Purpose And Use Of Appraisal

Chapter 18Real EstateAppraisal 2010 by Cengage LearningPurpose and Use of Appraisal Appraisal: Informal appraisal:Formal appraisal: Set prices, to base loanvalues, set insurancepremiums, set taxvaluesEstimate of valueWritten statement of animpartial opinion ofvalue based on analysisof relevant marketinformation 2010 by Cengage Learning2Defining Value Fair Market Value (or just Market Value): the cash price that a willing buyer will pay to awilling seller given reasonable exposure of theproperty to the marketplace each with fullinformation as to the potential uses of the propertyand neither under undue compulsion or hardship toact, no impediments as to title or terms.Nebraska common law definition: the price that someone ready to sell, but notrequired to do so, would be willing to accept inpayment for the property, and that someone readyto buy, but not required to do so, would be willingto pay for the property. 2010 by Cengage Learning3

Defining Value (b) Details of FMV:1) marketable title,2) elapsed time to close,3) motivation,4) informed sale/purchase,5) exposure to market,6) market terms,7) normal consideration (no specialfinancing). 2010 by Cengage LearningValuation Process Step by step procedure refined by the UniformStandards of Professional Appraisal Practice (USPAP) Define problem Conduct preliminary analysis/collect data Estimate highest and best use Estimate land value Estimate improved property value Reconcile results Report conclusion 2010 by Cengage Learning5Value Approaches Market Comparison Cost Income Comparable propertiesrecently soldAcquisition of land,build improvementsBased on monetaryreturn a property cangenerate 2010 by Cengage Learning6

Market Comparison Approach Comps (usually 3 to 5)Sales records, where to findAdjustments Market differences and time on marketDifferences of amenities, physical features, termsAdjusted market price (of each property)Correlation process (assign weight to moresimilar property) 2010 by Cengage Learning7Market Comparison Sample 2010 by Cengage LearningCost Approach (1) Determine cost of land Land is valued as vacantBased on comparablemarket information 2010 by Cengage Learning9

Cost Approach (2) Determine cost ofbuildingReproduction costExact replicaSame or similar materials Replacement costToday’Today’s prices andmethodsEquivalent usefulnessEliminates obsoletefeatures Square Foot MethodCost Handbook 2010 by Cengage Learning10Cost Approach (3) Physical Deterioration Estimate depreciation Functional obsolescence Wear and tearActs of natureOutmoded/outdatedEconomic obsolescence External forcesAppreciationNote: Depreciation may be expressed in other terms, “deterioration”, “obsolescence”are two of many that may appear in tests and other texts. 2010 by Cengage LearningDepreciation11(cont)A Loss in Value Actual Depreciation Physical deterioration (curable & incurable) Functional obsolescence (curable & incurable) External or economic obsolescence (incurable only) Fictional Depreciation IRS tax deduction 2010 by Cengage Learning.

Cost Approach (4) Compute value ofimprovementsCompute value ofpropertyCost of buildingLess: depreciationPlus: appreciationValue of improvementsAdd: value of LandValue of Property 2010 by Cengage LearningCost Approach (review)Step 1: Estimate land as vacant 30,000Step 2: Estimate new constructioncost of similar building 120,000Step 3: Less estimated depreciation -12,000Step 4: Indicated value of building 108,000Step 5: Appraised property valueby the cost approach 138,000 2010 by Cengage LearningCost ApproachSquare-foot Method 2010 by Cengage Learning13

Income Approach FormulaVariations Income RateIncome ValueRate Value Value Rate Income 2010 by Cengage LearningIncome Approach (1)I R V Capitalization RateIncome ( 18,000)Divided byRate ( 9%)EqualsValue ( 200,000) 2010 by Cengage Learning17Income Approach (2)I R V Projected IncomeProjected or scheduledgross income Obtained from review ofRent rolls based on fulloccupancyDeduct: vacancy andcollection loss 2010 by Cengage Learning18

Income Approach (3)I R V Operating Expenses Replacement Reserves Perform math forConsider past expensehistoryConsider futureexpensesDo not add capitalimprovements (newamenities)Estimate annual amountto replace certain itemsNet Operating Income(NOI) 2010 by Cengage Learning19Income Approach (4)I R V Capitalizing IncomeDepreciationPerform I/R VcomputationsConsider mortgageexpenseConsider effect ofdepreciation andfictional depreciation(tax writewrite-off) 2010 by Cengage LearningIncome ApproachNOIOperating expense ratio: 31,070 / 79,800 38.9% 2010 by Cengage Learning20

Choice of ApproachesMarket ApproachWill produce values best for residentialpropertyIdeal when number of comparable propertiessoldNew construction may not be represented bycomps 2010 by Cengage Learning22Choice of ApproachesCost Approach Used to value property without comps Used to value property without income streams Used to value property recently constructed or with“nonnon-standard”standard” construction 2010 by Cengage Learning23Choice of ApproachesIncome Approach Properties used for investment purposesApartment buildings, shopping centers, officebuildingsMay be price per unit (apartment) or price persquare footMay also determine if cheaper to build than buy 2010 by Cengage Learning24

Reconciliation and EstimateApply weight to each method as best fits theperceived market or the projectAdd the weighted valuesArrive at Best Estimate or Opinion of ValueNOTE: An appraisal does not take into consideration the seller’seller’s circumstances, or other subjective motivation. Noguarantee of sale at appraised value nor guarantee ofcondition of property or future value. Not a loan guarantee(though may establish loan to value ratio), nor an Offer topurchase. 2010 by Cengage LearningReconciliationMarket ApproachCost ApproachIncome Approach(example) 180,000 x 75% 135,000 200,000 x 20% 40,000 160,000 x 5% 8,000Final Indicated Value 183,000 2010 by Cengage LearningTypes of Appraisals and ReportingOptions Under USPAP Types of Appraisals Complete appraisal Limited appraisal Reporting Options Self-contained appraisal report Summary report Restrictive report 2010 by Cengage Learning25

Formats of Appraisal Reports1. Letter report2. Form report3. Narrative report4. Review appraisals5. Real estate analysis 2010 by Cengage LearningAppraiser License Certified General AppraiserCertified Residential AppraiserState licensed appraiserProvisional licensed real estate appraiserAppraiser trainee 2010 by Cengage LearningCompetitive Market Analysis Competitive Market Analysis (CMA) Not an appraisal methodAgents use to list and sell residential propertyIn Nebraska agents may charge for serviceSelect comparable homes Recent SalesOn market,market, and Off market (note: these would not beincluded in formal appraisal) Buyer AppealNo objective adjustments only subjective 2010 by Cengage Learning30

Competitive Market Analysis Worksheet 2010 by Cengage LearningCompetitive Market AnalysisGross Rent Multiplier Used like CMA for income producing propertyDivide Sales Price by Gross Rent ofcomparables equals GRMMultiply Gross Rent by GRM to arrive atmarket price of subject propertyGRM does not consider vacancies, expenses,and other expenses 2010 by Cengage LearningGross Rent Multiplier(continued)Gross RentMultiplier 245,000GrossAnnualRents 34,900No.2 160,000 22,988 6.96No.3 204,000 29,352 6.95No.4 196,000 27,762 7.06As a Group: 805,000 115,002 7.00BuildingSales PriceNo.1 7.02 2010 by Cengage Learning32

Principles of Valuez Principle of Anticipationz Principle of Substitutionz Highest and best use of a propertyz Principle of competitionz Principle of supply and demandz Principle of changez Principle of contributionz Principle of conformity 2010 by Cengage LearningPrinciples of Value Anticipation Substitution Highest and bestuseSupply and DemandDiminishing returnsand Contribution Price affected by expectedfuture benefitsMaximum price is cost ofsimilar propertyThe use that gives the greatestvalue (competition).Consideration of immediatefuture uses.Large supply lower price, lowdemand, lower priceTry to invest at 1 for 1value 2010 by Cengage Learning35Characteristics of ValueDUST Demand Utility Scarcity Transferability Need or desire forgood/serviceAbility of good/serviceto fill needGood/service must be inshort supplyGood/service must beavailable to market 2010 by Cengage Learning36

What is “Value” Market valueAssessed valueInsurance valueLoan valueEstate tax valuePlottage valueRental valueReplacement value 2010 by Cengage LearningEconomic Markets Buyer’s market – excess supply of housing forsale.Seller’s market – demand exceeds supply. 2010 by Cengage LearningProfessional Societies The American Institute of Real EstateAppraisers (AIREA) MAI SRA Society of Real Estate AppraisersNATIONAL Association of IndependentFee AppraisersFarm Managers and Rural AppraisersNational Society of Real Estate AppraisersAmerican Society of Appraisers 2010 by Cengage Learning

Key TermszzzzzzzAppraisalCapitalizeComparablesCost approachDepreciationFIRREAGross rent multiplierzzzzzzzHighest and best useIncome approachMarket approachMarket valueOperating expensesScheduled gross,Projected grossUSPAP 2010 by Cengage Learning

The American Institute of Real Estate Appraisers (AIREA) MAI SRA Society of Real Estate Appraisers NATIONAL Association of Independent Fee Appraisers Farm Managers and Rural Appraisers National Society of Real Estate Appraisers American Society of Appraisers Professional Societies