1. Chapter 7 Valuation Using the Sales Comparison and Cost Approaches
Real Estate
FIN 331
Fall 2013

2. Market Value, Investment Value, and Transaction Prices
Appraisals
An unbiased written estimate of the fair market value of a property
Appraiser’s final estimate of property value
Data upon which the estimate is based
Assumptions and calculations used to arrive at the particular estimate
Why Do We Have To Estimate Market Value?
To get an estimate of the probable selling price under current market conditions
Lenders require an estimate of market value to make a reasonable mortgage decision
Real estate markets are assumed to reflect near perfect competition; the implication is that transaction occur at or very near true (or intrinsic) values
Question: Are we all price takers?

3. Market Value, Investment Value, and Transaction Prices
The Appraisal Process: Uniform Standards of Professional Appraisal Practice (USPAP)
Identify the appraisal problem
Client & intended uses of appraisal
Date of valuation
Rights to be valued (fee simple, etc.)
Type of value to be estimated: market, insurance, or taxable value?
Important assumptions or conditions
Determine the required scope of work
Time & personal requirements
Outline of proposed appraisal report
Data & procedures used to complete required tasks

4. Market Value, Investment Value, and Transaction Prices
Perform data analysis
Market analysis: Effects of demand & supply
Highest & best use; use which is legally/physically/financially permissible
Highest & best use as though vacant: considers any possible use
Highest & best use as improved: must consider any cost of demolition
Determine value of land: Important to value separately from improvements
Apply 3 Approaches to Valuation
Sales comparison approach
Cost approach
Income approach

5. Market Value, Investment Value, and Transaction Prices
Reconcile indicated values from 3 approaches
Weight based on relative reliability of the three approaches
Report final value estimate
Report writing is an extremely important function
Must meet requirements of 1 of 3 reporting options
Self-contained report: full narrative description of process
Summary report: summary of conclusions, principal points of process
Restricted report: minimal discussion, limited to use by client

6. Sales Comparison Approach to Estimating Market Value
Basic Idea: Value of RE can be determined by analyzing the sale prices of similar properties
Why? In a competitive market, close substitutes should sell for similar prices
Major difficulty? How many truly close substitutes exist & how many of these have sold recently?
Selecting Comparable Sales
Must be properties that prospective buyers would consider substitutes
Should be arms-length transactions
Fairly negotiated prices that occurred under “normal” conditions
For example, not a distressed sale
Select to minimize required physical and locational adjustments

7. Sales Comparison Approach to Estimating Market Value
Data Sources
Public records (e.g., county property tax assessor)
Multiple listing service
Private vendors (title companies, others): CoStar for commercial properties
Adjustments to Comparable Sale Prices
Convert characteristics of each comparable to an approximation of subject
Sequence of adjustments
Transactional adjustments: nature of the deal (see list top of page 171)
Property adjustments: unique feature of property (ditto)
Recent price trends

8. Cost Approach to Estimating Market Value
Procedure
Estimated reproduction cost of improvements
− Estimated accrued depreciation
= Depreciated cost of building improvements
+ Estimated value of site
= Indicated value by the cost approach
The Major Assumption?: Cost of creating a property is related to its market value
Two concepts of cost:
Replacement cost: Cost to create something of equal utility (functionality)
Reproduction cost:
Cost of an exact physical replica
Complication in application?
Methods to estimate replacement cost
Quantity survey method
Cost per square foot or cubic foot
Unit in place

9. Cost Approach to Estimating Market Value
Sources replacement cost estimates
R.S. Means
Marshall and Swift
Consulting firms
Builders/contractors
Special Issue of Accrued Depreciation – Commercial Property
Difference between replacement cost & market value of improvements
Types of accrued depreciation that must be considered:
Physical deterioration: Loss in market value due to aging, decay & ordinary use
Functional obsolescence: Loss in value due to changes in tastes, preferences, technological innovations, or market standards
External (economic) obsolescence: loss of value due to neighborhood changes

10. Homework Assignment
Key terms: Accrued depreciation, Appraisal, Comparable properties, Market value, Property adjustments, Replacement cost, Reproduction cost, Restricted appraisal report, Transactional adjustments
Study questions: 2, 3, 4, 7, 8, 12