© 2009 by South-Western, Cengage Learning SAMIRLANDER Chapter 15

Florida Real Estate: Principles, Practices and License Law Chapter 15 Valuation of Real Property © 2009 by South-Western, Cengage Learning

Key Terms Appraisal Assemblage Capitalization Comparables CMA Cost Curable Depreciation Effective gross income Federally related transaction GRM Highest and best use Incurable Market value or fair market value

© 2009 by South-Western, Cengage Learning Key Terms Over-improvement Plottage Principle of substitution Progression Reconciliation Regression Replacement cost Sales comparison approach Situs Subject property UAPAP Valuation

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Appraisal: Appraisal: formal estimate of value of real property Comparative market analysis (CMA): Comparative market analysis (CMA): pricing

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Chapter 475 Florida State Law Licensee may not call a CMA an appraisal unless licensed or certified as an appraiser

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Licensee may not appraise property if valued above $250,000 If assignment is accepted USPAP Violation of USPAP $5,000 fine License suspension License revocation

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Part 1: Part 1: Real estate brokers, sales associates, and schools Part 2: Part 2: Appraisers Part 3: Part 3: Commercial Real Estate Sales Commission Lien Act Part 4: Part 4: Commercial Real Estate Leasing Commission Lien Act

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Federally related transaction Financial institutions insured or regulated by the federal government USPAP Procedures that appraiser’s must follow Appraisal Standards Board AQB

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Three approaches to value 1. Sales (market) comparison approach 2. Cost (reproduction) approach 3. Income approachReconciliation Weighted factoring Most applicable Clearly defines the problem

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value 3 categories of appraisal licensing & designations Certified general Certified residential Registered trainee

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value If valuation is misjudged by licensee Disciplined by FREC Waste of time Valuation: impartial estimate or opinion of value

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Valuation required when real property is: Sold or exchanged Financed Condemned Taxed Insured Partitioned Subject in a divorce

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Value: present worth of right to current and future benefits of ownership Types of value Market Book Insurable Assessed Condemnation Salvage

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Market Value or Fair Market Value: Market Value or Fair Market Value: price accepted by an informed willing seller and paid by an informed willing buyer No undue pressure Reasonable time Arm’s length transaction

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Market price: actual amount paid Cost: Cost: production Depreciation: Depreciation: loss in value Functional obsolescence Physical deterioration Economic/external obsolescence

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Figure 15.1 Valuation determines a market value Valuation can determines assessed value Valuation results in an estimated value Selling price may be different from the value Listing price may be different from the value from the value

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Desire to own or use the property Accompanied by purchasing power

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Usefulness Real property uses Shelter Income Agricultural

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Limited in supply Must be accompanied by demand

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Must be able to transfer ownership Liens, judgments, clouds on title affect value

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value ImmovableIndestructibleNonhomogeneous

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value I mmovable Economic factors are localized Situs: area preference

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value I ndestructible Land always remains

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Nonhomogeneous No two parcel of land are alike

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Anticipation Substitution Highest and best use Competition Supply and demand Diminishing and increasing returns Conformity

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Future benefit Investor: future financial return on investment Homeowner: future enjoyment of shelter and financial gain

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Principle of substitution: Principle of substitution: maximum value is determined by the cost to replace it with similar pro perty Equal utility and desirability

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Principle of highest & best use: Principle of highest & best use: legal and feasible use that produces the greatest land value Two types of analysis: Site as vacant Site as improved

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Profit encourages competition

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Value is affected by Supply: availability of property Demand: desire and ability to acquire property

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Factors influencing demand Consumer income Preference and taste Population size and household composition Availability of mortgage credit

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Factors influencing supply Available land Available materials Available skilled labor Available construction loans and financing

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Buyer's market Seller’s market Market indicators # of sales Sale prices Building permits

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Over- improvement Additional upgrades do not add corresponding value

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Maximum value is attained when the property conforms to use and style of the neighborhood

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Assemblage versus plottage Regression versus progression

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Regression: Regression: value of higher priced properties is decreased if located among lower priced properties Progression: Progression: value of lower priced properties is raised if located among higher priced properties

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Define the problem Preliminary analysis Highest and best use analysis Estimate of land value Application of 3 approaches Reconciliation of value Final estimate

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Subject property: Subject property: property being appraised Compared to similar recently sold properties Principles of substitution Sales Comparison AKA: Sales Comparison Approach Approach

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Determine type of value Comparables (comps): Comparables (comps): similar recently sold properties

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Greatest value attributable to the land Consideration of other legal uses Two types Highest and best use as vacant Highest and best use as improved

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Compares land value to other previously sold properties 1. Transactional adjustments 2. Locational adjustments 3. Physical adjustments

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Arrive at value for subject property Prepare the report with the estimated value

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Figure 15.4

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Figure 15.4

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Special use or single purpose properties Reproduction cost: Reproduction cost: exact replica Replacement cost: Replacement cost: same function and utility

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Step 1: Step 1: Estimate reproduction cost new Step 2: Step 2: Subtract accrued depreciation 3 ways to estimate cost new

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Step 1: Step 1: Construction cost of similar building Step 2: Step 2: Convert to cost per square foot Step 3: Step 3: Multiply cost per square foot by # of square feet Note: cubic foot method

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Step 1: Step 1: Installed cost of each major unit Step 2: Step 2: Add costs of all units plus profit and overhead Step 3: Step 3: Total all costs

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Step 1: Step 1: Cost of each individual item plus labor Step 2: Step 2: Total all material costs Step 3: Step 3: Add builder’s profit Step 4: Step 4: Total all costs

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Quantity survey: total cost of all labor and materials Most accurate, used the least Square foot: size of building used to estimate cost Most common, least accurate Unit-in-place: total cost of all major elements Figure 15.5

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Physical Deterioration Wear and tear

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Functional Obsolescence Outdated features Small closets Low ceilings Not enough bathrooms Inadequate wiring Outdated design or architecture

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Functional Obsolescence Over-improvement Superadequacy

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Incurable: Incurable: not economically feasible Curable: Curable: economically feasible Physical and functional deprecation may be curable or incurable

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Economic (External) Obsolescence Factors outside the property Always incurable

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Changes in surrounding area Environmental impacts Changes in highways serving property Closing of major business

© 2009 by South-Western, Cengage Learning Principle of Pricing & Value Cost new per Square Foot Home = $100 per sq ft Garage = $40 per sq ft Depreciation Information Estimated life new = 50 years Land Value $90,000 Effective age = 10 years Figure 15.7

© 2009 by South-Western, Cengage Learning Principle of Pricing & Value Solution 30 ft 1,200 sq ft X 40 ft Figure 15.7 Home 1,200 sq ft X $100 per sq ft $120,000 replacement value 20 ft X 20 ft 400 sq ft X $40 per sq ft $ 16,000 replacement value Garage $120,000 replacement value of home $ 16,000 replacement value of garage $136,000 before depreciation

© 2009 by South-Western, Cengage Learning Principle of Pricing & Value DEPRECIATION 100% 50 years Figure % = 2% depreciation per year X 10 years = 20% + $90,000 land $ 198,800 replacement value $136,000 before depreciation - 27,500 depreciation X 20% depreciation $27,200 depreciation $136,000 before depreciation $108,800 present value of improvement

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Income producing property Office buildings Apartment buildings Rental properties Mixed-use properties Income is converted to value by capitalization

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Capitalization: Capitalization: process of converting future income into current value

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Annual income and expense operating statement

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value PGI: PGI: potential gross income V&C: V&C: vacancy and collection losses OI: OI: other income EGI: EGI: effective gross income

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Effective gross income: potential gross income minus vacancy and collection losses plus other income

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Fixed expenses Property taxes Property insurance Variable expenses Maintenance Repairs Payroll Garbage removal Reserves for replacement

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Net operating income: Net operating income: effective gross income minus operating expenses Capitalization rate Capitalization rate: rate of return on investment desired by an investor

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Cap rate determines: Seller - price to sell Buyer - price to buy Appraiser – value of property

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Example: 10% return on investment Annual net income: $42,000 $42, = $420,000

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value 15 unit apartment building Rent of $700 per unit 5% vacancy Operating expenses: Property taxes$9,450 Insurance$1,000 Management/Acct. $10,000 Repairs/other $12,000 Cap Rate 10% Figure 15.8

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Potential Gross Income Figure 15.8 $700 rent per unit X 15 units $105,000 per month X 12 months $126,000 annual PGI Solution

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Vacancy and collection losses Figure 15.8 X 5% $126,000 annual PGI Solution $6,300 total V & C losses

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Effective Gross Income Figure 15.8 $126,000 annual PGI Solution - 6,300 total V & C losses $119,700 EFG

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Total operating expenses Figure 15.8 $9,450 taxes Solution 1,000 insurance $32,450 operating expenses $10,000 management & acct. $12,000 repairs & others

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Estimate of value Figure 15.8 Solution $87,250 NOI 10% cap rate $872,500 Estimated Value $872,500 Estimated Value = $872,500 = $872,500

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value The higher the rate The lower the value The lower the rate The higher the value Figure 15.8 Solution

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value GRM: GRM: informal method of determining value of income producing property Step 1: Step 1: Identify comparables Step 2: Step 2: Divide price by income Step 3: Step 3: Average GRM’s Step 4: Step 4: Multiply subject rent by GRM

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value All approaches used to determine property's value Greatest weight to approach best suited to the property

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Determines a reasonable estimate of price Appraisals Determine value as security for a loan Existing loans have no impact on vlaue CMA Relates to price Considers available financing

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Determine fair market vlaue MLS Professional reporting service Company records Observation Homes on market

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Listing and selling prices Type of financing Days on market Public records Appraisers

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Brokerage firm’s records First hand look to determine best comps Competition

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Financing that makes it easier to buy raises price Adjusting price for financing All cash – lowest price Loan assumption Conventional loan FHA & VA Best possible terms – highest price

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Information on subject Information on comps Fill in worksheet Make adjustments Attach “weights” to adjusted prices Consider current and expired listings

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value When selecting comps: The more the better (3-5) The more similar the better The more recent the better Avoid properties with prices significantly above or below other comps

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Same info as subject plus: Listing price and terms Days on market Actual selling price and terms “as similar as possible” Enter basic information

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Always adjust the comp Never adjust the subject Example: Comp has a fireplace Subject does not Subtract the estimated value of the fireplace from the comp

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Example: Subject has a fireplace Comp does not Add the estimated value of the fireplace to the comp C I A

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Land Value + Replacement cost - Depreciation = Estimated price

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Step 1: Step 1: Estimate price of land as vacant Step 2: Step 2: Estimate replacement of improvements Step 3: Step 3: Add the cost of land and replacement cost Step 4: Step 4: Deduct depreciation

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Market data approach Information from builders in area

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Square foot method Most useful due to simplicity Unit-in-place method Quality survey method

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Square foot method Determine cost factors for each major element Determine actual square footage of each major element Multiply Step 1 by Step 2

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Determine Cost Factors Ask reputable builders for cost per square foot Estimate handbook

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Determine Cost Factors 1 st floor heated area - $50 per square foot 2 nd floor heated area - $25 per square foot Garage - $30 per sq ft Basement - $15 per sq ft

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Determine Actual Square Footage Measure outside dimensions 480 sq ft 2,432 sq ft + 1,440 sq ft 4,352 sq ft Garage 1 st floor heated area 2 nd floor heated area Total square footage

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Determine Replacement Cost Multiply square footage for each element by the cost per square foot Total = $172,000

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value $ 30,000 $172,000 Total Land value Replacement cost $202,000

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Physical Deterioration Wear and tear Functional Obsolescence Outdated features Economic Obsolescence External conditions

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Physical deterioration is most common Cost to repair Inspect and note needed repairs Determine cost of repair Total all repair costs

© 2009 by South-Western, Cengage Learning Principles of Pricing & Value Estimate all functional and external obsolescence Replacement cost + land $202,000 Minus depreciation- $ 16,000 $186,000 $186,000 estimated price