Unit 15 – Real Estate Appraisal – Flashcards
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One of the primary benefits that contribute to real estate value is
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income
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One of the primary benefits that contribute to real estate value is
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appreciation
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One of the primary benefits that contribute to real estate value is
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use
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One of the primary benefits that contribute to real estate value is
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tax benefits
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Ownership of real estate produces income when there are leases on the land, the improvements, or on air, surface, or subsurface rights. Such income is part of real estate value because
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an investor will pay money to buy the income stream generated by ownership of the property
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Appreciation is
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an increase in the Market Value of a parcel of land over time, usually resulting from a general rise in sale prices of real estate throughout a market area. Such an increase, whether actual or projected, is another investment benefit that contributes to real estate value
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The way a property is used, for instance, whether residential, commercial, agricultural, recreational, in large part determines the
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property's value. Each kind of use has its own benefits
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Depending on current tax law, tax benefits from ownership of a property may take the form of
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preferred treatment of capital gain, tax losses, depreciation, and deferrals of tax liability. These tax benefits contribute to the income and potential sale price of a property
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Depending on current tax law, tax benefits from ownership of a property may take the form of preferred treatment of capital gain, tax losses, depreciation, and deferrals of tax liability. These tax benefits contribute to the
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income and potential sale price of a property
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One of the economic principles underlying real estate value is
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Supply and Demand
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One of the economic principles underlying real estate value is
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change
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One of the economic principles underlying real estate value is
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utility
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One of the economic principles underlying real estate value is
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highest and best use
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One of the economic principles underlying real estate value is
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transferability
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One of the economic principles underlying real estate value is
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conformity
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One of the economic principles underlying real estate value is
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anticipation
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One of the economic principles underlying real estate value is
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progression and regression
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One of the economic principles underlying real estate value is
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substitution
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One of the economic principles underlying real estate value is
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assemblage
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One of the economic principles underlying real estate value is
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contribution
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One of the economic principles underlying real estate value is
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subdivision
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The availability of certain properties interacts with the strength of the demand for those properties to establish prices. When demand for properties exceeds supply, a condition of scarcity exists, and real estate values
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rise. When supply exceeds demand, a condition of surplus exists, and real estate values decline. When Supply and Demand are generally equivalent, the market is considered to be in balance, and real estate values stabilize
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The availability of certain properties interacts with the strength of the demand for those properties to establish prices. When demand for properties exceeds supply,
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a condition of scarcity exists, and real estate values rise. When supply exceeds demand, a condition of surplus exists, and real estate values decline. When Supply and Demand are generally equivalent, the market is considered to be in balance, and real estate values stabilize
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The availability of certain properties interacts with the strength of the demand for those properties to establish prices. When demand for properties exceeds supply, a condition of scarcity exists, and real estate values rise. When supply exceeds demand,
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a condition of surplus exists, and real estate values decline. When Supply and Demand are generally equivalent, the market is considered to be in balance, and real estate values stabilize
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The availability of certain properties interacts with the strength of the demand for those properties to establish prices. When demand for properties exceeds supply, a condition of scarcity exists, and real estate values rise. When supply exceeds demand, a condition of surplus exists, and real estate values
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decline. When Supply and Demand are generally equivalent, the market is considered to be in balance, and real estate values stabilize
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The availability of certain properties interacts with the strength of the demand for those properties to establish prices. When demand for properties exceeds supply, a condition of scarcity exists, and real estate values rise. When supply exceeds demand, a condition of surplus exists, and real estate values decline. When Supply and Demand are generally equivalent, the market is considered to be in
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balance and real estate values stabilize
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The principal of Utility reflects the fact that
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a property has a use in a certain marketplace that contributes to the demand for it. Use is not the same as function. For instance, a swampy area may have an ecological function as a wetland, but it may have no economic utility if it cannot be put to some use that people in the marketplace are willing to pay for
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The principal of Transferability relates to
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how readily or easily title or rights to real estate can be transferred affects the property's value. Property that is encumbered has a value impairment since buyers do not want unmarketable title. Similarly, property that cannot be transferred due to disputes among owners may cause the value to decline, because the investment is wholly illiquid until the disputes are resolved
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The principal of anticipation are the benefits a buyer expects to derive from a property over a holding period influence what the buyer is willing to pay for it. For example,
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if an investor anticipates an annual rental income from a leased property to be one million dollars, this expected sum has a direct bearing on what the investor will pay for the property
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According to the principle of substitution, a buyer will pay no more for a property than the buyer would have to pay for an equally desirable and available substitute property. For example,
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if three houses for sale are essentially similar in size, quality and location, a potential buyer is unlikely to choose the one that is priced significantly higher than the other two
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The principal of contribution focuses on
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the degree to which a particular improvement affects Market Value of the overall property. In essence, the contribution of the improvement is equal to the change in Market Value that the addition of the improvement causes
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Contribution Example
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Adding a bathroom to a house may contribute an additional $15,000 to the appraised value. Thus the contribution of the bathroom is $15,000. Note that an improvement's contribution to value has little to do with the improvement's cost. The foregoing bathroom may have cost $5,000 or $20,000. Contribution is what the market recognizes as the change in value, not what an item cost. If continuous improvements are added to a property, it is possible that, at some point, the cost of adding improvements to a property no longer contributes a corresponding increase in the value of the property. When this occurs, the property suffers from diminishing marginal return, where the costs to improve exceed contribution
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This principle of Change relates to market conditions are in a state of flux over time, just as the condition of a property itself changes. These fluctuations and changes will affect the benefits that can arise from the property, and should be reflected in an estimate of the property's value. For example,
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the construction of a neighborhood shopping center in the vicinity of a certain house may increase the desirability of the house's location, and hence, its value
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This principle of Highest and best use holds that there is, theoretically, a single use for a property that produces the greatest income and return. A property achieves its maximum value when it is put to this use. If the actual use is not the highest and best use, the value of the property is correspondingly less than optimal. Technically, highest and best use must be legally permissible, physically possible, financially feasible, and maximally productive. For example,
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a property with an old house on it may not be in its highest and best use if it is surrounded by retail properties. If zoning permits the property to be converted to a retail use, its highest and best use may well be retail rather than residential
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The principle of Conformity holds that a property's maximal value is attained when its form and use are in tune with surrounding properties and uses. For example,
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a two bedroom, one bathroom house surrounded by four bedroom, three bathroom homes may derive maximal value from a room addition
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Progression is when
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the value of a property influences, and is influenced by, the values of neighboring properties. If a property is surrounded by properties with higher values, its value will tend to rise
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The principals of Assemblage, or the conjoining of adjacent properties, sometimes creates a
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combined value that is greater than the values of the unassembled properties. The excess value created by assemblage is called Plottage Value
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The principals of Assemblage, or the conjoining of adjacent properties, sometimes creates a combined value that is greater than the values of the unassembled properties. The excess value created by assemblage is called
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Plottage Value
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The division of a single property into smaller properties can result in a higher total value. For instance,
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a one acre suburban site appraised at $50,000 may be subdivided into four quarter acre lots worth $30,000 each. This principle contributes significantly to the financial feasibility of subdivision development
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The purpose of an appraisal influences an estimate of the value of a parcel of real estate. This is because
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there are different types of value related to different appraisal purposes
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One type of real estate value is
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mortgage
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One type of real estate value is
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condemned
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One type of real estate value is
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book
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One type of real estate value is
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assessed
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One type of real estate value is
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insured
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One type of real estate value is
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plottage
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One type of real estate value is
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leasehold
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One type of real estate value is
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salvage
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One type of real estate value is
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rental
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One type of real estate value is
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replacement
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One type of real estate value is
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appraised
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One type of real estate value is
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reproduction
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One type of real estate value is
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reversionary
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One type of real estate value is
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market
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Market Value is
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an estimate of the price at which a property will sell at a particular time. This type of value is the one generally sought in appraisals and used in brokers estimates of value
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Reproduction value is
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the value based on the cost of constructing a precise duplicate of the subject property's improvements, assuming current construction costs
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Replacement value is
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the value based on the cost of constructing a functional equivalent of the subject property's improvements, assuming current construction costs
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Salvage Value refers to the
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nominal value of a property that has reached the end of its Economic Life. Salvage Value is also an estimate of the price at which a structure will sell if it is dismantled and moved
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Plottage Value is
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an estimate of the value that the process of assemblage adds to the combined values of the assembled properties
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Assessed Value is
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the value of a property as estimated by a taxing authority as the basis for ad valorem taxation
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Condemned value is
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the value set by a county or municipal authority for a property which may be taken by eminent domain
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Depreciated value is
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a value established by subtracting accumulated depreciation from the purchase price of a property
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Reversionary value is
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the estimated selling price of a property at some time in the future. This value is used most commonly in a proforma investment analysis where, at the end of a holding period, the property is sold and the investor's capital reverts to the investor
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Appraised value is
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an appraiser's opinion of a property's value
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Rental value is
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an estimate of the rental rate a property can command for a specific period of time
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Leasehold value is
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an estimate of the Market Value of a lessee's interest in a property
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Insured value is
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the face amount a casualty or hazard insurance policy will pay in case a property is rendered unusable
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Book value is
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the value of the property as carried on the accounts of the owner. The value is generally equal to the acquisition price plus capital improvements minus accumulated depreciation
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Mortgage value is
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the value of the property as collateral for a loan
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Market Value is an opinion of the price that a willing seller and willing buyer would probably agree on for a property at a given time if
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the transaction is a cash transaction
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Market Value is an opinion of the price that a willing seller and willing buyer would probably agree on for a property at a given time if
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the property is exposed on the open market for a reasonable period
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Market Value is an opinion of the price that a willing seller and willing buyer would probably agree on for a property at a given time if
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buyer and seller have full information about market conditions and about potential uses
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Market Value is an opinion of the price that a willing seller and willing buyer would probably agree on for a property at a given time if
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there is no abnormal pressure on either party to complete the transaction
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Market Value is an opinion of the price that a willing seller and willing buyer would probably agree on for a property at a given time if
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buyer and seller are not related (it is an "arm's length" transaction)
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Market Value is an opinion of the price that a willing seller and willing buyer would probably agree on for a property at a given time if
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title is marketable and conveyable by the seller
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Market Value is an opinion of the price that a willing seller and willing buyer would probably agree on for a property at a given time if
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the price is a "normal consideration," that is, it does not include hidden influences such as special financing deals, concessions, terms, services, fees, credits, costs, or other types of consideration
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Market value is
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the highest price that a buyer would pay and the lowest price that the seller would accept for the property
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The market price, as opposed to Market Value, is
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what a property actually sells for
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Market price should theoretically be the same as Market Value if
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all the conditions essential for Market Value were present
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Market price may Not reflect the analysis of
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comparables and of investment value that an estimate of Market Value includes
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An appraisal is distinguished from other estimates of value in that
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it is an opinion of value supported by data and performed by a professional, disinterested third party
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Appraisers acting in a professional capacity are regulated by state laws and bound to
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standards set by the appraisal industry
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Appraisers acting in a professional capacity are regulated by
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state laws and bound to standards set by the appraisal industry
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A broker's opinion of value may resemble an appraisal, but it differs from an appraisal in that
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it is not necessarily performed by a disinterested third party or licensed professional and it generally uses only a limited form of one of the three appraisal approaches. In addition, the opinion is not subject to regulation, nor does it follow any particular professional standards
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An appraisal is used in real estate decision making to
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estimate one or more types of value, depending on the kind of decision to be made
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Appraisals may be ordered and used by
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mortgage lenders, government agencies, investors, utilities companies, and real estate buyers and sellers
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An appraisal helps in
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setting selling prices and rental rates, determining the level of insurance coverage, establishing investment values, and establishing the value of the real estate as collateral for a loan
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One way an appraisal helps is in
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setting selling prices and rental rates
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One way an appraisal helps is in
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determining the level of insurance coverage
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One way an appraisal helps is in
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establishing investment values
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One way an appraisal helps is in
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establishing the value of the real estate as collateral for a loan
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The most commonly used form for residential appraisals is the ______ promoted by the Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHMLC) (known as Fannie Mae and Freddie Mac, respectively)
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Uniform Residential Appraisal Report (URAR)
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A systematic procedure enables an appraiser to
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collect, organize and analyze the necessary data to produce an appraisal report
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The first step in an appraisal process is to
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define the appraisal problem and the purpose of the appraisal
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One thing that is involved in defining an appraisal problem and its purpose is
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identifying the subject property by legal description
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One thing that is involved in defining an appraisal problem and its purpose is
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specifying the interest to be appraised
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One thing that is involved in defining an appraisal problem and its purpose is specifying the purpose of the appraisal, for example,
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to identify Market Value for a purchase, identify rental levels, or establish a value as collateral for a loan
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One thing that is involved in defining an appraisal problem and its purpose is
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specifying the date for which the appraisal is valid
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One thing that is involved in defining an appraisal problem and its purpose is
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identifying the type of value to be estimated
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The second step in an appraisal process is to
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collect, organize and analyze relevant data about the subject property. Information relevant to the property includes notes and drawings from physical inspection of the subject, public tax and title records, and Reproduction Costs. Relevant information about the market includes environmental, demographic, and economic reports concerning the neighborhood, community, and region
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The third step in an appraisal process is to
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analyze market conditions to identify the most profitable use (highest and best use) for the subject property. This use may or may not be the existing use
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The fourth step in an appraisal process is to
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estimate the land value of the subject. An appraiser does this by comparing the subject site, but not its buildings, with similar sites in the area, and making adjustments for significant differences
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The fifth step in an appraisal process is to apply the three basic approaches to value to the subject, which is
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the Sales Comparison Approach, the cost approach, and the Income Capitalization Approach. Using multiple methods serves to guard against errors and to set a range of values for the final estimate
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The sixth step in an appraisal process is to reconcile the value estimates produced by the three approaches to value into a final value estimate. To do this, an appraiser must
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weigh the appropriateness of a particular approach to the type of property being appraised, and, take into account the quality and quantity of data obtained in each method
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The seventh and final step in an appraisal process is to
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present the estimate of value in the format requested by the client
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The Sales Comparison Approach, also known as the
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market data approach, is used for almost all properties. It also serves as the basis for a broker's opinion of value
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The Sales Comparison Approach, also known as the market data approach, is used for
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almost all properties. It also serves as the basis for a broker's opinion of value
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The Sales Comparison Approach, also known as the market data approach, is used for almost all properties. It also serves as the basis for
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a broker's opinion of value
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A Sales Comparison Approach is based on the principle of
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substitution, that a buyer will pay no more for the subject property than would be sufficient to purchase a comparable property, and, contribution, that specific characteristics add value to a property
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The Sales Comparison Approach is widely used because it takes into account
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the subject property's specific amenities in relation to competing properties
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Because of the currency of its data, the Sales Comparison Approach incorporates
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present market realities
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The Sales Comparison Approach is limited in that
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every property is unique. As a result, it is difficult to find good comparables, especially for Special Purpose properties. In addition, the market must be active; otherwise, sale prices lack currency and reliability
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The sales comparison approach consists of
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comparing sale prices of recently sold properties that are comparable with the subject, and making dollar adjustments to the price of each comparable to account for competitive differences with the subject. After identifying the adjusted value of each comparable, the appraiser weights the reliability of each comparable and the factors underlying how the adjustments were made. The weighting yields a final value range based on the most reliable factors in the analysis
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For a property to qualify as a comparable, for one thing, a property must
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resemble the subject in size, shape, design, utility and location
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For a property to qualify as a comparable, for one thing, a property must
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have sold recently, generally within six months of the appraisal
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For a property to qualify as a comparable, for one thing, a property must
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have sold in an arm's length transaction
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An appraiser considers
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three to six comparables, and usually includes at least three in the appraisal report
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An appraiser considers three to six comparables, and usually includes
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at least three in the appraisal report
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Appraisers have specific guidelines within the foregoing criteria for selecting comparables, many of which are set by secondary market organizations such as
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FNMA
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To qualify as a comparable for a mortgage loan appraisal, a property might have to be located within one mile of the subject. Or perhaps the size of the comparable must be within a certain percentage of improved area in relation to the subject. The time of sale criterion is important because
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transactions that occurred too far in the past will not reflect appreciation or recent changes in market conditions. An arm's length sale involves objective, disinterested parties who are presumed to have negotiated a market price for the property. If the sale of a house occurred between a father and a daughter, for example, one might assume that the transaction did not reflect Market Value. Principal sources of data for generating the sales comparison are tax records, title records, and the local multiple listing service
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An appraiser adjusts the sale prices of the comparables to account for competitive differences with the subject property. Note that the sale prices of the comparables are known, while the value and price of the subject are not. Therefore,
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adjustments can be made only to the comparables' prices, not to the subject's. Adjustments are made to the comparables in the form of a value deduction or a value addition
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In appraising, if a comparable property is better than the subject in some characteristic, an amount is
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deducted from the sale price of the comparable. This neutralizes the comparable's competitive advantage in an adjustment category
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Comparative Property Example
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A comparable has a swimming pool and the subject does not. To equalize the difference, the appraiser deducts an amount, say $6,000, from the sale price of the comparable. Note that the adjustment reflects the contribution of the swimming pool to Market Value. The adjustment amount is not the cost of the pool or its depreciated value. If the comparable is inferior to the subject in some characteristic, an amount is added to the price of the comparable. This adjustment equalizes the subject's competitive advantage in this area
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The principal factors for comparisons and adjustments in the appraising process are
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time of sale, location, physical characteristics, and transaction characteristics
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In appraising, an adjustment may be made if
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market conditions, market prices, or financing availability have changed significantly since the date of the comparable's sale. Most often, this adjustment is to account for appreciation
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In appraising, an adjustment may be made if
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there are differences between the comparable's location and the subject's, including neighborhood desirability and appearance, zoning restrictions, and general price levels
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In appraising, adjustments may be made for
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marketable differences between the comparable's and subject's lot size, square feet of livable area (or other appropriate measure for the property type), number of rooms, layout, age, condition, construction type and quality, landscaping, and special amenities
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In appraising, adjustments may be made for such differences as
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mortgage loan terms, mortgage assumability, and owner financing
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In appraising, adding and subtracting the appropriate adjustments to the sale price of each comparable results in an adjusted price for the comparables that indicates the
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value of the subject
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The last step in a property value approach is to perform a weighted analysis of the indicated values of each comparable. The appraiser, in other words, must identify which comparable values are more
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indicative of the subject and which are less indicative
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An appraiser primarily relies on experience and judgment to
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weight comparables
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There is no formula for selecting a value from within the range of all comparables analyzed. However, there are three quantitative guidelines, they are
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the total number of adjustments; the amount of a single adjustment; and the net value change of all adjustments. As a rule, the fewer the total number of adjustments, the smaller the adjustment amounts, and the less the total adjustment amount, the more reliable the comparable
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In terms of total adjustments in finding a property value, the comparable with the fewest adjustments tends to be most similar to the subject, hence the best indicator of
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value
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If a comparable requires excessive adjustments, it is increasingly
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less reliable as an indicator of value. The underlying rationale is that there is a margin of error involved in making any adjustment. Whenever a number of adjustments must be made, the margin of error compounds. By the time six or seven adjustments are made, the margin becomes significant, and the reliability of the final value estimate is greatly reduced
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In finding property value using comparables, the dollar amount of an adjustment represents the variance between the
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subject and the comparable for a given item
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In finding property value using comparables, if a large adjustment is called for, the comparable becomes
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less of an indicator of value
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In finding property value using comparables, the smaller the adjustment
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the better the comparable is as an indicator of value
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If an appraisal is performed for mortgage qualification, the appraiser may be restricted from making adjustments in excess of a certain amount, for example,
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anything in excess of 10 to 15% of the sale price of the comparable. If such an adjustment would be necessary, the property is no longer considered comparable
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The third reliability factor in weighting comparables is the
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total net value change of all adjustments added together
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In weighting comparables, if a comparable's total adjustments alter the indicated value only slightly, the comparable is a good indicator of
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value
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In weighting comparables, if total adjustments create a large dollar amount between the sale price and the adjusted value, the comparable is a
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poorer indicator of value
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Fannie Mae will not accept the use of a comparable where total net adjustments are in excess of 15% of the sale price. For example,
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an appraiser is considering a property that sold for $100,000 as a comparable. After all adjustments are made, the indicated value of the comparable is $121,000, a 21% difference in the comparable's sale price. This property, if allowed at all, would be a weak indicator of value
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A broker or salesperson who is attempting to establish a listing price or range of prices for a property uses a scaled down version of the appraiser's Sales Comparison Approach called a
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comparative market analysis, or CMA (also called a competitive market analysis)
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While the CMA serves a useful purpose in setting general price ranges, brokers and agents need to exercise caution in presenting a CMA as an
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appraisal, which it is not
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Two important distinctions between the an appraisal and a comparative market analysis are
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objectivity and comprehensiveness
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In performing a comparative market analysis, the broker is not unbiased: he or she is motivated by the desire to obtain a listing, which can lead one to
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distort the estimated price
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A broker's comparative market analysis is not comprehensive: the broker does not usually consider the full range of data about market conditions and comparable sales that the appraiser must consider and document. Therefore, the broker's opinion will be
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less reliable than the appraiser's
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The cost approach is most often used for
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recently built properties where the actual costs of development and construction are known
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The cost approach is used for
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Special Purpose buildings, which cannot be valued by the other methods because of lack of comparable sales or income data
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One of the strengths of the cost approach is that it
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provides an upper limit for the subject's value based on the undepreciated cost of reproducing the improvements
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One of the strengths of the cost approach is that it
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is very accurate for a property with new improvements which are the highest and best use of the property
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One of the limitations of the cost approach is that
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the cost to create improvements is not necessarily the same as Market Value
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One of the limitations of the cost approach is that
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depreciation is difficult to measure, especially for older buildings
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The cost approach generally aims to
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estimate either the Reproduction Cost or the Replacement Cost of the subject property
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Reproduction Cost is
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the cost of constructing, at current prices, a precise duplicate of the subject improvements
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Replacement Cost is
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the cost of constructing, at current prices and using current materials and methods, a functional equivalent of the subject improvements
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Replacement Cost is used primarily for
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appraising older structures, since it is impractical to consider reproducing outmoded features and materials. However, Reproduction Cost is preferable whenever possible because it facilitates the calculation of depreciation on a structure
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A cornerstone of the cost approach is the concept of
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depreciation
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Depreciation is
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the loss of value in an improvement over time
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Since land is assumed to retain its value indefinitely, depreciation only applies to
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the improved portion of real property
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The loss of an improvement's value can come from any cause, such as
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deterioration, obsolescence, or changes in the neighborhood
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The sum of depreciation from all causes is
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accrued depreciation
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An appraiser considers depreciation as having three causes, they are
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Physical Deterioration, Functional Obsolescence and Economic Obsolescence
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Physical Deterioration is
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wear and tear from use, decay, and structural deterioration. Such deterioration may be either curable or incurable
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Curable Deterioration occurs when
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the costs of repair of the item are less than or equal to the resulting increase in the property's value
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Curable Deterioration Example
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If a paint job costs $3,000, and the resulting value increase is $4,000, the deterioration is considered curable. Incurable Deterioration is the opposite: the repair will cost more than can be recovered by its contribution to the value of the building. For example, if the foregoing paint job cost $5,000, the deterioration would be considered incurable
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Functional Obsolescence occurs when a property has outmoded physical or design features which are no longer desirable to current users. If the obsolescence is curable, the cost of replacing or redesigning the outmoded feature would be offset by the contribution to overall value, for example,
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a lack of central air conditioning. If the Functional Obsolescence is incurable, the cost of the cure would exceed the contribution to overall value, for example, a floor layout with a bad traffic pattern that would cost three times as much as the ending contribution to value
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Economic (or external) obsolescence is
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the loss of value due to adverse changes in the surroundings of the subject property that make the subject less desirable. Since such changes are usually beyond the control of the property owner, Economic Obsolescence is considered an incurable value loss
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Examples of Economic Obsolescence include
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a deteriorating neighborhood, a rezoning of adjacent properties, or the bankruptcy of a large employer
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The cost approach consists of
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estimating the value of the land "as if vacant;" estimating the cost of improvements; estimating and deducting accrued depreciation; and adding the estimated land value to the estimated depreciated cost of the improvements
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To estimate land value, the appraiser uses the
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sales comparison method
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The sales comparison method of estimating land consist of
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finding properties which are comparable to the subject property in terms of land and adjust the sale prices of the comparables to account for competitive differences with the subject property. Common adjustments concern location, physical characteristics, and time of sale. The indicated values of the comparable properties are used to estimate the land value of the subject. The implicit assumption is that the subject land is vacant (unimproved) and available for the highest and best use
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One of several methods for estimating the reproduction or Replacement Cost of improvements is the
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unit comparison method (square foot method). The appraiser examines one or more new structures that are similar to the subject's improvements, determines a cost per unit for the benchmark structures, and multiplies this cost per unit times the number of units in the subject. The unit of measurement is most commonly denominated in square feet
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One of several methods for estimating the reproduction or Replacement Cost of improvements is the
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Unit in Place Method. The appraiser uses materials cost manuals and estimates of labor costs, overhead, and builder's profit to estimate the cost of constructing separate components of the subject. The overall cost estimate is the sum of the estimated costs of individual components
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One of several methods for estimating the reproduction or Replacement Cost of improvements is the
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Quantity Survey Method. The appraiser considers in detail all materials, labor, supplies, overhead and profit to get an accurate estimate of the actual cost to build the improvement. More thorough than the Unit in Place Method, this method is used less by appraisers than it is by engineers and architects
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One of several methods for estimating the reproduction or Replacement Cost of improvements is the
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cost Indexing Method. The original cost of constructing the improvement is updated by applying a percentage increase factor to account for increases in nominal costs over time
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One of several methods for estimating the reproduction or Replacement Cost of improvements is the
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estimate accrued depreciation. Accrued depreciation is often estimated by the straight line method, also called the economic age life method. This method assumes that depreciation occurs at a steady rate over the Economic Life of the structure. Therefore, a property suffers the same incremental loss of value each year
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One of several methods for estimating the reproduction or replacement cost of improvements is the
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Economic Life, the period during which the structure is expected to remain useful in its original use. The cost of the structure is divided by the number of years of Economic Life to determine an annual amount for depreciation. The straight line method is primarily relevant to depreciation from Physical Deterioration
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One of several methods for estimating the reproduction or Replacement Cost of improvements is the
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subtract accrued depreciation from reproduction or Replacement Cost. The sum of accrued depreciation from all sources is subtracted from the estimated cost of reproducing or replacing the structure. This produces an estimate of the current value of the improvements
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One of several methods for estimating the reproduction or Replacement Cost of improvements is to
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add land value to depreciated reproduction or Replacement Cost. To complete the cost approach, the estimated value of the land "as if vacant" is added to the estimated value of the depreciated reproduction or Replacement Cost of the improvements. This yields the final value estimate for the property by the cost approach
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The Income Capitalization Approach, or income approach, is used for
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income properties and sometimes for other properties in a rental market where the appraiser can find rental data
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One thing that the Income Capitalization Approach is based on is the principle of
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anticipation. The expected future income stream of a property underlies what an investor will pay for the property
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One thing that the income capitalization approach is based on is the principle of
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substitution. That an investor will pay no more for a subject property with a certain income stream than the investor would have to pay for another property with a similar income stream
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The strength of the income approach is that it is used by investors themselves to
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determine how much they should pay for a property
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In the right circumstances, the income approach provides a good basis for estimating
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Market Value
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The Income Capitalization Approach is limited in two ways, they are
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First, it is difficult to determine an appropriate Capitalization Rate. This is often a matter of judgment and experience on the part of the appraiser. Secondly, the income approach relies on market information about income and expenses, and it can be difficult to find such information
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The Income Capitalization Method consists of
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estimating annual net operating income from the subject property, then applying a Capitalization Rate to the income. This produces a principal amount that the investor would pay for the property
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Potential gross income is the
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scheduled rent of the subject plus income from miscellaneous sources such as vending machines and telephones
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An appraiser may estimate potential gross rental income using
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current market rental rates (market rent), the rent specified by leases in effect on the property (contract rent), or a combination of both
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Scheduled rent is the total rent a property will produce if
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fully leased at the established rental rates
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Market Rent is determined by
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market studies in a process similar to the sales comparison method
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Contract rent is used primarily if
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the existing leases are not due to expire in the short term and the tenants are unlikely to fail or leave the lease
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Effective gross income is
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potential gross income minus an allowance for vacancy and credit losses
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Vacancy loss refers to an amount of potential income lost because of
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unrented space
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Credit loss refers to an amount lost because of
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tenants failure to pay rent for any reason
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Credit loss and Vacancy loss are estimated on the basis of
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the subject property's history, comparable properties in the market and assuming typical management quality
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The allowance for vacancy and credit loss is usually estimated as a
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percentage of potential gross income
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Net operating income is
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effective gross income minus total operating expenses
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Operating expenses include
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fixed expenses and variable expenses
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Fixed expenses are those that are incurred whether the property is occupied or vacant, for example,
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real estate taxes and hazard insurance. Variable expenses are those that relate to actual operation of the building, for example, utilities, janitorial service, management and repairs
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Operating expenses typically include
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an annual reserve fund for replacement of equipment and other items that wear out periodically, such as carpets and heating systems
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Operating expenses do Not include
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debt service, expenditures for capital improvements, or expenses not related to operation of the property
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The Capitalization Rate is
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an estimate of the rate of return an investor will demand on the investment of capital in a property such as the subject. The judgment and market knowledge of the appraiser play an essential role in the selection of an appropriate rate for the subject property. In most cases, the appraiser will research Capitalization Rates used on similar properties in the market
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An appraiser obtains an indication of value from the Income Capitalization Method by
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dividing the estimated net operating income for the subject by the selected capitalization rate
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The gross rent multiplier (GRM) and gross income multiplier (GIM) approaches are simplified income based methods used primarily for properties that produce or might produce income but are not primarily income properties. Examples are
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single family homes and duplexes. The methods consist of applying a multiplier to the estimated gross income or gross rent of the subject. The multiplier is derived from market data on sale prices and gross income or gross rent
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The advantage of the income multiplier is that
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it offers a relatively quick indication of value using an informal methodology
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The income multiplier approach leaves many variables out of consideration such as
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vacancies, credit losses, and operating expenses. In addition, the appraiser must have market rental data to establish multipliers
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There are two steps in the gross rent multiplier approach
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First, select a gross rent multiplier by examining the sale prices and monthly rents of comparable properties which have sold recently. The appraiser's judgment and market knowledge are critical in determining an appropriate gross rent multiplier for the subject. The gross rent multiplier for a property is: Second, estimate the value of the subject by multiplying the selected GRM by the subject's monthly
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The gross income multiplier approach (GIM) approach is identical to the GRM approach, except that
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a different denominator is used in the formula
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In 1989, Congress passed the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) in response to the savings and loan crisis. This act included provisions to
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regulate appraisal
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Title XI of FIRREA requires that competent individuals whose professional conduct is properly supervised perform all appraisals used in
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federally related transaction
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As of January 1, 1993, federally related appraisals must be performed only by
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state certified appraisers
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A state certified appraiser is
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one who has passed the necessary examinations and competency standards as established by each state in conformance with the federal standards stated in FIRREA and USPAP (Uniform Standards of Professional Appraisal Practice). The criteria for certification as a minimum must follow those established by the Appraiser Qualifications Board of the Appraisal Foundation
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The Uniform Standards of Professional Appraisal Practice (USPAP) is
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a set of standards, guidelines and provisions for the appraisal industry. It resulted from the cooperation of nine national appraisal organizations in 1985
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In appraising, the Competence provision requires appraisers to
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assess whether they have the necessary knowledge and competence to perform a specific assignment. If they do not, they must disclose this fact
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In appraising, the departure provision permits appraisers to
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perform an appraisal that does not meet all the Uniform Standards of Professional Appraisal Practice guidelines provided they have informed the client of the limitations of the incomplete appraisal and if the partial appraisal will not be misleading
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Appraisal standards concern
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recognized appraisal methods
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Appraisal standards concern
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definition of due diligence
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Appraisal standards concern
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how appraisal results are reported
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Appraisal standards concern
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disclosures and assumptions
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Appraisal standards concern
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appraisal review
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Appraisal standards concern
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real estate analysis
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Appraisal standards concern
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mass appraisals
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Appraisal standards concern
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personal property appraisals
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Appraisal standards concern
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business appraisals
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Appraisal standards concern
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Appraisal standards concern
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Appraisal standards concern
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compliance with the Code of Professional Ethics and Standards of Professional Practice
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Prior to the establishment of state certification programs, the only indication of professional competence for an appraiser was membership in and designation by one of the
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national appraisal associations. These associations continue to provide education and recognition of professional accomplishment for appraisers
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Taxation on property requires
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notice of value
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Insurance on property requires
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notice of value
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The most exact way of determining value is with a
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state licensed and certified appraiser
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To complete a real estate transaction, a certified appraisal must be used if
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the loan will be sold in the secondary market
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Another way of determining value is to do a
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Comparative Market Analysis (CMA)
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Real estate brokers and their associates do comparative market analysis in order to
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let the seller know how much the property will probably bring on the open market
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Brokers use a range in doing a comparative market analysis rather than
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one specific price
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A broker cannot do an appraisal unless
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he is certified as an appraiser
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An appraisal is an
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estimate or opinion of value
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The goal of the appraiser is to determine
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the Market Value, Insurance Value, Salvage Value, and or the Tax Value of a property
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One of the goals of an appraiser is to determine
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the Market Value of a property
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One of the goals of an appraiser is to determine
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the Insurance Value of a property
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One of the goals of an appraiser is to determine
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the Salvage Value of a property
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One of the goals of an appraiser is to determine
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the Tax Value of a property
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Compensation of the appraiser is based on
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time and effort, never on the established price of the property
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The first step in the appraisal process is to
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define the problem
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In the first step of the appraisal process, the appraiser has to ask him herself
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"Why am I doing this appraisal? Is the purpose of this appraisal for Market Value, Insurance Value, Salvage Value, or Tax Value?"
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If an appraiser is hired to determine Market Value, he or she is looking for
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what the sales price would most likely bring in an open market if certain conditions were met
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One of the appraiser's ground rules is that
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payment must be in cash or its equivalent, the appraiser assumes the buyer is either paying cash for the property or is in the process of obtaining a loan
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One of the appraiser's ground rules is that
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the buyer and seller must be unrelated and acting without undue influence, menace, or duress
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Arms Length transactions means
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there is no relationship between a buyer and seller
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An appraiser must assume that no one has been
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forced into a contract to purchase the property
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One of the appraiser's ground rules is that
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the property must be marketed for a reasonable time in an open and free flowing market
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One of the appraiser's ground rules is that
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Both buyer and seller must be well informed consumers
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Reconcile estimated values for the final value estimates is
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the final step in the appraisal process, in which the appraiser reconciles the estimates of value received from the sales comparison, cost and income approaches to arrive at a final estimate of Market Value for the subject property
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An appraiser Never averages comparable sales to obtain a final value, instead the appraiser
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evaluates all three methods of appraising property, market data (sales comparison), cost, income, and determines which would be best to use for the property in question
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In the appraisal process, lastly, the appraiser may apply the income approach if
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the property is income producing. Usually, this is not the case in a residential property
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One of several types of appraisal reports is a
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a short business letter stating all essential data but not including supporting data
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One of several types of appraisal reports is a
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short or form that contains all basics of a regular appraisal and is used primarily for homes
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One of several types of appraisal reports is a
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narrative. The most comprehensive of all appraisal reports, used for commercial and investors
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There are many types of value as it relates to real estate, one is
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Tax Values used for property taxation
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There are many types of value as it relates to real estate, one is
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Insurance Values for homeowner's policies
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There are many types of value as it relates to real estate, one is
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value in Use. Value in Use is the history of income for a commercial property
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There are many types of value as it relates to real estate, one is
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liquidation value. Liquidation value is the value of the property if it required a fast sale
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There are many types of value as it relates to real estate, one is
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investment value is the importance to an investor
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The most important value for a real estate professional is
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Market Value
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Market Value is the definition used in all loans using federal money, for example,
answer
for any loans sold on the secondary market to Fannie Mae, Freddie Mac or Ginnie Mae
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Market Value is
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the most probable price 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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One assumption of Market Value is that
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the seller can provide a marketable title
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One assumption of Market Value is that
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both buyer and seller are well informed and not related to each other
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One assumption of Market Value is that
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neither buyer or seller are under duress, menace, or undue influence
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One assumption of Market Value is that
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market value refers to a specific date
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One assumption of Market Value is that
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the property is on the open market and exposed for a reasonable time
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One assumption of Market Value is that
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the terms are cash or its equivalent
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One difference between value, price, and cost is that
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value is the amount brought in an open market under the above assumptions
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One difference between value, price, and cost is that
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price is the amount the buyer will actually pay, sometimes with unusual circumstances
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One difference between value, price and cost is that
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cost is how much cash it takes to build and improve property
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Demand means
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how much call is there for this property?
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Utility means
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how useful is the property in connection with the buyer's needs?
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Scarcity means
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how hard to find is the property, how much of this type of property in this price range is there?
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Transferability means
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Can the seller provide a marketable title? Is the property free of encumbrances unless clearly stated? Will a lender be willing to loan on the property?
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Situs is the Latin word for
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location. In real estate location Situs is everything!
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A real estate professional can remember the components of value by the term
answer
D U S T S
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Highest and Best Use is
answer
the possible use of a property that would produce the greatest net income and thereby develop the highest value
question
Example of Highest and Best Use
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An area of the municipality has developed into commercial office buildings. If there is a vacant piece of land or a single family home in the area one could assume that the highest and best use for this property at that time would be for an office building
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The appraiser must look at a property as if it were
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vacant and as it now sits as improved property
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Sometimes the best use of property is to
answer
destroy existing buildings and rebuild new ones
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Substitution is
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the maximum value of a property tends to be set by the cost of purchasing an equally desirable and valuable substitute property. (Comparison shopping basis for market data approach)
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The value of a property increases when
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the supply is limited and decreases when there is too much property available
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The value of a property increases when
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the supply is short, and decrease when there is little demand
question
Example of Law of Supply and Demand
answer
When a property is placed on the market in an area where few properties are sold from year to year, the property will usually sell quickly. Conversely, when there are many properties to choose from, the market for an individual property will be less. If a large employer in an area closes, the likely effect on the area's real estate values will reflect the principle of Supply and Demand
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Demand and supply are opposites
answer
the lower the supply, the higher the demand,
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Demand and supply are opposites
answer
the higher the supply, the lower the demand
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Conformity refers to
answer
an appraisal principle of value based on the concept that the more a property or its components are in harmony with the surrounding properties or components, the greater the value. (The more the properties are alike, the more they retain value.)
question
Example of Conformity
answer
A million dollar home in a neighborhood of one hundred thousand dollar homes will not usually return the investment. Conversely, a one hundred thousand dollar home in a neighborhood of million dollar homes may benefit because of the value of the million dollar homes
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Regression and progression occurs between dissimilar properties. This means
answer
the value of the better quality property is affected adversely by the presence of the lesser quality property and a lesser house will benefit from a larger house
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Anticipation refers to that a property can
answer
increase or decrease in value in expectation of something in the future such as appreciation or rezoning
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Example of Anticipation
answer
If a person discovers that an airport is going to be built in an area and buys the land in anticipation of a future value
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Contribution means
answer
the value of any component may or may not give value to the whole
question
Example of Contribution
answer
A fully remodeled kitchen or bathroom adds to the value of a property. If a kitchen or bathroom has not been remodeled, it would subtract from value. While a finished basement that is below grade is nice to have, the seller may not realize full cost of the improvement when he sells the home. Appraisers may not give full value to the improvement if it does not have a walkout from that level. These types of components either add or subtract from value. A swimming Pool may cost more than it will bring in property value is the combining of two or more adjoining lots into one larger tract to increase their total value
question
Example of Assemblage
answer
an investor wants to buy property in an area because he or she believes that it will have a future value. He or she purchases one building after another until all the property desired is "assembled". Individually the properties had a lower value, but once it is all "assembled" into one piece, it should be worth more money. "Plottage" value is the increased value resulting from the combining of adjacent lots into one larger lot
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Competition is when
answer
one business attracts another business of similar type; together they may make more money then they would have singularly. Shopping areas in large cities attract shoppers every day because they draw the consumer to the area. Too little shopping does not draw consumers; too much competition is ruinous
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Change refers to
answer
that real property is constantly changing by expanded, stabilizing, declining, or rebirth. A subdivision is built, ages, decays, and is reborn with renovation
question
Change refers to that real property is constantly changing by
answer
expanded, stabilizing, declining, or rebirth. Shopping areas lose appeal popularity; they revitalize and come back to life again. A subdivision is built, ages, decays, and is reborn with renovation. Housing expands, decays, renews, and expands again
question
One of the Three Approaches to Value is the
answer
Sales Comparison Approach (also called Market Data Approach)
question
The Sales Comparison Approach is also called the
answer
Market Data Approach
question
The Market Data Approach is also called the
answer
Sales Comparison Approach
question
The Sales Comparison Approach is used for
answer
appraising residential property or vacant land
question
The Sales Comparison Approach compares the subject property to similar properties and makes adjustments on the basis of
answer
the date of the sale, the location, the physical features, and or amenities
question
An appraiser is asked to appraise a residential property Example,
answer
The appraiser finds a property which has sold located in the same neighborhood, and wants to use it as a comparable sale. The comparable has more bedrooms than the subject, one less bath, and one less garage. The appraiser will have to subtract the extra bedrooms, from the comparable sold price, add a bathroom to the comparable sold price, and add a garage to the comparable sold price to make the properties equal
question
One comparable Memory Tool is
answer
SBA. If the subject property is better, add value to the comparable
question
One comparable Memory Tool is
answer
CBS. If the comparable property is better, subtract value from the comparable
question
A comparable has a fireplace and the subject property does not, subtract the fireplace (value) from the comparable. The subject property has a fireplace and the comparable does not, add the fireplace (value) to the comparable. Adding and subtracting is always done to the
answer
comparable sold price, never the subject property
question
Cost Approach is also called the
answer
Summation Approach
question
Summation Approach is also called the
answer
Cost Approach
question
The Cost Approach is used on buildings which do not have market data because they are unusual properties such as
answer
school, post office, library, or a building without income, etc.
question
Reproduction Cost refers to
answer
replacing with the same materials as original construction (much more expensive!)
question
Replacement Cost refers to
answer
replace with current materials and methods with utility and function similar to original
question
Example of Reproduction Cost
answer
An historical building would usually be restored using the original materials as much as possible
question
Example of Reproduction Cost
answer
If a modern house burned, it would be rebuilt using current materials and methods of construction
question
Cost can be determined by one of three methods which are
answer
Square Foot Cost, Unit In Place, and Quantity Survey Method
question
Square Foot Cost is done by
answer
using outside measurement, how many square feet times a cost for either replacement or reproduction
question
In the Unit in Place Method, the Replacement Cost of a structure is estimated based on the construction cost per unit of measure of individual building components, including material, labor, overhead and builder's profit. Most components are measured in
answer
square feet, although items such as plumbing fixtures are estimated by cost. The sum of the components is the cost of the new structure
question
Quantity Survey Method refers to
answer
the quantity and quality of all materials (such as lumber, brick, and plaster) and the labor are estimated on a unit cost basis. These factors are added to indirect costs (for example, building permit, survey, payroll, taxes and builders profit) to arrive at the total cost of the structure. Because of the detail and the time consumed, this method is usually used only in appraising historical properties. It is, however, the most accurate method of appraising new construction
question
Steps involved in the Cost Approach
answer
1. Estimate the value of the land alone as if vacant. 2. Determine either the replacement or Reproduction Cost of the building. 3. Deduct all accrued depreciation from the Replacement Cost. 4. Add the estimated land value to the depreciated replacement or Reproduction Cost
question
Depreciation is
answer
a loss in value due to any cause, any condition that adversely affects the value of an improvement. For appraisal purposes, depreciation is divided into 3 classes according to its cause. Physical Deterioration, Functional Obsolescence, and external obsolescence
question
One of three types of depreciation is
answer
Physical Deterioration
question
One of three types of depreciation is
answer
Functional Obsolescence
question
One of three types of depreciation is
answer
Economic Obsolescence
question
Physical Deterioration is a reduction in
answer
utility, usefulness or value resulting from physical condition. The deterioration can be divided into either curable (painting or outine maintenance) or incurable types (installing siding on a building which also needs major interior repairs). This form of depreciation is caused by the action of the physical elements, such as wind or snow, or just ordinary wear and tear
question
Functional Obsolescence is a
answer
loss of value of an improvement due to functional inadequacies, often caused by age or poor design. Outmoded plumbing fixtures, inadequate closet space, poor floor plan, excessively high or low ceilings, or antiquated architecture are all examples of Functional Obsolescence. Functional Obsolescence may be curable such as putting in a new electric stove instead of wood burning stove. Functional Obsolescence may be incurable, as in the case of wide columns in a building that cannot be removed
question
Economic, Environmental, or External Obsolescence is
answer
a loss of value (typically incurable) resulting from factors that exist outside of the property itself; a type of depreciation caused by environmental, social, or economic forces over which an owner has little or no control. This can also be called locational, economic or environmental obsolescence
question
The Economic, Environmental, or External Obsolescence type of obsolescence is
answer
almost always incurable
question
The Economic, Environmental, or External Obsolescence type of obsolescence is almost always
answer
incurable
question
A convenience store locating next to your home is
answer
external absolescence
question
Effective Age differs from the actual age (chronological age) by such variable factors as
answer
depreciation, quality of maintenance, and the like
question
Remodeling can extend the Economic Life of a structure by
answer
reducing or mitigating the impact of actual age and increasing the structures life expectancy
question
Example of Economic Life
answer
If a person maintains a building keeping it in good repair, the "Effective Age" is reduced
question
Chronological Age is the
answer
actual age in years of the building, based on building date
question
The "Chronological Age" of a building cannot be
answer
changed
question
If a building is 20 years old, the "Chronological Age" is
answer
20 years
question
Physical Life is the
answer
actual age or life of a structure that is considered habitable as opposed to Economic Life
question
Example of Physical Life
answer
A building sitting vacant without a tenant has a "Physical Life" but there is no Economic Life because there is no income
question
Economic Life is the
answer
estimated period where an improved property will yield a return over and above economic rent. In the case of an older structure, economic refers to the period during which the remaining improvements are depreciated for tax purposes
question
Economic Life is the period which
answer
an improvement has value in excess of its Salvage Value
question
Economic Life is also called Service Life or Useful Life
answer
Useful Life
question
Economic Rent is also called
answer
Market Rent
question
Economic Rent is
answer
the amount of rental income a property can generate in an open free market at any given time, compared to contract rent which is the rent agreed to by the parties
question
When a property has repairs or updating that is economically feasible, it said to be
answer
curable
question
When the cost is too high, or impossible to fix, or due to outside influences beyond the owner's control, it is said to be
answer
incurable
question
The Income Approach is used for income generating properties such as
answer
apartments, retail centers, multi-tenant office buildings, etc
question
Steps Involved in the Income Approach is
answer
a. Estimate annual potential gross income. b. Subtract an appropriate allowance for vacancy and collection losses to arrive at an effective gross income. c. Deduct operating expenses (These do NOT include debt service or mortgage payments). This is Net Operating Income (NOI)
question
In an Income Approach, if you are given the monthly income and no other information in a problem you must assume that
answer
it is the net income. The first step is to multiply by 12 to find the annual net income, and then finish the problem
question
One step involved in the Income Approach is to Estimate the price a typical investor would pay for the income produced by this particular class and type of property. This is accomplished by estimating the rate of return that an investor would demand for this investment. This rate of return is called the
answer
Capitalization (Cap) Rate. Cap rate can also be considered the risk factor in buying a property. The higher the risk (cap rate), the lower the sale price should be
question
Some appraisers use a technique called gross rent multiplier (for residential) and gross income multiplier (for commercial). At best, this system is an educated guess because it is very difficult to
answer
(a.) find matching properties (b.) find properties whose owners price the rent correctly
question
By performing the Gross Income Multiplier, the same technique is used for income producing properties such a
answer
convenience store, grocery store, etc. Great care must be used to accurately determine the gross income per year
question
When using the gross income multiplier, the gross annual income is used, instead of
answer
monthly income
question
Because of the variables such as location, owner differences, etc., The gross income multiplier is
answer
a highly speculative method of determining value and should only be used as a confirming method, not as a primary method
question
The Competitive Market Analysis is a tool used by real estate professionals to
answer
obtain a list price
question
The Competitive Market Analysis is not
answer
an appraisal and should not be advertised as such
question
To obtain a quality Competitive Market Analysis, certain facts must be obtained. These are
answer
comparable homes (hopefully, in the same subdivision!) with the same number of bedrooms, baths, garages, comparable homes should be close to same age, sold comparables data should not be more than one year old, sold comparables data should use the same type of loans and comparables currently on the market should not be distressed homes such as in disrepair, a desperate seller, etc
question
Example of Anticipation
answer
If a person has knowledge that a zoning change is about to take place which will make the property more valuable and buys the property in anticipation of a future value increase
question
Regression is when
answer
the value of a property influences. If it is surrounded by properties with lower values, its value will tend to fall
