Real Estate Principles and Practices Chapter 17 The Appraisal Process © 2010 by South-Western, Cengage Learning

Key Terms Ad valorem tax Appraisal Appraisal report Capitalization rate Cost approach Depreciation Economic obsolescence FIRREA Functional obsolescence Gross income multiplier (GIM) Gross rent multiplier (GRM) Highest and best use Income approach Market price

© 2010 by South-Western, Cengage Learning Key Terms Market value Physical depreciation Plottage Progression Quantity survey method Regression Replacement cost Reproduction cost Sales comparison approach Tax assessment Unit-in-place cost approach method Value

© 2010 by South-Western, Cengage Learning Overview Purpose of appraisals Steps in the appraisal process Reporting of value Title XI of the Financial Institutions Reform, Recovery and Enforcement Act 1989 New regulations

© 2010 by South-Western, Cengage Learning Appraisal Opinion of worth of a parcel of property Appraisal process 1. Define the problem 2. Collect the data Economic Neighborhood Property

© 2010 by South-Western, Cengage Learning Appraisal 3. Apply the 3 approaches Sales comparison Cost Income 4. Correlate data and analyze results 5. Prepare the report

© 2010 by South-Western, Cengage Learning The Purpose of an Appraisal: Defining Value Value: Value: present worth of future benefit 1. Market value: 1. Market value: most probable selling price for property: No abnormal pressure Exposed to the open market for a reasonable time Buyer is knowledgeable Market Price: a Market Price: actual sales price

© 2010 by South-Western, Cengage Learning The Purpose of an Appraisal: Defining Value 3. Insurance value: 3. Insurance value: coverage to replace the structure 4. Estate tax value 4. Estate tax value: value of the deceased’s estate 5. Lease interest: 5. Lease interest: long term lease with reappraisal clause to determine leasehold value 2. Loan value 2. Loan value: greatest reason for appraisals

© 2010 by South-Western, Cengage Learning The Purpose of an Appraisal: Defining Value Assessed value X mill levy 1 Mill = 1/10 of 1 cent 6. Tax assessment:ad valorem 6. Tax assessment: establishes ad valorem tax tax value $270,000 Appraised value.30 Percentage taxed $ 81,000 Assessed value.070 Mill levy $ 5,670 Annual taxes $2.00 per $100 = $270,000 X $2.00 = $5,400

© 2010 by South-Western, Cengage Learning The Purpose of an Appraisal: Defining Value 8. Financial statement: 8. Financial statement: net equity 9. Third Party Companies: 9. Third Party Companies: transferred employees 10. Liquidation: 10. Liquidation: forced sale 11. Divorce Cases: 11. Divorce Cases: distribution of assets 7. Eminent domain: 7. Eminent domain: fair market value before and after method Partial taking: before and after method Just compensation

© 2010 by South-Western, Cengage Learning Forces Affecting Value Governmental (political) actions Economic (financial) forces Physical or environmental forces Sociological forces Modify, create, or destroy value

© 2010 by South-Western, Cengage Learning Forces Affecting Value Property taxes and services Laws and regulations Federal control Policies affect inflation and interest rates Regional and local government

© 2010 by South-Western, Cengage Learning Forces Affecting Value Inflation: values increase Recession: values decrease Regional and local economic conditions More spendable money = prosperity Future economic predictions

© 2010 by South-Western, Cengage Learning Forces Affecting Value Elements outside the subject property Topography Climate Location within the community

© 2010 by South-Western, Cengage Learning Forces Affecting Value Population trends Attitudes of people in the community Cultural amenities Value is created by: Desire Utility Utility Scarcity Scarcity Effective Purchasing Power Effective Purchasing Power

© 2010 by South-Western, Cengage Learning Collecting the Data General data Region, city and neighborhood Property Site Square footage of house Condition and extra features Special assessments

© 2010 by South-Western, Cengage Learning Approaches to Value Compares subject property to recently sold similar properties Cost to rebuild plus land Converts future income to present value

© 2010 by South-Western, Cengage Learning Sales Comparison Approach Market data approach: subject is compared to recently sold property Minimum of 3 comparables Adjustments made for differences If no sales in the area – expand the search area Time adjustments Most common approach for residential property

© 2010 by South-Western, Cengage Learning Sales Comparison Approach MarketAgeLocation Lot size Quality of construction Porches, decks, and patios General condition Living area Number of bedrooms Baths Baths Basements Basements Garages Garages Air conditioning and Air conditioning and heating systems heating systems Fireplaces Fireplaces Extras Extras Adjustments

© 2010 by South-Western, Cengage Learning Cost Approach Square foot method: cost per sq ft of building a similar structure X # of sq ft. AKA: Replacement Cost or Summation Approach $90,000 to build 1500 sq ft $90,000 ÷ 1500 = $60 per sq ft Cost to build X # of square feet 1500 sq ft X $60 = $90,000

© 2010 by South-Western, Cengage Learning Cost Approach Cubic foot method: considers volume 3. Unit in place cost approach method: 3. Unit in place cost approach method: cost of component parts 4. Quantity survey method: 4. Quantity survey method: detailed breakdown including cost of all material plus labor and profit AKA: Replacement Cost or Summation Approach

© 2010 by South-Western, Cengage Learning Cost Approach Replacement cost: Replacement cost: similar design and style using current costs and materials Reproduction cost: Reproduction cost: cost of constructing an exact duplicate AKA: Replacement Cost or Summation Approach

© 2010 by South-Western, Cengage Learning Cost Approach Steps in cost approach 1. Estimate site value as vacant 2. Estimate cost to replace improvement 3. Deduct depreciation 4. Subtract depreciation from replacement cost 5. Add land value AKA: Replacement Cost or Summation Approach

© 2010 by South-Western, Cengage Learning Income Approach Income Approach: net income Income Approach: value determined by future net income Gross rent multiplier (GRM) (GMRM): Gross rent multiplier (GRM) (GMRM): 1 – 4 family residential properties Gross income multiplier (GIM): c Gross income multiplier (GIM): commercial or industrial properties

© 2010 by South-Western, Cengage Learning Income Approach Comps sales price ÷ gross monthly income 1. Comps: recently sold rented properties 2. Sales price ÷ gross monthly income = GRM Gross Rent Multiplier

© 2010 by South-Western, Cengage Learning Income Approach CompsDatePriceIncomeGRM $168,000$ , , , SubjectToday?900?

© 2010 by South-Western, Cengage Learning Income Approach 3. Greatest consideration to most similar comps 4. Multiply subject’s gross rent by the GRM Gross Rent Multiplier $ gross rent X GRM $171,000Subject’s value value

© 2010 by South-Western, Cengage Learning Income Approach Net income is used to determine present value PGI 1. Estimate Potential Gross Income (PGI) EG Effective Gross Income (EGI): PGI minus vacancy and rent loss NO I 2. EGI minus operating costs = Net Operating Income (NOI) Income-Producing Properties

© 2010 by South-Western, Cengage Learning Income Approach 3. Capitalization rate: Net income of comp ÷ sales price of comp 4. Apply formula: NOI ÷ cap rate = value Capitalizing: Capitalizing: converts future income to present value Income-Producing Properties Capitalization rate: return of and on capital invested

© 2010 by South-Western, Cengage Learning Income Approach What to pay for a property? Net income ÷ desired rate of return Income-Producing Properties Income Rate = Value $15,000 10% = $150,000

© 2010 by South-Western, Cengage Learning Income Approach Analyze rental history: quality & durability 1. Contract rent high and short duration? 2. Long-term, below market rent leases? 3. Responsibly managed and maintained? 4. Past rental history? 5. If a regional shopping mall: Income-Producing Properties National chain? Surrounding market? Household income? 6. Location?

© 2010 by South-Western, Cengage Learning The Appraisal Report Appraisal report: Appraisal report: Oral, letter, form, narrative Minimum requirements: Identification of property Purpose Date of valuation Data used Limiting conditions / assumptions Indication of value Appraiser’s certification Appraiser’s signature

© 2010 by South-Western, Cengage Learning The Appraisal Report Oral report: used when time is of the essence Letter report: letter form without pertinent information or data analysis Form report: check boxes and comments sections Required by Fannie Mae and Freddie Mac Narrative report: includes verification and substantiation of the value opinion

© 2010 by South-Western, Cengage Learning The Appraisal Report 1. title page 2. letter of transmittal 3. table of contents 4. summary of the facts 5. objectives of the report 6. identification of the property 7. definition of value 8. property rights appraised 9. city data 10. neighborhood data Outline of Narrative Report

© 2010 by South-Western, Cengage Learning The Appraisal Report 11. taxes, zoning, and utilities 12. site description and value 13. building description & land improvements 14. analysis & interpretation 15. approaches to value used 16. reconciliation 17. certification 18. conclusion of value 19. limiting conditions & contingencies 20. appraiser’s qualification Outline of Narrative Report

© 2010 by South-Western, Cengage Learning The Professional Appraiser Most specialized division of real estate business Disinterest 3 rd party who follows an orderly process in determining property value

© 2010 by South-Western, Cengage Learning The Uniform Standards of Professional Appraisal Practice 1. 2,000 hours experience hours education hours USPAP 4. Pass examination Requirements for State Certification

© 2010 by South-Western, Cengage Learning The Uniform Standards of Professional Appraisal Practice 1. appraise federally related commercial transactions in excess of $250, appraise residential properties in excess of $1 million 3. appraise complex residential properties in excess of $250, appraise residential properties in excess of 4 units 5. must pass examination State Certification required to:

© 2010 by South-Western, Cengage Learning The Uniform Standards of Professional Appraisal Practice 1. 1,000 hours of residential experience + 1,000 hours of commercial education hours course work hours USPAP 4. pass an examination General Certification Requirements: