1. Chapter 17

2. Georgia Real Estate An Introduction to the Profession Eighth Edition
Chapter 17
Real Estate Appraisal

3. Key Terms appraisal capitalize comparables cost approach depreciation
fictional depreciation
gross rent multiplier (GRM)
highest and best use
income approach
market approach
market value
operating expenses
principles of value
projected gross
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4. Overview
Market value is the most probable price that a property should bring in a competitive and open market under all conditions requisite to a fair sale. Market value is the most probable selling price in an arm's-length transaction.
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5. Overview An arm's-length transaction is when a buyer and seller are
typically motivated
both parties are well-informed
both are acting in their own best interest
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6. Overview a reasonable time is allow for exposure in the open market
payment is made in terms of cash or comparable to cash
the price represents the normal consideration for the property sold
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7. Purpose and Use of Appraisals
To appraise real estate means to estimate its value. A formal appraisal is an independently and impartially prepared estimate expressing an opinion of defined value of an adequately described property as of a specific date supported by the presentation and analysis of relevant market information.
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8. The Real Property Valuation Process
The valuation process is the step-by-step procedure that appraisers use to conduct their work.
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9. The Real Property Valuation Process
The valuation process involves the following steps:
define the appraisal problem
conduct a preliminary analysis
collect the data
estimate the highest and best use of land as if vacant, and the property as improved
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10. The Real Property Valuation Process
estimate land value
estimate the improved property value through the appropriate value approaches
reconcile the results to arrive at defined value estimate
report the conclusion of value
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11. Characteristics of Value
Characteristics of value are: Demand Utility Scarcity Transferability.
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12. Characteristics of Value
Demand is desire coupled with ability. Utility refers to the usefulness or function of the product or service.
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13. Characteristics of Value
Scarcity means there must be a short supply relative to demand for there to be great value. Transferability is value to anyone other than the person possessing it. Transferability refers to marketable title. If the title has a defect, it will lower the value of the property.
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14. Principles of Value
The principle of anticipation states that present value is influenced by the anticipation of future benefit. Investors buy property in anticipation of future income.
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15. Principles of Value
The principle of substitution states that the present value of a property is influenced by what a person would have to pay for a reasonably desirable substitute.
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16. Principles of Value
The principle of competition states that demand creates profits, profits create competition, and competition stabilizes prices.
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17. Principles of Value
The principle of change reminds us that real property uses are always in a state of change.
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18. Principles of Value
The principle of conformity holds that maximum value was realize when there is a reasonable degree of homogeneity in the neighborhood.
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19. Principles of Value
The highest and best use of a property is the use that will give the property it's greatest current value.
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20. Principles of Value
The principle of supply and demand refers to the ability of people to pay for land coupled with the relative scarcity of land.
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21. Principles of Value
On the demand side, you should consider population growth, personal income, and personal references. On the supply side, you must look at the available supply of land and its relative scarcity.
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22. Principles of Value
When the supply of land is limited and demand is great, the result is rising land prices. Where land is abundant and there are relatively few buyers, the result is falling land prices.
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23. Principles of Value
The principle of increasing returns states that a dollar spent adds a dollar to cost but more than a dollar to value. The principle of decreasing returns states that a dollar spent adds a dollar to cost but less than a dollar to value.
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24. Principles of Value
The principle of contribution states that the worth of an improvement is measured by what it adds in overall value regardless of the cost.
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25. Multiple Meanings of the Word Value
Assessed value is value given to a property by the county tax assessor. Estate tax value is the value that federal and state taxation authorities establish for a deceased person's property.
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26. Multiple Meanings of the Word Value
Insurance value is concerned with the cost of replacing damaged property. Loan value is the value set on a property for the purpose of making a loan.
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27. Plottage Value
When two or more adjoining parcels are combined into one large parcel, it is called assemblage.
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28. Plottage Value
If the assemblage causes an increase in value over the cost, the process is referred to as plottage. The increased value of the large parcel over and above the some of the smaller parcels is called plottage value.
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29. Rental Value
Rental value is the value of a property expressed in terms of the right to its use for a specific period of time.
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30. Replacement Value
Replacement value is value as measured by the current cost of building a structure of equivalent utility.
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31. Value
Before preparing an appraisal, make certain you know its purpose, and then state it the beginning of your report.
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32. Buyer’s and Seller’s Markets
When supply and demand are unbalanced because of excess supply, a buyer's market exists. When demand exceeds supply, it is a seller's market.
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33. Value Approaches
There are three approaches to making a value estimate. The first is to locate similar properties that have sold recently. This is the market approach, also called the market data approach or market comparison approach.
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34. Value Approaches
The second approach is to add together the cost of the individual components that make up the property being appraised. This is the cost approach.
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35. Value Approaches
Depreciation is estimated and subtracted from the cost to obtain the current depreciated cost of the building. The land value is then estimated and added to the depreciated building cost to arrive at the estimate of value.
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36. Value Approaches
The third approach is to consider only the amount of net income that the property can reasonably be expected to produce for the owner, plus or minus any anticipated price increase or decrease. This is the income approach.
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37. Market Comparison Approach
In a market comparison approach, the residence to be appraised is called the subject property.
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38. Comparables
After becoming familiar with the physical features and amenities of the subject property, the next step is to locate houses with similar physical features and amenities that have sold recently. These are known as comparables or “comps”.
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39. Comparables
The more similar they are to the subject property, the fewer and smaller the adjustments that must be made. It is best to use comparable sales no more than six months old.
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40. Number of Comparables
Three to five comparables usually provide enough basis for reliable comparison. Choose the sales that require the fewest adjustments.
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41. Number of Comparables
Listings and offers to buy should not be used in place of actual sales. They do not represent a meeting of minds between a buyer and a seller.
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42. Adjustment Process
We make adjustments to the sales price of each comparable to make it equivalent to the subject property today. ALWAYS adjust the comparable, NEVER the subject.
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43. Remember the abbreviations CIA and CBS
Adjustment Process
Remember the abbreviations CIA and CBS
Comp
Inferior
Add
Comp
Better
Subtract
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44. Terms and Conditions of Sale
As a rule, the more accommodating the terms of the sale to the buyer, the higher the sales price, and vice versa.
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45. Terms and Conditions of Sale
We are looking for the highest cash price the subject property may reasonably be expected to bring, given adequate exposure to the marketplace and a knowledgeable buyer and seller not under undue pressure.
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46. Correlation Process
Some comparables are more like the subject property than others. The correlation process gives the appraiser the opportunity to assign more weight to the more similar comparables and less to the others.
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47. Vacant Land Valuation
Subdivided lots zoned for commercial, industrial, or apartment buildings are usually appraised and sold on a square foot basis. Another method is to value on a front foot basis.
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48. Competitive Market Analysis
The competitive market analysis is also commonly known as a CMA.
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49. Competitive Market Analysis
This method is based on the principle that value can be estimated not only by looking at similar homes that have sold recently but also by taking into account homes presently on the market plus homes that were listed for sale but did not sell.
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50. Competitive Market Analysis
The CMA is a listing tool that a sales agent prepares in order to show a seller what the home is likely to sell for. The CMA helps the agent decide whether or not to except the listing.
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51. Homes for Sale
The CMA will show similar homes currently offered for sale. These are homes the seller's property will compete against in the marketplace.
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52. Buyer Appeal
Factors that make a property more appealing to a buyer include good location, extra features, small down payment, low interest, meticulous maintenance, and a price below market.
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53. Buyer Appeal
A property is more salable if the sellers are motivated to sell, want to sell soon, will help with financing, and will list at or below market.
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54. Buyer Appeal
In addition to single-family houses the CMA can also be used on condominiums, cooperative apartments, townhouses, and vacant lots, provided sufficient comparables are available.
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55. Gross Rent Multipliers
When a property produces income, a popular market comparison method is the gross rent multiplier or GRM. The GRM relates the gross rent a property can produce to its purchase price.
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56. Gross Rent Multipliers
GRM is computed by dividing the sales price of the property by its gross annual rent. If you do work a GRM for a house, it is customary to use the monthly, not yearly, rent.
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57. Gross Rent Multipliers
The GRM method is simple to apply. GRM takes into account only the gross rental property produces. Gross rent does not allow for variations in vacancies, uncollectible rents, property taxes, maintenance, management, insurance, utilities, or reserves for replacements.
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58. Gross Rent Multipliers
The GRM also overlooks the expected economic lifespan of a property.
Sales Price
Gross Rent
= GRM
$700,000
$100,000
= 7 GRM
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59. Calculating a GRM Gross Annual Rents Building Sales Price Gross Rent
Multiplier
No.1
$245,000
$34,900
= 7.02
No.2
$160,000
$22,988
= 6.96
No.3
$204,000
$29,352
= 6.95
No.4
$196,000
$27,762
= 7.06
As a Group:
$805,000
$115,002
= 7.00
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60. Cost Approach
The market approach is of limited usefulness in valuing a fire station, school building, courthouse, or highway bridge. These properties are rarely placed on the market, and comparables are rarely found. The cost approach would be the most appropriate valuation tool for those situations.
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61. Cost Approach Step 1: Estimate land as vacant $ 30,000
Step 2: Estimate new construction cost of similar building $120,000
Step 3: Less estimated depreciation ,000
Step 4: Indicated value of building $108,000
Step 5: Appraised property value $138, by the cost approach
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62. Estimating New Construction Costs
Reproduction cost is the cost at today's prices of constructing an exact replica of the subject improvements using the same or very similar materials.
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63. Estimating New Construction Costs
Replacement cost is the cost, at today's prices and using today's methods of construction, for an improvement having the same or equivalent usefulness as the subject property. Replacement cost is the more practical choice.
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64. Square-Foot Method
The most widely used approach for estimated construction cost is the square-foot method. It is based on finding a newly constructed building that is similar to the subject building in size, design, materials and construction. The cost of this building is converted to cost per square foot.
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65. Square-Foot Method
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66. Quantity Survey Method
The most accurate but also the most time-consuming and difficult method to estimate construction cost is the quantity survey method. This estimates the cost of the building brick by brick, board by board.
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67. Unit in Place
The unit in place method takes into consideration the cost of the unit of construction inclusive of labor and materials and then estimates how many units would be needed.
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68. Physical Depreciation
Physical deterioration results from wear and tear through use. Actions of nature in the form of sun, rain, heat, cold, and wind. Physical deterioration can also result from neglect.
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69. Functional Obsolescence
Functional obsolescence results from outmoded equipment, faulty or outdated design, inadequate structural facilities and over-adequate structural facilities.
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70. Curable Depreciation
Curable depreciation is when the benefit to cure equals or exceeds the cost to cure.
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71. Incurable Depreciation
Incurable depreciation occurs when the cost to cure exceeds the economic benefit.
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72. Economic Obsolescence
Economic obsolescence is also known as external obsolescence. It is the loss of value due to external forces or events. Economic obsolescence is always considered to be incurable.
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73. Economic Obsolescence
The chronological age of the building is important to value. What is more important is the remaining economic life of the building and whether it is functionally adequate for use in the future.
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74. Computing Depreciation
The most common method of computing depreciation is the straight-line method. Actual age is the age of the property measured in years. Effective age is the age the building appears to be. It may appear older or newer.
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75. Computing Depreciation
Physical life is the number of years a building will be physically sound. Economic life is how long the building can continue to be productive. Economic life is always shorter than physical life.
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76. Computing Depreciation
To compute straight-line depreciation, the cost of the building is divided by the economic life. The resulting depreciation per year is multiplied by the effective age.
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77. Computing Depreciation
Building Cost
Economic Life
= Depreciation per Year
Depreciation per Year X Effective Age = Accrued Depreciation
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78. Depreciation Example
2,000 sq. ft bldg. x $68 per sq. ft. = $136,000 Cost New
X 10 Year Effective Age
$136,000 Cost New
60-Year Economic Life
= $22,66.67 Depreciation per yr
$2, Depreciation per year
$22, rounded to $22,700.00
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79. Final Steps in the Cost Approach
Current Construction Costs
Minus Depreciation
Plus Land
Equals total value of property
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80. Income Approach
The income approach considers the monetary returns a property can be expected to produce and converts that into a value the property should sell for if placed on the market today. To capitalize means to convert future income to current value.
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81. Income Approach = Value Rate $18,000 = $200,000 0.09 Income
= $200,000
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82. Income and Expense Forecasting
The best starting point is to look at the actual record of income and expenses for the subject property over the past 3 to 5 years.
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83. Income and Expense Forecasting
This is the projected gross, or scheduled gross, and represents expected rentals from the subject property on a fully occupied basis. Vacancy and collection losses are subtracted from this.
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84. Operating Expenses
The next step is to itemize anticipated operating expenses. We must consider both the properties past operating expenses and what we expect those expenses to be in the future.
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85. Operating Expenses
Improvements are not classified as expenses because they increase the usefulness of the property, which increases the rent the property will generate and therefore the properties value.
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86. Operating Statement Scheduled Gross Annual Income $84,000
Vacancy Allowance and Collection Losses ,200
Effective Gross Income $79,800
Operating Expenses
Property Taxes $ 9,600
Hazard and liability insurance ,240
Property management ,040
Janitorial services ,500
Gardener ,200
Utilities ,940
Trash pickup
Repairs and maintenance ,000
Other ,330
Reserves for replacement
Furniture & furnishings ,200
Stoves & refrigerators
Furnace &/or air conditioning
Plumbing & electrical
Roof
Exterior painting
Total Operating Expenses ,400
Net Operating Income $45,400
Operating Expense Ratio: $34,400 / $79,800 = 43.1%
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87. Operating Expense Ratio
Operating Expenses
Effective Gross Income
= Operating Expense Ratio
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88. Reserves
Reserves for replacement are established for items that do not require an expenditure of cash each year. Reserves are established for other items that must be replaced or repaired more than once during the life of the building, but not yearly.
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89. Net Operating Income
The operating expense total is then subtracted from the effective gross income. The balance that remains is the net operating income (NOI).
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90. Operating Expense Ratio
The operating expense ratio can be calculated by dividing the total operating expenses by the effective gross income.
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91. Capitalizing Income
The final step in the income approach is to capitalize the net operating income. What price should an investor offer to pay for a property that produces a given that income per year?
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92. Capitalizing Income
The solution is income divided by rate equals value.
Income
Overall Rate
= Value
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93. Depreciation
Fictional depreciation is what the US treasury allows property owners to deduct as an expense when calculating income taxes.
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94. Depreciation
The Internal Revenue Service allows a purchaser of an apartment building to completely depreciate the structure over a period of 27 1/2 years regardless of the age and condition of the structure.
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95. Choice of Approaches
When appraising a property that is bought for investment purposes, the income approach is the primary method of valuation. The cost approach can be used to determine whether it would be cheaper to buy land and build rather than to buy an existing building.
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96. Reconciliation Final Indicated Value $183,000
Market Approach $180,000 x 75% = $135,000
Cost Approach $200,000 x 20% = $ 40,000
Income Approach $160,000 x 5% = $ 8,000
Final Indicated Value $183,000
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97. Appraiser’s Best Estimate
The appraised value is the appraiser's best estimate of the subject property's worth. An appraisal is made as of a specific date. It is not a certificate of value, good forever until use.
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98. Appraiser’s Best Estimate
An appraisal does not guarantee that the property will sell for the appraised market value. The buyer and the seller determine the actual selling price.
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99. Formats of Appraisal Reports
There are three traditional formats to written reports.
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100. The Letter Report
The least formal report is the letter report. It contains the conditions of the assignment, a summary of the nature and scope of the appraiser's investigation, and an opinion of value.
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101. The Form Report
The form report is an appraisal made on a preprinted form. This is the most common type of report used for real estate loan appraisals.
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102. The Narrative Report
The narrative appraisal is the longest and most formal of the appraisal reports.
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