Real Estate Appraisal and Investments

Question 1

Valuation

Answer 1

is the act or process of developing an opinion of value by anyone. A real estate appraisal is an appraiser’s opinion of value resulting from the analysis of facts. An appraisal is not a determination of value; it is only an opinion.

Question 2

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

Answer 2

requires that a real estate appraisal used in connection with a federally related transaction be performed by a person licensed or certified by the state.

Question 3

A federally related transaction

Answer 3

is a real estate-related financial transaction involving a federal agency or a financial institution regulated or insured by a federal agency.

Question 4

A state-licensed appraiser

Answer 4

is a person licensed to make appraisals of:

• noncomplex one- to four-family residential units having a value of less than $1,000,000
• complex one- to four-family residential units having a value of less than $250,000
• nonresidential property having a value of less than $250,000

Question 5

A state-certified residential appraiser

Answer 5

is a person certified to make appraisals of:

• all types of residential property of one to four units without regard to transaction value or complexity
• nonresidential property having a value of less than $250,000

Question 6

A state-certified general appraiser

Answer 6

is a person certified to make appraisals of all types of real property, regardless of value.

Question 7

a competitive (or comparative) market analysis (CMA)

Answer 7

A real estate agent will present their opinion of value to assist the owner in setting a listing price or the buyer in making an offer. This opinion of value is called a competitive (or comparative) market analysis (CMA). It relates the subject property to similar properties that recently have sold and properties that currently are available for sale.

Question 8

Characteristics of Value

Answer 8

1. utility
2. scarcity
3. effective demand
4. transferability

Question 9

Utility

Answer 9

is the ability to satisfy a need or desire of a potential buyer. Land in an urban growth boundary has utility to a builder as the source of buildable lots, but land outside the urban growth boundary would lack such utility for a builder.

Question 10

Scarcity

Answer 10

is also needed. An item cannot have value unless there is also a degree of scarcity. As long as fresh air is plentiful, there is no demand to buy it, and it has no commercial value. Because of scarcity, value is influenced by supply and demand factors. Property with a view sells for more than property without a view because of scarcity. If every property in an area had a view of the mountains, there would be no additional value for the view.

Question 11

Effective demand

Answer 11

is demand for the item from people with a desire or need for it and the purchasing power to acquire it. The greater the desire or need for an item of those able to translate the desire or need into a purchase, the greater the potential value. A buyer may want a $2,000,000 house, but without the necessary funds, that desire would not influence the sale price of that house.

Question 12

Transferability

Answer 12

refers to the fact that, if benefits of an item are not transferable, the item has no value to a prospective purchaser. If property available for sale includes only a life estate, fewer rights are capable of being transferred, and it will have a lower value than a fee estate.

Question 13

3 basic physical characteristics of real estate

Answer 13

1. Immobility: The location of any given parcel of land cannot be change. The major factor affecting real property value is its location. This results in relative scarcity of usable land. The choices and preferences for a given area (called “situs”) cause similar parcels in different locations to have different values.
2. Indestructibility: Land may lose value and may change its appearance, but it generally does not disappear, unless there is a natural disaster.
3. Nonhomogeneity or heterogeneity: No matter how similar it may be to other parcels, each parcel has its own location and features (e.g., size, shape, topography).

Question 14

an unearned increment

Answer 14

Any increase in value resulting from these forces (Physical and environmental characteristics, Economic conditions, government or political regulations, Social influences), which are outside the influence and control of the property owner (e.g., from favorable rezoning, inflation, or population growth), is considered an unearned increment.

Question 15

Frame buildings

Answer 15

This is the type of construction used in most homes. They are buildings with exterior walls, floors, and roofs of combustible construction. Wood frame is the most typical in residential construction.

Question 16

Joisted Masonry buildings

Answer 16

These are buildings with exterior walls of masonry or fire-resistive construction.

Question 17

Light noncombustible buildings

Answer 17

are buildings with exterior walls of light metal or other noncombustible material, and noncombustible floors and roofs. These are typically steel frame buildings.

Question 18

A-frame

Answer 18

This style features steeply angled sides that also serve as the roof. The roof begins on both sides of the rectangular house and meet at the top in the shape of an “A”.

Question 19

Bungalow

Answer 19

These are typically one- or one-and-a-half-story homes with a sloping roof and exposed rafter tails. One might consider the bungalow to be the forerunner of the ranch style.

Question 20

Cape Cod

Answer 20

These houses originated in New England and are characterized by their one-and-a-half stories, steep roofs, gables, and a central chimney.

Question 21

Craftsman

Answer 21

Sometimes called the Arts and Crafts style is an American original.

Question 22

Colonial

Answer 22

This is represented by a variety of different building styles. It dates back to very early America and can be a simple home or an elaborate style, such as the Dutch Colonial with a full front porch and elaborate columns.

Question 23

Mid-Century Modern

Answer 23

This is a style that describes of lot of housing built from the 1940s through the early 1960s. These home most often are found in neighborhoods dating from the 1950s and usually are one level with clean and sharp lines.

Question 24

Ranch

Answer 24

A ranch home is usually one level and has a profile that is close to the ground. This home is found in many suburbs of cities.

Question 25

Split-Level or Tri-Level

Answer 25

These homes have floors levels that are staggered and the main level of the house is halfway between the upper and lower floors. Another variation is the Split-Entry, which has a central stairway located at the front door, which is halfway between the upper and lower floors.

Question 26

Victorian

Answer 26

These homes were built during the reign of Queen Victoria (1837–1901) and are characterized by steep pitched roofs and ornate decorative features.

Question 27

Sales comparison approach (market data approach)

Answer 27

In this approach, homes and land are valued by comparing prices paid for similar properties.

Question 28

Income approach

Answer 28

In this approach, properties that produce rental income (e.g., office buildings, apartments, retail properties) are valued based on their anticipated net income and rate of return. The appraiser will base the rate of return on rates received by investors who purchased similar properties.

Question 29

Cost approach

Answer 29

The cost approach is used most commonly when sales data are lacking for the sales comparison approach and rental data are insufficient for the income approach (e.g., in appraising a church or a single-use property). In this approach, the appraiser compares the existing property to a similar building to be built. They estimate the value of the land, the cost to replace the improvements on the land, and the depreciation that makes the improvements as they exist less desirable than new improvements.

Question 30

four-stage life cycle

Answer 30

1. integration (development or growth)
2. equilibrium (stability or maturity)
3. disintegration (deterioration, decline or old age)
4. revitalization or rehabilitation

Question 31

Regression

Answer 31

This concept holds that the value of better property will suffer if it is placed in an area of lesser valued homes. The value of a home built at a cost of $250,000 would suffer if placed in an area of $160,000 homes.

Question 32

Progression

Answer 32

This concept holds that the value of a lesser property will be enhanced if it is placed in an area of better homes. The value of a home built at a cost of $250,000 would be enhanced if placed in an area of $400,000 homes.

Question 33

an eight-step appraisal process

Answer 33

1. define the appraisal problem
2. conduct a preliminary analysis and develop a plan, and select and collect data
3. develop a highest and best use opinion
4. develop indicators of land or site value
5. develop indicators of improved property value
6. analyze prior sale, current agreements, options, or listings of the subject property
7. reconcile the value indicators to reach an opinion of value
8. report opinion(s) of value

Question 34

Obsolescence

Answer 34

is the loss in the usefulness of structures that causes them to become less desirable or less useful. Obsolescence is usually more difficult to correct than deterioration.

Question 35

Functional obsolescence

Answer 35

is the loss of value resulting from factors of inadequacy or overadequacy within the property itself, often caused by changes in construction materials, methods, equipment, and the desires of people.

Question 36

overadequacy

Answer 36

Factors of overadequacy would include a heating system too large for the house, decorations costing more than buyers are willing to pay for them, or other items exceeding reasonable requirements.

Question 37

inadequacy

Answer 37

Factors of inadequacy would include outdated plumbing features and components smaller than normally expected (e.g., a lack of closet space, a four-bedroom home with one bath, a poor room arrangement).

Question 38

External obsolescence (also called economic obsolescence)

Answer 38

is a loss in value resulting from conditions outside the property.
Among the many causes of external obsolescence are deterioration of the neighborhood caused by changes in use of neighboring properties, blight, changes in zoning and legislative restrictions, or fumes from a factory.
Because economic obsolescence is external to the property, it is generally incurable.

Question 39

an actual physical age

Answer 39

The actual age of improvements is the length of time they have been standing.

Question 40

an effective age

Answer 40

Effective age is the age of a similar and typical property of equal usefulness, condition and future life expectancy. It is the age the improvements appear to be, based on their condition.
Because the condition of the improvements depends on how well the property is maintained and whether it has been remodeled or upgraded, the effective age may be less or greater than the actual age.

Question 41

Physical life

Answer 41

is the period of time between the completion of building construction and the time when the building is no longer fit or safe to use. (The physical life of the building is terminated by deterioration.)

Question 42

Economic life

Answer 42

is the period of time between the completion of construction and the disappearance of the building’s ability to produce services or income sufficient to offset the expenses. (The economic life is terminated by obsolescence.)

Question 43

the cost approach (also called the summation approach, replacement cost approach, or reproduction cost approach)

Answer 43

This approach can be used to appraise almost any type of improved property, but as it requires a greater degree of skill than the sales comparison approach, the cost approach is not the preferred method when the sales comparison approach is applicable.
The cost approach, therefore, is most commonly used for specialty property such as public buildings, single-use factories, churches, etc. It is also used for evaluating property for fire insurance.

Question 44

Replacement cost

Answer 44

is the present cost of constructing a substitute structure equal to the existing structure in quality and utility but using current construction methods, materials, design, and layout.

Question 45

Reproduction cost

Answer 45

is the present cost of constructing a substitute structure that is an exact replica of the existing structure (i.e., with the same materials, quality of workmanship, design, and layout).
Because reproduction cost might involve estimating the costs of utilizing materials and construction practices that are outmoded, it would be impractical or even impossible to estimate in many instances; reproduction cost generally would be used only for unique properties.
Most often replacement cost, the cost of an equally desirable substitute, is used.

Question 46

Total Depreciation

Answer 46

Total Depreciation = (Annual Depreciation × Effective Age) × Cost

Question 47

Current Value

Answer 47

Current Value = (100% - Depreciation) x Cost

Question 48

the income approach (or capitalization approach)

Answer 48

This approach is used to appraise properties capable of producing rental income for the owner (i.e., apartments, office buildings, warehouses).
It bases the value of the property on the income the owner will receive and the rate of return the owner should find acceptable.
The premise for this approach is that value is the present worth of future benefits: Value equals the price a person pays today for the right to receive net income from the property in the future.
I = R × V

Question 49

A gross rent multiplier

Answer 49

is a factor. If this factor is multiplied by the rental price of a property, the result is an estimated market value.

The formula for using a gross rent multiplier is as simple as remembering its name.

Value = Gross Rent × the Multiplier

Sales Price ÷ Gross Rent = Multiplier

Question 50

Tax Credits

Answer 50

A tax credit is of greater value than an equal dollar amount of tax deductions.

A tax credit is a direct deduction from the tax due, rather than a deduction from taxable income.
For example, if a person is in the 30% tax bracket, a tax deduction of $1,000 will reduce that person’s taxable income by $1,000 and reduce taxes by $300. If that same person had a $1,000 tax credit, his taxes owed would be reduced by $1,000.

Question 51

amount realized

Answer 51

Selling Price
– Selling Expenses
Amount Realized

This is the total amount received for the property, including money, notes, mortgages and the value of any other property received.

Question 52

Capital Gain

Answer 52

Amount Realized
– Adjusted Cost Basis
Capital Gain (or Loss)
Realized in the tax year in which property sold
Recognized in the tax year for which it is taxed

Question 53

Tax Exemptions

Answer 53

A homeowner is eligible for a major tax break on the sale of a home.
- If she has owned and lived in a home as her main home for two of the past five years and has not excluded any gain on the sale of another home in the past two years, she may exempt $250,000 of gain. Therefore, if a person sells her home of two years and realizes a gain of $200,000, none of the gain is taxable. If she realizes a gain of $300,000, only $50,000 is taxable at the capital gains rate.

If there are co-owners, each is entitled to a separate exemption, if qualified. When a married couple files a joint return and each spouse has lived in the home as a main home for two of the past five years and has not excluded any gain on the sale of another home in the past two years, the exemption is $500,000 of gain, even if only one spouse has owned the property for the required two years.

The exemption is prorated if the two-year requirement is not met because of health, employment, or special circumstances.

Question 54

Principle of Substitution

Answer 54

• The market data approach is the main valuation principle and holds that a prudent person would not pay more for a product than he would pay for a reasonable substitute.
• The income approach holds that a person would not accept a lower rate of return than from a reasonable substitute.
• The cost approach holds that a person would not pay more than it would cost to build a reasonable substitute.