California Real Estate Principles, 10.1 Edition Chapter 10 Real Estate Appraisal

Chapter 10 Define appraisal and list the elements and forces that influence value. Distinguish between utility value and market value Define depreciation; outline the causes of depreciation; describe how to calculate depreciation Discuss the 3 approaches to value; outline the steps in each approach Define gross rent multiplier and cap rate

What is the purpose of the appraisal? Salvage value Insurance agent Realty company Tax assessor Bank Assessed value Market value Insured value Loan Value

APPRAISAL An estimate or opinion of value as of a specific date. The accuracy of an appraisal is determined by the Skill Experience Judgment of the appraiser

Licensing A person who meets minimum statutory requirements may be licensed or certified as an appraiser by the California Bureau of Real Estate Appraisers (BREA) by satisfying education (courses & hours), experience (hours) and testing criteria.

Appraisal License Requirements Licenses: Education Experience Trainee Appraiser Licensed Appraiser 150 hours 2,000 hours Certified Residential 200 hours 2,500 hours Appraiser Certified General 300 hours 3,000 hours Appraiser (1,500 must be non-residential Must have 15 hours of USPAP property) to obtain license & 7 hours to renew.

Value Value in Use Utility Value = Worth to an Owner Market Value = Value in Exchange “Highest price in terms of money for which a Property would sell in an open market, The seller not being obligated to sell, The buyer not being obligated to buy, Allowing for a reasonable length of time to effect the sale”

Value affected by Value Demand – desire to own Utility - usefulness 4 Elements: D U S T Demand – desire to own Utility - usefulness Scarcity – lack of abundance Transferability – can transfer ownership Subjective Value Emotional Value Historic Cost

P E P S Forces that change Value Political Forces Government: Zoning, Fiscal Policy, Taxes People: Environmental Protection, Education Economic Forces Consumer: Income, Employment, Credit, Interest Rates Physical Forces Natural: Land, Climate, Resources Man-Made: Buildings, Roads, Utilities Social Forces Area: Neighborhood, Living Standards People: Family Size, Lifestyle, Attitudes

PRINCIPLES OF VALUATION Highest and Best Use Change Balance Supply and Demand Contribution Substitution Progression – Regression Competition Conformity Anticipation

DEPRECIATION Physical Deterioration Worn out, run down, deferred maintenance, weathering Curable or Incurable Functional Obsolescence Out of date, poor floor plan, lack of modern appliances, out of style architecture Economic Obsolescence Neighborhood or Social Causes: Traffic, noise, flood zone, crime Incurable

DEPRECIATION: Functional Obsolescence Kitchen Family Dining Utility Living Bath Bedroom This 4-bedroom, 1 bath home with no access to the back yard from the family room and utility room far from the bedrooms where kitchen becomes a hallway is an example of functional obsolescence (a floor plan that does not fit today’s needs).

The Appraisal Process

Types of Appraisal Reports Form Report: Summary Report Narrative Report: Self-Contained Report

Cost Approach to Value Used primarily for: New construction Special purpose property Public buildings To replace/reproduce the improvements on the property. The upper limit to value. BEST used for unique properties with a limited market appeal

+ COST APPROACH Steps: Estimate the land value, as if it were vacant. Estimate the current replacement cost of the improvements Sq Foot x $ per sq foot = Current replacement cost Estimate and subtract depreciation of the improvements. Replacement cost Depreciation of Improvements Present Value of Improvements Add back the value of the land. + Present Value of Improvements Land Value Total Value

INCOME APPROACH Capitalization or Investment Approach Value based on income produced by the property Formula Gross Scheduled Income GSI Less Vacancy and Bad Debt - VAC Effective Gross Income EGI Less Operation Expenses - OE Net Operating Income NOI BEST for income producing properties Apartments, Retail, Office NOI = Value Cap Rate

Capitalization Rate I = R X V = V R I The higher the risk, The higher the capitalization rate. The higher the cap rate, the lower the value. $30,000 I 10% R = $300,000 5% R = $600,000

GROSS RENT MULTIPLIER Definition: A gross rent multiplier is a calculation of how many times the property’s rent goes into the price. It can be based on the monthly or annual rent.

GROSS RENT MULTIPLIER Comp. Sales Price Gross Monthly Rent Multiplier Comp. Monthly Rent (GMRM) Comp. Sales Price Gross Annual Rent Multiplier Comp. Annual Rent (GRM) THEN Gross Scheduled Income (GSI) x Gross Rent Multiplier (GRM) = Estimated Value ($) FAILS TO CONSIDER VACANCIES AND EXPENSES = = ©2011 Cengage Learning

Gross Rent Multiplier Example Sales Price $350,000 = 175 gross mo. Rent Mo. Rent $2,000 multiplier Sales Price $350,000 = 14.58 gross annual Annual Rent $24,000 multiplier ($2,000 X12mo.)

MARKET VALUE APPROACH The most probable price that real estate would bring in an arm’s length transaction, under normal market conditions, on the open market. BEST used for existing one-to-four unit residential property, vacant land and condominiums

Comparison Approach “If comparable homes sold for $XXX, then subject home should sell for $XXX” Select 3 to 5 comparable or similar properties with similar architectural style and character which have recently sold under reasonable market conditions in the same neighborhood Make adjustments for the different between the comps and subject property for amenities by adding or subtracting from their sales prices. - + - + - + - + 3. The result gives a value range for the subject property. From the value range, select the probably market value of the subject property.

MARKET DATA ANALYSIS Item Subject Property Comparables 1 2 3 Address Sales Price Data Source Date of Sale Location Site/View Design/Appeal Constr. Quality Age Condition # of Rooms # Bedrooms # Baths Liv. Area (sq ft) Garage/Carport Patio, pool, etc. 412 Acme Drive $335,000 Sales contract 9/1/00 Hi-qual suburb Inside lot Rambler/exc Good 7 yrs 8 4 2 ½ 2,700 2-car att 15 x 21 patio 131 Skip Rd $353,000 Present owner 6/29/00 Same Corner lot 6 yrs 7 3,300 15 x 26 patio 221 Sutter St $333,500 MLS 7/14/00 8 yrs 2,350 18 x 16 patio 168 Bow Rd $318,500 Selling broker 5/17/00 6 2,150 15 x 17 patio Additional Data 2 fireplaces Range, oven D/W disposal Central air D/W 1 fireplace Comments Subject has superior energy efficiency to comps 2 and 3 and is at least equal in this respect to comp 1. Principal difference between comps 1 and 2 is square footage.

Arm’s Length Transaction Neither party is under duress The property is on the market for a reasonable time. Both parties have full knowledge of the property’s assets and defects. No unusual circumstances exist. The price was not affected by special financing.

Chapter 10 Question Subject Comp #1 Comp #2 Value : ? Sale: $410,000 Sale: $350,000 Bedroom: 3 4 2 Bathroom: 2 3 1 Garage: 2 3 1 A bedroom in this area is valued at $15,000 A bathroom in this area is valued at $10,000 A garage in this area is valued at $5,000 What is the indicated value for Subject Property?

Chapter 10 Answer $410,000 $350,000 Comp # 1 Comp #2 $410,000 $350,000 - $15,000 + $10,000 -$10,000 + $15,000 - $ 5,000 +$ 5,000 $380,000 $380,000 The value for subject property is $380,000