.

True (When there are few, if any, comparable, the appraiser will likely rely more on the cost approach.)

Market Rent

What the property could rent for in the open market if unencumbered by any lease and available.

Functional Obsolescence

When a building is less desirable because of something inherent in the design of the structure.

External Obsolescence

When something outside of a property and outside of the control of a property owner makes it less desirable. Also called Economic Obsolescence.

Do you think you could use the income approach for estimating the value of a single family home you have no intention of renting?

Yes (Even if the property will not be rented, determining the value as IF it were being rented could be helpful. It might help a property owner decide whether to sell the house or rent it out, for example. And remember that an appraiser should consider all three appraisal approaches, making sure to weigh them appropriately when doing final reconciliation.)

Which of these would be considered functional obsolescence?

a bedroom through bedroom floor plan (Functional obsolescence is when a building is less desirable because of something inherent in the design of the structure.)

For which situation would the sales comparison approach be best?

a condo in a complex with high turnover (The sales comparison approach is deal when there is recent sales data in the subject property's area. It's not suitable for special purpose properties or investment properties for which there are not recent sales data to analyze.)

The electrical outlets in Dave's home are out of compliance. It will cost $8,000 to replace them, but will have little if no effect on the value of the property. This would most likely be considered

curable functional obsolescence (While the cost to bring the property up to code is not likely to be reflected in the property's value, if the repair must be affected, the repair is curable.)

Which actions do you think a property owner could take to increase the NOI?

cut expenses, increase the occupancy, and raise the rent. (Debt service does not figure into the NOI equation. The other actions, however, could affect net operating income positively. Now let's review.)

An appraiser used various cost manuals and regional multipliers, as well as her own experience, to determine that it would cost $69 per square foot to replace the subject property. At 2,880 square feet, she determines it would cost $198,720 to rebuild the house. To find the value of the subject property, she must also factor in

depreciation and land value (The cost approach must also take into account the accrued depreciation as well as the value of land.)

That figure of $127,800 does not give us the value of the subject property, however, does it? What must also be considered in order to arrive at an opinion of value using the cost approach?

depreciation, and site value (The cost approach must also take into account the accrued depreciation as well as the value of the site. The labor costs were no doubt figured into the cost to rebuild the house.)

Davis has been trying to sell his house for some time, but buyers seem to be turned off by the odor from a nearby chicken farm. This is an example of

external obsolescence (External obsolescence is when something is outside the boundaries of a property and outside the control of the property owner and makes it less desirable.)

The term "amenities", in reference to real property valuation, refers to the

features, both tangible and intangible, that enhance the desirability of real estate (Amenities, including a historically desirable location, preferred floor plan, or anything with value to a buyer, enhance the desirability of the real estate.)

The second bedroom of a house must be accessed through the first bedroom. This is an example of

functional obsolescence (Functional obsolescence occurs when a building is less desirable because of something inherent in the design of the structure.)

Which examples of deter location would MOST LIKELY be considered curable?

furnace too small for size of home, peeling paint on home's exterior, and shingles on roof damage (these would most likely be considered curable.)

Net operating income is calculated as

gross income minus operating expenses (In its simplest application, NOI is defined as gross income minus operating expenses.)

Which would most likely NOT be considered functional obsolescence?

home with crumbling roof (Functional obsolescence is a problem with the design of the structure itself. A roof can be replaced relatively easily; it's an example of physical deterioration.)

Which homes should an appraiser consider when finding comps?

homes that have sold recently in the subject's area (When an appraiser is looking for comps, he or she will look only at homes that have sold recently.)

When using the sales comparison approach to arrive at an opinion of value, an appraiser

looks into the recent past to analyze similar sales (The sales comparison approach looks at past sales that are similar to the subject property and that have recently sold in the area.)

Of these expenses, which would be included in the calculation to find net operating income?

property management fees, reserves for replacement, and property tax. (Of these, the net operating income should take into consideration property taxes, property management fees, and reserves for replacement. Debt service and depreciation are NOT counted toward the NOI.)

When completing the sales comparison approach, which is considered first in the sequence of adjustments?

property rights conveyed (The first adjustment to be made would be any difference in the property rights conveyed, for example, if the subject will be transferred fee simple and the comp was transferred as a leasehold estate. Some adjustments must be made first because they are adjustment as a percentage of the comparable's sales price, rather than a set dollar amount.)

Comp #2 has a deck: the subject property does not have a deck. Through matched pair analysis, the appraiser has determined that a deck in that neighborhood is worth $3,000. What is the appropriate way to apply this information when performing the sales comparisons approach to valuation?

subtract $3,000 from Comp #2 value (When making adjustments, you subtract the value of an additional feature from the comp's value.)

Comp #3 has five bedrooms; the subject property has four bedrooms. Through matched pair analysis, the appraiser has determined that a bedroom in that neighborhood is worth $7,500. What is the appropriate way to apply this information when performing the sales comparison approach to valuation?

subtract $7,500 from Comp #3 value (When making adjustments, an appraiser subtracts the value of an extra feature from the comp's value.)

Fiona is appraising a home that was built in 1875. Because of its unique architecture, it is on the National Register of Historic Places. Which cost estimate is Fiona more likely to need?

the reproduction cost (In this case, Fiona would most likely want to consider the reproduction costs in order to build an exact replica of this historic building.)

Which of the following would NOT suffer from depreciation?

unimproved land (Only improvements are depreciated, not land)

When performing the sales comparison approach, comparable sales should be

very similar in most respects (Comparable sales should be very similar in most respects.)