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BUSI 330 - Foundations of Real Estate Appraisal > Xtra - Study Notes > Flashcards

Xtra - Study Notes Flashcards

1
Q

Four Forces Affecting Land Valuation

Physical – geographic and environmental
e.g., climate, topography, transportation, schools

Economic
e.g., employment, supply, rental rates, construction costs

Government and Legal
e.g., public services, zoning, environmental protection

Social
e.g., population characteristics, lifestyle

A

P E G S

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2
Q

Principles Impacting Real Property Value

anticipation
change
supply
demand
competition
substitution
balance
contribution
surplus productivity
conformity
externalities
A

Principles Impacting Real Property Value

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3
Q

Four Forces of Value

•	Supply
o	Utility
•	Ability to satisfy want, need desire
o	Scarcity
•	Present or forecasted supply
•	Demand
o	Desirability
•	Purchaser’s wish to satisfy need/want
o	Effective Purchasing Power
•	Ability to participate in market
A

Four Forces of Value

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4
Q

Six Conditions of Market Value

  1. Most probable price
  2. Competitive market
  3. Fair sale
  4. Buyer and Seller knowledgeable
  5. No undue stimulus
  6. Reasonable time
A

Six Conditions of Market Value

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5
Q

First Principles of Value

1.	Problem Identification
•	Understand assignment objective
2.	Property Content
•	Physical, legal, financial, location
3.	Property Rights
4.	Function/Purpose
5.	Highest and Best Use
6.	Land Use Regulations
7.	Economic Variables
8.	Legal Issues
9.	Research
A

First Principles of Value

1.	Problem Identification
•	Understand assignment objective
2.	Property Content
•	Physical, legal, financial, location
3.	Property Rights
4.	Function/Purpose
5.	Highest and Best Use
6.	Land Use Regulations
7.	Economic Variables
8.	Legal Issues
9.	Research
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6
Q

Professional Competencies

Market Analysis
• Ability to collect and analyze information and statistics regarding the market characteristics of the area that one practices in

Integrity
• Ability to consistently take actions that match stated values and standards

Critical Thinking
• Ability to analyze problems systematically, organize information, identify key symptoms and causes and apply solutions

Relationship Building & Communication
• Ability to communicate with, understand and respond to others effectively

Self Development
• Being proactive in improving one’s personal capability

A

Professional Competencies

Market Analysis
• Ability to collect and analyze information and statistics regarding the market characteristics of the area that one practices in

Integrity
• Ability to consistently take actions that match stated values and standards

Critical Thinking
• Ability to analyze problems systematically, organize information, identify key symptoms and causes and apply solutions

Relationship Building & Communication
• Ability to communicate with, understand and respond to others effectively

Self Development
• Being proactive in improving one’s personal capability

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7
Q

Bundle of Rights

  • Sell or give away
  • Occupy
  • Lease
  • Mortgage
  • Create a life estate
  • Do nothing
A

Bundle of Rights

six rights

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8
Q

Ownership of Real Property Rights

• Physical Elements
o quality and quality of the property

• Legal Elements
o highest is unencumbered fee simple

• Financial Elements
o arms-length, or vendor financing

A

Ownership of Real Property Rights

three elements

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9
Q

Economic Foundation for Value of Real Estate
is represented by Four Agents of Production

  • Land
  • Labour
  • Capital
  • Entrepreneurial coordination
A

Economic Foundation for Value of Real Estate

is represented by Four Agents of Production

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10
Q

Joint Tenancy – ownership is unseparated in that one owner cannot sell without the other’s permission. This type of tenancy carries with it a right of survivorship.

Tenancy-in-common – a situation where two or more parties can own a property in different percentages. Each person can sell their interest without the other’s permission.

A

Joint Tenancy

Tenancy-in-common

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11
Q

Economic life is the period over which the property remains economically useful and viable.

Physical life is the period of time the structure is in existence until it becomes physically unstable.

A

Economic life

Physical life

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12
Q

Three Approaches to Value

  • Direct Comparison
  • Cost Approach
  • Income Approach
A

Three Approaches to Value

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13
Q

Market value is defined as the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.

A

Market value is defined as the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.

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14
Q

Categories of value

  • Value in exchange
  • Value in use
  • Objective value
  • Subjective value
  • Investment value
  • Going-concern value
  • Insurable value
  • Assessed value
A

Categories of value

  • Value in exchange
  • Value in use
  • Objective value
  • Subjective value
  • Investment value
  • Going-concern value
  • Insurable value
  • Assessed value
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15
Q

Valuation Process (Scope of Work)

  1. Identification of the Problem
  2. Scope of Work Determination
  3. Data Collection and Property Description
  4. Data Analysis
  5. Site Value Opinion
  6. Application of the Approaches to Value
  7. Reconciliation of Value Indications and Final Opinion of Value
  8. Report of Defined Value
A

Valuation Process (Scope of Work)

  1. Identification of the Problem
  2. Scope of Work Determination
  3. Data Collection and Property Description
  4. Data Analysis
  5. Site Value Opinion
  6. Application of the Approaches to Value
  7. Reconciliation of Value Indications and Final Opinion of Value
  8. Report of Defined Value
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16
Q

Scope of Work (aka Valuation Process)

The specific tasks and items necessary to complete the assignment include:

  • assembly and analysis of relevant information pertaining to the property being appraised,
  • listing and acquisition particulars if acquired within three years prior to the effective date of the appraisal,
  • an inspection of the subject property and the surrounding area,
  • assembly and analysis of pertinent economic and market data,
A

Scope of Work (aka Valuation Process)

The specific tasks and items necessary to complete the assignment include:

  • assembly and analysis of relevant information pertaining to the property being appraised,
  • listing and acquisition particulars if acquired within three years prior to the effective date of the appraisal,
  • an inspection of the subject property and the surrounding area,
  • assembly and analysis of pertinent economic and market data,
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17
Q

Scope of Work, continued

  • analysis of land use controls pertaining to the subject property,
  • a summary discussion of “highest and best use”, or most probable use,
  • a discussion of the appraisal methodologies and procedures employed in arriving at the indications of value,
  • photographs, maps, graphics and addendum/exhibits when deemed appropriate,
  • reconciliation of the collected data into an estimate of market value or market value range as at the effective date of the appraisal.
A

Scope of Work, continued

  • analysis of land use controls pertaining to the subject property,
  • a summary discussion of “highest and best use”, or most probable use,
  • a discussion of the appraisal methodologies and procedures employed in arriving at the indications of value,
  • photographs, maps, graphics and addendum/exhibits when deemed appropriate,
  • reconciliation of the collected data into an estimate of market value or market valu
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18
Q

Plottage is a value increment resulting from the assembly of two or more smaller sites. The result is that the combined utility is proportionately greater than the sum of the individual sites.

Assemblage is the merging of adjacent properties into one common ownership or use without necessarily increasing the utility.

A

Plottage

Assemblage

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19
Q

Excess land is not needed to serve or support the existing improvement. HABU of the excess land may or may not be the same as the HABU of the improved parcel. Excess land has the potential to be sold separately and must be valued separately.

Surplus land is not currently needed to support the existing improvement, but cannot be separated from the property and sold off. Surplus land does not have independent HABU and may or may not contribute value to the improved parcel.

A

Excess land

Surplus land

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20
Q

Building Standards

aka Building Codes – are regulations governing the health and safety of building construction

  • Structural instability
  • Fire resistance
  • Emergency egress
  • Adequacy of space, air, and light
  • Performance of mechanical and electrical systems
A

Building Standards

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21
Q

Zoning is a means of regulation of property whereby lands are divided into districts for the purpose of assigning restrictions on land use and on the use, bulk, and appearance of buildings on the land.

Legal non-conforming: uses and buildings that existed prior to the enactment or amendment of a zoning bylaw and do not conform and are accorded special status.

Legal conforming: uses and buildings that conform to existing bylaws.

A

Zoning

Legal non-conforming

Legal

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22
Q

Gross Living Area (GLA) is total area of finished, above-grade residential space; used for single-unit residential.

Gross Building Area (GBA) is total floor area of a building, including basement; used for multi-family, and industrial.

Gross Leasable Area (GLA) is total floor area designed for the occupancy and exclusive use of tenants including basements and mezzanines; used for shopping centres.

A

Gross Living Area (GLA)

Gross Building Area (GBA)

Gross Leasable Area (GLA)

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23
Q

Market Analysis

  • Property productivity analysis
  • Market delineation (geographic extent of the demand for a specific property)
  • Demand analysis and forecast
  • Competitive supply analysis and forecast
  • Supply and demand study
  • Capture estimation
A

Market Analysis

  • Property productivity analysis
  • Market delineation (geographic extent of the demand for a specific property)
  • Demand analysis and forecast
  • Competitive supply analysis and forecast
  • Supply and demand study
  • Capture estimation
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24
Q

Highest and best use

  • What would the land be worth if it were vacant and awaiting development
  • What is the site worth as presently developed with the existing improvements
A

Highest and best use

  • What would the land be worth if it were vacant and awaiting development
  • What is the site worth as presently developed with the existing improvements
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25
Q

Highest and Best Use Analysis

  1. Problem Definition
  2. Preliminary screening of alternative uses
  3. Analysis of alternative uses to determine highly probably uses
  4. Identify the most probable use with respect to:
    • Land use
    • Timing of the use
    • Market participants of that use
    • Financial analysis
A

Highest and Best Use Analysis

  1. Problem Definition
  2. Preliminary screening of alternative uses
  3. Analysis of alternative uses to determine highly probably uses
  4. Identify the most probable use with respect to:
    • Land use
    • Timing of the use
    • Market participants of that use
    • Financial analysis
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26
Q

HABU as though Vacant

Test legal permissibility
Test physical possibility
Test financial feasibility
Test maximum productivity
What is the “ideal” improvement?
A

HABU as though Vacant

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27
Q

HABU Improved Property

Test continuation of existing use
Test modification of existing use
Test demolition of existing use, and redevelopment

A

HABU Improved Property

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28
Q

Principle of Consistent Use

Land cannot be valued on the basis of one use while the improvements are valued based on another use. Improvements must contribute to land value to have value themselves. Improvements that do not represent the land’s HABU can have value as an interim use; alternatively, they can have no value or even negative value.

A

Principle of Consistent Use

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29
Q

Advantages of Direct Comparison Approach

Generally accepted by courts and tribunals

People understand it, and when listing or selling properties, often use it

When data is available, this is the most straightforward and simple way to explain and support an opinion of value

It is a good test of value for all types of properties, provided enough comparables are available

Works well for owner-occupied commercial and industrial properties

A

Advantages of Direct Comparison Approach

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30
Q

Disadvantages of Direct Comparison Approach

Sometimes there are few or no current sales that can be logically used

Comparisons are sometimes difficult and no two properties are ever exactly alike

Data is always historical and may not accurately predict future imminent, significant upward or downward trends

It is often difficult to ascertain all the pertinent information regarding individual sales, particularly terms of sale, motivation, etc.

A

Disadvantages of Direct Comparison Approach

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31
Q

The major principle that applies to the direct comparison approach is the principle of substitution: the value of a given property should be no more than the cost of buying another substitute property.

The major principle that applies to the cost approach is the principle of substitution: a property’s value will tend to be equal to the cost of acquiring an equally desirable substitute property; acquisition cost is the cost to construct this substitute property.

A

The major principle that applies to the direct comparison approach is the principle of …

The major principle that applies to the cost approach is the principle of …

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32
Q

Appraisal Principles basic to the direct comparison approach

  • Anticipation
  • Change
  • Supply and demand
  • Substitution
  • Balance
  • Externalities
A

Appraisal Principles basic to the direct comparison approach

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33
Q

Direct Comparison Procedure

  1. Research
  2. Verify
  3. Select
  4. Adjust the price
  5. Reconcile
A

Direct Comparison Procedure

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34
Q

Elements of Comparison / Order of Adjustments

Transactional adjustments
1.	Real property rights conveyed
2.	Financing terms
3.	Conditions of sale
4.	Expenditures made immediately after purchase
5.	Market conditions
Property adjustments
6.	Location
7.	Physical characteristics
8.	Economic characteristics
9.	Use or zoning
10.	Non-realty components of value
A

Elements of Comparison / Order of Adjustments

Transactional adjustments

Property adjustments

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35
Q

Unit of Comparison

A unit of comparison is used to compare dissimilar properties. It reduces the complex traits and characteristics of different properties into a common basis that facilitates comparison.
e.g., value per square foot, or square meter, or by frontage (either in feet or meter).

A

Unit of Comparison

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36
Q

IASS Inferior-Add, Superior-Subtract

Comparable Property Adjustment

If a feature of the Comparable Property is INFERIOR to the Subject Property – ADD to the Sale Price of the Comparable Property

If a feature of the Comparable Property is SUPERIOR to the Subject Property – SUBTRACT from the Sale Price of the Comparable Property

A

IASS

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37
Q

Reconciliation

Process by which the appraiser evaluates and selects, from among two or more alternative conclusions or indications of value, a single value estimate that is most applicable to the property being appraised.

A

Reconciliation

38
Q

Principles that influence land value

Anticipation: expectation of benefits to be derived in the future creates value

Change

Supply and demand: no object can have value unless scarcity is coupled with utility

Substitution: the greatest demand will be generated for the lowest-priced site with similar utility

Balance: when the various elements of a particular economic mix or a specific environment are in a state of equilibrium, land value is sustained; when the balance is upset, values change

A

Principles that influence land value

39
Q

Land is valued by:

  • Identifying the real estate and property rights
  • Encumbrances
  • Physical characteristics
  • Functional characteristics
  • Economic characteristics
  • Available utilities
  • Site improvements
  • Highest and best use
A

Land is valued by:

eight characteristics

40
Q

Land Valuation Techniques

  • Direct Comparison
  • Market Extraction
  • Allocation
  • Income Capitalization Techniques
  • Subdivision development methods
A

Land Valuation Techniques

five techniques

41
Q

Extraction Method to Find Land Value

Current Sale Price
-
RCN of House-new Less Estimated Depreciation
\+
Depreciated Value of Site Improvements
=
Land Value
A

Extraction Method to Find Land Value

42
Q

Cost Approach to Value

Market value of the site (land)
+
Replacement or Reproduction Cost of New Building(s) and Site Improvement
-
Depreciation of Building(s) and Site Improvements
=
Market Value of Property

A

Cost Approach to Value

43
Q

Principles of Cost Approach

Substitution: No one would pay more for a property that the cost to buy land and building something equivalent, assuming a normal time to complete the development.

Supply and demand: changes in prices, costs, or demand for the improvements under analysis

Contribution: improvements should not be too large or too small for the site and should be what the market wants in the way of new properties

Externalities: ensure that no external factors will impact the value of the finished project or increase the projected costs

HABU: optimal project is being built on the site, resulting in the highest return for the longest period of time

Conformity: cost and value are likely to be equal only when the cost represents the kind of expenditures which conform to the wishes and tastes of the market

A

Principles of Cost Approach

six principles

44
Q

Cost Approach Steps

  1. Value of site as vacant
  2. Reproduction cost or replacement cost?
  3. Estimate direct and indirect costs of the improvements
  4. Estimate entrepreneurial profit
  5. direct costs + indirect costs + entrepreneurial profit = cost of improvements
  6. Estimate depreciation
  7. Deduct estimated depreciation for total cost of improvements
  8. Contributory value of site improvements
  9. Add to cost of improvements
  10. Adjust the value conclusion if any personal property are included
A

Cost Approach Steps

10 steps

45
Q

Direct costs (hard)

  • Related to construction activity
  • Profit margin of builder or contractor
  • Entrepreneurial profit

Indirect costs (soft)

  • Administrative
  • Professional fees
  • Financing and interest
  • Taxes
  • Insurance
A

Direct costs (hard)

(three items)

Indirect costs (soft)

(five items)

46
Q

Advantages of Cost Approach

Useful for the valuation of special-purpose or unique properties

The cost approach can work well for newer buildings

Can be useful to determine “contributory value” of construction

Useful when the function of the report is to estimate value for insurance purposes

A

Advantages of Cost Approach

four advantages

47
Q

Disadvantages of Cost Approach

Assumes cost represents value, however, this is only likely when the building is new and represents HABU

Difficult to determine the cost of improvements

Difficult to estimate depreciation

Less effective for older buildings because of the difficulties of reliably estimating accrued depreciation

May be unable to estimate site value accurately

Does not reflect market behavior unless the market is in equilibrium

Cannot be used to value leasehold interests, or cases in which the property possesses latent value

A

Disadvantages of Cost Approach

seven disadvantages

48
Q

Reproduction cost: the cost to reproduce an exact replica of the subject improvements

Replacement cost: the cost of replacing the subject property with a structure that provides a similar level of utility

A

Reproduction cost

Replacement cost

49
Q

Methods of Estimating Reproduction or Replacement cost new

Quantity survey method: detailed breakdown

Unit-in-Place Method: pricing of each component

Comparative Method: estimate RC by comparing to costs of similar buildings to find a rate per unit

Cost Services Method: uses information from cost services company

Cost index trending: uses historical data to find cost indexes

A

Methods of Estimating Reproduction or Replacement cost new

five methods

50
Q

Causes of Depreciation

Physical deterioration – wear and tear from regular use, the impact of the elements or damage

Functional obsolescence – flaw in the structure, materials or design that diminishes the function, utility and value of the improvement

External obsolescence – a temporary or permanent impairment of the utility or saleability of an improvement or property due to negative influences outside the property

A

Causes of Depreciation

three causes

51
Q

In appraising, depreciation is a loss in property value from any cause.

The type of depreciation analyzed in an appraisal report is referred to as accrued depreciation.

This is the difference between the reproduction or replacement cost [new] of the improvements on the effective date of the appraisal and the market value of the improvements on the same date.

A

In appraising, depreciation is …

The type of depreciation analyzed in an appraisal report is referred to as …

This is the difference between the … and the … on the same date.

52
Q

Effective Age is based on the property’s present condition and general overall maintenance.

Effective age can be the same as, or lesser or greater than the actual age at the date of appraisal. It is an estimate and has to be justified by the appraiser.

A

Effective Age

53
Q

Economic Life refers to the period of time over which the improvements will contribute to the overall property value. Economic Life is normally shorter than physical life. It is an estimate.

Considerations in estimating economic life include:

  • Physical age, quality and condition of subject
  • Dependent upon economic cycles
  • When similar buildings undergo major renovation or rehabilitation
  • When similar lands have been rezoned to more intensive uses
  • When demolition permits are issued for similar buildings
A

Economic Life

Considerations in estimating Economic Life include:

(five examples)

54
Q

Total Economic Life and Useful life is the length of time that the improvements contribute to the value of the property and ends when the use for which it was original intended is no longer HABU.

Economic Life is normally shorter than physical life.

A

Total Economic Life and Useful life

55
Q

Remaining Economic Life (REL) and Remaining Useful Life: is the remaining expected (future) economically productive life span of the structure.

It is the difference between Economic Life and Effective Age.

A

Remaining Economic Life (REL) and Remaining Useful Life

56
Q

Short-lived items are usually building components or equipment such as furnaces, hot water tanks, carpets, roofing, kitchen cupboards, electrical fixtures, and windows and doors, i.e., those items whose life expectancy is less than the original structure.

Long-lived items are those building components with an expected remaining economic life that is the same as the remaining economic life of the entire structure, e.g., foundation, structural framing of floors, walls and roof structure.

A

Short-lived items

Long-lived items

57
Q

Curable: items of physical deterioration or functional obsolescence are economically feasible to cure if the cost to cure is equal to or less than the anticipated increase in the value of the property.

Incurable: if the cost to cure is more than the anticipated increase in value, the item is incurable

A

Curable

Incurable

58
Q 
Gross Income Multiplier
=
Selling price of the property
÷
Actual Monthly Rent

or

Gross Income Multiplier
=
Selling price of the property
÷
Actual Yearly Rent
A

Gross Income Multiplier

59
Q

Principal Methods of Estimating Depreciation

• Market Extraction
o Uses principle of contribution
o Comparison to other properties
o Rarely used

• Age-life (or Economic Age-Life)
o Often used

  • Modified age-life
  • Observed Condition (breakdown)
A

Principal Methods of Estimating Depreciation

four principal methods

60
Q

Age-life (or Economic Age-Life)

  • Effective age ÷ economic life = percentage depreciation
  • depreciated value = depreciation * property’s total cost

Modified Age-life (or Economic Age-Life)

• “immediate repair or replacement” components are costed first, then the age-life method is applied to the balance cost new of the structure

A

Age-life (or Economic Age-Life)

Modified Age-life

61
Q

Breakdown Method Categories

  • Physical deterioration – caused by wear and tear or the passage of time
  • Functional obsolescence – usually the result of the property no longer conforming to the a market requirement or not in compliance with the highest and best use
  • External obsolescence – caused by factors outside the property
A

Breakdown Method Categories

three categories

62
Q

Categories of Depreciation

Physical deterioration
• curable
• incurable – short-lived
• incurable – long-lived

Functional obsolescence
•	curable – deficiency
•	curable – modernization
•	curable – superadequacy
•	incurable – deficiency
•	incurable – superadequacy

External obsolescence
• locational
• economic

A

Categories of Depreciation

Physical

(three categories)

Functional obsolescence

(six categories)

External obsolescence

(two categories)

63
Q

Physical Deterioration

  • Deferred maintenance – curable
  • Short-lived – not curable physically or economically feasible and requires replacement in the short term
  • Long-lived – not curable and include those items that were not considered under the previous two categories.

Represents the accumulated loss in market value caused by physical wear and tear since the date the building was completed

Is tangible, such as items that are worn, broken, or no longer fulfilling their function

A

Physical Deterioration

  • Deferred maintenance – curable
  • Short-lived – not curable physically or economically feasible and requires replacement in the short term
  • Long-lived – not curable and include those items that were not considered under the previous two categories.

Represents the accumulated loss in market value caused by physical wear and tear since the date the building was completed

Is tangible, such as items that are worn, broken, or no longer fulfilling their function

64
Q

Functional Depreciation

Caused by a flaw in the structure, materials or design of an improvement when compared to HABU and most functional design requirements as at the effective date of appraisal

  • Curable caused by a deficiency requiring an addition
  • Curable caused by a deficiency requiring a substitution
  • Curable caused by a superadequacy that is economically feasible to cure
  • Incurable caused by a deficiency
  • Incurable caused by a superadequacy

Is the loss in value caused by an outmoded or inadequate design, or over-improvement beyond what the market demands.

Results from the perception of market participants, referring to items that may still be fulfilling their function, but the market does not demand them in their current form.

A

Functional Depreciation

Caused by a flaw in the structure, materials or design of an improvement when compared to HABU and most functional design requirements as at the effective date of appraisal

  • Curable caused by a deficiency requiring an addition
  • Curable caused by a deficiency requiring a substitution
  • Curable caused by a superadequacy that is economically feasible to cure
  • Incurable caused by a deficiency
  • Incurable caused by a superadequacy

Is the loss in value caused by an outmoded or inadequate design, or over-improvement beyond what the market demands.

Results from the perception of market participants, referring to items that may still be fulfilling their function, but the market does not demand them in their current form.

65
Q

External Obsolescence

  • Loss in value caused by factors outside a property and may be temporary or permanent
  • May be localized or market wide affecting a single property or class of properties
  • Frequently affects both land and buildings; important to isolate and allocate effects to either or both

• Methods of measuring external obsolescence

o Allocation of market – extracted depreciation
o Analysis of market data
o Capitalization of an income loss

A

External Obsolescence

  • Loss in value caused by factors outside a property and may be temporary or permanent
  • May be localized or market wide affecting a single property or class of properties
  • Frequently affects both land and buildings; important to isolate and allocate effects to either or both

• Methods of measuring external obsolescence

o Allocation of market – extracted depreciation
o Analysis of market data
o Capitalization of an income loss

66
Q

Physical curable deterioration - If the item has reached the end of their life expectancy, and are due for immediate replacement

Physical short-lived depreciation - If the item had remaining life

Physical long-lived depreciation - If the item had a remaining life the same as the building

Functional curable obsolescence - If the item was outdated but still functioning with some remaining life.

A

Physical curable deterioration - If the item has reached the end of their life expectancy, and are due for immediate replacement

Physical short-lived depreciation - If the item had remaining life

Physical long-lived depreciation - If the item had a remaining life the same as the building

Functional curable obsolescence - If the item was outdated but still functioning with some remaining life.

67
Q

Income Approach and the Appraisal Principles

• Anticipation is the forecasting of income and expense levels to estimate present value
o value is the present worth of future benefits

  • Change may reflect future changes to the quality and quantity of income
  • Change will affect return required by an investor and the way the investor values a property
  • Change will also affect supply and demand as society’s attitudes change for the type of space required
  • Supply and demand is related to competition or lack of it and determines present rental and vacancy rates, and future values
A

Income Approach and the Appraisal Principles

five principles

68
Q

Capitalization Rate

=

Yearly Income (after fixed + variable costs)

÷

Total Value of the Property

A

Capitalization Rate

69
Q

Potential Gross Income (PGI): The total income attributable to real property at full occupancy before vacancy and operating expenses are deducted

Effective Gross Income (EGI): The anticipated income from all operations of the real property after an allowance is made for vacancy and collection losses and an addition is made for any other income (aka gross realized revenue, or what is deposited)

Net Operating Income (NOI or IO): The actual anticipated net income that remains after all operating expenses are deducted from effective gross income, but before mortgage debt service and book depreciation are deducted

Equity Cash Flow (IE): The portion of net operating income that remains after total mortgage debt service is paid, but before ordinary income tax on operations is deducted

A

PGI

EGI

NOI

IE

70
Q

Return of capital: recovery of invested capital

Return on capital: the additional amount received as compensation for use of the investor’s capital

A

Return of capital

Return on capital

71
Q

Direct capitalization

Uses one year’s income to establish a value

Applied by using one of two basic methods

  • Applying an overall capitalization rate to relate value to the entire property income, i.e., net operating income
  • Using residual techniques that consider components of a property’s income and then applying a market-derived capitalization rate to each income component analyzed
A

Direct capitalization

Uses one year’s income to establish a value

Applied by using one of two basic methods

  • Applying an overall capitalization rate to relate value to the entire property income, i.e., net operating income
  • Using residual techniques that consider components of a property’s income and then applying a market-derived capitalization rate to each income component analyzed
72
Q

Steps in the Income Approach

  • Research income and expenses for the subject and the comparables
  • Estimate the potential gross income (PGI)
  • Estimate vacancy and collection allowances
  • Subtract vacancy and collection allowances from the PGI to arrive at effective gross income (EGI)
  • Estimate total operating expenses – fixed and variable
  • Subtract expenses from the EGI to arrive at net operating income (NOI)
  • Apply the direct capitalization rate to the NOI to arrive at value
A

Steps in the Income Approach

seven steps

73
Q

Expenses

• Fixed
o Property tax, insurance

• Variable
o Management fees, gas, water, sewer, cleaning, maintenance, decorating, etc.

• Replacement allowance
o Appraisal judgement
o Usually for major expenditures for short-lived components, e.g., carpeting, exterior painting, roof covering

A

Expenses

three types

74
Q 
Overall Capitalization Rate
=
Net Operating Income
÷
Selling Price
A

Overall Capitalization Rate

75
Q 
Net Operating Income
=
Selling Price
X
Overall Capitalization Rate
A

Net Operating Income

76
Q 
Selling Price
=
Net Operating Income
÷
Overall Capitalization Rate
A

Selling Price

77
Q

Rate of Return
or
What the Market Expects

Rate of Return
=
Income
÷
Value (or Price)
A

Rate of Return or What the Market Expects

78
Q 
Gross Income Multiplier
=
Selling Price
÷
Effective Gross Income
A

Gross Income Multiplier

79
Q

Reconciliation criteria

• Appropriateness
o Single family=direct comparison
o Analysis of HABU=cost approach
o Income producing=income approach

  • Accuracy
  • Quantity and quality of evidence

Final Opinion of value

  • Traditionally a point estimate
  • Rounded
A

Reconciliation criteria

• Appropriateness
o Single family=direct comparison
o Analysis of HABU=cost approach
o Income producing=income approach

  • Accuracy
  • Quantity and quality of evidence

Final Opinion of value

  • Traditionally a point estimate
  • Rounded
80
Q

Narrative Appraisal

  • Introduction
  • Premises of the appraisal
  • Presentation of data
  • Analysis of data and conclusions
  • Addenda
A

Narrative Appraisal

five sections

81
Q

The reported conclusion of HABU must answer this question: What would the probable buyer of the subject property do with the property to maximize its value?

CUSPAP’s “Reasonable Appraisal” standard is the ultimate test – ask yourself, “given the data and analysis you have presented, would another professional appraiser come to a similar conclusion?”

A

The reported conclusion of HABU must answer this question: … ?

CUSPAP’s “Reasonable Appraisal” standard is the ultimate test – ask yourself, … ?

82
Q

Cost Approach

• Land values
o Give information on land sales
o Estimate land value

• Cost out a house “new”
o May give the cost per sq ft, and may have to work out the size of the home from the measurements given
o Or, may have to derive the cost from the sales of a new homes
o Divide the sales of the new home by the square footage to work out a rate per sq ft

• Depreciation
o Give you age of the property / economic life of the property to work out the depreciation rate

A

Cost Approach

• Land values
o Give information on land sales
o Estimate land value

• Cost out a house “new”
o May give the cost per sq ft, and may have to work out the size of the home from the measurements given
o Or, may have to derive the cost from the sales of a new homes
o Divide the sales of the new home by the square footage to work out a rate per sq ft

• Depreciation
o Give you age of the property / economic life of the property to work out the depreciation rate

83
Q

Direct Comparison Approach

  1. Market Conditions (Time) adjustments
  2. Other adjustments
  3. Order of the adjustments
  4. Time adjusted
  5. Write a reconciliation
    • Find the best comparable (don’t average)
A

Direct Comparison Approach

  1. Market Conditions (Time) adjustments
  2. Other adjustments
  3. Order of the adjustments
  4. Time adjusted
  5. Write a reconciliation
    • Find the best comparable (don’t average)
84
Q

Income Approach

  1. Understand incomes and expenses
    • May mean making adjustments to either the income or expenses
    • Expenses that shouldn’t be shown, or expenses that should be shown
    • Or, may ask you to derive the income based on the number of suites and based on the vacancy or expense losses
  2. Calculate the Gross Income Multiplier (GIM)
  3. Calculate the Capitalization Rate
    • Using the net income and sale price of comparable properties
A

Income Approach

  1. Understand incomes and expenses
    • May mean making adjustments to either the income or expenses
    • Expenses that shouldn’t be shown, or expenses that should be shown
    • Or, may ask you to derive the income based on the number of suites and based on the vacancy or expense losses
  2. Calculate the Gross Income Multiplier (GIM)
  3. Calculate the Capitalization Rate
    • Using the net income and sale price of comparable properties
85
Q

HIGHEST AND BEST USE: the reasonably probable and legal use of property, that is physically possible, appropriately supported, and financially feasible, and that results in the highest value.

A

HIGHEST AND BEST USE: the reasonably probable and legal use of property, that is physically possible, appropriately supported, and financially feasible, and that results in the highest value.

86
Q

Market value is defined as the most probable price a property should bring in a competitive and open market, under conditions requisite to a fair sale, with the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.

A

Market value is defined as the most probable price a property should bring in a competitive and open market, under conditions requisite to a fair sale, with the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.

87
Q

Test of highest and best use

In order to be considered as the highest and best use of a property, any potential use must pass a series of tests, i.e.,

legally allowable
physically possible
financially feasible
maximally productive

A

Test of highest and best use

In order to be considered as the highest and best use of a property, any potential use must pass a series of tests, i.e.,

legally allowable
physically possible
financially feasible
maximally productive

88
Q

Legally allowable

Only those uses that are, or may be, legally allowed are potential highest and best uses. This may exclude uses that are not, and unlikely to become, allowed by zoning, uses forbidden by government regulations, and uses prohibited by deed restrictions or covenants.

Properties with a use that predates existing zoning or other property regulations may be legally nonconforming. Such grandfathered uses are generally legal even though they do not meet current zoning or other regulations. Since their use predates these regulations, they are “grandfathered in”. However, some such uses may not be reproduced if the legally nonconforming improvement is destroyed or damaged beyond a certain point.

“Legally allowable” can be a tricky conceptual test, because even uses that are currently not permitted may be considered. This happens when there is a reasonable prospect (at least 50%) that the regulation, zoning, deed restriction, etc. can be changed to permit the proposed use.

A

Legally allowable

Only those uses that are, or may be, legally allowed are potential highest and best uses. This may exclude uses that are not, and unlikely to become, allowed by zoning, uses forbidden by government regulations, and uses prohibited by deed restrictions or covenants.

Properties with a use that predates existing zoning or other property regulations may be legally nonconforming. Such grandfathered uses are generally legal even though they do not meet current zoning or other regulations. Since their use predates these regulations, they are “grandfathered in”. However, some such uses may not be reproduced if the legally nonconforming improvement is destroyed or damaged beyond a certain point.

“Legally allowable” can be a tricky conceptual test, because even uses that are currently not permitted may be considered. This happens when there is a reasonable prospect (at least 50%) that the regulation, zoning, deed restriction, etc. can be changed to permit the proposed use.

89
Q

Physically possible

Any potential use must be physically possible given the size, shape, topography, and other characteristics of the site. For example a 40,000-square-foot (3,700 m2) single story warehouse would not fit on a 10,000-square-foot (930 m2) site; therefore, that use would fail the physical possibility test.

A

Physically possible

Any potential use must be physically possible given the size, shape, topography, and other characteristics of the site.

90
Q

Financial feasibility

The highest and best use of a property must be financially feasible: the proposed use of a property must generate adequate revenue to justify the costs of construction plus a profit for the developer.

In the case of an improved property, with obvious remaining economic life, the question of financial feasibility is somewhat irrelevant.

In the case of an improved property with limited remaining economic life, the question of financial feasibility becomes a question of the maximally productive use of the site. If the value of the land as vacant exceeds the value of the property as improved less reversion/demolition costs, then redevelopment of the site becomes the maximally productive use of the property, and continued use of the existing improvements that do not represent the highest net value of the site is considered to be financially unfeasible.

A

Financial feasibility

The highest and best use of a property must be financially feasible: the proposed use of a property must generate adequate revenue to justify the costs of construction plus a profit for the developer.

In the case of an improved property, with obvious remaining economic life, the question of financial feasibility is somewhat irrelevant.

In the case of an improved property with limited remaining economic life, the question of financial feasibility becomes a question of the maximally productive use of the site. If the value of the land as vacant exceeds the value of the property as improved less reversion/demolition costs, then redevelopment of the site becomes the maximally productive use of the property, and continued use of the existing improvements that do not represent the highest net value of the site is considered to be financially unfeasible.

91
Q

Maximally productive use

Finally, the use must generate the highest net return (profit) to the developer. A property that could hypothetically be developed with residential, commercial or industrial development might only have one of those uses as its highest and best use.

A

Maximally productive use

Finally, the use must generate the highest net return (profit) to the developer. A property that could hypothetically be developed with residential, commercial or industrial development might only have one of those uses as its highest and best use.

92
Q

HABU Economic theory

The economic concepts of utility and substitution drive the highest and best use analysis. The highest and best use of a property determines its utility to a potential purchaser. The purchaser of such a property would pay no more than a competing property with the same utility while a seller would accept no less than a seller of a comparable property. That is true to the neighbourhood.

A

HABU Economic theory

The economic concepts of utility and substitution drive the highest and best use analysis. The highest and best use of a property determines its utility to a potential purchaser. The purchaser of such a property would pay no more than a competing property with the same utility while a seller would accept no less than a seller of a comparable property. That is true to the neighbourhood.

BUSI 330 - Foundations of Real Estate Appraisal (6 decks)

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