Aceable Agent Level 19
Approach #2 to Finding a Property's Value: Cost Approach
*Cost Approach* - aka summation approach or reproduction cost approach - the cost approach is a great method to use when putting a value on new construction - used for determining the value of unique, highly specialized, or historical buildings, such as museums or public libraries Steps: 1 Estimate the value of the land itself. 2. Estimate the new construction cost of improvements (using replacement cost, reproduction cost, or another method). 3. Add up any and all types of depreciation. 4. Subtract the accrued depreciation from the new construction cost to get the estimated value of current improvements. 5. Add the land value and improvement value together. Formula: reproduction cost - depreciation + land value = property value
Types of Ages:
1. Chronological age is the literal age of the property. If the home was built 30 years ago, its chronological age is 30. 2. Effective age is an estimated age that is influenced by the updates and quality of maintenance of the property. A 30-year-old house that has been well cared for might have an effective age of a young and spry 15.
Types of Obsolescence
1. Functional obsolescence: loss of value because a property's function or appearance has gone out of style or has been replaced by a more appealing or effective version 2. External (economic) obsolescence: loss of property value caused by negative forces outside the property which are beyond the control of the owner (unfavorable changes in the environment or market)
What two things are property taxes based upon?
1. the tax rate 2. the assessed value of the property taxes are calculated with this formula: *tax rate (X) assessed value = property taxes* - any property tax exemptions should be subtracted from the assessed value *before* it is multiplied by the tax rate
The IRV Formula
3 Steps: 1. Estimate the *net operating income* 2. Determine the *capitalization rate* 3. Apply the IRV formula to arrive at a *value estimate* formula: net operating income (I) / Capitalization rate (R) = Value (V)
Functional Obsolescence
A loss of value to an improvement to real estate arising from functional problems, often caused by age or poor design.
What are ad valorem taxes based upon?
Ad valorem taxes are based upon the value of the property
Age-life Depreciation Equation
Age of property / total useful life = depreciation (%)
An appraiser using the sales comparison approach will be most focused on what?
An appraiser using the sales comparison approach will be most focused on the market demand.
Situations Involving Appraisal
Any sale of real estate Mortgage lending, especially for government-backed loans Setting rental rates for leased property Finding investment values Government acquisitions of property Acquiring property insurance Tax assessment appeals
Subject Property Value Formula
Comparable Property sales (+/-) Adjustments = Subject Property Value
Georgia Uniform Percentage
In Georgia, property is required to be assessed at 40% of the fair market value unless otherwise specified by law. So, to find the assessed value of a property in Georgia, you just need to multiply the market value by 40%. If a home in Kennesaw has a market value of $200,000, calculating it's assessed value looks like this: So, $80,000 of the property's value can be taxed.
External Obsolescence
Losses of property value caused by forces or conditions beyond the borders of the property. The losses are deducted from a building's reproduction cost in the cost approach to estimating market value
In real estate transactions involving financing, to whom does the appraiser send the final appraisal?
The final appraisal is sent to a lender. The appraisal will then be reviewed by the underwriter to make sure it was done properly, and it will be checked to ensure it meets the lender's standards.
What are the three approaches to value?
The three approaches to value are the sales: 1. Sales comparison approach 2. Cost approach. 3. income capitalization approach
Potential Gross Income (PGI)
The total annual income the property would produce if it was at 100% occupancy (all units rented out) formula: contract rent + projected rent = PGI
Effective Gross Income (EGI)
The total annual income the rental property produces after subtracting vacancy losses from the potential gross income (PGI) and adding miscellaneous income - does not account for any expenses; only the total income produced by a property formula: PGI + other income - vacancy cost= EGI
Highest and Best Use Principle
The use for a property which will bring the best or highest returns or advantage as of a certain time; there is one most profitable and efficient use of any given tract of land, and this best use should dictate a tract's development. A property's highest and best use is achieved when the property is used for the most appropriate purpose and yields its highest possible returns.
The 8 Steps of Appraisal
There are eight steps to completing an appraisal: 1. Stating the objective 2. Listing the data needed 3. Gathering and recording data 4. Determining the highest and best use 5. Estimating the land value 6. Estimating value using applicable approaches to appraisal 7. Reconciling the final value estimate 8. Completing and presenting the value report
Methods for Determining Cost within the *cost approach*
There are several methods used for determining the new construction cost of improvements within the cost approach: 1. The quantity survey method- This involves the appraiser individually tallying up the value of everything that goes into the cost: labor and equipment, raw materials, business overhead, and other fees 2. The Unit-in-place method is less granular. It takes direct and indirect costs into account, but combines them into a simplified cost for a building component. 3. The square foot method is possibly the least accurate method, but it's the simplest and most widely used. The appraiser estimates a cost per square foot for that specific type of building and then multiplies it by the square footage of the structure.
Reconciliation
When an appraiser uses more than one method to estimate the value of a property, they should combine the data from each of the approaches An appraiser should not simply average the numbers. Instead, the appraiser should put the most weight on the data and approaches that are most relevant to the subject property.
Uniform Percentage
a percentage that is applied to the full market value of every property in a municipality - this %, multiplied by the property's full market value, yields the assessed value of a property - can be any number 100 or below, meaning a property's assessed value could be 50% of its market value, or maybe a full 100% of it's market value
Net Operating Income
a property's annual income that remains after paying its operating costs; income before interest and income taxes have been deducted; the most accurate representation of how much money a property actually brings in EGI - operating expenses = NOI
Cap Rates
a rate of return that calculates the percentage of expected annual income earned over a property's value; its the present value for expected future income earned -written as percentages; the # is the % of the value that an investor can expect to be returned to them in a given year formula: *net operating income / property value = cap rate* step 1: divide the NOI by the property value step 2: convert the decimal to a %
depreciation
a reduction in value for any reason 2 types: 1. Physical Deterioration- the loss of value caused by physical wear and tear over time 2. Obsolescence- a property's loss of value due to economic or functional factors 2 classifications: 1. Curable- If something is curable, that means it can be fixed and that the cost of doing so would be reasonable. 2. Incurable- could mean it's impossible to fix; but in most cases, it means that fixing it would not be worth the expense. EXAMPLES: -Curable physical deterioration: a broken window that can be replaced -Incurable physical deterioration: a major foundation problem that would cost more to fix than the structure is worth -Curable functional obsolescence: electrical wiring that can easily meet current safety standards if updated Incurable functional obsolescence: a very outdated floor plan and no HVAC system -Curable external (economic) obsolescence: No examples, because there is no such thing! By definition, the owner cannot fix the external factors causing depreciation of the property. -must be factored into the cost approach to finding value because, without it, you would be comparing a property to it's brand-new equivalent (which is more valuable because its new) -undeveloped land is never subject to depreciation
Evaluation
a statement regarding the usefulness or utility of property, but not the value of it. It's a study of the nature, quality, or utility of certain property interests in which a value estimate is not necessarily required. This sets it apart from an appraisal or valuation, which are more focused on determining value.
assessing unit
aka approved assessing unit; a department that has the power to assess real property (Such as a city, town, or county ); these units evaluate every piece of real property in their jurisdiction
Sales Comparison Approach
aka direct sales comparison approach or market data approach; property appraisal method that estimates value by comparing the subject property to the sales prices of similar properties in the same market area; the appraiser is concerned with the local market demand for the property
Income Capitalization Approach
aka income approach - appraises real estate based on it's income- it converts the income of a property into an estimate of it's value -determines an investment property's value based on its return y dividing its net operating income (NOI) by the capitalization rate (cap rate) of the property. The cap rate is the ratio of NOI to property value - generally used for commercial buildings formula: net operating income (I) / Capitalization rate (R) = Value (V)
Straight-line cost recovery
an accounting method in which depreciation expenses are deducted from a property's value.
Appraisal
an impartial, qualified appraiser's opinion of the value of a specific property as of a specific date, supported by relevant market information. It's very official. This unbiased estimate of value considers the nature, quality, and utility of an interest in or aspect of an identified piece of real estate and related property - the lender chooses the appraiser in a real estate sale to ensure that the appraiser won't be biased towards either party -any type of property can be appraised
Real Estate Appraiser
an individual authorized to perform appraisals, which estimate the value of real property -supply impartial and unbiased information in order to estimate the market value of a property - Appraisals must be done by certified real estate appraisers, NOT real estate agents -the Uniform Standards of Professional Appraisal Practice (USPAP) is the ethical code appraisers must follow
Gross Income Multiplier
analysis of income including rental and other forms of income from things like coin laundry, application processing fees, & various other fees to solve for GIM, add additional costs into the annual income that a property price is divided by
Appraisals & Loan-to-Value Ratio
lenders limit the amount of the loan to a certain percentage of the home's appraised value or sales price, whichever is lower. This limit is expressed as a loan-to-value ratio, or LTV.
Income capitalization approach
method of estimating the value of a property by applying a rate of return to the net income it produces
Cost Approach
method of estimating the value of a property by determining how much it would cost to replace the building or other improvements, minus the cost of depreciation, plus the value of the land itself
Vacancy cost
represents the loss of a property receives due to vacancies or collections
replacement cost
the cost of giving the new building similar features using comparable modern materials at current prices.
reproduction cost
the cost of procuring exact copies of the building's components, preserving the styles and materials used at the subject property's original construction. (You probably wouldn't do this unless the goal was to recreate the look of a historical building.)
Economic Life
the length of time for which an improvement on a property is expected to remain functional and useful.
Operating Expenses
the occasional or continuous expenses required for the operation of an income-producing property. EX: the salary of the building staff or maintenance costs.
Valuation
the process of collecting information and developing an opinion of value for real property; an estimation of value of an identified interest in a specific property as of a given date. The difference is that valuation does NOT have to be performed by a licensed appraiser.
Gross Rent Multiplier (GRM)
the ratio of the price of an investment property to its annual rental income before considering expenses like taxes and insurance property price / annual rent income = GRM step 1: multiply the monthly rent by 12 step 2: divide the selling price by the annual rental income
assessed value
the value placed on a property by a governmental unit for use in calculating property taxes -property taxes are ad valorem taxes, which means "according to value." For this reason, taxing authorities assess properties in order to determine how much owners owe in taxes full market value (X) uniform percentage = assessed value
how to get an assessed value
to get an assessed value, an assessor must make an assessment, or a determination of the market value of a property (assessing units employ assessors to perform these assessments ) -properties are reassessed every few years with updated assessment values -frequent reassessments mean that taxpayers are responsible for fair, equitable portions of their tax burden -Property taxes are ad valorem taxes, which means "according to value." For this reason, taxing authorities assess properties in order to determine how much owners owe in taxes.
