Florida Real Estate Principles, Practices & Law 39th Edition Unit 16: Real Estate Appraisal

Appraisal Regulation Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) The Appraisal Foundation Appraisal Qualifications Board (AQB) Appraisal Standards Board (ASB) State certified appraisers Certified residential appraiser Certified general appraiser

Federally Related Transaction Real estate-related financial (loan) transaction Sale, lease, exchange, financing, etc. Involves federal financial regulatory agency Requires services of an appraiser Must be written and conform to USPAP Also includes appraisals for Fannie Mae, Freddie Mac, FHA, and VA

Uniform Standards of Professional Appraisal Practice (USPAP) Set of guidelines for appraisal services Requires objective and impartial appraisals Establishes recordkeeping requirements Creates confidential appraiser-client relationship Unethical to accept compensation based on value

F.S. 475 and Appraisal Services Licensees may perform appraisals for compensation Appraisals must abide by USPAP Cannot perform appraisals for federally related transactions Cannot refer to themselves as certified appraiser CMAs and BPOs Do not have to comply with USPAP Are not appraisals

Concepts of Value Cost Price Value Expenditure to create an improvement (labor, materials, and land) Price Amount paid; the contract price Value Worth to many buyers and sellers at certain time

Types of Value Assessed value Insurance value Investment value Liquidation value Going-concern value Salvage value

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

Assumptions in Market Value Value applies to a specific date when title is transferred Buyer and seller are typically motivated Both parties are well informed or well advised, acting in their own best interests A reasonable time is allowed in the open market Payment is made in cash in U.S. dollars or in comparable financial arrangements Price is not affected by special financing or seller concessions

Characteristics of Value Demand Utility Scarcity Transferability

Principle of Substitution A prudent buyer or investor will pay no more for a property than the cost of acquiring, through purchase or construction, an equally desirable alternative property Sets upper limit of value

Highest and Best Use The most profitable use of a property, must be Legally permissible (zoning) Physically possible Financially feasible

Highest and Best Use As though vacant As improved Legal use of a site that would produce the greatest value Potential highest and best use of a site determines its value As improved How a site that has improvements on it can best be used Should improvements be demolished, renovated, or retained in present condition

More Principles of Value Increasing and decreasing returns Conformity Assemblage and plottage Progression and regression

Approaches to Estimating Real Property Value Appraisers use all three approaches to estimate value if sufficient data are available Sales comparison approach Cost depreciation approach Income approach

Relevance of Each Approach Sales comparison Vacant lots and single-family dwellings Income approach Income-producing properties Cost-depreciation New house and to cross-check other approaches Special-purpose properties

Sales Comparison Approach Value is estimated by reviewing recent sales of comparable properties (comps) similar to the subject property Sales must have occurred recently in the same market Comparable properties must be similar to the subject property Adjustments are made Transactional differences (changes in market conditions since the date of sale) Property differences (location, square footage, and so forth)

Adjustments for Property Differences Adjustments are made to each comparable property for differences between the comp and the subject CBS Comp Better = Subtract CIA Comp Inferior = Add

Adjustments for Transactional Differences Financing terms Appraiser adjusts each comparable for special financing terms like seller-paid points Conditions of sale Appraiser must research for abnormal pressure on the buyer or seller Market conditions Appraiser adjusts sale price of each comparable if market has changed since the comparable sold

Adjustments for Transactional Differences Square footage Appraiser adjusts sale price of each comparable based on whether the square footage is larger or smaller than the subject property Landscaping Appraiser adjusts sale price of each comparable based on the quality of landscaping

Reconciliation of the Comparables Each comp’s sale price is adjusted for differences between the comp compared with the subject Each comp is rated in terms of its similarity to subject property Rating is reflected in giving weight to each comparable The weighed comps determine the indicated value using the sales comparison approach

Cost-Depreciation Approach A knowledgeable purchaser will pay no more for a property than the cost of acquiring a similar site and constructing an acceptable substitute structure (principle of substitution) The maximum value can be measured by determining the cost to acquire an equivalent site and to reproduce a structure as if new, and subtract for depreciation

Cost-Depreciation Approach Formula Reproduction Cost of Structure − Accrued Depreciation = Depreciated Value of Structure + Estimated Value of Site = Indicated Value of Property

Step 1: Estimate Reproduction Cost Cost to duplicate a structure exactly Replacement cost Cost to build structure with same use and function but not exact copy Estimate cost using Comparative square-foot Comparative unit or unit comparison Cost estimation handbook Cost estimate based on current cost to construct a building of same size, design and quality

Step 2: Subtract Accrued Depreciation Accrued depreciation represents the loss in value between the subject and an exact new replica Land is not depreciated A defect is curable if it is cost-effective to correct

Types of Depreciation Physical deterioration Functional obsolescence Loss in value due to ordinary wear and tear Caused by use, lack of maintenance, exposure to elements Functional obsolescence Loss due to operational inadequacies, poor design, or changing tastes Overimprovement is also functional obsolescence External obsolescence Loss in value due to something outside of property lines

Age-Life Method Majority of appraisers take into account the observed condition of the subject property Based on a ratio of property’s effective age (age indicated by structure’s condition and utility) to its economic life (total years a structure is profitably useful)

Accrued Depreciation Formula Effective age ÷ Total economic life × Reproduction cost new = Accrued depreciation Alternative method Reproduction cost new ÷ Total economic life = Annual depreciation Annual depreciation × Effective age = Accrued depreciation

Steps 3 and 4: Cost-Depreciation Approach Estimate land value using sales comparison approach (include non-structural site improvements) Add land value to arrive at a final value

Income Approach Measures a flow of income projected into the future Market value is estimated based on the present worth of future income

Types of Income Potential gross income Effective gross income Annual income if fully rented, no collection loss Effective gross income PGI less vacancy and collection losses (plus non-rental income) Net operating income EGI less operating expenses

Operating Expenses Expenses that contribute to operation of property Fixed expenses Property taxes & hazard insurance Variable expenses Maintenance, utilities, supplies, etc. Reserve for replacements Allowance for future replacement of building components

Operating Expenses Not included in operating expenses Depreciation Costs of mortgage Personal expenses Income taxes Any expense that does not contribute to the operation of the property

Formulas Effective Gross Income (EGI) Net Operating Income (NOI) Potential Gross Income (PGI) – losses + other income = EGI Net Operating Income (NOI) Effective Gross Income (EGI) – operating expenses = NOI

IRV Formula I = Net Operating Income (NOI) R = Capitalization Rate V = Value (or sale price) Rate × Value = NOI NOI ÷ Value = Rate NOI ÷ Rate = Value

Reconciliation of Final Values The appraiser gives weight to each approaches value (usually a percentage) An appraiser who used all three approaches for a single-family house may give a higher percentage to the sales comparison approach than to the other two approaches because the actual sales of comps are a better indicator of the property’s value.

Gross Multipliers Gross rent multiplier (GRM) is the ratio between a property’s gross monthly rent and its selling price Gross income multiplier (GIM) uses annual income; includes income from rent and other sources

GRM Steps Estimate gross monthly rent for subject property Calculate a market-derived GRM by taking sale price of comparable properties and dividing by gross monthly rent, then calculate average market-area GRM Multiply gross monthly rent of subject by GRM to estimate value of subject property

Comparative Market Analysis (CMA) Licensees prepare CMAs to help buyers and sellers make informed decisions Not appraisal reports Based on properties Recently sold Currently on the market Recently expired listings