Chapter 16 - Real Estate Appraisal

Appraisal

An independent, impartial, and objective estimate (or opinion) of real property value that is defensible

The basis upon which an appraiser is paid for performing an appraisal

Amount of time and difficulty of the task (not based on the property value)

Governing standards under which all appraisals in federally related transactions must be performed

Uniform Standards of Professional Appraisal Practice (USPAP)

USPAP, definition for the actual or estimated amount required to create, product, or obtain a property, including labor, materials, financing expense, land management, overhead, and the contractor’s profit

Cost; 

Which may be more than, or less than, the market value of the property

USPAP, definition for the amount that is actually paid in a real estate transaction; the amount that the buyer is willing to pay, and the seller is willing to accept

Price;

Which may be more than, or less than, the market value of the property

USPAP definition for an opinion of the monetary worth of a property at a given time

Value
The appraiser gives an opinion of value for a specific type of valuation being performed, such as market value, liquidation value, or investment value

Four elements (characteristics) that interact to create or affect the value of real estate

1. Demand

2. Utility

3. Scarcity

4. Transferability

Value that is the most probable price at which the property will sell

Market value;

The amount that should be paid for the property, but not necessarily the amount asked or actually paid – might be higher or lower than the cost or price

Factors inherent in the definition of market value

• Property on market for reasonable time

• Buyer and seller informed and acting in own interest not under duress

• Seller can convey title

• Payment in U.S. dollars

Value assigned by the property appraiser for ad valorem tax purposes

Assessed value

Value used by insurance companies as the basis for insurance coverage

Insurable value

Value used to determine the value of a property to a specific individual investor or group of investors

Investment value

Value that is the amount that remains after all the assets of a business have been sold in a hurried, but not forced, sale and all liabilities have been paid

Liquidation value;

Used to estimate a failing business or the minimum value of a profitable business

Value that is the amount that can be received from the sale of the parts from a demolished structure

Salvage value

The type of value that results from an assemblage, or combining, of two or more adjacent parcels of land under one owner

Plottage value;

The value of the whole assemblage will typically be greater than the sum of the individual parcels

Value that is the amount of income (net present value) generated by the property in a certain use for a certain owner

Value-in-use;

May be higher or lower than market value

Principal of value that states that no one will pay more for a property than the amount necessary to acquire an acceptable substitute

Principle of substitution;

This is the basis for all mathematical methods that are used by appraisers to estimate value

Principle of value that states that circumstances can alter the market, which in turn may affect the value of real estate

Principle of change;

Appraisals are made as of a specific date to take this into account

Principle of value that recognizes that sellers compete with other sellers, and buyers compete with other buyers

Principle of competition;

Focuses on the effect of changes in supply 

and demand

Principle of value that states that the value of a property is sustained when it is similar in size, architectural style, and other features with properties in the same area

Principle of conformity

Principle of value that states that the value of a component of a property is the amount it adds to the total value of the property, or would decrease the value in the absence of the component

Principal of contribution

Principle of value that states that the best use for the property is the use that would most likely produce the greatest net return to the land over a given period of time

Principle of highest and best use

Principle of value that states that a lower priced property in an area that consists of more expensive properties will increase in value toward the level of the more expensive properties

Principle of progression;

Tends to create price conformity within an area

Principle of value that states that a higher priced property in an area that consists of lower priced properties will decrease in value toward the level of the less expensive properties

Principle of regression;

Tends to create price conformity within an area

Two key aspects of every appraisal that the appraiser must know

1. Purpose - estimate some type of defined value, such as market value or investment value

2. Intended use - how the appraisal will be used by the client, such as for a lender to determine whether to lend

Six steps performed in an appraisal

1. Define the problem

2. Determine scope of work

3. Data collection & analysis

4. Apply 3 approaches to value

5. Reconcile for final opinion of value

6. Prepare report

Information required by an appraiser for the first step in the appraisal process – defining the problem

• Client and other intended users

• Purpose and intended use

• Effective date

• Property characteristics

• Other conditions, laws, or regulations affecting scope of work

Two types of analysis performed as part of step 3 in the appraisal process – performing data collection and analysis

1. Market analysis (supply, demand, and marketability)

2. Highest and best use analysis (as vacant and as improved

Purpose for a highest and best use analysis of a property as vacant (the land)

Establish the value of the land (site) based on how it should be used rather than how it is currently used

Purpose for a highest and best use analysis of a property considering improvements, such as buildings

Determine whether the present use is the best use, or if an alternative use should be considered to maximize the value of the land (site) with improvements; alternatives include renovation or possible removal

Three approaches to value performed as step 4 in the appraisal process

1. Sales comparison (or comparable sales) approach

2. Cost-depreciation (or cost) approach

3. Income approach

Method used in step 5 of the appraisal process to reconcile the value indications and estimate a final opinion of value

The appraiser weighs the results of the 3 approaches according to their confidence and the appropriateness of the data; greater weight is given to the approach best reflecting the value of the subject to estimate the final value

Three report options for step 6 of the appraisal process – preparing a report of the defined value options

1. Form report

2. Narrative report

3. Oral report

Appraisal report that is typically used for residential appraisals and is typically required by primary and secondary lenders

Form report;

Standardizes the way in which information is reported

Comprehensive appraisal report, providing the client with the reasoning and conclusions of the appraiser in a detail; may contain as many as 50 to 300 or more pages

Narrative report

Appraisal report  given in court testimony

Oral report

Appraisal method that is based on and analysis of recent sales of similar properties in the same market

Sales comparison (or comparable sales) approach;

Sometimes referred to as the paired sales analysis approach

Appraisal principle of value that is the basis of the sales comparison approach

Principle of substituion

Applicable uses for the sales comparison approach

Residential properties or vacant land in an active market

Three steps in the sales comparison approach

1. Locate comparable properties

2. Adjust the comparable sales prices

3. Reconcile the adjusted sales prices

Property the appraiser is attempting to determine a value for

Subject property

Properties used in the sales comparison approach to estimate the value of the subject property

Comparable properties (comparables, or “comps”)

Characteristics of suitable comparable properties used in the sales comparison approach to value the subject property

Properties that have sold recently and are similar in design, size, location, age, and condition. Parties in the sale should be unrelated (arm’s length transaction)

Where adjustments are applied to properties property values in the sales comparison approach

Adjustments are always made to the comparable properties, NEVER the subject property, to make the comparable more like the subject property

How adjustments are applied to comparable properties in the sales comparison approach

• If the comparable is SUPERIOR to the subject, SUBTRACT from the comparable value

• If the comparable is INFERIOR to the subject, INCREASE (or add to) the comparable value

Adjustments made in the comparable sales approach

1. Financing terms

2. Conditions of sale

3. Market conditions

4. Location

5. Physical characteristics

 Reconciliation of the adjusted price of the 3 approaches to value:  1) sales comparison, 2, cost-depreciation 3) income approach

The appraiser uses experience and judgment to apply a weighted average in determining the subject value estimate; A simple average is not used

Appraisal method that is used to estimate the current cost of reproducing or replacing a building, minus an estimate of depreciation

Cost-depreciation (or cost) approach

Appraisal principle of value that is the basis of the cost-comparison approach

Principle of substitution;

No one would pay more for an existing property than the cost to purchase land and build a new building

Two ways of estimating the value of a subject property using the cost approach

1. Replacement cost

2. Reproduction cost

Estimate replacement cost

Estimate the cost at current prices to construct a comparable building with equal utility to the subject building using modern materials, design, and features

Estimate reproduction cost

Estimate the cost to construct, at current prices, an exact duplicate or replica of the subject building by using the same materials, design, and layout as the original; Used for historic properties

Applicable uses for the cost-depreciation approach

Newer properties, property proposed for renovation, insurance purposes, or properties infrequently sold in the real estate market

Steps in the cost-depreciation approach to estimate property value

1. Estimate the replacement cost (building)

2. Estimate the accrued depreciation (building)

3. Subtract to find the depreciated cost

4. Estimate the value of the land (comparable sales)

5. Add depreciated building cost to land value

Three methods for estimating the cost to replace or reproduce the main improvement (building) with the cost-depreciation approach

1. Quantity survey method 

2. Unit-in-place method 

3. Unit-of-comparison method

Estimate the cost of the main improvement using a detailed inventory and precise cost for each item to be constructed

Quantity survey method;

The most accurate method, but time consuming

Estimate the cost of each component of the property using nationally published cost manuals that provide information such as the cost per square foot, or cubic foot

Unit-in-place method;

Simpler and faster than the quantity survey method

Estimate the cost per square foot or cubic foot of an entire building using a recently constructed building with a known cost per square foot or cubic foot

Unit-of-comparison method;

The recently constructed building is referred to as a benchmark building

The three categories of depreciation used to estimate accrued depreciation in the main improvement (building) with the cost-depreciation approach

1. Physical deterioration

2. Functional obsolescence

3. External obsolescence

The type of depreciation that is due to either a deficiency, over-improvement, structural deficiency, or excess that affects the value of the property

Functional (or economic) obsolescence

Examples of functional obsolescence due to a deficiency (loss in value due to the failure of a property to meet current consumer preferences due to changes in building design or standards)

A home with structural deficiencies such as inadequate lighting, outdated fixtures, lack of central heat or air-conditioning, one bathroom in a four-bedroom house, or an inefficient floor plan

Examples of functional obsolescence due to over-improvement (an investment made to property that does not make the best use of the property or is excessive with respect to similar properties)

A swimming pool that cost 5 times as much to build as the market is willing to pay; Adding a bedroom to a house where the cost of the improvement far exceeds what the market values for the extra bedroom

The type of depreciation that is due to normal wear and tear from use, negligence, or aging of the building

Physical deterioration

Examples of physical deterioration

Broken windows, deteriorated roof shingles, faded or peeling paint, or worn carpeting

The type of depreciation caused by factors beyond the boundaries of the subject property

External obsolescence

Examples of external obsolescence

Location near an airport, busy or noisy roadway, landfill, wastewater treatment plant, of blighted area

The simplest method for estimating the percentage of accrued straight-line depreciation over the total economic life of a building - used with the cost-depreciation appraisal approach

Economic age-life method

The term that refers to the estimated number of years that a building will contribute value above the value of the land (100% of its useful life)

Total economic life (number of years)

The term that refers to the age a property appears to be due to extensive updates or excessive wear and tear (condition)

Effective age (# of years);

Not necessarily the actual age of the building

The formula used with the economic age-life method for estimating the rate of accrued depreciation over the total life of the building

Effective age ÷ 

Total economic life = 

Rate (%) of depreciation

The formula for estimating the dollar amount of accrued depreciation over the life of the building

Rate of depreciation x Reproduction cost of the building = Total accrued depreciation ($)

The appraisal method that is used to estimate the value that a property’s net earning power will support

Income approach

Applicable uses for the income approach

Income-producing property or valuation of a business

The two techniques that can be applied for the income approach

1. Direct capitalization

2. Gross multiplier

The mathematical technique used with the income approach in which future income is converted into a present value

Direct capitalization approach

The term that refers to the total annual income for the coming year

Potential gross income (PGI);

Can come from contract rent and market rent

The type of rent that is specified in a lease

Contract rent;

Used if existing tenants have excellent credit and long-term leases

The type of rent that it the amount that is estimated for vacant or owner-occupied space, and space occupied by tenants with short-term leases or those who have questionable credit

Market rent;

Based on rents charged in the market for comparable properties

The formula for calculating the effective gross income (EGI) which is the actual amount the owner can expect to receive from operation of the property for one year into the future

EGI = Potential gross income (PGI) – Vacancy & collection loss (V&C) + Other income (OI);

Other income may come from sources such as carport rentals or vending machines

The formula for estimating the net operating income (NOI) with the direct capitalization technique

NOI = Effective gross income (EGI) – Operating Expenses (OE)

The three types of operating expenses used to estimate value with the direct capitalization technique

1. Fixed expenses (FE)

2. Variable expenses (VE)

3. Reserves for replacements

Items NOT included in operating expenses

Mortgage payments, tax depreciation, capital improvements, personal expenses unrelated to operation of the property, and income taxes

Examples of fixed expenses (FE)

Expenses that do not change with occupancy such as property taxes and hazard insurance

Examples of variable expenses (VE)

Expenses that change with occupancy such as maintenance, utilities, trash removal, janitorial services, and management fees (usually a % of the EGI)

Examples of short-lived items where funds are set aside annually for replacement (reserves for replacement)

Items that wear out and must be replaced before the end of the economic life of the building, such as stoves, refrigerators, carpets, or roof covers

The term that refers to the rate of return on the investment that is derived from comparable properties in the same market

Capitalization rate

The math steps used with the direct capitalization technique to estimate value from the NOI and capitalization rate

𝑁𝑂𝐼/𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒=𝑉𝑎𝑙𝑢𝑒

The three forms of the IRV formula used to determine income (I), capitalization rate (R), or estimated value (V)

• NOI = Rate x Value
  I = R x V
  

• Value = NOI ÷ Rate
  V = I ÷ R
  

• Rate = NOI ÷ Value
  R = I ÷ V

The mathematical technique used with the income approach to estimate value based on a rent multiplier that is derived from comparable properties

Gross multiplier technique

The two types of gross multipliers used to determine value of a subject rental property from comparable properties rented at the time of sale

• Gross rent multiplier (GRM)
  

• Gross income multiplier (GIM)

The formula used to estimate the value for rental properties based on the monthly gross rental income

Gross rent multiplier (GRM) = Comparable sales price ÷ Gross monthly rent

The formula used to estimate the value of rental properties based on the annual gross rental income

Gross income multiplier (GIM) = Comparable sales price ÷ Annual gross rental income

The Part # of F.S. 475 that regulates real estate appraisers for the protection of the public

F.S. 475, Part II; Part I regulated real estate brokers, sales associates, and real estate schools

The board, created by F.S. 475, Part II, to administer and enforce the laws governing real estate appraiser

Florida Real Estate Appraisal Board (FREAB); Consists of 9 members, appointed by the governor and confirmed by the FL senate

The three levels of appraiser licensing

1. Registered trainee appraisers

2. State-certified residential appraisers

3. State-certified general appraisers

The level of appraisers that are certified by the DBPR to issue appraisal reports for any type of property classification

State-certified general appraisers

The level of appraisers who may perform appraisal services only under the direct supervision of a certified appraiser

Registered trainee appraisers

The level of appraisers who may perform appraisal services for real property of one- to four-residential units, but not for all property classifications

State-certified residential appraisers

The three types of valuations that real estate licensees may perform without additional licensing

1. Valuation in a non-federally related transaction

2. Comparative Market Analysis (CMA)

3. Broker Price Opinion (BPO)

The terms that a real estate licensee may never use to refer to valuation services performed in connection with the listing or sale of property, unless registered to do so

Appraiser or appraisal