Valuation and Market Analysis 14% Flashcards
Functional utility
Functional utility is defined as the “the ability of a property or building to be useful and to perform the function for which it is intended, according to current market tastes and standards, as well as the efficiency of a building’s use in terms of architectural style, design and layout, traffic patterns, and size and type of rooms.” The ultimate test of functional utility is marketability. If the property can be marketed for the same price as others in the area, there is no functional obsolescence.
The ultimate test of functional utility is
marketability
Property that is very seldom sold would be appraised by which appraisal techniques?
The cost approach
An example of property that is seldom sold would be government buildings or churches. There is usually no comparative information available on these types of properties. The cost approach relates to construction information which is readily available.
Most and least important to an appraiser
Location, recent comparable sales, and square footage are all important to an appraiser. Creative financing to facilitate the sale of the subject property may be a factor but is the least important of the choices.
The relationship between a property and a prospective purchaser is known as:
Value
Value can also be described as the relationship between a property and a prospective purchaser. The most probable price a property should bring in a competitive and open market under all conditions requisite to a fair sale (market value).
The 3 types of Obsolescence
Economic/External obsolescence is external and often incurable.
Functional obsolescence occurs inside the property lines. Physical deterioration refers to deferred maintenance.
What part or portion of the narrative report contains the estimate of value?
The letter of transmittal identifies the property, purpose of the appraisal, methods used, and value estimate.
capitalization rate
The rate of return a property will produce on the owner’s investment.
What does high risk do to the Cap rate?
Part of the capitalization rate measures the risk involved in an investment. Thus, the higher the risk the higher the CAP rate; the lower the the risk the lower the CAP rate. Leasing a building for a hardware store involves higher risk of vacancy than leasing for a post office and results in a higher CAP rate.
The biggest problem in using the cost approach to appraise an older building?
Accrued depreciation is difficult to estimate on very old properties.
For appraisal purposes, accrued depreciation is the difference between the cost to reproduce the property (as of the appraisal date) and the property’s current value as judged by its condition.
commercial real estate/property
A classification of real estate that includes income-producing property such as office buildings, gasoline stations, restaurants, shopping centers, hotels and motels, parking lots and stores. Public accommodations.
When appraising a commercial property, an appraiser would be least interested in:
original cost.
Because the value of commercial property is more often derived from its income earning potential.
Methods of finding Reproduction or replacement costs.
1) quantity survey method
2) unit-in-place method
3) square foot/cubic foot methods
quantity survey method
COST FROM SCRATCH
method for computing replacement cost with detailed estimate of the quantities of raw materials used and current price of materials and installation costs.
unit-in-place method
SIMPLIFIES TO COST PER UNIT MEASUREMENT
Simplifies cost by narrowing it down to specific UNITS. of use such as square feet and cubed feet. (Ex. drywall=$1.50/sq yd, painting=$.08/sq ft etc)
“The unit-in-place method is a method for computing replacement cost which uses prices for various building components as installed, based on specific units of use such as square footage or cubic footage. For example, insulation may cost $.07 per square foot, drywall $1.50 per square yard, painting $.08 per square foot, and so on.”
square foot/cubic foot methods
USES COMPARABLE PROPERTIES
Method for computing replacement cost which an appraiser multiply current cost per square food of a comparable building by the number of the square feet in the subject building.
The 3 approaches to valuation
1) Sales Comparison Approach/Market Approach
2) Cost Approach
3) Income Capitalization Approach
Sales Comparison Approach/Market Approach
The process of estimating the value of a property by examining and comparing actual sales of comparable properties.
Cost Approach
The process of estimating the value of a property by adding to the estimated land value, the appraiser’s estimate of the reproduction or replacement cost of the building, less depreciation.
site value + cost of reproduction or replacement - depreciation = value
$ land + $ construction - Depreciation = Value
Income Capitalization Approach
The income capitalization method analyzes a property’s anticipated future income.
The income approach estimates value based on the amount of net income a property is anticipated to produce over its remaining economic life.
A mathematical process for converting net income into an indication of value, commonly used in the income approach to value. The net income of the property is divided by an appropriate (capitalization) rate of return to give the indicated value. (Income ÷ Rate = Value)
Good for determining value based on rents:
Net operating Income or rent collected / Cap Rate = Value (NI/CR=V)
Good for determining value for residential property:
Sales Price/Gross Income= Gross Income Multiplier (GIM)
Market Value:
The most probable price a property should bring in a competitive and open market under all conditions requisite to a fair sale. It is assumed that the buyer and seller acted prudently and knowledgeably, and that the price is not affected by undue stimulus.
The 3 types of appraisal reports
1) Narrative Report
2) Summary Report
3) Restricted Use Report
Narrative Report
A narrative report is a complete document including all pertinent information about the area and the subject property, as well as the reasons and computations for the value consideration. It includes maps, photographs, charts, and plot plans.
Summary Report
A Summary of a Narrative Report
Includes only the most important details of appraisal analysis including a brief version of pertinent data and a shortened summary of appraisal techniques.
Restricted Use Report
Briefest and least descriptive report
The 3 stages of building a single-family dwelling
Land acquisition, development, and construction
The allocation method (also called the abstraction or extraction method)
is an appraisal method whereby the appraiser estimates the land value of any improved property by deducting or abstracting the value of any site improvements from the overall sales price of the property. The amount remaining is the estimated sales price or indicated value of the land.
Frontage
FRONTAGE is a term used to describe or identify that part of a parcel of land or an improvement on the land which FACES THE STREET.
The land residual technique is
a method of estimating the value of land through the capitalization of income used when the value of the land is not known.
Subdivision Map includes
site plans, elevations drawings and street locations ant other physical features
Improvements
1) Any structure, usually privately owned, erected on a site to enhance the value of the property—for example, building a fence or a driveway.
2) A publicly owned structure added to or benefiting land, such as a curb, sidewalk, street or sewer.
An appraiser will consider this part of the land value while valuing property
In a tight money market, when interest rates are increasing, but rental rates are stable, how does it influence the market value of real property?
The value of real property decreases during “tight money” conditions.
What is the best method for appraising a warehouse?
A warehouse is an income producing property and would be appraised using income capitalization.
The three great forces affecting value
Real estate undergoes constant change from physical economic social and political forces.
Who sets the Upper and Lower limits for house prices?
Sellers list high and buyers usually offer to pay less than they might agree to pay. In bargaining circumstances, asking prices establish the upper limit for prices in an area while offers to purchase will set the lower limit to which prices might fall.
Both buildings and neighborhoods go through life cycles. What are they?
As they are developed, they achieve GROWTH, attain a period of equilibrium (or STABILITY) in which little change is evident, then DECLINE as properties deteriorate. Then, if warranted, they are repaired and undergo a fourth stage, REVITALIZATION.
Growth, Stability, Decline, Revitalization
A “turnkey” project
A turnkey project is a development term meaning the complete construction package from ground breaking to building completion. All that is left undone is to “turn over the keys” to the buyer.
The 4 unities/characteristics of Market Value
Referred to as the four characteristics of market value: Demand, Utility, Scarcity, Transferability. On the state exam they are sometimes referred to as the “primary requisites of value.” Memory aid: DUST
“adjusted sales prices”
In appraisal, increases or decreases to the sales price of a comparable property are made to arrive at an indicated value for the property being appraised.
Cost Approach to Valuation
The primary steps of the cost approach are to (1) estimate the land value, (2) estimate the replacement cost of the building new, (3) deduct all accrued depreciation from the replacement cost and (4) add the estimated land value to the depreciated replacement cost.
$land+Replacement cost of new building-Accrued Depreciation=Value
Rehabilitation
the restoration of a property to a satisfactory condition without changing the plan, form, or style of the structure.
Effective age vs Actual Age
Effective age is the apparent(visual) age of a building based on observed condition rather than chronological age. The effective age of improvements to real property at the time of inspection differs from actual age by such variable factors as depreciation, quality of maintenance, and the like.
highest and best use
In appraising real estate, the most profitable, physically possible, and legally permissible use for the property under consideration.
In any case where the market value of real property is sought, that value must be based on its highest and best use.
Which of the following is an appraiser’s primary concern in the appraisal of residential property?
Marketability. If a residential property is not marketable, it is worthless.
The oldest appraisal method is the:
The sales comparison approach is the oldest and easiest method of appraising property.
business cycle
The wavelike movement of increasing and decreasing economic prosperity consisting of four phases: Expansion, Recession, Contraction and Revival.
In the appraisal of residential property, the cost approach is most appropriate in the case of:
New Property
Cost estimates per square foot can more easily be ascertained with new property. This is not to imply that the cost approach is always the best method for the appraisal of new property.
In order to accurately calculate a gross rent multiplier, what data would an appraiser obtain from comparable properties:
The gross rent multiplier is arrived at by dividing the monthly or annual gross rent into the selling price of the property.
Selling Price/Monthly or Annual Gross Rent=GRM
Gross Rent Multiplier: The figure used as a multiplier of the gross monthly income of a property to produce an estimate of the property’s value.
Value
This definition of value is most applicable to income producing properties. “The present worth of future benefits” have to do with the projected income stream.
Which of the following are deducted from gross income to determine net income for capitalization purposes?
taxes, insurance, management costs (research more…)
\+ $ Gross Income (yearly rent) - $ management costs - $ - $ taxes - $ insurance ------------------------------ = $ Net Income
Interest payments are NOT considered an expense when estimating the value of the property.
Objective value of a property
Objective value is what a reasonable person ends up paying for a property.
Market Value
A property with great amenity value would best be appraised by using the:
The correct answer is b: The comparison method would be used in this case by adjusting comparables to compensate for the amenities of the subject property.
Utility value
The value in use to an owner-user, which includes a value of amenities attaching to a property; also known as subjective value.
A property that has no utility has no value.
The building residual technique
The building residual technique is used to determine the value of the building only.
When using the building residual technique, the unknown value is the value of the: Building
Curable vs Incurable
Whether an item of depreciation is curable or incurable depends soley on the cost to cure.
Since economic obsolescence is caused by external forces there is usually nothing that can be done to change it therefore, it is incurable.
Depreciation
The decrease in the value of an asset when computing property value for tax purposes. It can also be a loss in the appraised value due to physical deterioration. The latter type of depreciation is curable when it can be remedied by repair or addition to the property, and incurable when there is no economical remedy.
Appreciation
An increase in the worth or value of a property due to economic or related causes, which may prove to be either temporary or permanent; opposite of depreciation.
What is stated in the “Statement of Purpose.”
The type of value being given is stated in the “Statement of Purpose.” Appraisals are used for various reasons (i.e., loans, insurance, taxation, public acquisition).
Demand
The amount of goods people are willing and able to buy at a given price; often coupled with supply.
In order for demand to be effective, it must be implemented by PURCHASING POWER
Strip centers
Strip centers (sometimes referred to as convenience centers) are characterized by adjoining buildings that are narrow in depth relative to their length. The typical design for these districts is a straight line of stores set back far enough from the street to allow for perpendicular parking.
Assemblage and Plottage Value
ASSEMBLAGE is the combining of two or more adjoining lots into one large tract. This is usually done to increase the value of the individual lots because a larger building capable of producing a larger net return may be erectd on a larger parcel. The resulting added value is called PLOTTAGE VALUE.
The most important date on an appraisal
Since the value could change for a variety of reasons during escrow, the most important date on an appraisal is the date escrow closes or in this question the date of recording.
3 Methods of Calculating Depreciation
1) Straight line, 2) sum-of-the-years-digits, and 3) sinking fund are all methods of calculating depreciation.
Obsolescence is a loss in value due to a decrease in the usefulness of property caused by decay, changes in technology, people’s behavior, patterns and tastes, or environmental changes. Its not a method of calculating depreciation but more a categorizing a CAUSE FOR DEPRECATION.
Straight-line Method
A method of depreciation, also called the age-life method, that is computed by dividing the adjusted basis of a property by the number of years of estimated remaining useful life. (See adjusted basis, depreciation)
“Return on” and “Return of”
An investor is allowed a “return on” his/her investment which is the same as interest, and a “return of” which is depreciation.
The “return on” is the investor’s profit.
The “return of” allows for depreciation of the wasting asset.
The effect of depreciation is:
Basis, as it relates to income property goes down each year as the owner deducts depreciation. It may also go up with the addition of capital improvements. Basis or book value will never reach zero because the land does not depreciate.
Basis
The dollar amount that the Internal Revenue Service attributes to an asset for purposes of determining annual depreciation or cost recovery, and gain or loss in the sale of the asset.(See adjusted basis, depreciable basis, original basis)
The 3 Valuation approaches and what each is best for
- The sales comparison approach is most applicable to the appraisal of vacant land.
- The cost approach is most applicable to the appraisal of special purpose properties such as a church.
- The income approach is used in the appraisal of an income-producing property.
- The gross rent multiplier is used as a substitute for the income approach in the valuation of a single-family home.
When analyzing the income produced by a property, an appraiser is concerned with:
amount of income.
prospect of continued income.
quality of tenants.
All of these are important factors to consider when calculating net income for capitalization purposes.
Reconcilation
In appraisal, reconcilation is the process of interpreting the data gathered by bringing the various value estimates into mutual relationship with one another to determine a final estimate of value. With this process, the comparables are always adjusted to the subject property.
In appraisal, the adjustment process, whereby, comparables are adjusted to the subject property is known as: reconcilation
adjusted basis
The original cost basis of a property reduced by certain deductions and increased by certain improvement costs. The original basis determined at the time of acquisition is reduced by the amount of allowable depreciation or depletion allowances taken by the taxpayer, and by the amount of any uncompensated property losses suffered by the taxpayer.
Book value
Book value is the adjusted basis of an asset and usually differs from appraised value or market value.
Capitalization is a process whereby an appraiser:
Capitalization is a mathematical process used in estimating the value of income producing property by applying a certain capitalization rate to the net operating income.
NET INCOME / C RATE = VALUE
Capitalization Rate
The rate of return a property will produce on the owner’s investment
Allocation and extraction are methods of appraisal for
Allocation and extraction are methods of land or site valuation
Amenities
are features both tangible and intangible that enhance and add to the value or desirability of real estate. In a condominium for example, common amenities include a swimming pool, clubhouse, and a good view.
The income approach would NOT be used when appraising:
residences in a subdivision.
When there are no suitable comparables or in this case no income to capitalize, the income approach is not a viable method.
Value is best described as
Worth
Value is generally described as the amount of money deemed to be the equivalent in worth of the subject property. Cost does not equal value nor does equity.
Calculating Cap Rate
Cap Rate: ratio of the property’s net income to its purchase price
1) Calculate Gross Income
monthly rent x 12 months in a year
(ex. $750/mo x 12 mo = $9,000/year)
2)Subtract the operating expenses associated with the property from the gross income.
(ex.)
$9,000 (Gross Income)
-$900 Property management
-$450 Maintenance
-$710 Taxes
-$650 Insurance
———————————-
= $6,290 (Net Income)
3) Divide the net income by the property’s purchase price.
Net Income/Purchase Price=Capitalization Rate
(ex. $6,290(Net Income) /$40,000(Purchase Price) = 0.157
= 15.7% (Cap Rate)
THE HIGHER THE CAP RATE THE MORE FAVORABLE THE RETURN ON THE INVESTMENT
Finding Value when Cap rate is known
Net Income/Cap Rate= Value
Ni/Cr=V
A “sinking fund”
is established to gradually amass enough money to satisfy a debt or to meet a specific requirement. The sinking fund method of depreciation contemplates periodic investments of equal amounts of money in a compound-interest-bearing account whereby the investment plus the compound interest will be used to replace the improvement at the end of its economic life.
“return on” investment
The net annual income (gross income-expenses) divided by the original cash investment equals a percentage return on investment.
Another way to look at it: ROI is the velocity of money; How fast my money is moving, how fast can I get back my initial investment back in my pocket.
The “return on” part of the capitalization rate is the same as interest. If interest rates increase, the capitalization rate increases.
Evaluation tools that are extremely useful in determining how much bang you are really getting for your buck in real estate.
1) Cap Rate
Net Operating Income ÷ Property Value=Cap Rate(%)
or, NI or NOI ÷ Price = Cap Rate(%)
2) ROI (“return-on” investment)
Annual Cash Flow ÷ Equity = ROI
ROI
ROI (“return-on” investment)
Annual Cash Flow ÷ Equity = ROI
(NI or NOI) - (mortgage payment) ÷
*Remember that your cash flow is your Net Operating Income (NOI) minus your mortgage payments (mortgage payment includes your principal/debt repayment and the interest)
Supply and Demand
Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship. Supply represents how much the market can offer.
When Supply is high, Demand is low and prices are
When Demand is low
prices increase as availability decreases
Economic vs Physical Life
Economic life is the estimated period over which an improved property may be profitably utilized so it will yield a return. The physical life is the estimated period during which a physical thing is habitable if normally maintained. Typically, physical life is expected to be longer than economic life.
When its best to use the Cost Approach
Since the cost approach looks at the cost of constructing an identical building with current materials and techniques, it tends to set the upper value of the property. The cost approach is ideal for new properties and special purpose properties that have no comparables in the area or which produce no income - examples are museums, schools, churches, and libraries.
Highest and best use
Highest and best use refers to use of land. It is that use of the land that will produce the greatest NET INCOME designated and credited to the land.
Depth tables
Depth tables are tables of percentage used to provide a uniform system of measuring the additional value of lots which may be more valuable because of added depth. Depth tables are used on vacant land usually for commercial property.
i————-i a higher front foot to depth ratio for
i i commercial property has higher
i i depth value.
i i
i————-i
front foot
??After capitalizing the net income of a property and then deducting the replacement cost of the improvements, an appraiser has established the:
??The total value of a property is made up of the value of the land plus improvements.
site value + improvements = total value of property
