Chapter 21 Appraising Real Estate

  1. Appraising
    • Appraisal is an estimate or opinion of value based on supportable evidence.
    • Appraisal Report--is an opinion of market value in a property given to a lender or client with detailed and accurate information
    • Appraiser--an independent professional trained to provide an unbiased estimate of value in an impartial or objective manner, according to the appraisal process.
    • A prfessional service perfomed for a fee.
  2. Regulation of Appraisal Activites
    • Title XI of the Financial Institutions Reform, Revocery and ENforcement Act of 1989, (FIRREA) requires that apprisers be licensed or certified according to the individual state law.
    • Appraisers are also expected to follow the Uniform Standards of Professional Appraisal Practice. (USPAP) established by the foundation's Appraisal Standards Board
    • COntinuing Education is required
    • In PA--Three Classes of certification:
    • State Certified Genral Real Estate Appraiser--permitted to appraise any residential or non residential property.  For federally related transactions, only a certified general appraiser may appraise commercial property valued over $1million
    • State Certified Residential Real Estate Appraiser--permitted to appraise only residential propery of one to four units, regardless of whether the transaction is federally or non federally related.  May only appriase properties over $250,000
    • Broker/Appraiser--permitted to appraise only properties valued under $250,000 that are not involved in federally related transaction.  After September 1998, any real estate broker who desires certification nyst meet the qualification  for a certified general or residential appraiser.
    • CPE--Certified PA Evaluator certificates are used to indivisuals who meet certain education requirements and pass an exam
  3. Competetive Market Analysis
    • Not an appraisal and must never be represented as one.
    • Real Estate Commission's rules narrowly define a CMA as a written analysis or opinion relating to the probable sales price of a specific property.
  4. Broker's Price Opinion BPO
    • Less expensive alternative of valuating property often used by lenders working with home equity lines, financing, portfolio,mangement, loss mitigation and collections
    • Fannie Mae and Freddie Mac provide forms that are used by real estate licensees who perform BPOs for a fee
    • BPO cannot be used if the matter involves a federally related transaction that requires an appraisal and/or the transaction occurs in a state tjat requires an appraisal's license such as PA
    • Anyone in PA that performs a BPO in PA must be cartified appraiser
    • Licensees may not perform a BPO.
  5. The Appraisal Process
    • Orderly set of procedures used to collect and analyze date to arrive at a reasonable market value conclusion.
    • Data is divided into tow basic classes:
    • General Data--covers nation, region, city and neighborhood .  Of particular importance is the neighborhood where the appraiser finds the physical, econimic, social and political influences that directly affect the value and potential of the subject property.
    • Specific Data--which covers the details of the subject property, as well as the comparative data relating to costs, sales, income and expenses of properties similar to and competitive with the subject property.
  6. The Appraisal Process, CONT
    • Once the approaches have been reconciled and an opinion of value has been reached, the appraiser prepared a report for the client.  The report should:
    • Identify the real estate and real property interest being appraised and state the purpose and intended use of the appraisal
    • 1.  State the problem
    • 2.  List the data needed and the sources
    • 3.  Gather, record, verify and analyze the neceessary data--general data, specific data, data for each approach
    • 4.  Determine the highest and best use.
    • 5.  Estimate the land valus...seperately from the parcel
    • 6.  Estimate value by each of the tree approached--sales comparrison, cost, income
    • 7.  Reconcile the estimated values for the final value estimate
    • 8.  Report the final value estimate
    • Plus--
    • 1.  Define the value to be estimated
    • 2.. State the effective date of the process of collection, confirming and reporting the data
    • 3.  List all assumptions and limiting conditions that affect the analysis, opinion and cnclusions of value
    • 4.  Describe the information considered, the appraisal procedures followed, and the reasoning that supports the report's conclusions(if an approach was excluded, the report should explain why)
    • 5.  Describe the appraisers opinion of the highest and best use of the real estate
    • 6.  Describe an additional information that may be appropriate to show compliance with the specific guidelines established in the Uniform Standards of the Professinal Appraisal Practice USPAP or to clearly identify and explain any departures from the guidelines and 
    • 7.  Include a signed certification, as required by the USPAP
  7. VALUE
    • To have value in the real estate market, a property must have the following characteristics:
    • DUST
    • 1.  Demand--the need or desire for possession or ownership backed by the financial means to satisfy the need
    • 2.  Utility--the capacity to satisfy human needs and desires
    • 3.. Scarcity---an infinate supply
    • 4.  Transferability--the realtive easee with which ownership rights are transferred from one person to another
  8. Market Value
    • The most probable price a property should bring in a fair sale.
    • Following conditions are essential to market value--
    • 1.  The most probable price is not the average or the highest price
    • 2.  The buyer and the seller are unrelated and acting without undue pressure
    • 3.  Both buyer and seller are well informed about the property's use and potential, including it's assets and defects.
    • 4.  Reasonable time must be allowed for exposure in the open market
    • 5.  Payment must be made in cash or it's equivialnt
    • 6.  THe price must represent a normal market price for property sold, unaffected by special by special financing amounts or terms, services, fees, costs, or credits incurred in the market transaction
  9. Market Value vs, Market Price
    • Market price is the actual selling price of the property
    • Cost may not equal either market value or market price.
    • Market value is an opinion of value based on an analysis of date
    • Market Price--is what the property actually sells for.
  10. Market Value vs. Cost
    Cost does not equal market value--a homeowner may install a swimming pool pool for $20K, the cost of the improvement may not add $20K to the value of the poroperty.
  11. Basic Principles of Value
    • 1.  Anticipation--value is created by the expectation of that certain benefits will be realized in the future.
    • 2.  Change--no physical or economic condition remains constant.  Real Estate business is subject to market demands, like any other business.
    • 3.. Competition--the interaction of supply and demand.  EX:  the success of a retail store may cause investors to open similar stores in the area.
    • 4.  Conformity--the maximum value is realized when a property is in harmony with it's surrounding and the use of land conforms when a property is in harmony with it's surrounding and the use of the land conforms to existing neighborhood standards.  SIngle family residential neighborhood, buildingsshould be similar in design, size and age.
    • 5.  Contribution--the value of any part of a property is measured by it's effect in the value of the whole parcel.  Installation of a swimming pool or a greenhouse may not add value, but remodeling an outdated kitchen or bathroom may.
    • 6.  Highest and Best Use--is the most profitable single use that is legal and feasible and will bring he most money over time.  Use must be:  legally permitted, economically or financially feasible. physically possible and the most profitable or maximally productive.  A parking lot in a busy downtown area does not maximize the productivity of the land to the extent that a building would.
  12. Increasing and Dimishing Returns
    • The addition of improvements to land and structures increases value only to the asset' maximum value.
    • Beyond that point, additional improvements no longer affect a property's value
    • As long as money spent on improvements produces an increase of  value, the law of increasing  returns applies.
    • At the point where additional improvements do not produce  a proportionate increase increase in value or income, the law or diminishing returns applies--no matter how much money is spent on the property, the property's value does not keep the pace with expenditures.  A remolded kitchen or bathroom or kitchen, might increase the value of a home.  Adding gold faucets or restaurant quality appliances would be an unrecoverable expense for the owner.
  13. Plottage
    • holds that merging or consolidating adjacent lots into a single larger one produces a greater total land value than the sum of two sites are valued seperately.  If two adjacent lots are valued at $35K each, their total consolidated value into one larger lot inder a single use might be $90K.  
    • The process of merging the two lots under one owner is ASSEMBLAGE.
    • PLOTTAE refers to the amount that the property value is increased by successful assemblage.
  14. Regression and Progession
    • Regression--the worth of a higher quality poperty is adversely affected by the presence of a lower quality property.
    • Progression--the value of a modest home would be higher if would be loacted among larger, fancier properties.
  15. Subsitution
    • Holds that the property's maximum value tend to be set by how much it would cost to purchase an equally desireable and valuble substitue property
    • IT is the foundatin of the sales comparison approach.
  16. Supply and Demand
    • The value of a property depends on the number of properties available in the marketplace--the supply of the product.
    • When supply increases, value decreases.  When demand increases, value increases.
    • Other factors include the prices of other properties, the number of prospective purchasers and the price buyers are willing to pay.
  17. The Three Approaches to Value
    • To arrive at an accurate estimate of value, appraiser traditionally use thre basic valuation techniques:
    • The sales comparison approach, the cost approach and the income approach.  The three methods serve as checks against each other.  Each methos addresses a specific type of property.  They are used on every property
  18. The Sales Comparison Approach, (The Market Data Approach)
    • Heavily weighted for residential and vacant land.
    • Comparing the subject propert, the property being appraised, with recently sold comparables.
    • Becasue no two parcels are completely alike, each comparable property must be analyed for differences and similarities between it and the subject property.  The approach is a good example of the principle od substitution.  The sales prices of the comparibles must be adjusted for any differences.  The elements for comparison afor which adjustments must be made are as follows:
    • Property Rights--adjustment must be made whn less than the fee simple legal bundle of rights are involved.  Includes land leases, ground rents, life estate, easements, deed restrictions and encroachments.
    • Financing Concessions--finacing terms must be considered, including adjustments for differences such as mortgage loan terms and owner financing or owner buy-downs by a builder-developer.
    • Market Conditions--interest rates, supply and demand, and other economic indicators must be analyzed
    • Conditions of Sale--adjustments must be made for motivational factors that would affect the sale, such as foreclosure, a sale between family members or some nonmentary incentive.
    • Market Conditions SInce the Date of Sale--An adjustment must be made if economic changes occur between the date of the sale of the comparable property and the date of the appraisal.
    • Location or Area Preference--Simialr properties might differ in price from neighborhood to neighborhood or even between locations within the same neighborhood.
    • Physical Features and Amenities--features such as building's age, size and condition may require adjustments.
  19. The Cost Approach--
    • Heavily weighted for new consturction and special properties with not a lot of comparisons, churches, etc.
    • Based on the principle of substitution
    • Consists of five steps--
    • 1.  Estiamte the value of the land as if it were vacant and available for it's highest and best use.
    • 2.  Estimate the current cost of constructing buildings and site improvements
    • 3.  Estimate the amount of accrued depreciation, loss in value, resulting from the physical deterioration, funtional obsolescence, and external dpreciation from the construction cost.
    • 4.  Add the estimated land value to the depreciated cost of the buildings and site improvements to arrive at the total property value.
    • 5.  Add the estimated land value to the depreciated cost of the buildings and site improvements to arrive at the total property value

    • Value of the Land = $50,000
    • Current cost of construction = $180,000
    • Accured deprecition = $20,000
    • $180,000-$20,00 = $160,000
    • $50,000+$160,000 = $210,000
    • In this example, the total property value is $210,000
  20. Reproduction and Replacement Cost New
    • Reproduction cost--the construction cost at current prices of an exact duplicate of the subject improvement, including both the benefits and the drawbacks of the property.
    • Replacement Cost New--the cost at current prices to construct an improvement similar to the subject property, but not necessarily an exact duplicate, using current construction materials and techniques.  More frequently used in appraising older structures because it eliminates obsolete features and takes advantage of current construction materials and techniques.
  21. Determining reproduction or replacement cost new
    • Appraiser using the cost approach computes the reproduction or replacement cost of building using one of the following methods:
    • Square foot method--the cost per square foot of a recently built comparable structure is multiplied by the numbter of square feet, using exterior dimensions, in the subject building. 
    • The most common and easiest method of cost estimation.
    • Also called the comparison method.
  22. Unit in Place Method
    • The cost of the structure is estimated based on the construction cost per unit of measure on individual building components, including material, labor, overhead and builders profit.  
    • Most componets are measured in square feet, although items such as plumbing fixtures are estimated by cost.
    • The sum of the components is the cost of the new structure.
  23. Quality Survey Method
    • Quality and quantity 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, (building permit, survey, payroll, taxes, builder's profit, etc), to arrive at the toatl cost of the structure.  
    • Because it is very detailed and time consuming, the quantity-survey method is ususally used only when appraising historic properties, however, it is the most accurate method of appraising new construction
  24. Index Method
    Factor representing the percentage increase to the present time of construction costs is applied to the origional cost of the subject property.  Because this method fails to take into avvount individual property vairables, it is useful only as check of the estimate reached by one of the other methods.
  25. Depreciation
    • A loss in value due to any cause.
    • Refers to a condition tjat adversely affects the value of an improvement to real property
    • LAND does not depreciate--it retains it's value indefinately, except in such rare cases as down-zoned urban parcels, improperly developed land or misuded farmland.
    • It is considered curable and incurable, depending on the contrubution of the expendature to the value of the property.
  26. Three Types of Depreciation
    • Physical Deterioration
    • FUnctional Obsolescence
    • External Depreciation
  27. Physical Deterioration
    Curable item--can be repaired, such as painting wall, is economically feasible and would result in an increase in value equal to or exceeding the cost.

    Incurable item--it's correction is not economically feasible or would not contribute a comparable value to to the building, such as crack in the foundation.  The cost of the repair may not warrent the financial investment.
  28. Functional Obsolescense
    • Obsolescense means a loss in a value from the market's response to the item.
    • Outmoded or undesireable physical design features are curable.  Such features could be replaced or redesigned at a cost that would be offset by the anticipated increase in ultimate value.
    • Outmoded plumbing can easily be replaced.
    • An office building that cannot be air conditioned, suffers from incurable functional obsolence if the cost outweighs it's contribution to the value.
  29. External Depreciation
    • Depreciation is always incurable if caused by negative factors not on the subject property, such as environmental, social, or economic forces.
    • Close proximity to a poluting factory or a deteriorating neighborhood are factors that could not be cured by the owner of the subject propery.

    Can be evaluated only by considering the actions of buyers in the marketplace.
  30. Straight-line Method or the Economic Age-Life Method
    • Easiest, but least precise way to determine depreciation.
    • Depreciation is assumed to occur at an even rate over a structure's economic life.--the period during which it is expected to remain useful for it's origional intended purpose.
    • The properties cost is divided by the number of years of it's expected economic life to derive the amount of annual depreciation.

    EX:  $420,000 property may have a land value of $240,000 and an improvement vaule of $180,000.  IF the improvements are expected to last 60 years, the annual straight line depreciation would be $3000 ($180,000/60 years).  Such depreciation can be calculated as an annual dollar amount or as a percentage of the improvement's replacement cost.
  31. The Income Approach
    • Done on every property, even residential
    • Heavily weighted for income producing properties.
    • Based on the present value of the rights of the future income.  It assumes that the income derived from a property will, to a large extent, control the value of that property.
    • Used for valuation of income-producing properties such as apartment buildings, office buildings, shopping centers and the like.
  32. Five steps in estimating value using the income approach.
    • 1.  Estiamte annual potential and income
    • 2.  Deduct appropriate allowance for vacency and rent loss. and arrive at effective gross income.
    • 3.  Deduct the annual operating expenses, from effective gross income to arrive at the annual operating income.  Managment costs are always included even if the current owner manages the property.  Morgage payments are debt service and are not operating expenses.  Capital expenditures are not considered expenses. though an allowance can be calculated representing the annual usuage of each major capital item.
    • 4.  Estimate the price a typical investor would pay for the income produced by this particular type and property.  This is done by estimating the rate of return, or yield, than investor will demand  for the investment of capital in this type of building. This rate of return is called the capitalization rate or cap rate and is determined by comparing the relationship of net operting income to the sales prces of similar properties that have sold in the current market.            EX:  A comparable property that is producing an annual net operating income of $15,000 is sold for $187,500.  The cap rate is $15,000/187,500 or 8%.  it may be concluded that 8% is the rate that the appraiser should apply to the subject property if other comparable properties sold atprices that yielded substantially the same rate.
    • 5.  Apply the capitalization rate to the property's annual net operating income to arrive at the estimate of the property's value.

    • Income/rate=valueincome/value=rate valuexrate=income
    • Net operating income/Capitalization rate=value.

    Nite hthe inverse relationshio between the rate and calue.  As the rate goes down, the value estimate increases.
  33. Gross Rent or gross income multipliers
    • Gross Rent Muliplier GRM--one to four unit residential RENTAL property, the GRMis used.
    • Gross Income Multiplier, GIM--would be used for the appraisal value.
    • One to Four Residential Units--
    • Sales Price \ Monthly Gross Rent = Gross rent multiplier GRM
    • Five or more units and commercial--
    • Sales Price \ Annual Gross Income =  Gross Income Multiplier.

    Rental Income x GRM = Estimated Market Price
  34. Reconciliation
    • The art of analyzing and effectively weighing the findings from the three approaches.
    • An appraiser explains not only the appropriateness of each approach, but also the relative reliability of the date within each approach in lin with the type of value sought.
    • The appraiser should also explain how the data reflect the market functions.
    • The process does not take the average of the three estimates of value.  An average implies that the data and the logic applied in each of the approached are equally valid and reliable and should, therefore be given equal weight.  However, certain approaches are more valid and reliable with some kinds of properties than with other.
Card Set
Chapter 21 Appraising Real Estate
Chapter 21 Appraising Real Estate