Ch. 16 - Types of Appraisal

Direct costs (hard costs)

- cost of labors; Materials Labor, including contractors and subcontractors Equipment Profit Overhead Storage of materials during construction Security during construction Temporary construction building Temporary walls and fencing Utilities used during construction Contractors' performance bond

Cost Approach

- used when a separate valuation of a property's improvement is needed. -useful in determining the estimate of special purpose property values when there is no real "market" of such properties. (public buildings, schools, and churches.) - based on the assumption that the cost of acquiring a site, improving the site to make it suitable for building, and producing the building, provides a good indication of what a property is worth.

short-lived vs long-lived components

--Short-lived components-- refer to the items whose remaining physical life is less than, or shorter than the overall property's total estimated remaining economic life. -these are factors that will have to be replaced as they wear out over the years—the roof, painting, gutters, kitchen cabinets and counters, decorating, etc -Because these items cannot be fixed, but can be replaced, they are often referred to as physical deterioration-curable-deferred. --Long-lived components--impact the entire property because they are not easily replaced. These components include such items as the property's foundation and footings.

Construction Cost Estimates

-All materials -Equipment -Labor

Abstraction Method

-Appraisers apply the abstraction method of depreciation by using market data to discover some indication about a property's depreciation amount.

3 techniques to measure depreciation

-Breakdown method-- separates depreciation charges based on origin of the loss (or what caused it) with each component estimated separately through either observation or the engineering method. -Abstraction or market method-- extract depreciation directly from the market. -Age-life method-- use this method to estimate the improvements' typical economic life and their effective age.

three main appraisal methods.

-Cost -- Method of estimating value based on the economic principle of substitution. Per this approach, the value of a building cannot be greater than the cost of purchasing a similar site and constructing a building of equal utility. -Income --Means of appraising property based on the assumption that value is equal to the present worth of future rights to income. -Sales comparison --A valuation method based on the substitution principle. It involves evaluating the subject property against comparable ones that have lately sold. --When used together, each approach keeps the others in check and limits the value range the final figure will fit into.

Incurable Functional Obsolescence: Deficiency or caused by "Super adequacy"

-Deficiencies--components that simply do not meet the current expectations of the market. For example, a home without a dishwasher. The appraiser measures deficiencies based on the rent loss that can be attributed to that deficiency multiplied by the property's applicable gross monthly rent multiplier. -Super adequacies --(functional obsolescence-super adequacy)--improvements that were made after the property's construction or anything that was originally constructed with the house, if those components do not add value that is, at a minimum, equal to the cost of those components. Super adequacies are usually components added by the homeowners that are suited for their unique living style/needs but that have little value/usefulness to others. -the older the house is the more super adequacies it has because its owners want to improve it. -large percentage of super adequacies are incurable.

What are the two analytical tools used in data analysis and comparison?

-Elements of Comparison -Units of Comparison

External Obsolescence vs Functional Obsolescence

-External obsolescence -- caused by changes external to the property, such as the decline of value in a neighborhood, or other negative environmental force -Functional obsolescence--caused by changes within the property, such as a poor floor plan, mechanical inadequacy or over-adequacy, or functional inadequacy or over-adequacy due to the property's size, style, age, or other "internal" factor that limits its use or functionality.

General vs. Specific data

-General data - This is information about the property's location - its country, region, city, and, most importantly, its neighborhood. The neighborhood helps the appraiser determine those social, economic, physical and political influences that directly impact the property's value and potential. -Specific data- This information pertains to the subject property and to comparable properties in the market area—physical, legal, locational, cost, income and expense information, as well as details about the prices of comparable sales.

Quantity Survey Method of Costing Improvements;

-Many contractors use this comprehensive method to build a house. -creates a very detailed inventory of all the necessary materials and equipment to build the house. -applying the cost of each item (as of the appraisal date), and estimating the number of labor hours needed to install each item, using the current (again, as of the appraisal date) labor rates. -Finally, the appraiser must add the other costs—overhead, profits, and any indirect costs—to the costs of the materials, labor, and equipment.

Two types of costing used in cost appraising--replacement cost and reproduction cost.

-Replacement Cost-- the cost of creating a structure and other improvements that provide the same or very similar usefulness, but using current material and design standards, based on the current prices for materials and labor. -Reproduction Cost --the cost of constructing an exact duplicate of the subject building at current prices. -is easier to use, it is less practical, because identical materials (as those used in older buildings) are difficult to find and and construction methods and design continually evolve (and old construction methods become outdated)

appraisal report forms

-Short- or long-form narrative reports--is that the appraiser provides all the information needed to support the value conclusions, estimates, and opinions expressed in that report to convince the client that the value estimate is sound. -Form reports--majority of today's single-family appraisals are made on the uniform residential appraisal report (URAR). Small income properties, planned unit developments, cooperatives, condominiums, and commercial reports, Freddie Mac and Fannie Mae also use other forms. -Letter or oral reports--it is the appraiser's responsibility to keep and maintain all related notes, records of fact, and all information regarding each value analysis, opinion, and conclusion the appraiser reached and expressed within that letter or report.

3 costing methods

-Square foot or cubic foot method--comparative-unit method, the appraiser multiplies the cost per square foot (or cubic foot) of a recently built comparable structure by the number of square feet in the subject property. -more generalized look at the costs -Unit-in-place method--segregated cost method, the appraiser multiplies the construction cost (including the construction materials, labor, overhead, and the builder's profit) per square foot by the number of square feet of that component part in the subject building. -more generalized look at the costs (more exact than square foot method) --Quantity survey method--an appraiser adds the total costs (both direct and indirect costs, which include the site preparation, all phases of construction, the fixtures, and other expenses) to build or install all of a new building's component parts. -most accurate cost estimate because all of the building's components are analyzed. This method is generally the one used by builders, contractors, and cost estimators.

Capitalization Rate

-The rate of the return on an investment -way to figure out how much they should pay for a particular property. -determined by extracting and then applying the sales of similar investment properties to the subject property's net income.

Indirect costs (soft costs)

-any construction-related costs that do not fall under the heading of "direct costs" are part of the indirect costs: Professional services, which include architect's fees, surveyor's fees, engineer's fees, appraisal fees, and legal fees and expenses Developer's overhead expenses Building permits and licenses Interest and taxes Insurance premiums Expenses associated with selling, including commissions, advertising, promotions, etc. Carrying costs from the time of the property's completion until it is sold or occupied

Incurable Physical Deterioration

-based on the physical condition of the property's components, most often occurs because the property and/or its components are old and have suffered wear and tear. -the property's total physical life would equal its total economic life if there were no other forms of depreciation.

Depreciation

-difference between the current cost of an improvement on the date of the appraisal and the value of the improvement in place on the property. - or loss of utility (usefulness) and consequently, value, from any cause or for any reason; or as an effect caused by deterioration and/or obsolescence.

Sales Comparison Approach

-formerly known as the market data approach - requires an appraiser to make direct comparisons between the subject property (the one being appraised) and other sold or listed (for sale) properties. -it provides the best indication of a property's market value. -used for all types of properties to determine market value and provide a broker's opinion of value.

Age life method

-house's lifespan in various ways, as follows: Physical life Economic life Remaining economic life Effective age -The age life method of estimating depreciation is based primarily on observation.

Principle of Substitution

-important factor in the market data approach to valuation. -when there are several commodities, products, or services that offer or provide the same basic uses (which fulfill the buyer's needs or desires), the one priced the lowest will be in the most demand, and consequently, receive the widest distribution.

Curable Physical Deterioration

-include the typical maintenance tasks that any prudent homeowner should have completed by the appraisal date to ensure he receives the maximum profit when he sells his home. -minor plumbing, electrical and carpentry repairs (in other words, fixing that leaky faucet, squeaky door, or too-tight window), interior and exterior painting (or at least paint touch-ups), minor redecorating, and other relatively inexpensive fixes. -although almost all physically deteriorated components can be cured (corrected) at a price, for a physically deteriorated element to classify as "curable," the cure or fix must contribute more money to the home's value than the cure costs.

Income Approach

-is a valuation method used to estimate the value of income-producing real estate: commercial properties and investment properties. -The premise of anticipation - the expectation of future benefits - forms the basis of the income approach. -Appraisers use it to determine how much money a property can be expected to earn in the future. -methods of calculating the income approach, including direct capitalization, gross income multiplier, and discounted cash flow methods.

Highest and Best Use

-is determined by market forces, not by the owner, developer, or appraiser. -reflects how the property is perceived in the marketplace and provides the basis for investigating all aspects of the subject property's competitive position in the market. -should specify when the optimal use could be achieved and who would be the most likely buyer or user.

Curable Functional Obsolescence

-is due to a deficiency of some type, such as the need for an additional bathroom (in those homes where there is enough space for one), or the need for new counters, fixtures, or cabinets in a kitchen. -can be caused by other deficiencies like inadequate electrical service and hot water systems. -to determine if a particular form of obsolescence is curable, it must be determined if the value added by correcting the problem is more than it costs for the correction itself.

Obsolescence

-loss of utility in an asset (in this case, real estate). It is therefore a key consideration in the value of a property because it directly affects the property's usefulness. If a property stops being useful, it loses its value to people.

External (economic) obsolescence

-the loss of value to a property's improvements that is caused by factors that are external to (or outside of) a property's boundaries. -caused by the property's specific location - its region, community, or neighborhood - and is incurable because there is no way for the property owner to "fix" a problem that exists outside of his or her property's boundaries. -external factors that can negatively impact a property's value include unattractive natural features (swamps and gross rivers), poorly maintained houses as neighbors, nearby highways, economic forces, transportation, property taxes, employment opportunities, government actions, educational services

Direct Capitalization

-used when a property's income is not expected to vary (much) over time, does not require specific income projections -direct capitalization assumes that the subject property and comparables' future income expectations are basically similar.

Five methods of direct capitalization.

1)Contractor's Method (or Cost Method)-- used only to value properties that are not sold or purchased on the market (general appraisal principle of cost approach) 2)Development Method (or Residual Method)--only used to value bare land, or to value properties that are immediately ready for development or redevelopment. (general appraisal principle of cost approach) 3)Comparable Method- sales comparison approach-- used for most property types, as long as there is sufficient evidence of previous sales. 4)Investment Method/Income Method--used for most rent-producing (leased) commercial (and residential) property 5)Accounts Method/Profits Method--used in the practice of trading properties such as restaurants, nursing homes, or hotels - where there is little existing or available rate-specific evidence.

Steps in Sales Comparison Approach

1)studying the market and selecting the comparable 2)Collect and verify the data 3)analyze and compare each individual comparable w/ subject 4)analyze and compare each individual comparable 5)reconcile the newly adjusted prices of the comparables to develop an indicated value

Unit-In-Place Method Steps:

1-Divide the building into different components. 2-Estimate the cost of labor and material that would be needed to install each unit into the building. 3-Compile the costs of these components as of the date of the appraisal.

Five steps to creating a value estimate using the income approach;

1-Estimate the property's annual potential gross income. 2 -Deduct an appropriate, market-based allowance for losses due to vacancies and collections. (effective gross income) 3-Deduct the property's annual operating expenses( management costs, NOT mortgage payments), from this effective gross income to determine the property's annual net operating income. 4-Create an estimate of what the typical property investor would pay 5-Apply the cap rate to the annual net income of the subject property to arrive at the property value estimate.

Square Foot Method of Costing Steps:

1-Find the dimension of the building. 2-Use that dimension to calculate the number of square feet of ground covered by the building. 3-Calculate the cost of a comparable new building; use that cost data to create the estimate. If no such (new) comparable data is available, the appraiser should use the basic construction prices from a cost manual.

Gross Rent Multiplier (GRM)

1-Select a gross rent multiplier by examining the sales price and monthly rents of comparable properties that have recently sold. 2-Estimate the value of the subject by multiplying the selected gross rent multiplier by the subject's monthly income. -Sales Price ÷ Gross Rent = Gross Rent Multiplier -Monthly Rent x GRM = Estimated Value -Sales Price ÷ Gross Annual Income = Gross Income Multiplier

Steps in Cost Approach

1-estimating the site value. 2-estimate the improvements' reproduction cost. 3-estimate the amount of depreciation from all causes (physical deterioration, functional obsolescence, and external obsolescence.) 4-subtract the total estimated depreciation from each improvement's reproduction 5-add the following numbers to derive the applicable value: the value of the site, the value added by landscaping and other site improvements, and the cost of all the improvements at their depreciated value (in other words, the improvements less the applicable depreciation).

Explain reconciliation.

After determining the three separate estimates, the appraiser must reconcile the various estimates to create a statement of the property's final value estimate. -final resolution, the bringing together of the valuation methodology, to arrive at a supportable, final conclusion.

Reproduction cost is the dollar amount required to construct what? A structure that provides the same or very similar usefulness, but using current material and design standards A similar property An antique replica item An exact duplicate, but at current prices

An exact duplicate, but at current prices

Why must an appraiser be careful when using an age of life method of depreciation?

Appraisers must be extremely careful in using this method because errors are not uncommon when estimates are significantly based on observation.

What types of properties is the income approach used to value? Residential properties only Residential and commercial properties Investment and residential properties Commercial and investment properties

Commercial and investment properties

comparable supply data vs comparable demand date

Comparable supply data -- analyze will include existing and proposed inventories of competitive properties, and vacancy and absorption rates. Comparable demand data -- process and analyze will include demographic, income, employment, and other such information descriptive of potential users/owners of the subject and its comparables.

What are the three most reliable sources for obtaining cost data?

Cost Services Cost Indices Cost Data File

What type of components include typical maintenance tasks that any prudent homeowner should complete, prior to appraisal, such as minor plumbing, electrical repairs and carpentry repairs? Functional obsolescence Curable physical deterioration Long-lived components Specific components

Curable physical deterioration

Curable vs Incurable

Curable--something that can be fixed or otherwise remedied. Incurable--something that is permanent and cannot be undone or repaired.

Steps in Appraisal Process

Define the problem Plan the work Collect data (accurate data in a methodical manner is absolutely mandatory) Analyze and process data (general market and the specific property) Apply three approaches of value Reconcile final estimate Communicate final value

What is defined as the difference between the current cost of an improvement on the date of the appraisal and the value of the improvement in place on the property? Allowance Value Depreciation Inflation

Depreciation

Advantages and Disadvantages of Income Approach

Disadvantages: -relevant information is not available or readily accessible from internal reporting systems. -requires subjective cash flow allocation. - appraiser forced to use limiting assumptions. Advantages: -no need for market transactions because this approach does not use comparable market info, but instead, gathers the future returns from the owner. -illustrates the relationship between the returns of investment on a security and the returns on the overall market portfolio. -uses forecasted cash flows or technology-generated earnings (or tech-related cost savings). -uses the capitalization technique to calculate the systematic component of risk. -uses the IP asset's discounted rate - which considers the systematic risk - to calculate the present value of its cash flows.

What is the first step to value in the income approach? Estimate potential gross income. Estimate effective gross income. Calculate NOI. Report findings.

Estimate potential gross income.

Describe the difference between external and functional obsolescence.

External obsolescence is caused by changes external to the property, such as the decline of value in a neighborhood. Functional obsolescence is caused by changes within the property, such as a poor floor plan or mechanical inadequacy or over-adequacy.

Obsolescence is divisible into two parts. What are they? Functional and external Internal and external Functional and decorative Functional and nonfunctional

Functional and external

Income Capitalization Formula

Income/Rate = Value Income/Value = Rate Value x Rate = Income

What does the sales comparison approach require an appraiser to do?

It requires an appraiser to make direct comparisons between the subject property (the one being appraised) and other sold or listed (for sale) properties.

Which of the following is NOT a disadvantage of using the income approach? At times, relevant information is not available from internal reporting systems. It requires subjective cash flow allocation. The appraiser is forced to use limiting assumptions. It requires an objective cash flow allocation.

It requires an objective cash flow allocation.

When information is available on a sufficient number of comparable sales, offerings, and listings in the current market, the resulting pattern is the best indication of what? Market value for the subject property Cost new for the subject property Future income potential for the subject property Market oversaturation

Market value for the subject property

What types of expenses are NOT considered operating expenses?

Operating expenses do not include debt service, expenditures for capital improvements, or expenses not related to operation of the property.

What is evidenced by an improvement's decay, cracks, structural defects, wear and tear, dry rot and more? External obsolescence Physical depreciation Deficiencies Adequacies

Physical depreciation

What is not a method by which an appraiser can estimate a building's replacement or reproduction cost? Square foot method Unit-in-place method Quality assurance method Quantity survey method

Quality assurance method

What is the formula for determining the gross income multiplier? Sales Price x Gross Annual Income Sales Price ÷ Gross Annual Income Sales Price ÷ Net Annual Income Sales Price ÷ Gross Adjusted Monthly Income

Sales Price ÷ Gross Annual Income

What is not a value approach an appraiser will use to derive indications of value? Sales comparison Cost Systematic comparison Income capitalization

Systematic comparison

What are the criteria for using the "matched pairs" technique?

The appraiser must choose two sales in the market. One sale must contain the item for which the adjustment is being sought. The other must not contain that adjustment item.

After estimating the property's annual potential gross income, then deducting an appropriate, market-based allowance for losses due to vacancies and collections, the remainder is termed what?

The property's effective gross income

What cost improvement method begins with the contractor listing all materials, equipment and labor necessary to install each item? The segregated cost method The quantity survey method The comparative-unit method The unit-in-place method

The quantity survey method

What is the only technique acceptable to many sophisticated purchasers of appraisals? The technique of comparison The sales technique The technique of matched pairs The value of technique

The technique of matched pairs

The final value selected is a judgment made by the appraiser based on the comparable sales used within the last 12 months. the most reliable indicators. the most recent comparables. all the information available.

all the information available.

Potential gross income minus an allowance for vacancy and credit losses equals: net operating income. effective gross income. gross income. total operating expenses.

effective gross income.

To begin the square foot method of estimating reproduction cost, the appraiser must: find the square foot price for the component. determine depreciation. find the dimensions of the subject building. calculate the cost of a new building.

find the dimensions of the subject building.

The ratio to convert annual income into market value is called: the cap rate. gross potential income percentage. gross income multiplier. direct capitalization multiplier.

gross income multiplier.

The technique to extract the amount of the adjustment from the market is called: elements of similarity. comparable sales. exact comparables. matched pairs.

matched pairs.

preliminary survey

sets the stage for determining the most effective way to accomplish the appraisal.

Appraisers must follow the accepted procedure of reviewing and judging each sale based on how it compares to the: sold properties. neighboring properties. subject property. listed properties.

subject property.