Appraisal
estimate of value.
USPAP
clarifies the valuation process standards
Three approaches to estimating value
Market comparison approach (MCA)
Cost Approach
Income Approach
Fair Market Value
most probable cash selling price
Fair Market Value Assumptions
1. All parties had adequate time
2. Property has reasonable exposure time
3. No party is under duress
4. All parties act prudently and with self-interest
5. All parties are well informed
6. Prices do not reflect other considerations (e.g., special financing, seller concessions)
Real Estate Valuation: What is Investment Value
what a property is worth to the INVESTOR
Real Estate Valuation
1. Invest if one's investment value GREATER than fair market value.
2. Fair Market Value is a consensus opinion of investors' individual investment values
3. One with the highest investment value likely will be the highest bidder.
Price
amount agreed upon by two parties
Cost
historial figure whose relation to value diminishes over time
Value
generally defined as fair market value
Relationship between price, cost and value
A building cost $300,000 to construct five years ago, its FMV is $270,000 today, but its desperate owner will sell for price of $255,000 today
Insurance value
how much coverage the lender requires the owner to carry on the improvements
Appraised Value
value opinion of a qualified appraiser as to whether the sale price is fair, given current economic conditions
Salvage value
a "fire sale" value to sell an illiquid property immediately
Assessed value:
how much the tax assessor values the property for ad valorem tax purposes
Foreclosure value
sheriff's opening bid at a foreclosure sale
Condemnation value
amount the government will pay for property via eminent domain
Mortgage value
how much a lender will fund. (loan/value) * lesser of SP or appraised value
Book value
historical cost - cumulative depreciation
Depreciated value
Fair market value - cumulative depreciation
When will Book value = Depreciated Value?
when Historical cost = FMV
Leased Fee Value
residual value of a leased property to the owner
Leasehold Value
the value of a lease to a tenant
Four Appraisal Principles
1. Highest and Best Use (MCA, Income and Cost)
2. Substitution (MCA)
3. Anticipation (Income)
4. Contribution (Cost)
Highest and Best Use
(MCA, Income and Cost) - 1/4 appraisal principles
The use that generates the highest net return over the holding period, given current market conditions.
To determine HBU, the use must be:
1. Legally permissible
2. Physically Probable
3. Financially Feasible
4. Maximally Productive.
HBU - Legally permissible
satisfy zoning laws, building codes, fire codes, safety codes
HBU - Physically Probable
shape, size and topography of the property must satisfy the use
HBU - Financially feasible
PV of benefits > PV of costs
HBU - Maximally Productive
choose the use that satisfies the three criteria (Legally permissible, Physically probable, Financially feasible) and maximizes ROI
Substitution
MCA - 2/4 appraisal principles
When assets provide the same utility, the lower priced one should sell first
Anticipation
Income - 3/4 appraisal principles
Value is a function of the PV of the property's anticipated income stream
Contribution
Cost - 4/4 appraisal principles
The value of a component part of a property equals the amount if contributes to overall value
Three Appraisal Approaches
1. MCA
2. Income
3. Cost
MCA:
the indicated value of the subject property equals the sale prices of comps that have sold recently and are in close proximity to the subject, +/- adjustments for dissimilarities
Income:
the indicated value of the subject property equals the PV of the anticipated income stream
Cost:
the indicated value of the subject property equals the value of the land as though vacant plus the DEPRECIATED value of the improvements
MCA: Market Comparison Approach
indicated value of the subject property = the sale prices of comparisons that have sold recently and are in close proximity to the subject, +/- adjustments for similar characteristics
MCA is based on the principle of?
Substitution: when properties have equal utility, the one with the lowest price likely will sell first
Six Steps of MCA
1. Gather comparable sales data
2. Choose the comps from Step 1 that are most similar the subject property
3. Adjust the comps from Step 2 for dissimilarities
4. Determine the adjusted market price for each comp
5. VALUE weight the comp's AMP
6. Determine the subject's indicated value
Step 1 of MCA
Gather comparable sales data
Choose comps that have sold recently and are in close proximity to the subject
Gather data from the MLS, public sources, public records, lenders, builders, appraisers
Clean the data for inaccuracies
Step 2 of the MCA
Choose comps from Step 1 that are most similar to subject property
The more similar the comps and subject are, the less need there will be for adjustments
Ideally, all comps will be next door and will have just sold today
Step 3 of the MCA
Adjust the comps from Step 2 for dissimilarities
Quantify the adjustment magnitude: use the matched pairs technique. Use the COST approach to determine how much a component part contributes to overall value.
Determine the adjustment direction
-Theoretically transform the comps to be just like the subject via adjustments
-Always adjust the comps sale price.
-Define the preferred characteristics
-Adjusted downward if the comp has preferred, adjust upward if the subject has preferred.
Step 3 Continued of MCA (5 Most common Adjustments)
1. Conditions of sale
2. Financing Terms
3. Market Conditions
4. Location
5. Physical Characteristics
Conditions of Sale
special sales concessions offered by the seller
Financing Terms
special below market seller or third-party financing. most of the PV of the financing saving will be capitalized into higher sales price
Market conditions
changes in the economy that affect value (e.g., interest rates, unemployment rates, S&D factors)
Location
adjust for the comps and the subject being in different locations
Physical Characteristics
adjust for the comps and the subject having different amenities
LA, BR, baths, fireplace, lot size, etc
Step 4 of the MCA
Determine the adjusted market price (AMP) for each comp
AMP: each comp's sale price, +/- the dollar adjustments from Step 3
The range of the comp's AMP should be much higher than the range of the comps' sale prices.
AMPs theoretically represent the transformed comps' value, as though they were the subject property
Step 5 of the MCA
Value weight the comps' AMPs
Comps more similar to the subject receive a higher weight. These subjective weights are a function of the number and the magnitude of adjustments from Step 3.
Step 6 of the MCA
Determine the subject's indicated value
Calculate the products of the AMPs and weights
Sum these projects
This sum = indicated value of the subject property
Limitations of the MCA
based on past trends, may be a lack of sales data (i.e., properties that have sold recently), inadequate # of comps similar, appraisals become obsolete very rapidly, value weighting the AMPs can be subjective
Income Approach
indicated value of the subject property = PV of the anticipated future income stream
Income Approach is based on the principle of?
Anticipation (value is a function of the present worth of the anticipated income stream produced by the property)
Limitations of the Income Approach
cannot be used for non-income producing properties, forecasting CFs can be subjective and inaccurate, formulating cap rate inaccurately can cause large variations in the indicated value.
Direct Capitalization: Calculating Value
Net Return on Investment / Capitalization Rate
NOI
PGI - VBD + MI - OE = EGI - OE
potential gross income - vacancy and bad debts + misc. income - op expenses = effective gross income - operating expenses
OER
operating expense / effective gross income
Overall Capitalization Rate: Capitalization
conversion of future income into value.
Reflects an investor's return "on" investment and return "of" investment (?)
Assumes no debt and taxes
A before-tax calcuation
Theoretical Approach to calculating Capitalization Rate
risk free rate + inflation premium + cash flow risk premium + reinvestment risk premium
Market Extraction Approach
capitalization rate: average implied cap rate of comps.
Indicated value: Subject property's NOI = cap rate calculated by market extraction approach
Band of Investment Approach
Identical to the WACC in finance
= [(Loan/Value)
Mortgage Constant] + [(down payment/value)
(BTCF/Down payment)]
Band of Investment Approach
The most reliable method of estimating cap rates
Tailored to the investor
Easy to apply and explain
BOI Example:
1. Determine LTV, ETV. (ETV = 1-LTV%)
2. AMC: {interest %/ [1-1/(1+interest %)^# of years]}
3. EDR: BTCF / Down payment
Cap rate: (LTV
Mortgage constant) + (ETV
EDR)
EDR: BTCF/Down payment
Cost Approach
Indicated value of the subject property = the value of the land as though vacant, plus the depreciated value of the improvements
Cost Approach is based on the principle of
Contribution.
The value of a component part equals how much it contributes to overall value.
Cost approach is..
Method of last resort when MCA and Income approach are not indicated
Limitations of the Cost Approach
Difficult to measure costs accurately
Difficult to measure land values in built-up areas
Depreciation estimates are subjective
Cannot be used for raw land or older improved properties
Over-value distressed properties
Ignores buyer/seller interaction
Ignores future benefits to be derived (favorable forthcoming zoning, improving economy)
May falsely assume property is held in a fee simple (?) estate
Cost Approach to Value (5 Steps)
1. Estimate land as vacant
2. Estimate new construction cost of similar building
3. Less estimated depreciation
4. Depreciated value of building
5. Appraised property value by the cost approach
Step 2 Cost Approach
Estimate improvements' reproduction and replacement costs new
Reproduction: a replica with construction materials identical to the subject
Replacement: an improvement with utility equal to the subject
Step 3 Cost Approach
Physical Deterioration
Functional Obsolescence
External Obsolescence
Physical Deterioration
Curable: immediate (deferred maintenance)
Incurable: (Short-lived items / Long-lived items)
Functional Obsolescence
Curable
Incurable
External Obsolescence:
Locational
Economic
Physical Deterioration
wear and tear: resulting from use and aging
Curable Physical Deterioration
deferred maintenance that will be cured immediately upon taking title
PV of benefits must be > PV of costs
Incurable Physical Deterioration
deficiencies are not feasible to correct
PV of benefits < PV of costs
Physically possible, but economically feasible
2 types: short lived, long-lived
Short-lived incurable physical deterioration
components with some remaining useful life, but whose remaining useful life < the structure's remaining useful life.
Roof has 5 RUL, but structure has a 20 year RUL
Long-lived incurable physical deterioration
components whose remaining useful life > larger structure's RUL
framing and slab will last at least as long as the improvement's RUL
Functional Obsolescence:
loss in value due to design, structure or materials
often based on current trends and tastes
not necessarily a function of age (??)
curable: new lighting, new faucets
incurable: raise ceiling height, change wiring to copper
External Obsolescence
loss in value due to adverse exogenous factors (pollution, foul odors, etc)
caused by outside factors --> only incurable
External Obsolescence: Locational
locational: adverse influence on only a few surrounding parcels being in a fixed location
b/c the site already capitalizes the adverse influence, only the improvement is adjusted for this factor (avoids double counting)
External Obsolescence: Economic
market wide adverse affect
ex: interest rates changing, rising taxes, excess supply, rising unemployment
Appraisal Regulations
The appraisal foundation
Federal Regulation
Developing the appraisal
Appraisal licensing requirements
Reporting Standards (12) - NEED BOOK
The Appraisal Foundation
establishes and approves uniform appraisal standards and appraiser qualifications
Federal Regulations
relies on The Appraisal Foundation for appraisal standards and appraiser qualifications
Developing the Appraisal
created USPAP (???) standards
Appraisal licensing requirements
must use state certified or licensed appraiser for all RE related financial transaction
Reporting Standards
set forth by USPAP (pg 505)
Formats of Appraisal Reports
1. Letter report
2. Form report
3. Narrative report
4. Review Appraisals
5. Real Estate Analysis
Letter Report
1-5 page informal report where appraisal details are not needed
Form Report
appraisal on preprinted form with checklists
Narrative report
longest and most formal appraisal report
Review appraisals
report on an existing appraisal's adequacy and appropriateness
Real Estate Analysis:
provides information, recommendations and conclusions about subject property, but does NOT (indicate value???)
Appraiser License
Certified General RE Appraiser
Certified Residential RE Appraiser
State Licensed RE Appraiser
Provisional licensed Real Estate Appraiser
Appraiser Trainee
See pp 509-510
Texas Regulations
TALCB
if appraisal not under USPAP guidelines; must include statement
THIS IS AN OPINION OF VALUE OR COMPARATIVE MARKET ANALYSIS AND SHOULD NOT BE CONSIDERED AN APPRAISAL.
Texas Regulations: Broker's Price Opinion
opinion of value given by a licensee to seek a listing agreement
Texas Regulations: Comparative Market Analysis
price comparison of similar properties to determine a listing, selling or rental price.