Real Test 4 Chapters 7 and 21

Comparative Market Analysis

price comparison of similar properties to determine a listing, selling or rental price

Broker's Price Opinion

opinion of value given by a licensee to seek a listing agreement

If you have not followed USPAP guidelines then include this statement:

THIS IS AN OPINION OF VALUE OR COMPARATIVE MARKET ANALYSIS AND SHOULD NOT BE CONSIDERED AN APPRAISAL.

TALCB

www.talcb.state.tx.us

Certified General RE Appraiser

Appraiser License

Certified Residential RE Appraiser

Appraiser License

State Licensed RE Appraiser

Appraiser License

Letter report

1-5 page informal report where appraisal details are not needed
Formats of Appraisal Reports

Form report

appraisal on preprinted form with checklists
Formats of Appraisal Reports

Narrative report

longest and most formal appraisal report
Formats of Appraisal Reports

Review appraisals

report on an existing appraisal's adequacy and appropriateness
Formats of Appraisal Reports

Real Estate Analysis

provides information, recommendations and conclusions about subject property, but does NOT indicate value
Formats of Appraisal Reports

The Appraisal Foundation

establishes and approves uniform appraisal standards and appraiser qualifications
Appraisal Regulations

Federal Regulation

relies on The Appraisal Foundation for appraisal standards and appraiser qualifications
Appraisal Regulations

Developing the Appraisal

created following uspap standards
Appraisal Regulations

Appraisal Licensing Requirements

must use State certified or licensed appraiser for all RE related financial transactions
Appraisal Regulations

Reporting Standards (12)

set forth by USPAP (pp. 505)
Appraisal Regulations

Unrelated to 27.5 / 39 year straight-line depreciation

Accrued Depreciation Categories

Physical Deterioration

Curable - immediate (deferred maintenance)
Incurable
Short-lived items
Long-lived items
Accrued Depreciation Categories

Functional Obsolescence

Curable
Incurable
Accrued Depreciation Categories

External Obsolescence

Locational
Economic
Accrued Depreciation Categories

Five Steps of the Cost Approach
Step 2

Estimate improvements' reproduction and replacement costs new

Reproduction
Step 2

a replica with construction materials identical to the subject

Replacement
Step 2

an improvement with utility equal to the subject

Costs Approach to Value
Step 1

Estimate land as vacant

Costs Approach to Value
Step 2

Estimate new construction
cost of similar building

Costs Approach to Value
Step 3

Less estimated depreciation

Costs Approach to Value
Step 4

Depreciated value of building

Costs Approach to Value
Step 5

Appraised property value by the cost approach

Difficult to measure costs accurately

Limitations of the Cost Approach

Difficult to measure land values in built-up areas

Limitations of the Cost Approach

Depreciation estimates are subjective

Limitations of the Cost Approach

Cannot be used for raw land or older improved properties

Limitations of the Cost Approach

over-values distressed properties

Limitations of the Cost Approach

Cost Approach
Indicated value of the subject property equals:

The value of the land as though vacant, plus the depreciated value of the improvements

Cost Approach
Based on the Principle of contribution

The value of a component part equals how much it contributes to overall value

Cost Approach
Method of Last Resort

when MCA and Income approach are not indicated

Band-of Investment Example

You borrow 80% of the purchase price for 25 years at 12%. Forecast BTCF = $5,880 and your down payment is $42,000. Calculate the overall cap rate using the BOI approach.
Recall: Ro = (LTV x AMC) + (ETV x EDR)
LTV = 80%, so ETV = 20%
AMC (Mortgage Constant

The most reliable method of estimating cap rates

Three Methods of Calculating Ro
Band-of-Investment Approach (cont.)

Tailored to the the investor

Three Methods of Calculating Ro
Band-of-Investment Approach (cont.)

Most commonly used method because easy to apply and explain

Three Methods of Calculating Ro
Band-of-Investment Approach (cont.)

Identical to WACC (WEIGHTED AVG COST OF CAPITAL) in finance:
Ro = (wd x kd) + (we x ke)

Three Methods of Calculating Ro
Band-of-Investment Approach (cont.)

In real estate, the BOI equation is:
Ro = (LTV x AMC) + (ETV x EDR)

Three Methods of Calculating Ro
Band-of-Investment Approach (cont.)

Cap rate equals the average of other investors' cap rates on comps within close proximity

Three Methods of Calculating Ro
Market Extraction Approach

Extract comps' cap rates from the market

Three Methods of Calculating Ro
Market Extraction Approach

Very low search costs

Three Methods of Calculating Ro
Market Extraction Approach

Not emphasized by appraisers because it assumes the investor is "average

Three Methods of Calculating Ro
Market Extraction Approach

Ro= r(f) + In(p) + ? + r(r)
? r(f) = risk-free rate
? In(p) = inflation premium
? ?(standard dev) = cash flow risk premium
? r(r) = reinvestment risk premium

Three Methods of Calculating Ro
Theoretical Approach

Ro: Capitalization = conversion of future income into value
Reflects an investor's return "on" investment and return "of" investment

Overall Capitalization Rate

Assumes no debt and no taxes

Overall Capitalization Rate

A before-tax calculation

Overall Capitalization Rate

V = NOI / Ro
NOI = V x Ro
Ro = NOI / V

Direct Capitalization

NOI = PGI - VBD + MI - OE = EGI - OE
Equation 1 of the EVM

Direct Capitalization

OER = OE1/ EGI1

Direct Capitalization

Cannot be used for non-income producing properties

Limitations of the Income Approach

Forecasting cash flows can be subjective and inaccurate

Limitations of the Income Approach

Formulating cap rate inaccurately can cause large variations in the indicated value

Limitations of the Income Approach

Indicated value of the subject property equals:
PV of the anticipated future income stream

Income Approach

Value is a function of the present worth of the anticipated income stream produced by the property

Based on the Principle of anticipation

Based on past trends

Limitations of the MCA

May be a lack of sales data (i.e., properties that have sold recently)

Limitations of the MCA

Inadequate number of comps similar enough to the subject

Limitations of the MCA

Appraisals become obsolete very rapidly

Limitations of the MCA

Value weighting the AMPs can be subjective

Limitations of the MCA

Calculate the products of the AMPs and weights
Sum these products
This sum equals the indicated value of the subject property

Six Steps of the MCA
Step 6: Determine the subject's indicated value

Six Steps of the MCA
Step 5: 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

Six Steps of the MCA
Step 4: Determine the Adjusted Market Price (AMP) for each comp

Step 4: 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 comps' AMPs should be much smaller than the range of the comps' sale prices
AMPs theoretically represent

Quantify the adjustment magnitude
- use the matched pairs technique
- use the cost approach to determine how much a component part contributes to overall value

Six Steps of the MCA
Step 3: Adjust the comps from Step 2 for dissimilarities

Determine the adjustment Direction (+ or -)
- theoretically transform the comps to be just like the subject via adjustments
- always adjust the comps, sale prices, not the subject's price
- define the preferred characteristics
- adjust downward if the com

Six Steps of the MCA
Step 3: Adjust the comps from Step 2 for dissimilarities

Five most common adjustments:
- A. Conditions of sale = special sales concessions offered by the seller
- e.g., seller-paid closing costs / points, non-arms-length deals, divorce or lawsuit settlements, condemnation or foreclosure sales

Six Steps of the MCA
Step 3: Adjust the comps from Step 2 for dissimilarities

- B. Financing Terms = special below market seller or third-party financing
- most of the PV of the financing saving will be capitalized into a higher sales price

Six Steps of the MCA
Step 3: Adjust the comps from Step 2 for dissimilarities

- C. Market Conditions = changes in the overall economy that affect value (e.g., interest rates, unemployment rates, S&D factors)
- D. Location = adjust for the comps and the subject being in different locations
- E. Physical Characteristics = adjust for

Six Steps of the MCA
Step 3: Adjust the comps from Step 2 for dissimilarities

Choose the comps from Step 1 that are most similar to the subject property

Six Steps of the MCA
Step 2

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

Six Steps of the MCA
Step 2

Gather comparable sales data

Six Steps of the MCA
Step 1:

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

Six Steps of the MCA
Step 1:

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 dissimilar characteristics

Market Comparison Approach

Based on the Principle of Substitution:
When properties have equal utility, the one with the lowest price likely will sell first

Market Comparison Approach

MCA: ...the sale prices of comps that have sold recently and are in close proximity to the subject property , + / - adjustments for dissimilarities

Three Appraisal Approaches

Income: ... the PV of the anticipated income stream

Three Appraisal Approaches

Cost: ... the value of the land as though vacant, plus the depreciated value of the improvements currently

Three Appraisal Approaches

Four Appraisal Principles
Substitution:

(MCA) When assets provide the same utility, the lower priced one should sell first

Four Appraisal Principles
Anticipation

(Income) Value is a function of the PV of the property's anticipated income stream

Four Appraisal Principles
Contribution

(Cost) The value of a component part of a property equals the amount it contributes to overall value

Four Appraisal Principles
Highest and Best Use: (MCA, Income & Cost)

The use that generates the highest net return over the holding period, given current market conditions
To determine HBU, the use must be:
A. Legally Permissible - satisfy zoning laws, building codes, fire codes, safety codes, etc.
B. Physically probable -

Real Estate Valuation
Book value

historical cost minus cumulative depreciation

Real Estate Valuation
Depreciated value

FMV minus cumulative depreciation (ALWAYS WANT TO BE GREATER)
When will Book Value = Depreciated Value?
When Historical Cost = Fair Market Value

Real Estate Valuation
Leased fee value

residual value of a leased property to the owner

Real Estate Valuation
Leasehold value

the value of a lease to a tenant

Real Estate Valuation
Insurance value

how much coverage the lender requires the owner to carry on the improvements. (Ex. If your $100 house burns down Ins will pay $141 to replace it)

Real Estate Valuation
Appraised value

value opinion of a qualified appraiser as to whether the sale price is fair, given current economic conditions

Real Estate Valuation
Salvage value

a "fire sale" value to sell an illiquid property immediately

Real Estate Valuation
Assessed value

how much the tax assessor values the property for ad valorem tax purposes

Real Estate Valuation
Foreclosure value

sheriff's opening bid at a foreclosure sale

Real Estate Valuation
Condemnation value

amount the government will pay for property via imminent domain

Real Estate Valuation
Mortgage value

how much a lender will fund
(L/V) * (lesser of SP or appraised value)

Real Estate Valuation
Price vs. Cost vs. Value

Rarely equal each other, yet used interchangeably
Price = amount agreed upon by two parties
Cost = historical figure whose relation to value diminishes over time (ie $10,000 in 1969 compared to today)
Value = generally defined as FMV in this context
Examp

Real Estate Valuation
Investment value

what a property is worth to the investor
Invest if one's investment value > Fair Market Value
FMV is a consensus opinion of investors' individual investment values
One with the highest investment value likely will be the highest bidder

Real Estate Valuation
Fair market value

most probable cash selling price, assuming:
All parties have adequate time
Property has reasonable exposure time
No party is under duress (no one is forced to make deal)
All parties act prudently & with self-interest (ie seller wants the most money possib

An estimate of value

Appraisal

USPAP

(Uniform Standards of Professional Appraisal Practices) - clarifies the valuation process standards

Three approaches to estimating value:

Market comparison approach (MCA)
Cost approach
Income approach

Legally Enforceable Agreement
Contract

legally enforceable agreement to do or not to do something

Legally Enforceable Agreement
Express Contract

parties declare intentions either orally or writing

Legally Enforceable Agreement
Lease

lessor agrees to convey possession / use, while lessee agrees to pay full rent timely

Legally Enforceable Agreement
Implied Contract

created by actions of parties, not orally or in writing
Taxi ride or dining in a restaurant

Legally Enforceable Agreement
Bilateral

promise exchanged for a promise
Buyer promises to pay agreed price
Seller promises to deliver F&C title

Legally Enforceable Agreement
Unilateral

promise exchanged for performance
"If you do X, then I will do Y

Legally Enforceable Agreement
Forbearance

agreement NOT to do something
Mortgagee agrees NOT to foreclose if borrower meets all obligations

Legal Effect of Contracts
Valid

meets all requirements of law

Legal Effect of Contracts
Void

no legal effect, so not a contract and not binding on any party

Legal Effect of Contracts
Voidable

one party bound, but not the other
NHL player with option in last year
Commercial tenant with option to renew

Legal Effect of Contracts
Unenforceable

may have been valid at an earlier time, but now enforcement is barred
Beyond Statute of Limitations
Beyond expiration date of option

Competent parties

Contract Essentials

Mutual agreement

Contract Essentials

Lawful objective

Contract Essentials

Consideration

Contract Essentials

In writing

Contract Essentials

Must be of legal age and sound mind

Competent Parties

Power of Attorney

giving another party the power to act on your behalf

Corporations

person contracting on behalf of corporation must have authority and be of legal age and sound mind

Must be agreement to the contract provisions

Mutual Agreement

Offeree accepts, rejects or counter

Mutual Agreement

Offer and Acceptance

offeror makes offer to offeree, who accepts by communication

Counter-Offer

offeree makes changes to original offer and submits new offer

Prohibits fraud, misrepresentation or mistake
If so, contract is not valid

Mutual Agreement

Fraud

act intended to deceive, so as to have other party convey something of value

Innocent Misrepresentation

act NOT intended to deceive, but provided wrong information (e.g., DART service canceled)

Mistake

ambiguity in negotiations (e.g., wrong parcel) or mistake of fact (e.g., reduced parking spaces via condemnation)

Contractual Intent

all parties must have intended to contract

Duress

no party is forced, threatened or put in an unfair advantage
If so, offer can be voided by harmed party

3. Lawful Objective

Contract cannot call for performing illegal act (e.g., paying rent with weed)

4. Consideration

each party must provide something of value to prove a bargain has been made

5. In Writing

Statute of Fraud and UCC require all RE transactions be written and signed by all parties

Effective March 1, 2001

Electronic Transactions

E-sign

electronic signature legal

Texas requires writing under old Statute of Frauds for severe transactions like foreclosure and eviction

Electronic Transactions

Breach of Contract
Wronged party has six alternatives:
Partial performance

accept partially fulfilled K

Breach of Contract
Wronged party has six alternatives:
Unilateral Rescission

rescind K because other party is not performing

Breach of Contract
Wronged party has six alternatives:
Specific Performance

sue to force other party to perform

Breach of Contract
Wronged party has six alternatives:
Money damages

sue for $ if damages can be monetized

Breach of Contract
Wronged party has six alternatives:
Liquidated damages

amount agreed to in advance, should one party breach K

Breach of Contract
Wronged party has six alternatives:
Mutual Rescission

parties agree to rescind K

Statute of Limitations
Written

contracts have 4 years

Statute of Limitations
Oral

contracts have 2 years limit