Real Estate Appraisals And Investments Flashcards
VALUATION
Is the act or process of developing an opinion of value by anyone.
APPRAISAL
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.
Licensing APPRAISERS
- 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. - 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. - State Certified General Appraiser
Person certified to make appraisals of all type of properties regardless of value.
FIRREA
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.
Valuation and Appraisal
VALUE, PRICE and COST
Value is worth.
Can be subjective or objective.
Subjective Value aka utility value, value in use, or investment value..
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.
OBJECTIVE VALUE aka value in exchange or market value..
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.
PRICE and COST
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.
Price and value differ when
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
COST IS
The total amount of money, labor, materials and services spent to produce or develop the item.
It does not necessarily reflect or control value.
Characteristics of Value
- Utility. Ability to satisfy a need or desire
- Scarcity degree of scarcity about supply an demand
- Effective Demand demand for an item from people with a desire or need for it and the purchasing power to acquire.
- Transferability. If benefits of an item is not transferable, the item has no value to a prospective purchaser.
Physical and Economic Characteristics of Real Estate
Unique to real estate affects its use and value.
3 basic physical characteristics of real estate
- Immobility: the major fact affecting real property value is its location.
- Indestructibility: Land may lose value and may change appearance but it generally does not disappear.
- 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)
4 GENERAL FORCES affecting real estate values
- Physical and Environmental which can encourage or prevent development.
Physical e.gs. Schools, shopping, transportation. Environmental e.gs. Earthquake, hurricane, flood etc - Economic conditions which cause property values to increase or decline.
E.gs. Employment and wage trends, interest rates, availability of mortgage money - Governmental or political Regulations: Direct tax levels, zoning, growth
- 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.”
ECONOMIC CONCEPTS AND PRINCIPLES
Characteristics of real property lead to certain economic concepts and principles related to valuation.
Principal of ANTICIPATION
ANTICIPATION
Holds that value is created by the expectation of future benefits to be derived from ownership and use of the property.
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.
Principle of SUBSTITUTION
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.
What are the 3 appraisal approaches
- Sales Comparison Approach. Aka the market data approach. Home and lands are valued by comparing similar properties
- Income Approach. Re Rental Properties are valued based on their anticipated net income and rate of return.
- 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.
Principle of CHANGE
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.
4 stage life cycle of CHANGE
- Integration. (Development or growth)
- Equilibrium. (Stability or maturity)
- Disintegration (deterioration, decline or old age)
- Revitalization or rehabilitation
Principle of CONFORMITY.
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.
Under improvements, over improvements and misplaced improvements are
Those improvements that lack conformity with their surroundings
This leads to 2 related concepts:
- Regression: this concept that the value of better property will suffer if it is placed in an area of lesser value.
- Progression: this concept holds that the value of a lesser property will be enhanced if it is placed in an area of better homes.
Principle of SUPPLY AND DEMAND
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.
Principle of INCREASING AND DIMINISHING RETURNS
Holds that the value of property is governed by the contribution made by 4 agents of production.
4 agents of production
- Land
- Labor
- Capital (capital)
- 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.
Principle of Competition
Holds that profits will encourage competition and excess profits tend to create excessive competition which can destroy profits.
Principle of CONTRIBUTION
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.
One aspect of Contribution is the ratio of the land to building area.
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.
HIGHEST AND BEST USE. Principle
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.
Increased value may result from dividing larges parcels into smaller ones or
Creating greater utility by putting several parcels together.
Putting several parcels under 1 owner is called ASSEMBLAGE.
The addd value resulting from assemblage is called PLOTTAGE. (PLOTTAGE increment)
THE APPRAISAL PROCESS
- Define the appraisal problem
- Conduct a preliminary analysis
- Develop highest pet and best use opinion
- Develop indicators of land or site value
- Develop indicators of improved property value
- Analyze prior sale, current agreements, options or listings of the subject property
- Reconcile the value indicators to reach an opinion of value
- Report opinion(s) of value
UNIFORM RESIDENTIAL APPRAISAL REPORT. (URAR)
The general description is necessary to ensure that the proper structures are selected for comparison.
Divides the describe into the following categories:
- General description
- Exterior description
- Foundation
- Basement
- Insulation
- Room list
- Interior
- Heating
- Kitchen equipment
- Attic
- Amenities
- Car Storage
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DEPRECIATION is defined as a loss in value from any cause.
It results when improvements begin to lose acceptability to prospective purchasers or renters.
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.
ACCRUED DEPRECIATION
Depreciation results from physical deterioration and obsolescence.
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.
PHYSICAL DEPRECIATION.
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.
Physical Deterioration may be curable or incurable.
- Deterioration is curable when items are repairable or replaceable and it makes economic sense to repair or replace.
- 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.
OBSOLESCENCE
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.
FUNCTIONAL OBSOLESCENCE
Is loss of value due to factors of inadequacy or overadequacy w/in the property itself.
External Obsolescence aka economic obsolescence.
Is loss in value resulting from conditions outside the property
Since economic obsolescence is external to the property, it is generally incurable.
PROPERTIES HAS AN AN ACTUAL PHYSICAL AGE AND AN EFFECTIVE AGE
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.
Depreciation and obsolescence limit the usefulness of improvements to a physical life and an economic life.
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.
Appraisal Approaches
Sales Comparison
Cost Approach
Income Approach
SALES COMPARISON APPROACH aka. Market Data Approach
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.
Sales Comparison Approach
Each comparable property is compared to the subject property taking into consideration the following elements of comparison:
- 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.
COST APPROACH aka summation approach, replacement cost approach or reproduction cost approach
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.
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.
Following steps are used:
- Estimate the land value
- Add the estimated cost of replacing or reproducing the improvements with new ones.
- Estimate and deduct the depreciation to the improvements.
Based on the principle of substitution
Cost Approach methods commonly used to estimate cost are
The comparative cost method
The unit-in-place method
The quantity survey approach
Comparative cost method aka square-foot or cubic-foot method
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.
Unit-in-place method
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.
Quantity survey method
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.
Quantity survey cont’d
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.
Calculating accrued depreciation entails measuring loss of value that already occurred over the past life of the improvement.
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.
To estimate the depreciation, appraiser estimates property’s age.
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
Mathematical Alternative
Current Value = (100% divided by Depreciation) times Cost
Land
Plus current value of improvements
Equals current property value
INCOME APPROACH aka capitalization. Approach. For rental income.
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
Net income is gross less operating expenses
To estimate net income , the appraiser must establish “scheduled gross income”
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
Next step is to estimate Operating Expenses which include:
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
CAPITALIZATION RATE
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.
RECAPTURE RATE
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.
GROSS RENT MULTIPLIER for smaller income properties
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
RECONCILIATION
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.
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.
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.
