Real Estate Appraisals And Investments

Question 1

VALUATION

Answer 1

Is the act or process of developing an opinion of value by anyone.

Question 2

APPRAISAL

Answer 2

In real estate is an appraiser’s opinion of value resulting from an analysis of facts.

An appraisal is not a determination of value, only an opinion.

Question 3

Licensing APPRAISERS

Answer 3

1. State licensed Appraiser, licensed to make appraisals
   1-4 family residential units having a value of less than one million dollars
   Complex 1-4 family residential units having a value of less than $250,000.
   Non residential properties having a value of less than $250,000.
2. State Certified Residential Appraiser
   All types of properties of 1-4 units without to transaction or complexity
   Non residential property having a value of less than $250,000.
3. State Certified General Appraiser
   Person certified to make appraisals of all type of properties regardless of value.

Question 4

FIRREA

Answer 4

Federal institutions Reform, Recovery and Enforcement Act

Is used in a federally related transaction is a real estate transaction involving a federal agency or a financial Institution regulated or insured by a federal agency.

Appraisers must meet requirements of The Appraisal Foundation.

Question 5

Valuation and Appraisal

VALUE, PRICE and COST

Answer 5

Value is worth.

Can be subjective or objective.

Question 6

Subjective Value aka utility value, value in use, or investment value..

Answer 6

It is value related to the use for a specific user even if there is no identifiable open market for the item

I.e. schools, churches, libraries, single-use factories, industrial facilities and company headquarters

When buyers are willing to pay more in a property than they know they would be able to realize on resale, the value to them reflects a SUBJECTIVE value.

Question 7

OBJECTIVE VALUE aka value in exchange or market value..

Answer 7

It does not relate to just a specific user.. market value is determined by buyers and sellers, not by appraisers.

Appraisers can only give opinions as to what that value might be.

Question 8

PRICE and COST

Answer 8

Market value is not the same of market price or cost.

The actual amount paid for the property will be its price aka market price.

Question 9

Price and value differ when

Answer 9

Parties are not equally motivated( the buyer has subjective reasons for wanting the property).

Parties are pressured to buy or sell (e.g. pending foreclosure)

Parties are not well-informed or are victims of misrepresentation or high-pressure tactics

Question 10

COST IS

Answer 10

The total amount of money, labor, materials and services spent to produce or develop the item.

It does not necessarily reflect or control value.

Question 11

Characteristics of Value

Answer 11

1. Utility. Ability to satisfy a need or desire
2. Scarcity degree of scarcity about supply an demand
3. Effective Demand demand for an item from people with a desire or need for it and the purchasing power to acquire.
4. Transferability. If benefits of an item is not transferable, the item has no value to a prospective purchaser.

Question 12

Physical and Economic Characteristics of Real Estate

Answer 12

Unique to real estate affects its use and value.

Question 13

3 basic physical characteristics of real estate

Answer 13

1. Immobility: the major fact affecting real property value is its location.
2. Indestructibility: Land may lose value and may change appearance but it generally does not disappear.
3. Non-homogeneity or heterogeneity: No matter how similar it may be to others, each parcel has its own location and features.

This results in real estate markets being local in character.

Adjustments relating to supply and demand occur slowly resulting in real estate cycles of oversupply ( buyer’s market). And under supply ( sellers market)

Question 14

4 GENERAL FORCES affecting real estate values

Answer 14

1. Physical and Environmental which can encourage or prevent development.
   Physical e.gs. Schools, shopping, transportation. Environmental e.gs. Earthquake, hurricane, flood etc
2. Economic conditions which cause property values to increase or decline.
   E.gs. Employment and wage trends, interest rates, availability of mortgage money
3. Governmental or political Regulations: Direct tax levels, zoning, growth
4. Social Influences: Population growth or decline

Any increase in value resulting from these forces which are outside the influence and control of the property owner is considered “unearned increment.”

Question 15

ECONOMIC CONCEPTS AND PRINCIPLES

Characteristics of real property lead to certain economic concepts and principles related to valuation.

Answer 15

Principal of ANTICIPATION

Question 16

ANTICIPATION

Holds that value is created by the expectation of future benefits to be derived from ownership and use of the property.

Answer 16

This is the basic principle of the appraisal of income property. The appraiser attempts to estimate the present value of income to be received in the future.

Question 17

Principle of SUBSTITUTION

Answer 17

Holds that the value of property that is replaceable tend to be set by the cost of acquiring an equally desirable substitute property without undue delay.

This principle is the basis for all appraisal approaches.

Question 18

What are the 3 appraisal approaches

Answer 18

1. Sales Comparison Approach. Aka the market data approach. Home and lands are valued by comparing similar properties
2. Income Approach. Re Rental Properties are valued based on their anticipated net income and rate of return.
3. Cost Approach. Used when sales data is lacking. In this approach the appraiser compares existing property to a similar building to be built. He estimates value on the cost of land, the cost of improvements and the depreciation that makes the improvements as they exist less desirable than new improvements.

Question 19

Principle of CHANGE

Answer 19

Holds that value estimates are valid only at a specific point in time as neighborhoods and properties tend to go through 4 stage life cycle.

Question 20

4 stage life cycle of CHANGE

Answer 20

1. Integration. (Development or growth)
2. Equilibrium. (Stability or maturity)
3. Disintegration (deterioration, decline or old age)
4. Revitalization or rehabilitation

Question 21

Principle of CONFORMITY.

Answer 21

Holds that maximum value is realized when there is reasonable degree of architectural homogeneity and land uses are compatible and conform to the area standards.

Question 22

Under improvements, over improvements and misplaced improvements are
Those improvements that lack conformity with their surroundings

This leads to 2 related concepts:

Answer 22

1. Regression: this concept that the value of better property will suffer if it is placed in an area of lesser value.
2. Progression: this concept holds that the value of a lesser property will be enhanced if it is placed in an area of better homes.

Question 23

Principle of SUPPLY AND DEMAND

Answer 23

Holds that an increasing supply of units or a declining demand for them adversely affects the price they can obtain in the market.

Buyers market supply of houses available exceeds the demand.

Sellers market the demand for houses exceeds the supply and prices go up.

Question 24

Principle of INCREASING AND DIMINISHING RETURNS

Answer 24

Holds that the value of property is governed by the contribution made by 4 agents of production.

Question 25

4 agents of production

Answer 25

1. Land
2. Labor
3. Capital (capital)
4. Coordination (management). Are paid, the remaining value is the land.

There are increasing returns as larger amounts of these agents produce greater net benefits.

However, once the maximum value of the property is reached, any further increases in these agents would not produce enough of a return to justify the additional investments.

Question 26

Principle of Competition

Answer 26

Holds that profits will encourage competition and excess profits tend to create excessive competition which can destroy profits.

Question 27

Principle of CONTRIBUTION

Answer 27

Holds that the value of an improvement is measured by its contribution for the net return of the property I.e. whether the money spent would add value in excess of the cost and at an acceptable rate of return. This would apply
To covert a basement to an apartment or whether to install a pool in an apartment complex.

Question 28

One aspect of Contribution is the ratio of the land to building area.

Answer 28

This becomes important in determining if the land is being used in a comparable ratio to the properties surrounding the subject property and whether the land is being put to its HIGHEST AND BEST USE.

Question 29

HIGHEST AND BEST USE. Principle

Answer 29

Holds that the use that at the time of the appraisal is most likely to yield the greatest net return over a given time period. This return could be measured in Money or amenities . Amenities are aspects of location or design that make the property more desirable, eg. fireplaces, proximity to shopping and schools, building style etc.

Under this principle only those uses that are legal,possible, probable and economically feasible can be considered. Public and Private restrictions dictate what uses are legal and permissible. When both apply, the more stringent restrictions prevail, whether public or private.

Question 30

Increased value may result from dividing larges parcels into smaller ones or
Creating greater utility by putting several parcels together.

Answer 30

Putting several parcels under 1 owner is called ASSEMBLAGE.

The addd value resulting from assemblage is called PLOTTAGE. (PLOTTAGE increment)

Question 31

THE APPRAISAL PROCESS

Answer 31

1. Define the appraisal problem
2. Conduct a preliminary analysis
3. Develop highest pet 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 32

UNIFORM RESIDENTIAL APPRAISAL REPORT. (URAR)

The general description is necessary to ensure that the proper structures are selected for comparison.

Answer 32

Divides the describe into the following categories:

1. General description
2. Exterior description
3. Foundation
4. Basement
5. Insulation
6. Room list
7. Interior
8. Heating
9. Kitchen equipment
10. Attic
11. Amenities
12. Car Storage
    13 comments

Question 33

DEPRECIATION is defined as a loss in value from any cause.

It results when improvements begin to lose acceptability to prospective purchasers or renters.

Answer 33

Some appraisers look at depreciation from the standpoint of what has happened.

Others from the standpoint of what is likely to happen.

The loss in value from what has happened is ACCRUED depreciation.

Question 34

ACCRUED DEPRECIATION

Depreciation results from physical deterioration and obsolescence.

Answer 34

Is the difference between the value of the building at the time of appraisal and the current replacement cost of the structure in new condition.

The land does not depreciate, only the improvements.

From the moment they are added to the land, they begin to lose value in relation to their cost, if new.

Question 35

PHYSICAL DEPRECIATION.

Answer 35

Is the wear and tear or breaking down of their physical structure, which takes place over time.

It can be evidenced by decay, dry and wet, insect damage, wear and tear and vandalism.

A major contributing factor is deferred maintenance. Deferred maintenance is usually identified as a lump sum expense needed for overdue repairs.

Question 36

Physical Deterioration may be curable or incurable.

Answer 36

1. Deterioration is curable when items are repairable or replaceable and it makes economic sense to repair or replace.
2. Deterioration is incurable when an item is not repairable or replaceable or when it would not be economically feasible to repair or replace them at the time.

Question 37

OBSOLESCENCE

Answer 37

Is the loss in the usefulness of structures that causes them to become less desirable or less useful.

It is outdated due to new inventions, construction , equipment etc.

It is outdated due to public’s preferences.

Question 38

FUNCTIONAL OBSOLESCENCE

Answer 38

Is loss of value due to factors of inadequacy or overadequacy w/in the property itself.

Question 39

External Obsolescence aka economic obsolescence.

Answer 39

Is loss in value resulting from conditions outside the property

Since economic obsolescence is external to the property, it is generally incurable.

Question 40

PROPERTIES HAS AN AN ACTUAL PHYSICAL AGE AND AN EFFECTIVE AGE

Answer 40

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

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 , based on their condition.

Since 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

Depreciation and obsolescence limit the usefulness of improvements to a physical life and an economic life.

Answer 41

Physical life 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.

Physical life of the building is terminated by deterioration.

Economic life is the period 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 42

Appraisal Approaches

Answer 42

Sales Comparison

Cost Approach

Income Approach

Question 43

SALES COMPARISON APPROACH aka. Market Data Approach

Answer 43

This is valuation based on the prices paid for comparable properties.

Since it is using a comparison, it is based on the principle of substitution.

This is generally the best method of estimating value of any property.

OST deed show actual price paid for the property.

Question 44

Sales Comparison Approach

Each comparable property is compared to the subject property taking into consideration the following elements of comparison:

Answer 44

1. Condition of sale. Terms and conditions of the sales should be determined to see if they are typical for the market.

Date of sale: each property compared should be reasonably current.

Location: adjustments must be made to compensate for locational differences

Physical. Characteristics: may be determined by inspection of the properties, MLS data, interviews with a buyer and seller or agent. Factors affecting value would be floor plan, degree of repair, size, room, count, lack of a garage, design, view special features, quality of materials, landscaping or lack there of, .

IMPORTANT: acquisition cost or purchase price is not relevant in estimating value using this approach.

Question 45

COST APPROACH aka summation approach, replacement cost approach or reproduction cost approach

Answer 45

This kind of approach requires a greater degree of skill than the sales approach.

The cost approach is most commonly used for specialty property such as. Public buildings, single use factories, churches, etc. it is used for evaluating property for fire insurance.

Most difficult aspect is estimating the depreciation so this type of approach where this difficulty is least likely to exist , such as appraisals of new buildings.

Question 46

Cost Approach is that the value of improved property can be estimated by adding the value of the land to the depreciated cost of the improvements on the land.

Answer 46

Following steps are used:

1. Estimate the land value
2. Add the estimated cost of replacing or reproducing the improvements with new ones.
3. Estimate and deduct the depreciation to the improvements.

Based on the principle of substitution

Question 47

Cost Approach methods commonly used to estimate cost are

Answer 47

The comparative cost method

The unit-in-place method

The quantity survey approach

Question 48

Comparative cost method aka square-foot or cubic-foot method

Answer 48

Is fast, inexpensive and easy to understand so it is a commonly used approach.

It involves comparing subject property w/ other similar blogs whose costs are known. Those costs when divided by the# of sq fr ( residential) or by cubic ft (commercial) provide a unit cost per square ft or per cu. ft.

Unit cost multiplied by sq ft or cu ft of subject Bldg.

Question 49

Unit-in-place method

Answer 49

Is a modification of the quantity survey..

It involves combining all the costs into a unit cost for each portion of the building installed(or in place).

Costs of floor structure, appliances, framing, stairway, heating, plumbing, roof, and
Foundation generally are based on this method.

Question 50

Quantity survey method

Answer 50

Is the most detailed and complex of the methods and most frequently used by builders and professional cost estimators as the basis for a bid on a construction contract.

It involves a complete itemization of all direct costs e.g. hours of labor, cubic yards of concrete, etc. and
indirect costs e.g. office overhead, insurance, interests, permits, contractors permits.

Question 51

Quantity survey cont’d

Answer 51

If the building is .highest and best use for the land . And the land value and reproduction or replacement cost of new improvements have been properly estimated, the total of land value and the cost new will yield the upper limit of
Value of the property. (Land + Cost New = Upper Limit of Value.). Which is the maximum value not current market value.

Current market value is derivedaftercalculating accrued depreciation and then deducting it from the upper limit.

Question 52

Calculating accrued depreciation entails measuring loss of value that already occurred over the past life of the improvement.

Answer 52

The simplest method though least accurate is the “straight-line (age-life) method.

This method is based on the presumption that improvements depreciate at an equal rate each year until the end of economic life when Bldg would be torn down.

Question 53

To estimate the depreciation, appraiser estimates property’s age.

Answer 53

Normally , appraiser uses effective age after curing any curable depreciation, rather than actual age.

The appraiser
Multiplies abnnual rate of depreciation by the effective age to determine total% of value lost.
Multiply that % by the replacement cost of the I,provements to arrive at the dollar amount of the loss.

Total Depreciation = (annual Depreciation x Effective age) x Cost.

The final step in the process is to deduct the depreciation of improvements to arrive at the current market value.

Land + Cost of Improvement - Depreciation = current property value

Question 54

Mathematical Alternative

Answer 54

Current Value = (100% divided by Depreciation) times Cost

Land
Plus current value of improvements
Equals current property value

Question 55

INCOME APPROACH aka capitalization. Approach. For rental income.

Answer 55

Value of property capable of producing rental income for owner.
The premise for this approach is that value is the present worth of future benefits.

Formula is. I= R x V. Remember as IRV. ( income, rate and value)

I income is the anticipated annual net income produced by property

R. Rate is the capitalization rate

V. Value is the present worth of the property

Since net income is% of the value, in estimating value, the income is divided by the rate: the income is divided by the rate to get the value

I= R x V. Therefore I divided by R = V

Question 56

Net income is gross less operating expenses

To estimate net income , the appraiser must establish “scheduled gross income”

Answer 56

Scheduled gross income is arrived after analysis of:
Historical rent ( paid by tenant in previous years)
Contract rent ( rent currently paid by tenants)
Economic or market rent ( amt of rent that could be obtained if it were vacant and ready to rent or were used for the highest and best use.)

This amount is adjusted to account for vacancies or unpaid rent anticipated lost.

When vacancies and delinquencies are deducted, the resulting figure is
EFFECTIVE GROSS INCOME

Question 57

Next step is to estimate Operating Expenses which include:

Answer 57

Fixed expenses eg. property taxes and insurances

Variable expenses ; utilities, advertising, management, repairs, decorating

Reserves for replacements: appliances charge 1/10 of annual cost for 10 years

Deducted expenses do not include income tax payments, depreciation,or mortgage interest payments

Question 58

CAPITALIZATION RATE

Answer 58

Is a rate of return that converts net income to value.

The capitalization rate consists of a return ON the investment and a OF the investment.

Question 59

RECAPTURE RATE

Answer 59

Rate of return OF the investment ( or the accrual for depreciation)
If the depreciation rate is 2% then the investor needs a 2% return for RECAPTURE IN ADDITION TO THE RATE DESIRED ON HIS INVESTMENT.

Once the cap rate is determined, then the appraiser can capitalize the income by
Dividing the net income by cap rate to get value.

The higher rate produces lower value since the higher rate implies greater risk.

Question 60

GROSS RENT MULTIPLIER for smaller income properties

Answer 60

This is considered the income approach for residential properties.

A gross rent multiplier is a factor.

Value= Gross rent x the multiplier

After estimating the fair market rental for a subject property, based on comparable rental properties, appraiser would multiply the estimated rent by the multiplier to get the estimated property value

Sales Price divided by Gross rent = Multiplier

Question 61

RECONCILIATION

Answer 61

Not all approaches are equally appropriate for a particular property.. the appraiser would interpret the data obtained and apply to each of his value estimates a weight proportionate to its merits in the particular instance.

He would give the most weight to the income approach for income property,
The sales comparison approach for marketable property and the cost approach for property not commonly bought and sold in the market such as churches and public blogs.

The weighing is the final step in estimating the market value. This is called reconciliation or correlation.

Question 62

REVIEW
VALUATION AND APPRAISALvalue is the relationship between items and persons wanting those items.

Differences in value are caused by 4 value characteristics: utility, scarcity, transferability, and demand.

Real estate value is influenced by physical charcteristics: immobility, indestructibility, in homogeneity or heterogeneity and by
4 general forces: economic conditions, government regulations , social influence and environmental.

Answer 62

The most complete appraisal report is a narrative report. The appraiser uses different approaches then analyzes and compares the results in a process called reconciliation or correlation.

The characteristics of real property lead to certain economic concepts and principles relating to the valuation of real property.

The principle of highest and best use holds the maximum value of land exists when property is used for its highest and best use.

This is possible, feasible and legally permissible use that, at the time of the appraisal is most likely to yield the greatest net return over a given period of time.