Chapter 15 (Estimating Real Property Value)

Question 1

Federally related transaction

Answer 1

Any real estate–related financial transaction that a federal financial institution’s regulatory agency (FFIRA) has either contracted for, or regulates, and requires the services of an appraiser.

Question 2

Transaction value

Answer 2

The loan amount in most appraisal assignments.

The specified value threshold of $250,000 is called the de minimis requirement.

Question 3

Types of Value

Answer 3

1. Assessed value is the value used as a basis for property taxation.
2. Insurance value is an estimate of the amount of money required to replace a structure in the event of some catastrophic event such as fire.
3. Investment value is the price an investor would pay, given the investor’s own financing requirements and income tax situation. This type of value is personal to a particular investor.
4. Liquidation value is the value associated with a rapid sale. The amount of dollars a property should bring in a foreclosure sale is an example of liquidation value.
5. Going-concern value is the value of an income-producing property or business characterized by a significant operating history.
6. Salvage value is the estimated amount for which improvements can be sold at the end of a structure’s useful life.

Question 4

Market Value

Answer 4

While the word value has many different meanings, market value is of special interest to the field of real estate.

The concept of market value is based on a theory that in any open market there will be a number of buyers and sellers. If hundreds of transactions are concluded over time, some parties will pay too much and some will pay too little. But the vast majority of value decisions by both buyers and sellers will tend to converge in a fairly small range.

That range represents a range of market value, whether the market is dealing in houses, oranges, cattle, or something else.

Many definitions of market value, or fair market value as it is sometimes called, can be found.

Fannie Mae and Freddie Mac require the following definition of market value for the appraisal of all real property securing a mortgage intended for sale to either of those major secondary market agencies:

The most probable price that a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.

Inherent in this definition are the assumptions that:

market value applies to a specified date and may change with the passage of time;
the seller is able to convey a marketable title;
buyer and seller are typically motivated, and neither buyer nor seller is under any compulsion or pressure to conclude a sale;
both buyer and seller are well informed and acting in their individual best interests;
the property is exposed for sale on the open market for a reasonable time;
the terms of sale are in cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
the price represents a normal consideration for the property, unaffected by creative financing or sales concessions such as seller contributions or buydowns.

Question 5

Cost, Price, and Value

Answer 5

1. Cost is the total expenditure required to bring a new improvement into existence plus the cost of the land. A contractor will install site improvements (water, sewer, and so forth); acquire the necessary permits; secure the services of architects, engineers, surveyors, and other professionals; construct the building; landscape the site; market the property; and so forth. The total of these expenditures is called cost. A contractor wants the cost to be less than the price a consumer will pay—and the consumer will pay more than the cost only if the consumer perceives the property’s value to exceed its cost.
2. Price refers to the amount of money actually paid in a transaction. Price and value are not necessarily equal. For example, you might purchase a computer for $2,000. Its price was $2,000. However, it may actually command less (or more) than $2,000 in exchange if you were to attempt to sell the computer. In real estate, price is synonymous with contract price.
3. The value of a good or service is determined by its ability to command other goods or services in exchange. Exchange value is the monetary value of a good or service to many buyers and sellers at a particular time. Today, we regard exchange value as market value, which is the consensus of the interactions of many buyers and sellers in the marketplace.

Question 6

Overimprovement

Answer 6

An owner invests more money in a structure than the owner may reasonably expect to recapture.

Question 7

Characteristics of Value

Answer 7

To have value, goods or services must possess the following four traits:

• To remember the characteristics of value, remember DUST:
  1. Demand
  2. Utility - In real estate, utility means the ability to provide useful services and benefits to an owner or tenant. (To fill a need)
  3. Scarcity - When apartments are scarce, landlords can increase rents, and the excess demand will fill any resulting vacancies.
  4. Transferability - The legal ability to convey title and possession of goods creates transferability. This is an unusually important factor in real estate.

Value cannot exist in cases where rights in land and the use of property cannot be transferred.

Question 8

Highest and Best Use

Answer 8

The most profitable legal way that a property can be used.

The use must be:

legally permissible (zoning);
physically possible (soil type, the site's shape, size, and slope); and
financially feasible (income generated considering cost of improvements).

2 Types: Use of Vacant Land and Use of Improved Property

Question 9

There are three approaches to estimating real property value:

Answer 9

Sales comparison approach (comparable sales method)
Cost-depreciation approach (cost method)
Income approach (income method)

Question 10

Reconciliation

Answer 10

A process of weighted averaging used in the sales comparison approach to bring the adjusted values of several comparable properties into a single estimate of value.

In a reconciliation, any detected errors are corrected and, based on the type of property, a degree of priority (importance) is assigned to each approach used.

For example:

If the property being appraised is a vacant lot in an established neighborhood, the sales comparison approach is considered the most relevant approach to value.

If the property is an income-producing property, the income capitalization approach usually is given the most importance.

The cost-depreciation approach usually is most significant for newly constructed homes and for cross-checking the other two approaches.

It is also considered the most relevant approach when appraising special-purpose properties such as hospitals, schools, or government buildings.

Question 11

Principle of Substitution

Answer 11

A prudent buyer or investor will pay no more for a property than the cost of acquiring an equally desirable substitute property.

The principle of substitution is the basis for all three approaches to market value.

Question 12

Sales Comparison Approach

Answer 12

A method for estimating value by comparing similar properties with the subject property based on the theory that a knowledgeable purchaser will pay no more for a property than the cost of acquiring an equally acceptable substitute property.

The sales comparison approach (also called the comparable sales approach or market approach) is based on the premise that the value of a property can be estimated accurately by reviewing recent sales of properties (comparables or comps) similar to the property being appraised (subject property) and comparing those properties with the subject property.

Because time can affect property values, the sales used for comparison purposes must meet two qualifications:

1. They must have occurred recently in the same market area where the subject property is located.
2. The comparable properties selected must be similar to the subject property.

To remember how adjustments are made, remember CBS versus CIA:

*Comp
Better
Subtract

vs.

*Comp
Inferior
Add

Question 13

Adjustment Grid

Answer 13

The process of comparison in the sales comparison approach is organized into an adjustment grid.

The adjustment grid is used to ensure that no adjustment factor important to a value conclusion is overlooked.

Question 14

Adjustment Process

Answer 14

The appraiser prepares the adjustment grid by first entering the street address and sale price for each selected comparable.

Adjustments for transactional differences such as conditions of sale, financing terms, and changes in market conditions since the date of sale are made first, followed by adjustments for property characteristics. Those adjustments include the following:

1. Financing terms.

Appraisers must confirm the financing associated with each sale because the sale price could reflect special financing terms, such as seller financing or seller-paid points.

Assume the financing associated with each of the sales was conventional financing and that it was typical financing for the market area.

2. Conditions of sale.

Appraisers must research the conditions of sale to determine if the buyer or seller was under abnormal pressure to buy or sell or if there was a special relationship between the parties to the transaction, such as between family members or business associates. In the example below, the appraiser verified the conditions of sale for each of the sales and found them to be normal.

3. Market conditions.

A property that sold last month or last year may sell for more, or for less, today, even though the property itself has not physically changed.

The criterion for making an adjustment for market conditions is whether the price paid for a comparable property, if that property were sold on today’s market, would differ from the price paid during some other period of time. Referring to the chart below, we see that the appraiser adjusted Comparable (Comp) 1 plus $2,830. Assume that Comp 1 sold six months ago and the appraiser has estimated a market conditions adjustment of 4% annually (or 2% for six months). The appraiser is adjusting the sale price of the comparable to estimate what the comp would have sold for under today’s market conditions. Similarly, Comp 2 sold three months ago so the appraiser has entered a plus $1,360 adjustment (or 1%). Comp 3 sold very recently, so a market conditions adjustment was not needed.

4. Square footage.

Assume Comp 1 is 160 square feet larger than the subject property.

Because Comp 1 is superior to the subject property with respect to square footage, a downward adjustment is needed. The appraiser has estimated $60 per square foot as an appropriate unit of comparison and has entered an adjustment of minus $9,600 (or 160 square feet × $60). Because Comp 2 is 20 square feet smaller than the subject, the appropriate upward adjustment is needed.

5. Landscaping.

Because Comp 3 has nicer landscaping, compared with the subject property, a downward adjustment is made to Comp 3.

Question 15

Example

What is the estimated market value of a subject lot that is 110’ × 120’ (13,200 sq. ft.)?

Answer 15

Adjustment Analysis

Comparable Sales:
Sale 1: A lot 100’ × 120’ located across the street from the subject lot sold recently for $36,800.
Sale 2: A lot 110’ × 120’ in the same neighborhood as the subject lot sold recently for $37,000.
Sale 3: A lot 100’ × 100’ in a different but similar-quality neighborhood sold recently for $36,000.
Sale 4: A lot 130’ × 150’ located in a different but similar neighborhood but near a railroad sold recently for $39,800.

Solution:

Sale 1: $36,800 ÷ 12,000 sq. ft. = $3.067 per sq. ft.
Sale 2: $37,000 ÷ 13,200 sq. ft. = $2.803 per sq. ft.
Sale 3: $36,000 ÷ 10,000 sq. ft. = $3.600 per sq. ft.
Sale 4: $39,800 ÷ 19,500 sq. ft. = $2.041 per sq. ft.

Reconciliation:

Sale 1: $3.067 × .35 = $1.073
Sale 2: $2.803 × .30 = $.841
Sale 3: $3.600 × .20 = $.720
Sale 4: $2.041 × .15 = $.306 
              100% = $2.940 = $2.94 per sq. ft.

Total square footage of subject lot: 13,200
Reconciled value per sq. ft.: × $2.94
Estimated market value of subject lot = $38,808 (round to $38,800)

Note that in the reconciliation process, sale 3 was given less weight in the final analysis because it was in a different neighborhood, and sale 4 was given the least weight because of its proximity to a railroad track and its location in a different neighborhood. If all the comparables had been considered good representations of the subject property, the appraiser would have given all four comparables equal weight and simply averaged them to arrive at a value per square foot.

Question 16

Cost-Depreciation Approach

Answer 16

Estimate value by taking cost minus depreciation plus site value, based on the theory that a knowledgeable purchaser will pay no more for a property than the cost of acquiring a similar site and constructing an acceptable substitute structure.

The maximum value of a property can be measured by determining the cost to acquire an equivalent site and to reproduce a structure as though new, and then subtracting accrued depreciation.

The cost-depreciation approach formula is:
      reproduction cost of the building 
      – accrued depreciation 
      = indicated value of the building
      \+ estimated value of the site 
      = indicated value of the property

Question 17

There are four steps in the cost-depreciation approach.

Answer 17

Step 1

Estimate the current reproduction (or replacement) cost of the improvements as of the appraisal date.

Reproduction cost is the amount of money required to build an exact duplicate of the structure.

Replacement cost is the amount of money required to replace a structure having the same use and functional utility as the subject property but using modern, available, or updated materials. Consider a historic bungalow home.

The cost to duplicate the home in exact detail, including the hand carved trim on the porch, is reproduction cost. However, if the home were to be reconstructed in the same bungalow style but with modern materials and techniques, this cost is replacement cost.

• Three cost estimating methods are described here, with the most technical and precise method first:
  1. Quantity survey method.

This method involves a detailed inventory of all labor, materials, products, and indirect costs, plus the builder’s profit, required to reproduce a building. The number of items is then multiplied by the cost per item. For example, in a single-family dwelling with three baths, multiply the cost of one commode by 3, the cost of one bathtub by 3, etc. If 1,000 linear feet of 2-by-6s are required at a cost of $.50 per foot, the cost would be $500.
The man-hours for each type of labor involved are estimated and multiplied by the cost per hour. All costs are totaled and then added to overhead and indirect costs. The builder’s profit then is added. The aggregate of all costs is the reproduction cost of a new building.

2. Unit-in-place method.

This method is more practical for appraisers and requires less technical ability. The cost of materials plus the cost of labor to install them is calculated for each component of a structure, such as the driveway, parking area, roof, foundation, walls, and floors. For example, the unit-in-place cost for a square of roofing (100 square feet) can be obtained. The unit cost is then multiplied by the number of units in the entire roof. Each separate component is treated in the same manner. Adding the costs of installed equipment and fixtures and builder’s profit results in the total reproduction cost of the structure.

3. Comparative square-foot or cubic-foot method.

This method is sometimes called the comparative unit method or the unit comparison method. The cost of reproducing a recently built property similar in size and function to the subject property is often used as a basis for estimating the reproduction cost. To reduce errors in this method, square-foot or cubic-foot costs are obtained for a standard (or benchmark) house of average size for the locality. Exterior walls are used for measurements. Adjustments are then made for quality, shape, and extra features.

Step 2

Estimate the amount of depreciation from all causes (physical deterioration, functional obsolescence, and external obsolescence) and deduct it from the reproduction (or replacement) cost.

The appraiser begins with an estimate of what it would cost to reproduce the structure as though new today. But the subject property is usually not a brand new structure. The difference between the structure’s reproduction (or replacement, if applicable) cost new and the perceived market value of the structure today in its actual condition is called accrued depreciation. Depreciation is the loss in value caused by things such as wear and tear, poor design, or the structure’s surroundings (proximity). Accrued depreciation is the total depreciation that has accumulated over the years.

Depreciation can be curable or incurable. Curable depreciation occurs when a building component has been added or repaired and the owners are able to get their money back in added value. For example, assume it costs $1,500 to repair and clean the screens in a screened-in porch. If potential buyers would pay at least $1,500 more for the home because of the condition of the porch, the depreciation is curable. Incurable depreciation occurs when a building component has been added or repaired but the owners are unable to get their money back in added value. For example, assume a home has five-year-old kitchen appliances in excellent working order. The owners purchase all new kitchen appliances for $20,000. If potential buyers are unwilling to pay an extra $20,000 for the home with new appliances, the depreciation is incurable.

Generally, accrued depreciation is associated with a structure’s age. As a building grows older, it loses value because of exposure to the sun and rain, as well as general usage. However, not all depreciation is associated with age. Depreciation in a structure can be attributed to three major causes:

1. Physical deterioration.

Physical deterioration includes ordinary wear and tear caused by use, lack of maintenance, exposure to the elements, and physical damage. Brittle roof shingles or a worn out central air-conditioning compressor are examples of physical deterioration.

2. Functional obsolescence.

Anything that is inferior due to operational inadequacies, poor design, or changing tastes and preferences is functional obsolescence. Examples include a poor traffic pattern, too few bathrooms, or an inadequate amount of insulation. An overimprovement is also considered functional obsolescence.

3. External obsolescence.

Any loss in value due to influences originating outside the boundaries of the property, such as an expressway adjacent to a residential subdivision or deterioration of the neighborhood, is external obsolescence. Because external obsolescence is normally beyond the control of the property owner, it is considered incurable.

Land is not depreciated in the cost-depreciation approach. Only the buildings or other improvements to land are subject to these three types of depreciation because the site value is estimated separately, typically using the sales comparison approach. Any adjustments to the site for size, location, and nonstructural improvements were already made when the appraiser applied the sales comparison approach to estimate the site value. When the cost to reproduce the improvements is determined, depreciation is applied only to that portion of the property.

Step 3

Estimate the value of the site and nonstructural site improvements, assuming the site is vacant and will be put to its highest and best use. The value of land is normally determined by the sales comparison approach, explained earlier.

Step 4

To derive the property’s estimated value, add the estimated value of the site, including site improvements, to the depreciated structure value.

For example, if neighboring comparable properties are selling for $5 per square foot and the lot on which the subject structure stands has an area of 11,000 square feet, the land value is estimated to be $55,000.

The estimated property value of the subject property is as follows:
$210,000 depreciated structure + $55,000 site value = $265,000 estimated value of subject property

Question 18

Lump-Sum Age-Life Method

Answer 18

Sometimes, appraisers estimate each category of depreciation separately. However, the vast majority of residential appraisals that employ the cost-depreciation approach use the lump-sum age-life method to estimate accrued depreciation. The method is so named because it estimates a single value for accrued depreciation.

The lump-sum method is based on a ratio of a property’s effective age to its economic life. Effective age is the age indicated by a structure’s condition and utility.

Chronologically, a home may be five years old. However, if the structure has been well maintained, its effective age may be only two years. There is no precise method for estimating effective age. The appraiser estimates a structure’s effective age by observing the structure’s current condition. A structure’s total economic life (or useful life) is the total estimated number of years that the structure is expected to contribute to the property’s value.

The appraiser divides the effective age of the structure by the total economic life of the structure.

Refer to the accrued depreciation formula below:

  effective age ÷ total economic life × reproduction cost new = estimated total accrued depreciation

For example, suppose an appraiser estimates that the effective age of a 10-year-old building is four years. The appraiser estimates the cost to reproduce the structure as though new today is $225,000. If the total economic life is 60 years, what is the amount of accrued depreciation?
(4 years effective age ÷ 60 years economic life) × $225,000 reproduction cost new = $15,000 accrued deprecation

The lump-sum age-life method of calculating depreciation assumes that a structure depreciates at a constant rate. For this reason, it is sometimes called straight-line depreciation (the same amount of depreciation each and every year).

To demonstrate this point, let’s calculate the accrued depreciation in the previous example by first determining the amount of annual depreciation. Divide the reproduction cost by the economic life. The result is the annual depreciation. Multiply the annual depreciation by the effective age to derive the total accrued depreciation:
$225,000 reproduction cost new ÷ 60 years economic life = $3,750 annual depreciation × 4 years effective age = $15,000 accrued depreciation

An alternate accrued depreciation formula is:
      reproduction cost new 
      ÷ total economic life
      = annual depreciation
      × effective age
      = accrued depreciation

The value of the structure today, in its current condition, is estimated by subtracting the accrued depreciation from the reproduction cost new:
$225,000 reproduction cost new - $15,000 accrued depreciation = $210,000 depreciated structure

Question 19

Effective age

Answer 19

The age indicated by a structure’s condition and utility.

Question 20

Economic Life

Answer 20

The total estimated time in years that an improvement will add value.

Question 21

Income Approach

Answer 21

An estimated market value based on the present worth of future income from the subject property.

The object of the income approach (also called the income capitalization approach) is to measure a flow of income projected into the future.

This method is a complete departure from the sales comparison and cost-depreciation approaches.

The income approach develops an estimated market value based on the present worth of future income from the subject property.

It is the primary approach for appraising income-producing property and for comparing possible investments.

Question 22

Potential Gross Income (PGI)

Answer 22

The total annual income a property would produce if it were fully rented and no collections losses were incurred.

Question 23

Effective Gross Income (EGI)

Answer 23

The result of deducting vacancy and collection losses from annual potential gross income plus adding any income from miscellaneous sources.

Question 24

Vacancy and collection losses

Answer 24

The expected income loss that will result from occasional turnover of tenants and periodic vacancies, as well as the likelihood that not all of the rental income will be collected.

Even when a property is 100% occupied, the probability of continuous total occupancy is unlikely. Therefore, some vacancy and collection losses should always be deducted from PGI.

The formula to calculate effective gross income is:
      potential gross income (PGI)
      – vacancy and collection losses
      \+ other income
      = effective gross income (EGI)

Question 25

Net Operating Income (NOI)

Answer 25

The income remaining after subtracting all relevant operating expenses from EGI. Operating expenses are grouped into three separate categories: (1) Fixed expenses (e.g., property taxes, hazard insurance); (2) Variable expenses (e.g., utilities, maintenance, management, supplies, janitorial, garbage collection); and (3) Reserve for replacements. The term reserve for replacements refers to a reserve allowance that provides for the periodic replacement of building components, such as roof coverings and heating and air-conditioning equipment that wear out at a faster rate than structural components. The formula to calculate net operating income is: effective gross income (EGI) - operating expenses = net operating income (NOI) All costs of financing, income taxes, personal expenses, and business-related expenses (such as payroll and advertising) that do not contribute to actual operation of the property are business expenses, not operating expenses. Depreciation is not an operating or a business expense (it does not involve an outlay of cash) and is not used to calculate NOI. NOI is thus the annual income (before mortgage or income tax payments) that may be expected to occur over the remaining economic life of a property. It is this income (NOI) that is capitalized into present value. To use the income approach, an appraiser must know the annual NOI produced by the property or be able to forecast the annual NOI based on reasonable estimates. Licensees may have access to the accounts; may be provided the information required; or in the case of a vacant lot on which a business building will be constructed, may project a pro forma NOI statement from several existing similar properties.

Question 26

Net Operating Income Examples

Answer 26

Suppose your client is considering construction of a 10-unit apartment building. You are estimating the value of the vacant property zoned for apartments. Your survey of other apartment projects of similar size and quality in the market area reveals that each of the proposed new apartments could be competitive if rented at $665 per month. The survey also discloses that an annual vacancy and collection loss rate of 10% is typical for the area. By using normal costs of operation, a pro forma statement can be developed to indicate the probable annual NOI. (Note: Begin by estimating the potential gross income [$665 rent × 10 units × 12 months = PGI].) *See solution in Picture Diagram "Figure15.2.1" Once known or estimated, the NOI is usually divided by an overall capitalization rate (OAR). The OAR normally is determined by using the sale prices and NOIs of similar properties in the market area. Dividing the NOI of a property by its current value or sale price produces an OAR. income (NOI) ÷ value (sale price) = rate (OAR) The components of this formula are said to be market-driven—that is, income figures and recorded sale prices represent the market in action. That is the reason most licensees, appraisers, and others prefer the OAR as a capitalization rate. The same procedure could be used to determine the OAR for other types of income-producing properties. Once an appropriate capitalization rate and NOI are determined, the IRV formula is used to estimate the present value of income-producing properties. For example, using the results of the pro forma statement in the earlier problem and the market area OAR of 10%, the estimated value of the property is calculated. $34,830 (NOI) ÷ .10 rate = $348,300 estimated value Investors, on the other hand, often prefer to specify a capitalization rate because investors are free to choose the acceptable rate of return they desire. When the type of estimated value is investor-driven, the minimum rate of return acceptable to the investor is frequently used as the capitalization rate. Net annual income is then divided by the specified capitalization rate to obtain the investment value of the property. It is important to mention, however, that this is not market value, but rather investment value. Investment value is the value of property to a particular investor based on the investor's desired rate of return, risk tolerance, and so forth. Market value is objective and impersonal; investment value is subjective and based on personal criteria.

Question 27

Investment value

Answer 27

The value of a property to a particular investor based on the investor's desired rate of return and risk tolerance.

Question 28

Direct Capitalization Relationships: IRV Formulas

Answer 28

*See Figure15.2.3 For example, a small income property produces an annual net income of $8,000. Your client wants you to tell her the amount of money that she may invest in the property to provide a return of 10% per year from the investment. V = I ÷ R = $8,000 ÷ .10 = $80,000 So the investment value to this investor is $80,000 if a 10% rate of return is required from the subject property. Sound income and expense data are critical in the use of the income capitalization approach. It is also important to realize that a definite relationship exists between present value, net income, and capitalization rate. If, for example, the capitalization rate (R) is increased and the net income (I) remains constant, the present value (V) will be less. Or if the net income (I) goes up and the capitalization rate (R) remains constant, the present value (V) will be greater.

Question 29

Gross Rent Multiplier (GRM)

Answer 29

The ratio between a property's gross monthly rental income and its selling price. The GRM is a simple substitute for the income capitalization analysis for one- to four-unit residential rental properties. The GRM applies to rental income only. Although one can use either monthly or annual rent, it is customary to use monthly rent when calculating a GRM. The GRM is found by dividing the sale price by the gross income: sale price ÷ gross monthly rent = gross rent multiplier (GRM) For example, a single-family property sold for $229,400. This residential investment property earns a monthly rental income of $1,850. What is the property's GRM? $229,400 sale price ÷ $1,850 gross monthly rent = 124 GRM Multipliers must be determined for each local area. A multiplier is market-derived by using comparable properties and averaging the results. To establish a market-derived GRM, an appraiser must locate recent sales and rental data from at least four rental properties that are comparable to the subject property. The sale price of each comparable rental property is divided by the property's gross rent to calculate each property's GRM. The individual GRMs are averaged to estimate a market area GRM. Then the market area GRM is used to estimate the subject property's market value: rental income × market area GRM = estimated market value For example, an appraiser has found five rental properties that are comparable to the subject property. Below is the sale price and monthly rent for each of the five sales. What is the market area GRM? * See solution in Figure15.2.4 857. 1 (sum of GRMs) ÷ 5 comparable sales = 171.4 market area GRM For example, the appraiser has estimated the fair market rent for the subject property to be $560 per month. What is the estimated market value of the subject property using the market area GRM of 171.4? $560 rental income × 171.4 GRM = $95,984 or $96,000 (rounded)

Question 30

Gross Income Multiplier (GIM)

Answer 30

The ratio between a property's gross annual income and its selling price. The gross income multiplier (GIM) is used with small income-producing properties. Notice that the procedure for calculating a GIM is basically the same as for calculating a GRM. However, the GIM refers to all income a property may produce, while the GRM refers to rent only. The GIM typically uses annual income, whereas the GRM typically applies monthly rent. sale price ÷ gross annual income = gross income multiplier (GIM) For example, a commercial property produces $50,000 of annual gross income. The property recently sold for $400,000. What is the property's GIM? $400,000 sale price ÷ $50,000 gross annual income = 8.0 GIM For example, the appraiser has projected that the subject property can generate a gross annual income of $58,000. What is the estimated market value of the subject property using the market area GIM 8.0? $58,000 annual gross income × 8.0 GIM = $464,000

Question 31

Additional Appraisal Terms

Answer 31

Assemblage: The combining of two or more adjoining properties into one tract; the process of consolidating properties. This is usually done to increase the usability and value of the resulting consolidation. Plottage: The added value as a result of assembling (combining) two or more properties into one large parcel. Progression: The principle that the value of an inferior property is enhanced by its association with superior properties of the same type. Regression: The principle that the value of a superior property is adversely affected by its association with an inferior property of the same type. Situs: Refers to people's preferences, both physical and economic, for a certain area owing to factors such as weather, job opportunities, and transportation facilities.

Question 32

Categories of Comparables

Answer 32

A CMA typically presents information concerning three major categories of properties: (1) recently sold, (2) currently on the market, and (3) recently expired listings. 1. Recently sold. Studying the sale prices of similar properties in the same market area that have recently sold provides information concerning what buyers have been willing to pay for similar properties. The amount of recent sale activity and the average days on the market are also valuable information. 2. Currently on the market. Studying the asking prices of properties in the market area provides important information concerning what the sellers of similar properties are asking in today's market. When properties with equally desirable characteristics are available, buyers normally choose the property with the lowest price. Therefore, the seller should price the property taking into consideration the average asking price of competing properties. 3. Recently expired listings. Properties that were listed but failed to sell often were priced too high. This information helps to explain to sellers the consequences of overpricing listings.

Question 33

Common Elements of Comparison

Answer 33

It is important that all properties used in the CMA be similar to the subject property in size, age, amenities, and location. Adjustments should be made for important differences compared with the subject property, such as swimming pools, condition, style, and so forth. Examples of features that must be considered include location, size, and shape of the lot; landscaping; construction quality; style, design, and age of the structure; square feet; and number of rooms. Adjustments are made to the comps (comparables) using the same procedure as discussed in the sales comparison approach.

Question 34

Computer-Generated CMAs

Answer 34

Software programs are available that will organize the data sales associates gather into attractive presentations. Many MLS service providers offer software for REALTOR® members to download the comparable information directly into a listing presentation package.

Question 35

Summary of Important Points

Answer 35

Real estate licensees who conduct real estate appraisals are required to comply with USPAP. Appraisal reports involving a federally related transaction must be prepared by a state-certified or licensed appraiser. Market value is the most probable price that a property should bring in a competitive and open market under all conditions requisite to a fair sale, with the buyer and the seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Value is determined by what consumers are willing to pay in the marketplace. Price refers to the amount of money actually paid. Cost is the total expenditure to create the improvement. An overimprovement occurs when an owner invests more money in a structure than the owner can reasonably expect to recapture. To have value, goods and services must possess four traits: (1) demand, (2) utility, (3) scarcity, and (4) transferability. Highest and best use is the most profitable use of a property. The use must be legally permissible, physically possible, and financially feasible. The three approaches to estimating value are (1) sales comparison approach, (2) cost-depreciation approach, and (3) income approach. The principle of substitution is the basis for all three approaches. The sales comparison approach compares similar properties to the subject property. The comparable properties' sale prices are adjusted upward or downward to reflect differences between each comparable and the subject property. If a comparable is superior to the subject property on a given feature, a downward adjustment is made to the comp. If a comparable is inferior to the subject property, an upward adjustment is made to the comp. The adjusted sale prices of the comparables are reconciled using a weighted average to estimate the market value of the subject property. The cost-depreciation approach estimates the market value of a property based on the cost to buy an equivalent site and to reproduce the structure as if new, less depreciation. Reproduction cost is the amount of money required to build an exact duplicate of the structure. Replacement cost is the amount of money required to replace a structure having the same use and functional utility as the subject property but using modern, available, or updated materials. The three methods used to estimate reproduction cost are (1) quantity survey method, (2) unit-in-place method, and (3) comparative square-foot method. Depreciation is the loss in value. Accrued depreciation is the total depreciation that has accumulated over time. Depreciation is curable when a building component has been added or repaired and the owners are able to get their money back in added value. If the owners are not able to recoup the cost of the repaired or added item, it is said to be incurable depreciation. The three major causes of depreciation are (1) physical deterioration, (2) functional obsolescence, and (3) external obsolescence. The lump-sum age-life method of estimating depreciation is based on a ratio of the property's effective age to its economic life. Effective age is the age indicated by a structure's condition and utility. Total economic life is the total estimated number of years that a structure is expected to contribute to the property's value. The income approach develops an estimated value based on the present worth of future income from the subject property. The approach capitalizes net operating income into value. Potential gross income (PGI) is the total annual income a property would produce if it were fully rented and no collection losses were incurred. Effective gross income (EGI) is calculated by subtracting vacancy and collection losses from the PGI. Net operating income (NOI) is the income remaining after subtracting operating expenses from EGI. The three categories of operating expenses are (1) fixed, (2) variable, and (3) reserve for replacements. The gross rent multiplier (GRM) is the ratio between a property's gross monthly rent and its selling price. The gross income multiplier (GIM) is the ratio between a property's gross annual income and its selling price.