Chapter 11 - Appraisal & Market Analysis

Question 1

Appraisal

Answer 1

An estimate of the value of property resulting from an analysis of facts about the property at a specific time. An opinion of value. An appraisal is typically done when there’s a transfer of property, for financial reasons (i.e., refinance), or for tax purposes (i.e., estate planning).

Question 2

Appraiser

Answer 2

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 process.

Question 3

What factors come into play when valuing/appraising a property?

Answer 3

DUST:

1. Demand - higher demand results in increased value; lower demand results in decreased value
2. Utility - the more useful the property, the higher the value (i.e., handicap bars in a bathroom at senior housing)
3. Scarcity - amount of supply available - higher supply, lower value; lower supply, higher value
4. Transferability - ability to transfer clean, clear title to another person w/o restrictions

Question 4

Assessed Value

Answer 4

A valuation placed upon a piece of property by a public authority as a basis for levying taxes on the property.

Question 5

Cost of a Property

Answer 5

The total dollar expenditure for labor, materials, legal services, architectural design, financing, taxes during construction, interest, contractor’s overhead and profit, and entrepreneurial overhead and profit (may or may not equal value).

Question 6

Demand

Answer 6

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

Question 7

Insured Value

Answer 7

The value of an asset or asset group that is covered by an insurance policy; can be estimated by deducting cost of non-insurable items (e.g. land value) from market value.

Question 8

Investment Value

Answer 8

The specific value of an investment to a particular investor or class of investors based on individual investment requirements; distinguished from market value, which is impersonal and detached.

Question 9

Market Value

Answer 9

The highest price in terms of money which a property will bring in a competitive and open market and under all conditions required for a fair sale / arm’s length transaction

• -equal motivation for both the buyer and seller (neither is affected by undue pressures)
• -acting in parties best interest (buyer and seller are acting prudently & knowledgeably - well informed about the risk and rewards associated with the pending agreement)

Question 10

Sales Price

Answer 10

The amount a purchaser agrees to pay and a seller agrees to accept in an arms length transaction (no related parties involved in the purchase & sale).

Question 11

Scarcity

Answer 11

A lack of supply

Question 12

Transferability

Answer 12

The ability to transfer ownership of property from one person to another.

Question 13

Utility

Answer 13

The ability to give satisfaction and/or excite desire for possession.

Question 14

Value

Answer 14

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

Question 15

What are the various types of property values?

Answer 15

1. Investment Value
2. Insured Value
3. Value-in-Use
4. Assessed Value
5. Mortgage Value

Question 16

Value-in-Use

Answer 16

value determined by the current use of the property

• -EX: single-site retail facility operated as a pharmacy may not convert well to be a single-site restaurant (i.e., less valuable to a restaurant investor than to another retail investor)
• -typically used for commercial properties

Question 17

Mortgage Value

Answer 17

value of the mortgage on the property - value changes in the event that the property owner takes out a new mortgage, but is NOT affected if the property increases/decreases in value

Question 18

What factors affect market value?

Answer 18

• -Equal Motivation
• -Parties Best Interest
• -Exposure on Open Market - must be reasonable time the property is listed for sale & property must have exposure to the open market.
• -Consideration - buyer must be willing to pay for the property in cash or the equivalent of cash
• -Financing Considerations - buyer must be able to secure financing to facilitate the purchase
• -Pricing of Property Sold - price must be considered normal consideration for similar properties

Question 19

Market Value vs. Sales Price vs. Cost

Answer 19

Market Value - highest price of a property in a competitive and open market
Cost - includes all the money that is spent in purchasing, developing, & owning/financing a property
Price - bottom line in the real estate transaction - what did the buyer agree to pay?

Question 20

What external factors have an impact on home values?

Answer 20

1. Population Trends
2. Family Composition
3. Aging Population
4. Economics - employment opportunities, cost of financing (i.e., interest rates), etc.
5. Construction Costs (hard & soft costs)
6. Quality of Services (ex: Local Transportation, Fire & Policemen, internet access, trash pickup, etc.)
7. Weather
8. Taxes
9. Quality of Schools

Question 21

Highest and Best Use

Answer 21

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 profit. This is the starting point for an appraisal.
–Commercial property are most often subjected to this valuation method (i.e., gas station cannot be easily converted to a restaurant)

Question 22

Principle of Anticipation

Answer 22

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

Question 23

Principle of Change

Answer 23

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.
–EX: changes in supply & demand, interest rates, and property conditions

Question 24

Principle of Conformity

Answer 24

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 - a time when being unique is invaluable!

Question 25

Principle of Contribution

Answer 25

A component part/feature of a property is valued in proportion to its contribution to the value of the whole–add or subtract in a CMA. Holds that maximum values are achieved when the improvements on a site produce the highest (net) return, commensurate with the investment.
–EX: gourmet kitchen would not be a selling point for a buyer that’s single and eats out most nights

Question 26

Principle of Progression

Answer 26

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

• -Increasing & Diminishing returns
• -EX: if most properties in a neighborhood consist of 4-bedrooms homes with gourmet kitchens and there’s 1-2 homes built 15 years ago with 2 bedrooms and a standard kitchen, the larger homes may suffer a small decrease in value while the smaller homes may see a small increase.

Question 27

Principle of Substitution

Answer 27

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.

Question 28

Principle of Competition

Answer 28

Supply & Demand always affects property valuation - the more buyers there are, the higher demand for property thus driving value up. The fewer buyers, or the more properties that exist, the lower the value of the property.

Question 29

Principle of Regression

Answer 29

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

• -Increasing & Diminishing returns
• -EX: Sub-division surrounded by 2 mobile home parks - higher valued properties in the sub-division will be considered worth less because of the surrounding properties values of the mobile homes

Question 30

Sales Comparison Approach Appraisal

Answer 30

The appraisal/valuation method which compares a subject property’s characteristics with those of comparable properties which have recently sold in similar transactions.

• -compares property to other similar properties (i.e., ranch home to another ranch home) in the immediate area that were sold within the past 6 months
• -typically used with residential properties (1-4 dwelling units)
  1. Appraiser compares the subject property w/ a minimum of 3 similar properties that were recently sold nearby (calculates the average square footage value)
  2. Using the principle of contribution, the appraiser determines what features add/subtract value to/from the subject property (i.e., home capacity, home condition/age, rights/location/financing)
  3. The appraiser then adjusts the prices to determine the value of the subject property

Question 31

Cost Approach Appraisal

Answer 31

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.

• -typically used for buildings with a specific use, like schools & churches AND newly constructed homes
  1. Valuation of the Land - location, size, whether the land is level, shape, etc. affect the value
  2. Determine the Cost of Development - reproduction vs. replacement (how much would it cost for the property to be newly constructed?)
  3. Calculate Depreciation, taking physical deterioration, functional obsolescence, and location obsolescence into consideration
  4. Value = value of land + replacement cost - depreciation

Question 32

Quantity Survey Method

Answer 32

Determining the cost of development by adding up everything from the most minor of fees to each piece of material the builder would need to construct the property.
–Rarely used - a lot of work

Question 33

Unit-in-place Method

Answer 33

Determining the cost of development by combining direct and indirect cost for a specific piece of construction - accurately and consistently estimates the cost of installing bathrooms, elevators, etc.

Question 34

Square Foot Method

Answer 34

Determining the cost of development by using the floor area of the structure - cost assigned per square foot or cubic foot
–least accurate method and least commonly used

Question 35

Income (Capitalization) Approach

Answer 35

An appraisal method applied to income producing properties, which involves applying a market capitalization rate to the property’s net operating income

• -typically used for commercial properties, large apartment complexes, & multi-family homes (> 4units)
  1. Calculate the NOI by obtaining the Market Rent, average vacancy rates, & operating expenses - Effective Gross Income - Operating Expenses
  2. Calculate the capitalization rate - net operating income / sales price
  3. Calculate the appraised value - NOI / cap rate

Question 36

Capitalization Rate

Answer 36

The % of the investment the investor will receive each year from the net income of the property
–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 - indication of risk.
Capitalization Rate = Net Operating Income (NOI) / Purchase Price
**The lower the capitalization rate, the higher the property value (less risky)
**The higher the capitalization rate, the lower the property value (more risky)

Question 37

Net Operating Income

Answer 37

Income (Rents) - Operating Expenses (normal expenses such as taxes, insurance, maintenance, utilities, excludes mortgage payments)

Question 38

Effective Gross Rent

Answer 38

Rents if 100% occupied - Anticipated Vacancy Rate