Appraisal
(Valuation)
Is an estimate or an opinion of property's value
An appraisal is an opinion, not an indisputable scientific conclusion
Two competent appraisers may disagree about the value of a particular property.
In most residential transactions, the seller
Valuation
**See Appraisal
Appraisal report
It usually takes the form of a written statement, called an appraisal report, setting forth the appraiser's opinion of the value of a piece of property as of a given date."
The appraiser's fiduciary duties to the client require the appraiser to disclose
Purpose & Function of an Appraisal
In appraisal terminology, a distinction is made between the purpose and the function of an appraisal."
In addition to helping to determine a fair price or a maximum loan amount, an appraiser's services are regularly required in order to:
-identify raw la
Purpose
The basic purpose of an appraisal is to estimate value; in most cases the appraiser is estimating the property's market value
Function
The function of an appraisal refers to the reason the appraisal is being made or how the appraisal will be used.
This can vary widely.
Ex. An appraisal's function may be to help a seller decide on a fair listing price, or to help a buyer determine how mu
Appraiser-Client Relationship
An appraiser may work for
-a financial institution,
-a private corporation with an active real estate department,
-a government agency, or
-an appraisal company.
Or an appraiser may be self-employed, hired to appraise property for a fee.
A self-employed
Fee appraiser
A self-employed appraiser
Client
(Principal)
The person who employs the appraiser
Appraiser
(Agent)
Is the client's agent
Appraisers make a distinction between the purpose and the function of an appraisal
Appraisers are primarily concerned with the concept of value.
Licensing & Certification of Appraisers
The state of California licenses and certifies appraisers.
California doesn't require all appraisers to be licensed or certified, but it offers licensing and certification for those who need them to comply with federal law.
An appraiser must be licensed
USPAP
(Uniform Standards of Professional Appraisal Practice)
USPAP is a set of guidelines adopted by the Appraisal Foundation, a nonprofit organization.
(An appraiser who fails to abide by these standards in order to defraud a federally insured lender could be
Value
Value is a term with many meanings.
Value can be defined as the present worth of future benefits.
It can also be defined as an item's ability to command other items in exchange.
Another definition of value is the relationship between a desired thing and
Elements of Value
For a product to have value, it must have four basic attributes, called the elements of value:
-utility,
-scarcity,
-demand, and
-transferability
The more useful and scarce the item, the greater the demand and the higher the value (provided the item is t
Utility
Filling a need or serving a purpose.
A product must render a service or fill a need in order to have value
But utility must exist in conjunction with the other elements of value or the product has no economic value.
Ex. Air has great utility, but it's uni
Scarcity
In relatively short supply, or difficult to obtain.
Generally, the scarcer an item is, the greater its value.
For instance, if diamonds were to become much more plentiful, their value would decline.
Demand
Producing a desire to own.
Demand is also an essential part of value.
There is demand for an item if it produces a desire to own.
And there is effective demand when that desire is coupled with purchasing power.
Transferability
Possession and ownership rights can be transferred.
Of course, if an item can't be transferred from one party to another, it won't have any economic value.
Transferability refers to the ability to transfer possession and control of the rights that constit
Effective demand
The desire of those with purchasing power
Demand is also an essential part of value.
There is demand for an item if it produces a desire to own.
There is effective demand when that desire is coupled with purchasing power
Types of Value
For appraisal purposes, value falls into two general classifications:
1. value in use and
2. value in exchange.
Value in use
(Utility value)
Value in use reflects how useful the property is to a particular person, the owner.
The subjective value that a particular person places on a property, while value in exchange is the objective value of a property as viewed by the average p
Value in exchange
(Market Value)
The objective worth of a product in the competitive marketplace
Property's value in use and value in exchange may be quite different, depending on the circumstances.
Ex. A large, expensive, one-bedroom home, designed, built, and occupied by
Market value
(Value in exchange)
Market value is the most probable price the property should bring under all conditions needed for a fair sale.
The price someone should pay for the property under normal conditions.
The most probable price that a property should bring
Market Value vs. Market Price
It's important to distinguish between market value and market price.
Market Price
The price someone paid for the property in an actual transaction (the sales price).
Market price is the price that was actually paid for a property, regardless of what kind of conditions the sale took place under (whether the parties to the transaction we
Principles of Value
Of the major forces that influence our attitudes and behavior, four interact to create, support, or erode property values:
-social ideals and standards,
-economic fluctuations,
-government regulations, and
-physical and environmental factors.
A change in
Unearned increment
When the value of a property increases due to outside forces, the increase is referred to as an unearned increment."
If a property's value increases purely because of outside forces, the increase is called an unearned increment.
Highest and best use
An appraiser doesn't just consider how the property is currently being used, but also what its highest and best use would be.
The highest and best use is the use which, at the time of appraisal, is most likely to produce the greatest net return from the p
Net return
Net return usually refers to net income, but it can't always be measured in terms of money.
With residential properties, for example, net return might manifest itself in the form of amenities�the pleasure and satisfaction derived from living on the proper
Principle of Change
The principle of change states that a property's value changes constantly, in response to changing social, economic, governmental, and environmental conditions, and in response to changes in the property itself.
Every property has a four-phase life cycle:
Effective date of the appraisal
Because value is always subject to change, an estimate of value must be tied to a given date, called the effective date of the appraisal.
Integration
(Growth)
(Development)
Integration is the early stage, when the property is being developed.
Growth
**See Integration
Development
**See Integration
Equilibrium
Equilibrium is a period of stability, when the property undergoes little, if any, change.
Disintegration
Disintegration is a period of decline, when the property's economic usefulness is near an end and constant upkeep is necessary.
Rejuvenation
(Revitalization)
Rejuvenation is a period of renewal, when the property is reborn, perhaps with a different highest and best use.
Rejuvenation or revitalization of a property can take different forms.
-Rehabilitation
-Remodeling
-Redevelopment
Rehabilitation
If a building is restored to good condition without being changed
Remodeling
If the floor plan or style is altered
Redevelopment
An entire neighborhood can be rejuvenated by redevelopment, as when rundown buildings are demolished and replaced in an urban renewal project.
Revitalization
**See Rejuvenation
Economic life
(Its useful life)
A property's economic life is the period when the land and its improvements are profitable.
Physical life
The time span during which an improvement is still standing through it no longer has economic life.
The economic life almost always ends before the physical life.
Principle of Anticipation
According to the principle of anticipation, people buy property in anticipation of receiving benefits from it in the future.
An appraiser must consider not only the present state of the property, but how it may change in the future.
People buy property in
Principle of Supply and Demand
According to the principle of supply and demand, as the demand for a certain type of real estate in a certain location exceeds the supply, the market value of properties in that category tends to rise.
Likewise, as the supply exceeds the demand, the marke
Principle of Substitution
According to the principle of substitution, the maximum value of a property is set by how much it would cost to obtain another property that is equally desirable.
The principle of substitution is the basis for all three of the methods of appraisal we will
Principle of Conformity
The principle of conformity states that a reasonable degree of conformity among the properties in a neighborhood has a positive effect on their value.
The maximum value of land is achieved when there's an acceptable degree of social and economic conformit
Principle of progression
According to the principle of progression, an inexpensive home is generally worth more in a neighborhood of better homes than it would be worth in a neighborhood of similar homes
The value of a home of much lower quality than those around it is increased
Principle of regression
The principle of regression holds that a valuable property surrounded by less expensive properties will tend to be worth less than it would be worth surrounded by similar homes.
The value of a large, expensive home in a neighborhood of small, inexpensive
Principle of Contribution
An improvement may contribute less or more to the value of the property than it costs.
The principle of contribution requires an appraiser to distinguish between the cost of an improvement and its contribution to value.
The principle of contribution conce
Principle of Competition
The value of property is affected by competition. Every property competes with other properties of the same type.
A profitable business will attract competitors to the area, which will tend to lower its profits and, therefore, its value.
Competition can h
Principle of Balance
A property's value is maximized when the agents in production are in balance. The agents in production are labor, coordination, capital, and land.
When a property is serving its highest and best use, neither too much nor too little of its earnings are att
Agents in production
-Labor
-Coordination
-Capital
-Land
Labor
Human activity that provides goods or services
Coordination
A form of cooperation requiring parties to pursue a common strategy in order to avoid the mutually undesirable outcome arising from the pursuit of divergent strategies
Capital
An economic system in which investment in and ownership of the means of production, distribution, and exchange of wealth is made and maintained chiefly by private individuals or corporations, esp. as contrasted to cooperatively or state-owned means of wea
Land
All natural resources used to produce goods and services.
Appraisal Process
Properly done, the appraisal process is orderly and systematic.
While there's no official procedure, appraisers generally carry out the appraisal process in the following manner.
1. Define the problem
2. Determine what data is needed and where it can be f
Appraisal Process 1.
Define the problem
Each client wants an appraiser to solve a specific problem: to estimate the value of a particular property as of a particular date and for a particular purpose.
The first step in the appraisal process is to define the problem to be solv
Appraisal Process 2.
Determine what data is needed and where it can be found
The data that the value estimate will be based on is divided into two categories: general and specific.
General data concerns matters outside the subject property that affect its value.
It includes p
Appraisal Process 3.
Gather and verify the general data
2 types of general data:
The first is information about the economic situation in the community and how it might affect the subject property's value.
The second type of general data is information about the condition of
Appraisal Process 4.
Gather and verify the specific data
Specific data is information about the subject property itself.
For information about the land, the appraiser performs a site analysis.
For information about the structures built on the land, the appraiser performs a bu
Appraisal Process 5.
Select and apply the valuation method(s)
In some cases, the appraiser will approach the problem of estimating value three different ways:
1. with the sales comparison approach,
2. the cost approach, and
3. the income approach.
In other cases, she will use
Appraisal Process 6.
Reconcile value indicators for the final value estimate
The figures yielded by each of the three approaches are called value indicators; they give indications of what the property is worth, but aren't final estimates themselves.
The appraiser will take in
Appraisal Process 7.
Issue appraisal report
The formal presentation of the value estimate and an explanation of what went into its determination are made in the form of an appraisal report.
The last step in the appraisal process is to present the final estimate of value and t
Improved value
The value of land and its improvements together
General data
Concerns matters outside the subject property that affect its value (about the neighborhood and other external influences), such as the economic situation in the community.
An appraiser performs a neighborhood analysis to evaluate how the neighborhood aff
Specific data
Concerns the subject property itself.
-Specific data has to do with the property itself.
The appraiser will gather information about the title, the buildings, and the site.
Often the appraiser will evaluate the site (the land and utilities) and the improv
Value indicators
The results of the different appraisal methods are referred to as value indicators. The appraiser reconciles the value indicators to arrive at a final value estimate.
The figures yielded by each of the three approaches are called value indicators; they gi
Gathering Data
Once the appraiser knows what property she is to appraise and what the purpose of the appraisal is, she begins to gather the necessary data.
Data is broken down into general data (about the neighborhood and other external influences) and specific data (ab
Economic Trends
The appraiser examines economic trends for hints as to the direction the property's value might take in the future.
A trend is a series of related developments that form a pattern.
Economic trends can take shape at the local, regional, national, or intern
Trend
A trend is a series of related developments that form a pattern
-population trends
-employment, price, & wage levels
-building cycles
-tax & interest rates
-building costs
The appraiser examines economic trends to see how they might affect the property's
Neighborhood Analysis
A property's value is inevitably tied to its surrounding neighborhood.
A neighborhood is a residential, commercial, industrial, or agricultural area that contains similar types of properties.
Its boundaries are determined by physical barriers (such as hig
Neighborhood Analysis 1.
Percentage of home ownership
Is there a high degree of owner-occupancy, or do rental properties predominate?
Owner-occupied neighborhoods are generally better maintained and less susceptible to deterioration.
A high percentage of home ownership stabilizes
Neighborhood Analysis 2.
Vacant homes and lots
An unusual number of vacant homes or lots suggests a low level of interest in the area, which has a negative effect on property values.
On the other hand, significant construction activity in a neighborhood signals strong interest in
Neighborhood Analysis 3.
Conformity
The homes in a neighborhood should be reasonably similar to one another in style, age, size, and quality.
Strictly enforced zoning and private restrictions promote conformity and protect property values.
Neighborhood Analysis 4.
Changing land use
Is the neighborhood in the midst of a transition from residential use to some other type of use?
If so, the properties may be losing their value.
Neighborhood Analysis 5.
Contour of the land
Mildly rolling topography is preferred to terrain that's either monotonously flat or excessively hilly.
A neighborhood's aesthetic qualities are always important.
Mildly rolling topography is preferred to terrain that is either monoton
Neighborhood Analysis 6.
Streets
Wide, gently curving streets and cul-de-sacs (short dead-end streets) are more appealing than narrow or straight streets. Streets should be hard-surfaced and well maintained
Neighborhood Analysis 7.
Utilities
Is the neighborhood adequately serviced by electricity, water, gas, sewers, telephones, and cable TV?
Neighborhood Analysis 8.
Nuisances
Nuisances in or near a neighborhood (odors, eyesores, industrial noises or pollutants, or exposure to unusual winds, smog, or fog) hurt property values.
Neighborhood Analysis 9.
Prestige
Is the neighborhood considered prestigious, in comparison to others in the community?
If so, that will increase property values.
Neighborhood Analysis 10.
Proximity
How far is it to traffic arterials and to important points such as downtown, employment centers, and shopping centers?
Neighborhood Analysis 11.
Schools
What schools serve the neighborhood?
Are they highly regarded?
Are they within walking distance?
The quality of a school or school district can make a major difference in property values in a residential neighborhood.
Neighborhood Analysis 12.
Public services
Is the neighborhood properly serviced by public transportation, police, and fire units?
Neighborhood Analysis 13.
Government influences
Does zoning in and around the neighborhood promote residential use and insulate the property owner from nuisances?
How do property tax rates compare with those of other neighborhoods nearby?
High property taxes may discourage new con
Neighborhood
A neighborhood is a residential, commercial, industrial, or agricultural area that contains similar types of properties.
Its boundaries are determined by physical barriers (such as highways and bodies of water), land use patterns, the age or value of home
Site Analysis
The primary purpose of the site analysis is to determine the property's highest and best use.
In the site analysis, the appraiser looks at various physical characteristics of the property, including the lot's size, shape, and topography.
A thorough site a
Site Analysis 1.
Width
This refers to the lot's measurements from one side boundary to the other.
Width can vary from front to back, as in the case of a pie-shaped lot on a cul-de-sac.
Site Analysis 2.
Frontage
Frontage is the length of the front boundary of the lot, the boundary that abuts a street or a body of water, can be one of the most important considerations.
This is particularly true with retail property, which is often valued in dollars per fr
Site Analysis 3.
Area
Area is the size of the site, usually measured in square feet or acres.
Comparisons between lots often focus on the features of frontage and area.
Commercial land (especially retail property) is usually valued in terms of frontage; that is, it's wort
Site Analysis 4.
Depth
Depth is the distance between a site's front boundary and its rear boundary.
A lot's depth is the distance between its front and rear boundaries.
Greater depth doesn't always translate into greater value.
Greater depth (more than the norm) can mean
Site Analysis 5.
Shape
Lots with uniform width and depth (such as rectangular lots) are almost always more useful than irregularly shaped lots.
This is true for any kind of lot�residential, commercial, or industrial.
Site Analysis 6.
Topography
A site is generally more valuable if it's aesthetically appealing.
Rolling terrain is preferable to flat, monotonous land.
On the other hand, if the site would be costly to develop because it sits well above or below the street or is excessivel
Site Analysis 7.
Utilities
Site analysis includes an investigation into the availability and cost of utility connections.
Remote parcels lose value because the cost of bringing utility lines to the site is high or even prohibitive.
Site Analysis 8.
Site in relation to area
How a lot is situated in relation to the surrounding area influences its value.
For instance, a retail store is often worth more if it's located on a corner, because it enjoys more exposure and its customers have access from two d
Commercial acre
A commercial acre is the buildable portion of an acre that remains after part of the land has been dedicated for streets, sidewalks, and parks.
Newly subdivided land is sometimes measured in commercial acres.
Excess land
Additional square footage might simply be considered excess land.
For instance, when two comparable properties derive most of their value from the length of their frontage on a lake, it doesn't necessarily matter that one property is deeper, and thus larg
Depth table
In some situations a depth table is used to evaluate how a lot's depth affects its value.
This is a table of mathematical factors that can be multiplied by the front foot value of a standard lot to estimate the value of a lot with a specified depth.
Depth
Plottage
The increment of value that results when two or more lots are combined to produce greater value
Under certain circumstances, combining two or more adjoining lots to achieve greater width, depth, or area will make the larger parcel more valuable than the s
4-3-2-1 rule
There are various rules of thumb concerning the relationship between depth and value.
One of the most common is the 4-3-2-1 rule.
The front quarter of a lot holds 40% of its overall value; the second quarter holds 30%; the next quarter holds 20%; and the
Corner influence
A corner position usually adds to the value of a commercial property, since a corner property has access and exposure on two streets.
This increase in value is called corner influence.
The effect the corner location has on the value of a business site
On
Building Analysis
The improvements to the site must also be analyzed, along with any special amenities.
(Amenities are attractive features such as a nice view or beautiful landscaping.)
Of course, the functional utility of a home depends on the needs and desires of its occ
Building Analysis 1.
Construction quality
Is the quality of the materials and workmanship good, average, or poor?
The appraiser will also pay particular attention to the quality of the workmanship and materials that went into the construction of the building, and to its curre
Building Analysis 2.
Age/condition
How old is the home?
Is its overall condition good, average, or poor?
If the foundation shows signs of cracking, or doors and windows don't close properly, an appraiser may recommend a soil engineer's report to check the soil stability.
Building Analysis 3.
Size of house (square footage).
Among the most important considerations in an appraisal is the size of the building.
Both residential and commercial buildings are measured in square feet.
The outside dimensions of a home are used to calculate its square f
Building Analysis 4.
Orientation
Orientation refers to how a building is positioned on the property in relation to views, privacy, and exposure to wind, sunlight, and noise.
Building Analysis 5.
Basement
A functional basement, especially a finished basement, contributes to value.
(As we mentioned earlier, however, the amount a finished basement contributes to value often isn't enough to recover the cost of the finish work.)
Building Analysis 6.
Interior layout.
Is the floor plan functional and convenient?
It shouldn't be necessary to pass through a public room (such as the living room) to reach other rooms, or to pass through one of the bedrooms to reach another.
Building Analysis 7.
Number of rooms
The appraiser will add up the total number of rooms in the house, excluding the bathrooms and (usually) any basement rooms.
Building Analysis 8.
Number of bedrooms
The number of bedrooms has a major impact on value.
For instance, if all else is equal, a two-bedroom home is worth considerably less than a three-bedroom home.
Building Analysis 9.
Number of bathrooms.
A full bath is a lavatory (wash basin), toilet, bathtub, and shower; a three-quarters bath is a lavatory, toilet, and either a bathtub or a shower (not both); a half bath is a lavatory and toilet only.
The number of bathrooms can have
Building Analysis 10.
Air conditioning
The presence or absence of an air conditioning system is important in hot regions.
Building Analysis 11.
Energy efficiency
With spiraling energy costs, an energy-efficient home is more valuable than a comparable one that isn't.
Energy-efficient features such as double-paned windows, good insulation, and weather stripping increase value.
Building Analysis 12.
Garage/carport
As a general rule, an enclosed garage is considered better than a carport.
How many cars can the garage accommodate?
Is there work or storage space in addition to parking space?
Is it possible to enter the home directly from the garage or c
Amenities
Attractive features such as a nice view or beautiful landscaping
Methods of Appraisal
Once the appraiser has accumulated the necessary general and specific data, he will begin applying one or more of the three methods of appraising property:
-the sales comparison approach,
-the cost approach, and
-the income approach
Different types of pro
Methods of Appraisal-Approach to Value- Sales Comparison Approach
(Market data approach)
The sales comparison approach relies on the recent sales prices of comparable properties to estimate the market value of a property.
It is also called the market data approach because it uses information gathered about recent transa
Comparable sales
(Comparables)
A comparable property is one that is similar to the subject property and has recently been sold under normal conditions.
Comparing the subject property to similar properties that have recently sold
If the appraiser notices that any of these
Elements of Comparison
The primary elements of comparison an appraiser evaluates when choosing comparables are date of sale, location, physical characteristics, terms of sale, and conditions of sale.
"To determine whether a particular sale can legitimately be used as a comparab
Date of Comparable Sale
A comparable sale should be recent, within the past 6 months if possible.
Recent sales give a more accurate indication of what's currently happening in the marketplace.
If the market has been inactive and there aren't 3 legitimate comparable sales from th
Location of Comparable Sale
Whenever possible, comparables should be selected from the neighborhood where the subject property is located.
In the absence of any legitimate comparables in the neighborhood, the appraiser can look elsewhere, but the properties selected should at least
Physical Characteristics
To qualify as a comparable, a property should have physical characteristics (construction quality, design, amenities, etc.) that are similar to those of the subject property.
However, there usually will be significant physical differences between a subjec
Terms of Sale
The terms of sale can affect the price a buyer will pay for a property.
Attractive financing concessions (such as seller-paid discount points or seller financing with an especially low interest rate) can make a buyer willing to pay a higher price than she
Conditions of Sale
Last but not least, a comparable sale can be relied on as an indication of what the subject property is worth only if it took place under normal conditions.
In other words, it was an arm's length transaction, both the buyer and the seller were informed of
Comparing Properties & Making Adjustments
A proper comparison between the subject property and each comparable is essential to an accurate estimate of value.
The more similar the properties, the easier the comparison.
A comparable property that's the same design and in the same condition as the s
Adjusted selling price
Taking into account differences in time, location, physical characteristics, and terms of sale, in order to arrive at an adjusted selling price for each comparable
Use of Listings
When comparable sales are scarce (Ex. when the market is just emerging from a dormant period), the appraiser may compare the subject property to properties that are presently listed for sale.
The appraiser must keep in mind, however, that listing prices t
Cost Approach
The second method of appraisal, the cost approach, is based on the premise that the value of a property is limited by the cost of replacing it.
Using the cost approach, the appraiser estimates the replacement cost of the building, deducts depreciation, an
Capitalization Rate 3.
Summation method
The cost approach involves estimating the value of land and buildings separately, then adding the estimates together, it's sometimes called the summation method
The appraiser builds a capitalization rate for the subject property by consid
Reproduction cost
The reproduction cost is how much it would cost to build an exact replica of the building. Since this is usually not a reliable indicator of a building's value, it is generally not used in the cost approach.
The cost of constructing an exact duplicate�a r
Replacement cost
The replacement cost is the cost of building improvements with the same utility as those on the subject property, using modern materials and construction methods.
The current cost of constructing a building with a utility equivalent to the subject's�that
Estimating Replacement Cost
The replacement cost of a building can be estimated in three different ways:
1. the square foot method,
2. the unit-in-place method, and
3. the quantity survey method
Square Foot
(Comparative cost method)
(Comparative unit method)
The appraiser multiplies the structure's square footage by the current construction cost per square foot. This is the method appraisers use most often to estimate replacement cost.
The simplest way to es
Unit-in-Place method
Method of estimating replacement cost, the appraiser estimates separately the costs of the various components of the subject structure, then adds them together to find the total cost.
The unit-in-place method involves the use of cost manuals or bids from
Quantity Survey method
The quantity survey method involves a detailed estimate of the quantities and prices of construction materials and labor, which are added to the indirect costs (building permit, survey, etc.) for what is generally regarded as the most accurate replacement
Estimating Depreciation
The indirect methods of estimating depreciation are the capitalization method and the market data method.
The direct methods are the straight-line method and the engineering method.
The straight-line method is the most widely used, while the engineering m
Depreciation
Depreciation is a loss in value due to any cause.
The three categories of depreciation are physical deterioration, functional obsolescence, and external obsolescence.
Loss in value due to any cause.
Depreciation is curable if the cost of correcting it cou
Functional obsolescence
Functional obsolescence is depreciation caused by functional inadequacies or outmoded design.
Functional obsolescence may be curable or incurable.
Any defect within property boundaires that is not physical deterioration
Depreciation caused by functional i
Types of Depreciation
Value can be lost as a result of:
-physical deterioration,
-functional obsolescence, or
-external obsolescence
Note that more value is typically lost due to functional and external obsolescence than to physical deterioration
Most forms of physical deterio
Physical deterioration
Physical deterioration is depreciation resulting from wear and tear, damage, or structural defects.
It may be curable or incurable.
Curable physical deterioration is often called deferred maintenance.
A loss in value due to wear and tear, damage, or struc
Curable depreciation
(Deferred maintenance)
If the cost of correcting it could be recovered in the sales price when the property is sold
Incurable depreciation
If it's impossible to correct, or if it would cost so much to correct that it would be impractical to do so
Ex. A home that is positioned too close to the street is an example of incurable functional obsolescence.
The cost of moving the structure back on
Deferred maintenance
**See Curable depreciation
Functional utility
(Functional utility)
A building's functional ability to fulfill the desires of its occupants or users; it includes attractiveness as well as actual usefulness
External obsolescence
(Economic obsolescence)
It is depreciation caused by forces outside the property, such as neighborhood decline or proximity to a nuisance. External obsolescence is always incurable.
Less frequently it is called environmental or locational obsolescence.
Th
Estimating Depreciation Methods
Accurately estimating how much depreciation has accrued is the most difficult phase of the replacement cost approach.
Depreciation estimates are often highly subjective, and they're never any more reliable than the judgment and skill of the appraiser who
Estimating Depreciation- Capitalization method
When applying the capitalization method to estimate depreciation, the appraiser uses the income approach to value to estimate the current value of the building.
This figure, which is called the capitalized value, should be lower than the appraiser's repla
Estimating Depreciation- Market data method
With the market data method, the appraiser uses the market data (sales comparison) approach to estimate the current value of the building.
Again, the appraiser subtracts this value estimate from the replacement cost estimate, and the difference is the dep
Estimating Depreciation- Straight-line method
(Age-life method)
The straight-line method of estimating depreciation is the easiest method to apply.
The appraiser estimates what the useful life (economic life) of the building would be if it were new.
She then divides the estimated useful life into the
Estimating Depreciation- Engineering method
(Observed condition method)
**MOST RELIABLE
The engineering method of estimating depreciation, sometimes called the observed condition method, calls for the appraiser to inspect the structure, making observations about actual depreciation.
The conclusions
Market data
Sales comparison
Capitalized value
Used in the Income Approach to appraisal.
Capitalized Value: A mathematical formula that investors use to compute the value of a property based on net income.
Net income divided by rate is equal to value.
Age-life method
**See Estimating Depreciation- Straight-line method
Observed condition method
**See Estimating Depreciation- Engineering method
Effective age
It should be noted that when an appraiser considers the age of a property, he's concerned with its effective age, rather than its actual chronological age.
The effective age depends on how long the appraiser believes the structure will remain productive i
Adding Land Value
The last step in the replacement cost process is to add the value of the land to the depreciated value of the improvements.
The value of the land is estimated by the sales comparison method.
Prices recently paid for lots similar to the subject lot are com
Income Approach
(Capitalization method)
In the income approach to value, an appraiser changes net income into value by using a capitalization rate.
The method of appraising property in which net income is converted into value using a capitalization rate.
The third method
Capitalization method
**See Income Approach to Value
Potential Gross Income
(Gross scheduled income)
(Economic rent)
A property's potential gross income (also called its economic rent) is the amount it would rent for if it were available for rental in the current market.
The first step is calculating the property's potential gros
Economic rent
(Potential gross income)
(Gross scheduled income)
The rent that a property would earn on the open market if it were currently available for rent, as distinguished from the rent it's actually earning now (the contract rent).
What it would earn on the open
Contract rent
(Historical rent)
What it is actually earning now,
The amount of rental income due from the tenant as agreed in the lease agreement
Here's an example. Jean owns a commercial property she leases to a cafe on a three-year lease.
Bad debt & vacancy factor
There are going to be tenants who don't pay their rent.
So the appraiser must make a deduction from potential gross income to allow for occasional vacancies and unpaid rents
This deduction is expressed as a percentage of the potential gross income.
EX. Th
Effective gross income
Effective gross income is the property's potential gross income minus a bad debt and vacancy factor.
A property's potential gross income, minus a bad debt and vacancy factor.
Once the bad debt and vacancy factor is deducted, the appraiser is left with a m
Operating Expenses
From the effective gross income, the appraiser deducts the expenses connected with operating the building.
They fall into 3 classifications:
1. fixed expenses,
2. maintenance expenses, and
3. reserves for replacement
The income that is left when operating
Fixed expenses
Property taxes and hazard insurance.
-Real estate taxes
-Hazard insurance
Maintenance expenses
Services for tenants, utilities, supplies, cleaning, repairs, administrative or managerial expenses, and building employee wages.
-Tenant services
-Utilities
-Supplies
-Cleaning
-Repairs
-Administrative
-Employee wages
Reserves for replacement
Regular allowances set aside to replace structures and equipment that are expected to wear out, such as roofs, heating equipment, air conditioners, and (in a residential building) kitchen ranges and refrigerators.
-Funds set aside on a regular basis for:
Net income
Net income is calculated by subtracting operating expenses from effective gross income.
A property's effective gross income, minus operating expenses.
The income that is left when operating expenses are deducted from effective gross income
It's net income
Debt service
Some expenses, such as the owner's income taxes, the depreciation reserves, and the mortgage payments aren't deducted from the effective gross income to arrive at the net income.
These aren't considered operating expenses from an appraisal standpoint.
Do
Capitalization
The capitalization rate is the rate of return an investor wants on his or her investment in a property.
To arrive at a value estimate using the income approach, an appraiser divides the subject property's net income by an appropriate cap rate.
The process
Recapture
In effect, the capitalization rate is the rate of return an investor (a potential purchaser) would like to receive from the money she invests in the property (the purchase price).
The capitalization rate should usually take into consideration the return O
Interest
A return on an investment
A return on an investment
The investor's ability to recoup the purchase price of the property at the end of his term of ownership.
Overall rate
A capitalization rate that provides for both interest and recapture
The investor will take this into account by choosing a capitalization rate that provides for recapturing the purchase price of the improvements (return of the investment) as well as inter
Capitalization Rate Selection
To appraise property using the income approach, the appraiser must be familiar with the rate of return that investors generally demand for similar properties.
There are a number of methods an appraiser may use to determine an appropriate capitalization ra
Capitalization Rate 1.
Direct comparison method
When the appraiser could analyze recent sales of comparable income properties and assume that the subject property would have a capitalization rate similar to theirs
Capitalization Rate 2.
Band of investment method
Taking into account prevailing mortgage interest rates that would apply to the investor's loan, in addition to the rate of return required on the investor's equity investment
Summation Method 1.
Safe rate
The rate paid on secure investments such as savings accounts or long-term government bonds
Summation Method 2.
Risk rate
The portion of the rate designed to compensate the investor for the hazards that are peculiar to the investment; this component increases or decreases according to the degree of risk involved.
Summation Method 3.
Nonliquidity rate
The extra return an investor will expect from a nonliquid investment such as real estate
Summation Method 4.
Management rate
The part of the rate that compensates the owner/investor for managing the investment and reinvesting the money the investment yields
Summation method
**See Capitalization Rate 3.
Quality
How reliable the tenants are
Durability
How long the income can be expected to last
Capitalization Methods
The building residual technique is used to value a building.
The land residual technique is used to value land. The property residual technique is used to value an entire property.
After the appraiser has calculated the subject "property's net income and
Building residual technique
The building residual technique is used to estimate the VALUE of the BUILDING on the subject property.
It's used when land values are stable and easily determined, or when appraising an older building where depreciation is difficult to measure.
To apply t
Land residual technique
In the land residual technique, the BUILDING is appraised separately.
The land residual technique is used to estimate the VALUE of the subject property's LAND.
Appraisers apply this technique when the land is the site of a new building that represents the
Property residual technique
Treats the LAND AND BUILDING as one.
The property residual technique is used to find the VALUE of the PROPERTY.
This is no different from the basic capitalization procedure (Value = Income � Capitalization Rate) that you're already familiar with, though;
Gross Income Multipliers
Residences generally aren't thought of as income-producing properties, so traditional income analysis techniques don't apply.
If a residential appraiser uses the income approach at all, he will use a simplified version called the gross income multiplier m
Gross income multiplier method
(Gross rent multiplier method)
An appraiser uses the gross income multiplier method to estimate the value of a single-family home used as a rental property.
The appraiser locates comparable rental properties that have recently sold, then analyzes the rela
Gross rent multiplier method
**See Gross income multiplier method
Site Valuation
The methods used to value land include the sales comparison method, the land residual method, the distribution method, and the development method.
There are a number of situations in which an appraiser values a site apart from any improvements.
A client m
Vacant land
(Raw land)
Unimproved property
Site Valuation 1.
Sales Comparison Method
The sales comparison method is the one used most often to appraise vacant land. The appraiser uses recent sales of comparable sites to estimate the value of the subject site.
The sales comparison approach is the method of site valu
Site Valuation 2.
Land Residual Technique
The land residual method, which we discussed earlier, applies the income approach to site valuation.
It's used for improved property when the land value can't be estimated by the sales comparison approach (because of a lack of comp
Site Valuation 3.
Distribution Method
(Allocation)
(Abstraction)
The distribution method, also called allocation or abstraction, is used to value the site of an improved property.
The appraiser analyzes recent comparable sales to determine what portion of each sales price
Site Valuation 4.
Development Method
(Anticipated use method)
The development method, also known as the anticipated use method, is commonly used for vacant land when the highest and best use is subdivision development.
The appraiser estimates the future value of the develo
Reconciliation & Final Estimate of Value
Throughout the appraisal process, the appraiser is gathering facts on which he will base the ultimate conclusion, the final estimate of the property's value.
In many cases, the facts require nothing beyond simple verification; their meaning is self-eviden
Reconciliation
Reconciliation is the process of assembling and interpreting the value indicators in order to arrive at a final value estimate.
Appraisers refer to the assembly and interpretation of all the facts that influence a property's value as reconciliation
Narrative report
A narrative report is a thorough, detailed, written presentation of the facts and reasoning behind the appraiser's estimate of value.
The property value is usually stated in the section of the narrative report that discusses the purpose of the appraisal
Form report
A brief, standard form used by lending institutions and government agencies (for example, the FHA and the VA), presenting only the key data and the appraiser's conclusions.
This is the MOST COMMON type of appraisal report.
The Uniform Residential Appraisa
Arm's length transaction
A sale in which there is no pre-existing family or business relationship between the parties.
Normal sale conditions: Generally, a sale can be considered to have taken place under normal conditions if it was an arm's length transaction (a sale between unr
Sales comparison approach
The method of appraisal in which the appraiser compares the subject property to recently sold comparable properties.
Capitalization rate
The rate of return an investor wants on her investment in the property.
Percentage of home ownership
**See Neighborhood Analysis 1.
Vacant homes and lots
**See Neighborhood Analysis 2.
Conformity
**See Neighborhood Analysis 3.
Changing land use
**See Neighborhood Analysis 4.
Contour of the land
**See Neighborhood Analysis 5.
Streets
**See Neighborhood Analysis 6.
Utilities
**See Neighborhood Analysis 7.
**See Site Analysis 7.
Nuisances
**See Neighborhood Analysis 8.
Prestige
**See Neighborhood Analysis 9.
Proximity
**See Neighborhood Analysis 10.
Schools
**See Neighborhood Analysis 11.
Public services
**See Neighborhood Analysis 12.
Government influences
**See Neighborhood Analysis 13.
Width
**See Site Analysis 1.
Frontage
**See Site Analysis 2.
Area
**See Site Analysis 3.
Depth
**See Site Analysis 4.
Shape
**See Site Analysis 5.
Topography
**See Site Analysis 6.
Site in relation to area
**See Site Analysis 8.
Construction quality
**See Building Analysis 1.
Age/condition
**See Building Analysis 2.
Size of house (square footage)
**See Building Analysis 3.
Orientation
**See Building Analysis 4
Basement
**See Building Analysis 5.
Interior layout
**See Building Analysis 6.
Number of rooms
**See Building Analysis 7.
Number of bedrooms
**See Building Analysis 8.
Number of bathrooms
**See Building Analysis 9.
Air conditioning
**See Building Analysis 10.
Energy efficiency
**See Building Analysis 11.
Garage/carport
**See Building Analysis 12.
1. An appraisal is:
A. a scientific determination of a property's value
B. a property's average value, as indicated by general and specific data
C. an estimate of a property's value as of a specific date
D. a mathematical analysis of a property's value
C. an estimate of a property's value as of a specific date
2. The focus of most appraisals is the subject property's:
A. market value
B. market price
C. sales price
D. value in use
A. market value
3. A property's highest and best use is:
A. the use that will generate the greatest net return
B. the best use it could be put to if there were no zoning or other restrictions
C. the use that best promotes the public health, safety, and welfare
D. the use
A. the use that will generate the greatest net return
4. The earliest phase of a property's life cycle, when it is being developed, is called:
A. substitution
B. regression
C. integration
D. disintegration
C. integration
5. Developers have announced plans to build a multimillion dollar shopping center next door to a vacant commercial lot you own. Property values in the area will tend to increase as a result of this announcement. This is an example of the principle of:
A.
D. anticipation
6. The owner of an apartment building has asked an appraiser to determine if it would make financial sense to put in a swimming pool for the tenants' use. The appraiser will be most concerned with the principle of:
A. regression
B. substitution
C. conform
D. contribution
7. If someone were to build a high-quality home costing $550,000 in a neighborhood where all of the other homes were valued at around $275,000, the more expensive home would suffer a loss in value. This illustrates the principle of:
A.regression
B. supply
A.regression
8. An appraiser gathers general data in a:
A. site analysis
B. building analysis
C. neighborhood analysis
D. None of the above
C. neighborhood analysis
9. The sales comparison approach would almost certainly be much more important than the other two methods (the cost approach and the income approach) in the appraisal of:
A. a six-unit apartment building
B. an industrial building
C. a shopping center
D. a
D. a single-family home
10. A residential appraiser looking for good comparables is most likely to consider homes that:
A. have not changed hands within the past three years
B. are currently listed for sale
C. were sold within the past three to six months
D. were listed for less
C. were sold within the past three to six months
11. In which of the following situations would the sales comparison method of appraisal be least reliable?
A. When all of the comparables are in the same price range
B. When the real estate market has been inactive for quite a while
C. When some of the co
B. When the real estate market has been inactive for quite a while
12. When applying the sales comparison method to appraise a single-family home, an appraiser would never use as a comparable a similar home that:
A. sold over six months ago
B. sold recently but is located in another neighborhood
C. was sold by owners who
C. was sold by owners who were forced to sell because of financial difficulties
13. When using the replacement cost approach, which of the following would be least important?
A. Current construction cost per square foot
B. Rental cost per square foot
C. Depreciation
D. Estimated land value
B. Rental cost per square foot
14. An appraiser is applying the cost approach in valuing an elegant building that was built in 1894. Which of the following is most likely to be true?
A. The building's replacement cost is the same as its reproduction cost
B. The building's replacement c
B. The building's replacement cost is a better indicator of its market value than its reproduction cost
15. In the income approach to value, which of the following isn't considered to be one of the property's operating expenses?
1. General real estate taxes
2. Maintenance expenses
3. Reserves for replacement
4. Mortgage payments
4. Mortgage payments
Appraiser's fee
The appraiser's fee must be set before the appraisal is performed, based on the anticipated difficulty of the appraisal and on rates customary in the local market.
The fee cannot be tied to how much the appraiser concludes the property is worth.
It is not
Appraiser Ethics
Although an appraiser is acting on behalf of her client, it's a serious ethical violation if an appraiser gives a false estimate of a property's value to serve the client's purposes.
Deliberately overvaluing or undervaluing a property may amount to action
Federally related loan
Appraisals prepared by licensed or certified appraisers are required in federally related loan transactions.
A loan made by any bank or savings and loan association that is regulated or insured by the federal government.
Loans for $250,000 or less are exe
Certified General Real Estate Appraisers
Certified General Real Estate Appraisers may appraise any type of real property.
This license requires:
-300 hours of appraisal education,
-3,000 hours of appraisal experience (including 1,500 hours appraising nonresidential properties) over at least 30 m
Certified Residential Real Estate Appraisers
May appraise any one- to four-unit residential property, and nonresidential properties valued up to $250,000.
This license requires:
-200 hours of appraisal education,
-2,500 hours of appraisal experience over at least 30 months,
-an associate's degree (o
Residential License
An appraiser with a Residential License may appraise any one- to four-unit residential property valued up to $1 million, and nonresidential properties valued up to $250,000.
This license requires:
-150 hours of appraisal education,
-2,000 hours of apprais
Trainee License
An appraiser with a Trainee License must work under the technical supervision of a licensed appraiser.
The trainee may assist with any appraisal within the scope of the supervising appraiser's license.
This license requires:
-150 hours of appraisal educat
Property value
For an appraiser evaluating residential property, the primary considerations are marketability and acceptability.
Those qualities are the fundamental basis for the property's value.
Sale
A sale can be considered to have taken place under normal conditions if:
-it was an arm's length transaction (a sale between unrelated parties);
-the property was offered on the open market for a reasonable length of time;
-both parties acted prudently an
Utility value
The value of property to its owner or user.
Social ideals/standards
-Demographics (population size, growth, density, & distribution)
-Family size & living arrangements
-Attitudes about education
-Trends in archiectural design & utility
-Other trends, such as a preference for energy-efficient homes
Government regulations
-Zoning ordinances
-Building codes
-Environmental regulations
-Fire regulations
-Taxation policies
Physical/Environmental factors
-Climate
-Topography
-Soil characteristics
-Flood control
Effective date
Every appraisal is tied to a given date, called the effective date of the appraisal
In-fill development
Construction of small-scale developments on vacant pockets of land remaining within the city
This results in higher density in urban neighborhoods where current uses may not match the area's highest and best use.
Surplus productivity
To determine whether a property's agents in production are in proper balance, an appraiser deducts an amount attributable to each one from the property's gross earnings.
The appraiser deducts for labor (wages paid as operating costs), for coordination (ma
Feasibility study
Evaluate whether such a project would be profitable, given the economic conditions and other general data
Rental Rates
Property managers often use the market data approach (the sales comparison approach) to establish rental rates for apartments.
Rents charged for comparable apartments indicate the appropriate rent for the managed apartments.
However, when an appraiser val
Normal sale conditions
Generally, a sale can be considered to have taken place under normal conditions if it was an arm's length transaction (a sale between unrelated parties); the property was offered on the open market for a reasonable length of time; both parties acted prude
Value ceiling
In the cost approach, the appraiser estimates how much it would cost to build a replacement of the improvements that are on the subject property.
Because of this, the cost approach is well suited to appraisal of newly constructed buildings.
To the apprais
Functional utility
A building's functional utility is based on its ability to fulfill the desires of its occupants or users. Thus, functional utility includes not only actual usefulness, but also attractiveness.
So outdated architectural features that are no longer consider
Capitalized method
In the capitalization method, the appraiser uses the income approach to estimate the building's currenct value.
The building in its current state is worth less than a brand new replacement that has not yet depreciated.
So the capitalized value should be l
Market Data method
To estimate depreciation with the market data method, the appraiser estimates the building's current value using the market data (sales comparison) approach.
Then the appraiser subtracts the value arrived at throught the market data approach from the repl
Straight-line method
(Age-life method)
To estimate depreciation using the straight-line method, the appraiser first judges how long the building's useful life (its economic life) would be if it were new.
Next, she divides the building's replacement cost by the useful life to
Engineering method
(Observed condition method)
(Breakdown method)
It requires the appraiser to inspect the building and make judgements about the extend of the actual deprecitaion.
While this method of estimating depreciation requires the most skill on the part of the appra
Economic obsolescence
**See External obsolescence
Gross scheduled income
**See Potential gross income
Summation
The summation method divides the capitalization rate into four components. The appraiser assigns a figure to each component, then adds them together to arrive at a capitalization rate.
The 4 components are:
1. the safe rate,
2. the risk rate,
3. the nonli
Capitalization income
After the appraiser has calculated the subject property's net income and chosen a cap rate, there's one final step.
This last step is capitalizing the property's income to arrive at an estimate of value.
Income � Rate = Value
Economic changes that affect