Chapter 17 Concepts

Question 1

appraisal

Answer 1

is an estimate or opinion of value, completed by a licensed appraiser, of a specific property as of a specific date.

Question 2

To conduct a formal appraisal that can be used in federally related transactions, appraisers

Answer 2

must be licensed by the state

Question 3

Certified residential appraisers usually appraise

Answer 3

residential properties

Question 4

certified general appraisers typically appraise

Answer 4

commercial properties

Question 5

The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA)

Answer 5

was passed by Congress for the primary purpose of overhauling regulations of the thrift industry. However, a major portion of this Act was for the regulation of appraisers performing appraisals for federally related loan transactions. This Act established many federal agencies charged with the task of setting appraisal standards and minimum qualification requirements.

Question 6

The Appraisal Qualifications Board sets

Answer 6

qualification standards and requirements for state-certified appraisers

Question 7

The Appraisal Standards Board sets

Answer 7

minimum standards of practice

Question 8

In North Carolina, appraisers are

Answer 8

licensed and certified through the North Carolina Appraisal Board after meeting minimum education and experience requirements and passing state examinations

Question 9

As an exception to the North Carolina Appraisers Act, NCGS 93E

Answer 9

licensed real estate brokers are allowed to perform a comparative market analysis as long as they do not in any way represent themselves as a real estate appraiser.

Question 10

The Act defines a CMA as

Answer 10

“…the analysis of sales of similar recently sold properties in order to derive an indication of the probable sales price of a particular property by a licensed real estate broker.”

Question 11

In the North Carolina Real Estate Manual, brokers are cautioned to

Answer 11

never refer to their estimate of value as an appraisal and to consider making some clarifying statement about it being an informal estimate of probable sales price and not to be confused with an appraisal.

Question 12

Only active full brokers (nonprovisional) may perform a BPO or CMA (terms are synonymous per statute) for a fee as long as

Answer 12

the BPO is not intended to determine value of a property for the purpose of originating a mortgage loan or any purpose where an appraisal is required by law

Question 13

A broker’s BPO/CMA may only

Answer 13

estimate the “probable selling price” or “probable leasing price” of a property, not the “value” or “worth” of a property

Question 14

Value (In terms of real estate appraisal)

Answer 14

may be described as the present worth of future benefits arising from the ownership of real property.

Question 15

What does the Acronym DUST stand for?

Answer 15

Demand: the need or desire for possession or ownership backed by the financial means to satisfy that need

Utility: the capacity to satisfy future owners’ needs and desires; how future owners can make good use of the property

Scarcity: a finite supply

Transferability: the relative ease of transfer of ownership rights from one person to another; often relates to clear title and satisfactory physical condition

Question 16

The goal of an appraiser is to

Answer 16

estimate market value

Question 17

Market value VS market price

Answer 17

Market value is an opinion of value based on an analysis of data that may include not only an analysis of comparable sales but also an analysis of potential income, expenses, and replacement costs (less depreciation).

Market price, on the other hand, is what a property actually sells for—its sales price.

Question 18

Market Value VS Cost

Answer 18

Cost represents past expenditures on the property: what the owner has spent on the property.

One of the most common misconceptions about valuing property is that cost represents market value.

Cost and market value may be equal and often are when the improvements on a property are new. But more often, cost does not equal market value.

Question 19

Four forces affect property values:

Answer 19

Social forces - Social forces that affect property values include trends in marriage and divorce rates, family size and longevity, and desirability of social activities.

Economic forces - Economic forces include income and employment levels, the rate of property taxation, current interest rates, and general economic growth.

Political forces - Political forces include government activities such as zoning and building codes, growth management, environmental legislation, and tax structures.

Environmental conditions - Environmental conditions that affect property values include topography, location, climate, size, shape, proximity to major arterials, jobs, and public transportation.

Question 20

What is Substitution Principle? (Value)

Answer 20

The principle of substitution states when several items with essentially the same amenities and utilities are available, the item with the lowest price will attract the most demand. This principle is the cornerstone of the sales comparison approach to value.

Question 21

Supply and demand (Value)

Answer 21

This principle states that the value of a property will change if the supply decreases and the demand either increases or remains constant—and vice versa.

Question 22

Conformity

Answer 22

Conformity means that maximum value is realized if the use of land conforms to existing neighborhood standards. In residential areas of single-family houses, for example, buildings should be similar in design, construction, size, and age. Subdivision protective covenants rely on the principle of conformity to ensure maximum future value.

Question 23

Anticipation

Answer 23

This principle holds that value can increase or decrease in anticipation of some future benefit or detriment affecting the property. For example, the value of a house could be affected by rumors that an adjacent parcel may be converted to some different use in the near future.

Question 24

Contribution

Answer 24

This principle affirms that the value of any component of a property is defined by what its addition contributes to the value of the whole or what its absence detracts from that value.

For example, the cost of installing an air-conditioning system and remodeling an older office building may be greater than is justified by the increase in market value (a function of expected net increases) that may result from the improvement to the property.

In residential properties, an owner sometimes will make a super-improvement such as installing solid mahogany kitchen cabinets. While these cabinets may be quite attractive, the average buyer will not pay for the added cost of this over improvement.

Question 25

Competition

Answer 25

This principle states that profits tend to attract competition. For example, the success of a retail store may motivate investors to open similar stores in the area. This tends to mean less profit for all stores concerned unless the purchasing power in the area increases substantially.

Question 26

Change

Answer 26

No physical or economic condition remains constant. Real estate is subject to natural phenomena, such as tornadoes, fires, and routine wear and tear of the elements. The real estate business also is subject to the changing demands of its market, as is any business. It is an appraiser’s job to study the past to be better able to predict the effects of natural phenomena and the behavior of the marketplace in the future.

Appraisers must also be sensitive to the stage of progression within the neighborhood life cycle. Most residential neighborhoods go through four phases of the cycle of change: growth, stability, decline, and renewal. The area’s position within the life cycle will affect value.

Question 27

The four factors that affect value are demand, utility, supply, and transferability (T/F)

Answer 27

False

demand, utility, scarcity, and transferability.

Question 28

The four factors that affect value are demand, utility, supply, and transferability (T/F)

Answer 28

False

Question 29

1) What is the appraisal process?

2) What are the two types of data?

Answer 29

1) The appraisal process is an orderly set of procedures used to collect and analyze data to arrive at an ultimate value conclusion. The data are divided into two basic classes:

2:
Specific data - covering details of the subject property (the property that is being appraised) and including comparative data relating to costs, sales, and income and expenses of properties similar to and competitive with the subject property.

General data - covering the nation, region, city, and neighborhood. Of particular importance is the neighborhood, where an appraiser finds the physical, economic, social, and political influences that directly affect the value and potential of the subject property.

Question 30

The steps an appraiser takes in carrying out an appraisal assignment are as follows:

Answer 30

1) Define the problem: The kind of value to be estimated must be specified, and the valuation approach(es) most valid and reliable for the kind of property under appraisal must be selected.

2) Determine and perform appropriate scope of work: Based on the approach(es) the appraiser will be using, the types of data needed, and the sources to be consulted are listed.

3) Collect and analyze the data: Specific data about the subject site and improvements must be collected and verified. Depending on the appraisal approach(es) used, comparative information relating to sales, income, expenses, and construction costs of comparable properties must be collected.

4) Determine the highest and best use: The appraiser analyzes market forces such as competition and current versus potential uses to determine the reasonableness of the property’s present use in terms of its profitability

5) Estimate the land value: The features and sales prices of comparable sites are compared with the subject property to determine the value of the land alone. Neither the cost nor the income approach can be used to estimate land value.

6) Estimate the value by each of the three approaches: The sales comparison, cost, and income capitalization approaches are used to estimate the value of the subject property.

7) Reconcile the estimated values for the final value estimate: The appraiser makes a definite statement of conclusions reached, usually in the form of a value estimate of the property. Note that the three approaches are never simply averaged.

8) Report the final value estimate: After the three approaches have been reconciled and an opinion of value has been reached, the appraiser prepares a formal written report for the client. All information used to estimate the value of a property should be included in this report.

Question 31

A complete appraisal report should:

Answer 31

identify the real estate and real property interest being appraised;

state the purpose and intended use of the appraisal;

define the value to be estimated;

state the effective date of the value and the date of the report;

describe the process of collecting, confirming, and reporting the data;

list all assumptions and limiting conditions that affect the analysis, opinion, and conclusions of value;

describe the information considered, the appraisal procedures followed, and the reasoning that supports the report’s conclusions (if an approach was excluded, the report should explain why);

describe (if necessary or appropriate) the appraiser’s opinion of the highest and best use of the real estate;

describe any additional information that may be appropriate in order to show compliance with specific guidelines established in the Uniform Standards of Professional Appraisal Practice (USPAP) or to clearly identify and explain any departures from these guidelines;

include a signed certification, as required by the Uniform Standards.

Question 32

1) What is the Uniform Residential Appraisal Report?

2) What are the major sections of the form?

Answer 32

1) a document to report appraisals, one of the most frequently used is the Fannie Mae Form 1004

2)

Subject: identification of the property being appraised

Neighborhood: information showing boundaries, characteristics, and market conditions

Site: information on lot dimensions, utilities, topography, off-site improvements, easements, flood conditions, etc.

Description of improvements: general descriptions, exterior, interior, foundation, effective age, etc.

Comments: additional features, condition of improvements, and adverse environmental conditions

Cost approach: showing applicable estimates derived from the cost approach

Sales comparison analysis: showing three comparables and adjustments and estimated value derived from the sales comparison approach

Indicated value by the income approach

Reconciliation: showing the final estimate of value, the date of the estimate, signatures, and license numbers of the appraisers

Question 33

To arrive at an accurate estimate of value, three basic approaches, or techniques, are traditionally used by appraisers:

Answer 33

1) The sales comparison approach

2) The cost approach

3) The income capitalization approach

Question 34

Sales Comparison Approach (Market Data Approach)

Answer 34

an estimate of value is obtained by comparing the subject property (the property under appraisal) with recently sold comparable properties (properties similar to the subject).

This approach is most often used in valuing single-family homes and land. Because no two parcels of real estate are exactly alike, each comparable property must be compared with the subject property, and the sales prices of the comparables must be adjusted for any dissimilar features.

Question 35

The principal factors for which adjustments must be made fall into four basic categories (The Sales Comparison Approach):

Answer 35

1) Date of sale. An adjustment must be made if economic changes occur between the date of sale of a comparable property and the date of the appraisal.

2) Location. An adjustment may be necessary to compensate for location differences. For example, similar properties might differ in price from neighborhood to neighborhood or even within the same neighborhood.

3) Physical features. Physical features that may require adjustment include age of building, size of lot, landscaping, construction, number of rooms, square footage of living space, interior and exterior condition, presence or absence of a garage, a fireplace or an air conditioner, and so forth.

4) Terms and conditions of sale. This consideration becomes important if a sale is not financed with a standard mortgage. Be sure that the sale was an arm’s-length transaction, which means that the property did not sell for an unusually high or low price because of a special relationship between the buyer and seller. An example would be a low-price sale between a parent and child.

Question 36

Comparables (comps)

Answer 36

selected should be as similar to the subject property as possible, and should have been recently sold (preferably within the past 120 days) in an open and competitive market, under typical market conditions, when the seller and buyer are well informed and are not acting under undue pressure

Please note that the acceptable age of comps is greatly dependent upon the degree of change in the market condition within a particular local area. For example, in markets where prices have been very stable for a long period of time, a comparable that has closed within 12-15 months may be acceptable.

After a careful analysis of the differences between comparable properties and the subject property, the appraiser assigns a dollar value to each of the major differences. On the basis of the appraiser’s knowledge and experience, the appraiser estimates dollar adjustments that reflect actual values assigned in the marketplace.

Question 37

Comparative Market Analysis (CMA)

Answer 37

An informal version of the sales comparison approach is used by real estate brokers to help a seller-client set a realistic asking price for residential real estate or to help a buyer-client determine a reasonable purchase price in an active market

Question 38

The Cost Approach

Answer 38

The cost approach to value is also based on the principle of substitution, which states that the maximum value of a property tends to be set by the cost of acquiring an equally desirable and valuable substitute property

Question 39

The cost approach consists of five steps:

Answer 39

Estimate the value of the land as if it were vacant and available to be put to its highest and best use, based on the sales comparison approach, because land cannot be depreciated.

Separate the land from the improvements, and estimate the current cost of constructing the building(s) and site improvements based, in general, on cost data and experience.

Estimate the amount of accrued depreciation of the improvements resulting from physical deterioration, functional obsolescence, or economic obsolescence.

Deduct the accrued depreciation from the estimated construction cost of the new building(s) and the contributory depreciated value of site improvements.

Add the estimated value of the land to the depreciated cost of the building(s) and site improvements to determine the total property value.

Question 40

There are two ways to look at the construction cost of a building for appraisal purposes (step 2):

Answer 40

Reproduction Cost and Replacement Cost

Question 41

Reproduction cost

Answer 41

Reproduction cost is the dollar amount required to construct an exact duplicate of the subject building at current prices

Question 42

Replacement Cost

Answer 42

Replacement cost is the construction cost, at current prices and using modern materials and methodology, of a property that is not necessarily an exact duplicate but serves the same purpose or function as the original property.

**most often used in appraising because it eliminates obsolete features and takes advantage of current construction materials and techniques.

Question 43

Depreciation

Answer 43

refers to any condition that adversely affects the value of an improvement to real property. Land does not depreciate because it is here forever and can always be put to its highest and best use when economically and legally feasible to do so.

Question 44

For appraisal purposes, depreciation is divided into three classes according to its cause:

Answer 44

Physical deterioration—curable & incurable

Functional obsolescence—curable & incurable

Economic (environmental or external or locational) obsolescence—incurable only

Question 45

Physical deterioration curable & incurable:

Answer 45

Repairs that are physically possible and economically feasible and will result in an increase in appraised value equal to or exceeding their cost fall into this category. Routine maintenance, such as painting and roof replacement, is an example of curable physical deterioration.

Physical deterioration—incurable: Repairs to major structural components of a building, which deteriorate at different rates, may not be economically feasible and therefore fall into this category. Examples are load-bearing walls and foundations.

Question 46

Functional obsolescence—curable:

Answer 46

Physical or design features that are no longer considered desirable by property buyers but can be replaced or redesigned at low cost constitute this class of depreciation. For example, outmoded fixtures, such as plumbing, are usually easily replaced. Room function might be redefined at no cost if the basic room layout allows it. A bedroom adjacent to a kitchen, for instance, may be converted to a family room.

Functional obsolescence—incurable: Currently undesirable physical or design features that cannot be remedied easily are considered functionally obsolete. Many older multistory industrial buildings are considered less suitable than one-story buildings, for example. An office building that cannot be air-conditioned because of the cost of duct installation also suffers from functional obsolescence. A residential example might be a home with five bedrooms but only one bath.

Question 47

Economic (environmental or external or locational) obsolescence—incurable only:

Answer 47

Caused by factors outside the subject property, economic (environmental or external or locational) obsolescence cannot be considered curable. For instance, proximity to a nuisance, such as a polluting factory, is an unchangeable factor that cannot be cured by the owner of the subject property. economic obsolescence also may be referred to as locational obsolescence

Question 48

Age-life method

Answer 48

The easiest but least precise way to determine depreciation

uses the effective age of a building and its economic (useful) life

When the cost of an asset is depreciated evenly over its useful life, this is called straight-line method of depreciation. Depreciation is assumed to occur at an even rate over a structure’s economic life, the period during which it is expected to remain useful for its original intended purpose. To derive the amount of annual depreciation, the property’s cost is divided by the number of years of its expected economic life.

Question 49

Special-purpose properties

Answer 49

The cost approach is most helpful in the appraisal of special-purpose buildings such as schools, churches, and public buildings. Such properties are difficult to appraise using other methods because there are seldom any local sales to use as comparables, and these properties ordinarily do not generate income.

Question 50

In the appraisal of special-purpose properties, an ____________ appraiser may complete only a cost approach analysis and may estimate market value based on the results of that approach alone. But just because a structure was originally constructed for a certain purpose does not mean that it is necessarily the highest and best use for the property.

This being the case, a market analysis of other properties having the same projected highest and best use is very important in this type of appraisal. Adjustments must be made for such variables as modification costs, location, time of sale, lot sizes, and the like, to make valid comparisons between the comparables and the subject property.

Answer 50

-inexperienced

Question 51

The Income Capitalization Approach/Income Approach

Answer 51

is based on the present worth of the future rights to income. It assumes that the income derived from a property will control the value of that property. The income approach is used for valuation of income-producing properties—apartment buildings, office buildings, shopping centers, and the like.

Question 52

In using the income approach to estimate value, an appraiser must work through the following steps:

Answer 52

1) Estimate the annual potential gross income using rents from comparable properties, as well as income from other sources such as concessions, laundry facilities, and vending machines.

2) Based on market experience, deduct an appropriate allowance for vacancy and rent collection losses to arrive at the effective gross income.

3) Based on appropriate operating standards, deduct the annual operating expenses of the real estate from the effective gross income to arrive at the annual net operating income (NOI). Operating expenses include taxes, insurance, maintenance, repairs, and reserves for replacement. Management costs are always included as operating expenses, even if the current owner manages the property and does not show a cost for this item. Mortgage payments of principal and interest, are debt service and are not considered operating expenses. For example, if a property owner spends $35,000 a year on operating expenses and $25,000 a year on mortgage payments, the $35,000 would be subtracted from effective gross income to determine the property’s net income; the $25,000 of mortgage payments (debt service) would not. Appraisers always assume a cash purchase and therefore an individual’s mortgage expenses are not relevant to this calculation.

4) Estimate the price a typical investor would pay for the income produced by this particular type and class of property. This is done by estimating the rate of return (or yield) that an investor will demand for the investment of capital in this type of building. This rate of return is called the capitalization (or cap) rate and is determined by comparing the relationship of NOI to the sales prices of similar properties that have sold in the current market. For example, a comparable property that produces an annual NOI of $15,000 is sold for $187,500. The capitalization rate is $15,000 ÷ $187,500, or 8%. If other comparable properties sell at prices that yield substantially the same rate, it may be assumed that 8% is the rate that the appraiser should apply to the subject property. Note that the cap rate is inversely related to the market value of the property; as one goes up, the other goes down.

5) Finally, the capitalization rate is applied to the property’s annual NOI, resulting in the appraiser’s estimate of the property value.

Question 53

Formulas important in estimating the value of income-producing property are (4):

2 solve for value

1 solves for rate

and 1 solves for income

Answer 53

Net Operating Income ÷ Capitalization Rate = Value

income ÷ Rate = Value

income ÷ value = rate

Value × Rate = Income

Question 54

Gross rent multipliers or gross income multipliers

Answer 54

The GRM relates the sales price of a property to its expected rental income. (Gross monthly income is used for residential property; gross annual income is used for commercial and industrial property.)

Sales price ÷ Rental income = gross rent multiplier

Question 55

Reconciliation

Answer 55

is the art of analyzing and effectively weighing the findings from the different approaches used.

To come up with a valid estimate, the appraiser must give more weight to the most appropriate appraisal method for that particular type of property.

Question 56

To reconcile for differences in the adjustments of comparable properties, appraisers use the process of simple averaging. (t/f)

Answer 56

False

To reconcile those differences, appraisers use weighted averaging

Question 57

In the process of reconciliation, a broker should consider not only the number of adjustments made to comparables but also the monetary amount of the adjustments. (T/F)

Answer 57

True

Before determining how much weight to assign to comparables, brokers should review the number of adjustments made, as well as the monetary value of those adjustments. The greater the number of adjustments and/or the monetary value of those adjustments, the less meaningful the comparable is in estimated the probable sales price of the subject.

Question 58

In order to produce an appraisal, North Carolina individuals must be properly licensed by the North Carolina Appraisal Board. (t/f)

Answer 58

true

Question 59

The formula for income capitalization is effective gross income divided by capitalization rate equals value. (t/f)

Answer 59

false

The formula for income capitalization is net operating income divided by capitalization rate equals value.

Question 60

The formula to arrive at a gross income multiplier is gross sales price of a comparable property divided by gross monthly income. (t/f)

Answer 60

true

The formula for the GRM is gross (or unadjusted) sales price divided by gross (or unadjusted) monthly income (or rent).