Chapter 15 - Intro To Real Estate Appraisal Flashcards
Highest and best use is defined as the use of land which, within all CONSTRAINTS for example, zoning bylaws), will provide the maximum NET RETURN during the foreseeable future. Will result in the highest Value
Rough test: building burned down, would the same type of building be constructed in its place. There is latent value ( redevelopment potential) if not put to maximum use.
Appraisers are typically called upon to estimate objective values, which are categorized into the following:
Insurance value Lending value Taxable value Actual value Market value
Define cost approach
The Cost Approach is a method of last resort that is used for a very UNIQUE property like a church, Pulp Mill etc.
A method of appraisal which determines the value of a property by adding the market value to the cost of replacing the existing building
Method of last resort. Can’t find comparable.
The COMPARATIVE method of appraisal bases the value of the subject property on the PRICE of similar properties which have SOLD recently.
Works best where there is lots of information. Typically residential home, condos, rental apartments the comparative method is best.
Define ceiling price
The ceiling price is the maximum price that a purchaser is willing to pay for a property
What is latent value (hidden value)
Latent value is
The value possessed by a property which has potential for redevelopment because it is currently not employed at its highest and best use.
A single family residence is only house on the block not yet converted to the commercial use which is the Zoning
When a property possesses latent value a higher value may result through a change of use.
A property which is not employed in its highest and best use possesses LATENT VALUE
The direct comparison approach is based on the principle of SUBSTITUTION
An estimate of the value of an interest in real property is called:
A An appraisal ( or property valuation)
An appraiser must understand the purpose of appraisal assignment. A STATUTORY reason, for example, for expropriation or taxation purposes or a MARKET reason, such as buying, selling, leasing, or developing a property.
What value is expressed a lump sum, it is referred to as a CAPITAL VALUE appraisal.
Real Estate is different than other assets because:
They are:
1/ It is Unique
2/ it has low turnover
3/ it is durable (the life of a building depends on economic durability, not physical durability)
4/ Immobile
5/ leads to externalities, positive and negative
Real Estate is different than other assets:
It is Unique, has low turnover, highly local, it is durable (the life of a building depends on its economic durability, NOT its physical durability)
It’s immobile, Leads to externalities, positive and negative.
The flow of information concerning real property is limited and difficult to collect
— the turnover rate for real property is LOW, compared to stocks. Stock’s you can sell quickly as opposed to homes.
All properties are unique. Difficult to find properties are alike.
The flow of information concerning real property lis limited and difficult to collect because:
The turnover rate of real property is low. Takes time to sell unlike stock market.
- Stock if real property is limited in quantity
- illiquidity compared to Luquidity (ex stock market)
It is highly local
One side of street could be more expensive than other side. Local markets are different.
It is durability Economic vs Physical. Which one you value more
Generally economic durability is worth more.
Commercial building. Rate of return. How much will i make more money. As long as it makes more money.
Leads to Externalities - positive and negative
Externalities are physically next to you.
Positive:
Schools. Hospitals
and Parks are positive
Negative
Factory
Prisons
Golf course
These affect property value
Real Estate values are influenced by Externalities.
Externalities are things like what EXISTS PHYSICALLY NEXT to homes or commercial buildings.
For instance oil prices increase is not externality
Unemployment is NOT an externality.
Virus Covid is not an externality.
Who can do Appraisals?
Anyone can do appraisals
BUT
BC is self-regulating by professional association
Require education programs, experience, code of ethics, insurance
Effectively cant get appraisal work without designation
Why clients request appraisal? Why are they done?
1/ A STATUTORY (Government) REASON - for Expropriation or taxation purposes
2/ MARKET REASON (personal or business)- such as buying, selling, leasing or developing a property; where the appraiser may consider the market data and is not forced to follow government statutes.
What is market value
An estimate of what property is likely to sell for in an arms length transaction between buyer and seller, if the property is on the market for a reasonable time when market conditions remain unchanged.
Appraisers Legal Responsibilities
Legal liability
No set limit of allowable error in appraisal work
Margin of error 10%. The courts have recognized that a reasonable margin of error exists when calculating damages resulting from a negligent appraisal.
No license required
An appraiser may be held liable for negligence if a property is over valued.
Calculating margin if error in appraisals
Take the Appraisal amount and divide by sales price
Just divide Appraised Value with the sale price.
Appraisal divided by Sale
App. 462,000. (Numerator)
Sale. 410,200. (Denominator)
= 1.126
Factors Affecting Value
House, lot locaton
Neighborhood
Local economy
Regional economy
Prov’l / National Economy
Special Purchaser - will greatly extend the range of bids
Highest and Best Use ( the most profitable legal use of the property)
Special Purchaser
On the exam they dont consider famous people like Prime Minister or Football Player or painter as special purchaser.
They want someone like a retail merchant who wants a specific view. Or they want it for a special reason.
Special Purchasers are not famous people. DON’T PICK FAMOUS PEOPLE
What would account for difference in selling price in two identical homes
If there was an urgency like you bought another house and now you need to sell current home, you may sell it st lower price.
Factors most likely Affecting market Value — short term factor
For exam they are looking for Short Term Trends
Short term Trends
- Consumer pessimism or optimism
- change in interest rates (mtg, bonds, loans)
Long Term Trends
- shift in age composition
- goverment programs affecting real estate
- supply and cost of raw materials
- shift in govt composition
Usually on the Exam****
The “Subject of Appraisal”
It “is the legal rights of ownership vested in a particular piece of real estate”
Legal interests are:
- air space
- fee simple ownersip
- leasehold estate
- condo ownership
- easements
Objective Value
It is verifiable. Same thing as sales Price or value in exchange
What it sold for. Verifiable. In the records.
Subjective Value or Market Value
Is not the subjective value (opinion) of the Owner
What the owner thinks it is valued at. Based on his feelings.
In an investment analysis you could include the “value to owner”. Like for a church They might have an idea.
Floor Price - Lowest price the seller wants
Buyers ceiling has to be higher than Floor
Lowest price the seller wants.
- Asking price. Listing price is higher than floor price but lower than ceiling.
Ceiling Price the maximum price the Buyer can pay based on how much he can afford
Ceiling price will be equal to or above the asking price
Highest price Buyer will pay. What buyer aporoved by bank. Buyer will offer lower than ceiling price
Comparative Method - Direct Comparison Method
Compare your property to other properties sold in your area.
Compare similar property that sold recently
1/ residentual
2/ empty lots
- rely on market evidence from similar properties -
RECENT SALE - refers to when market conditions remain same
Arms length transactions - no previous relationship by parties
similar - with respect to factors judged important buyers and sellers
Principle of Substitution (IASS)
you do plus or minus of bedrooms or bathrooms ir other unique features
- reflects opinion from the appraiser. Dont need any one elses opinion
Cost Method. - Nothing to Compare such as a Church. This method is just a GUESS.
Used for these unique properties:
Temple/ Church/ mill/ concrete plant
Cost Method cannot be used for Vacant Land. Because this method estimates the cost of LAND and cost to Build IMPROVEMENTS. Should use Comparative method. It is possible to use cost method for residential properties or anything that has improvements on it.
Cost of improvement is determining by the CURRENT REPLACEMENT COST.
Cost method is considered the least reliable method of Appraisal
1/ no income
2/ unique - nothing to compare like a church
3/ based on replacement cost
Look at cost of land and replacement cost of building
Income (Investment) Method - anything that has income producing. Don’t care about depreciation since Looking at Economic Value
Used for:
- Rental properties
- Commercial properties
- multi unit building
Look at rate if return
No depreciation Used
Residual (hybrid) method - Latent Value - not highest and best use - better for redevelopment
Latent Value ( not at best use)
Residential development Potential
Residential house in middle of business district
In its most simple form, the Residual Approach allows site value to be estimated by deducting from the value as developed, construction costs (either site servicing or building costs, depending on circumstances), marketing costs, finance costs, professional fees, developer’s profit and other costs, to derive a Residual Value that is then expressed as the site value. Use of computer-based analysis and spreadsheet programs has allowed the residual to develop a sometimes very sophisticated form but, whether simple or complex, the technique has to be applied correctly.
Comparative
Cant use
Non arms length sale property. Related parties are non arms length. Can’t use.
Special Purchasers are not Famous People.
—They could be someone who wants to create economic value such as a business man.
Value in exchange is Market Value
The Sale Price. Objective Value. The property sold for.
To find range if the sale price was within 10% of appraised value
Example
AP = 102,000
SP = 91,000
Do +/- of Appraised Value
102,000 x 1.10% = 112,200
102,000 x .90% = 91,800
SP was more than 10% below Appraised value. It was out of range.
Is Cost Method reliable
It is the least reliable. Churches, unique properties
Latent value is
Hidden value in redevelopment
Like small house among skyscrapers on downtown. Not the Highest or Best Use HBU
Externalities are something located next to your home or property, models GEO political problems that affect property value.

Comparative (Market Comparison Method)
—residential (houses and condos)
— empty lots
Based on theory of substitution — similar properties which are recently sold are comparable
“Recent” refers to when market conditions remain stable
— arms length transaction— no previous relationship of parties
— similar with respect to factors judged important by buyers and sellers
Market Analysis or Background Analysis
— indicate the current status of the subject property, in relation to property value
— to confirm that comparable property are selected from the same market as the subject property
— to provide client with socio-economic determinants of supply and demand
ALL ABOVE ARE TRUE
In a fast selling market the SELLER may get less than the market value of the property.
Prices could be increasing on a daily weekly basis
In a fast selling market the SELLER may get less than the market value of the property.
Arms Length sales not a representation of market value. As discount could have been give to a family member
Wood burning Furnace is a functional CURABLE depreciation
— something that is outdated or outmoded
When applying Cost Approach To house built 50 years ago the value of improvement is determined by the CURRENT REPLACEMENT COST OF CONSTRUCTING A MODERN EQUIVALENT OF THE SUBJECT PROPERTY.
Comparative Approach uses RECENT. WHAT IS RECENT?
A period of time time during which supply and demand conditions have not changed.
Recent is the period of time immediately preceding the appraisal date, during which property values in the region have remained stable.
In cost approach the major difficulty is experienced calculating INCURABLE PHYSICAL DEPRECIATION
Remember you have to build modern replacement of the building but something INCURABLE would be hard to replace. Especially in a church.
Reproduction Cost is best defined as:
The current cost of constructing an Exact Replica of the subject property.
Functional Depreciation can be defined as as:
The loss in value caused by outmoded or inadequate design.
Cost method of appraisal is not generally used to value:
Vacant Land, since there are NO improvements the COST approach could not be used.
In a Comparative Appraisal with a Vendor Supplied Mortgage:
It can be used as a comparable BUT the price must be adjusted downward to offset the benefit provided by the below market interest rate on the mortgage.
In Residual approach to appraisal it is not necessary the subject property and comparable have a market value of zero in their current use.
It is necessary However they have similar highest and best use after redevelopment, gave similar current uses, expect to undergo redevelopment at a similar point of time.
The Residual Method of Appraisal should be used for A Vacant Lot that possess Latent value
Where the subject property possesses Development potential 
Vacant Lot — use COMPARATIVE METHOD
Vacant Lot with Developmental potential — use RESIDUAL METHOD
Real estate different than other assets.
They have unique characteristics. Real estate is Heterogeneous. Stocks are Homogeneous, not different Fromm each other
Low turn over. Don’t get the flow of information in real estate sales.
It is very local. Agents try to focus in their area.
Durable and immobile. Lasts longer and not moveable
Leads to externalities, positive and negative. Airport could be good and people like it. Some don’t like the noise.
Why appraisals needed?
Mortgages finance Expropriation Property tax assessment Insurance Legal estate planning and divorce
Informal appraisal
- for buying / selling homes
No licensing requirements in BC, but Banks want accredited appraisers to do it.
Some error allowable. 10% acceptable by courts
Negligence
Hedley Byrne. - duty of care third parties.
Not meant for third party to rely on it. Appraiser will put disclaimer “you can’t use without my permission”
Real Estate Agents do Market Assessment not appraisal
However, courts do expect a duty of care.
Ceiling Price Buyer (BC). The max price Buyer will pay
Floor (Seller) Price The Lowest Price Seller will accept.
If Ceiling lower than Floor — sale will not happen.
If they do agree on price, this is called
— VALUE IN EXCHANGE
— MARKET VALUE
This sale was completed Objectively.
— Value at a point in time
— reasonably expected price
— no undue influence (arms length)
— adequate time and exposure to market (advertising).
Appraisal Methods
- Comparative (market) method
— residential: houses and condos
— simple commercial - Cost Method
— unusual/ Unique properties
— method of last resort - Income Method
— most commercial properties - Residual Method
— properties with latent value and not at highest and best use
— value in use . $10,000,000
— deduct Cost to Construct. - 2,000,000
— site Prep. - 1,000,000
Residual Value (land mkt value 7,000,000
