RE 101 Ch. 11: Lesson 11: Real Estate Appraisal - Terms

Appraisal

An appraisal is an estimate or opinion of a property's value. The term is generally used to refer to an opinion rendered by an expert appraiser, set forth in a formal written statement called an appraisal report.

fee appraiser

An appraiser who works either as an independent contractor or for an independent appraisal firm.

Federally Related Loan

A federally related loan is 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 exempt from the certified or licensed appraiser requirement, however.

Certified Real Estate Appraisers

may appraise any type of real property.

Certified Residential Real Estate Appraiser

may appraise any one-to-four-unit residential property, and nonresidential properties valued up to $250,000.

Residential License Appraiser

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.

Trainee License Appraiser

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.

Elements of Value

To have value, an item must have four basic attributes that are known as the elements of value.

Utility: Filling a need or serving a purpose.Scarcity: In relatively short supply, or difficult to obtain.Demand: Producing a desire to own. (Effective demand refers to the desire of those with purchasing power.)Transferability: Possession and ownership rights can be transferred.

Generally, the more useful and scarce the item, the greater the demand and the higher the value (provided the item is transferable).

Market Price

The price someone paid for the property in an actual transaction (the sales price).

Market Value

The price someone should pay for the property under normal conditions.

Social Ideals and Standards

- Demographics (population size, growth, density, and distribution)

- Family size and living arrangements

- Attitudes about education

- Trends in architectural design and utility

- Other trends, such as a preference for energy-efficient homes

Economic Trends

- Local economic conditions

- National economic trends

- Employment trends and wage levels

- Cost and availability of financing

Government Regulations

- Zoning ordinances

- Building codes

- Environmental regulations

- Fire regulations

- Taxation policies

Physical/Environmental Factors

- Climate

- Topography

- Soil characteristics

- Flood control

Unearned Increment

Value added to land due to increased development and demand, none which the owner is responsible for.

Each of the four major forces affects value independently of the property owner's efforts.

For instance, a property's value could increase simply because of a population increase in the area, and not because the owner has improved the property in any way.

If a property's value increases purely because of outside forces, the increase is called an unearned increment.

Rehabilitation

If a building is restored to good condition without being changed, it's called rehabilitation.

Remodeling

If a building's floor plan or style are altered, it's known as remodeling.

Redevelopment

And an entire neighborhood can be rejuvenated by redevelopment. An urban renewal project in which existing buildings are demolished and replaced is an example of redevelopment.

Redevelopment may also take the form of in-fill development, where older low-density buildings are replaced with higher-density buildings that make more effective use of the land.

Principle of Comformity

Within a neighborhood, a reasonable degree of conformity among the properties has a positive effect on their value. This is especially true for residential neighborhoods. While some variety is desirable, if there's great disparity between the quality and condition of neighboring homes, that tends to depress property values.

This is known as the principle of conformity.

Principle of Progression

The value of a property is also affected by the company it keeps.An unattractive, inexpensive, or poorly maintained home is generallyworth more in a neighborhood of better homes than it would be in a neighborhood of similar homes. This is the principle of progression.

Principle of Regression

Conversely, an expensive, well-kept home is worth less in a neighborhood of inexpensive or rundown homes than it would be if it were surrounded by other high-end properties. This is the principle of regression.

Principle of Contribution

The principle of contribution concerns how improvements made to property affect its value.

As you might expect, when a property owner makes improvements—building new structures, remodeling, and so on—the improvements usually increase the property's value. However, any given improvement may contribute less to the value of the property than it cost to make.

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 (management costs), and for capital (principal and interest invested in the property).

The remaining earnings are called the surplus productivity. The surplus productivity is attributed to the land.

Appraisal Process Steps

The Appraisal Process:

Define the problem

Determine the scope of work

Collect and verify data

Analyze data

Determine site value

Appraisal methods

Reconciliation

Issue report

Trend

The appraiser examines economic trends to see how they might affect the property's value in the future.

A trend is a series of related developments that form a pattern.

Although national trends can be significant, local economic trends and conditions have the greatest impact on the value of real estate.

Frontage

the length of the lot 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 front foot.

Commercial Acre (Buildable Acre)

A commercial acre is the buildable portion of an acre that remains after dedications have been made for streets, sidewalks, and parks.

Depth

A lot's depth is the distance between its front and rear boundaries. Greater depth doesn't always translate into greater value.

Depth Table

In certain situations, a depth table is used to estimate the impact of a lot's depth on its value.

A depth table 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 tables are not considered accurate enough for most appraisal purposes.

For example, an appraiser would not ordinarily use a depth table in estimating the market value of residential property. However, a tax assessor might use a depth table when valuing commercial property for tax purposes.

Orientation

Another consideration in the building analysis is the building's orientation—how it is positioned on the property in relation to views, privacy, and exposure to wind, sunlight, and noise.

Feasibility Study

One final point about gathering data. If an appraiser is performing a feasibility study for residential development, she won't be concerned with specific data concerning the proposed development.

The goal of a feasibility study is to evaluate whether such a project would be profitable, given the economic conditions and other general data.

Sales Comparison Approach

A method for estimating the market value of a property by comparing similar properties to the subject property.

Cost Approach

A method of estimating value based on the economic principle of substitution; the value of a building cannot be greater than the cost of purchasing a similar site and constructing a building of equal utility.

Replacement Cost

A property's replacement cost is how much it would cost to build improvements with the same utility as those on the subject property, using modern materials and construction methods.

Appraisers typically work with the replacement cost, especially if the improvements aren't brand new.

Reproduction Cost

A property's reproduction cost is how much it would cost to build an exact replica of the improvements.

This can be a reliable indication of value if the property being appraised is new or nearly new, because the materials and skilled labor necessary to replicate the property would still be available at competitive prices.

Curable Depreciation

Depreciation is considered curable if the cost of correcting it could be recovered in the sales price when the property is sold.

Incurable Depreciation

Depreciation is incurable if it's impossible to correct, or if it's so expensive to correct that repair is impractical.

Deferred Maintenance

Curable physical deterioration is often referred to as deferred maintenance.

Functional Obsolescence

Functional obsolescence is a loss in value due to functional inadequacies such as defects in design, outdated fixtures, or an inadequate floor plan.

Examples include obsolete kitchen appliances, one-car garages, and too few bathrooms in relation to the number of bedrooms.

Like physical deterioration, functional obsolescence may be curable or incurable.

External Obsolescence

External obsolescence is also called economic obsolescence. Less frequently it is called environmental or locational obsolescence. This is a loss in value from causes outside the property itself.

Adverse zoning changes, undesirable surroundings, traffic congestion, a shortage of essential services nearby—such as transportation, schools, and shopping—are all examples of external obsolescence.

Capitalization Method

In the capitalization method, the appraiser uses the income approach (which we will discuss in the next section) to estimate the building's current value.

This estimate is called the capitalized value. This method is most appropriate for rental properties, for which a likely monthly income can be determined.

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 through the market data approach from the replacement cost. The difference is the estimated depreciation.

Straight Line Method Approach

The straight-line method assumes that depreciation occurs at a constant rate throughout a property's life. To use this method, the appraiser first judges how long the building's useful life (its economic life) would be if it were new.

After that, she divides the building's replacement cost by the useful life to get an annual depreciation figure.

Effective Age

The difference between the theoretical economic life of a structure and its actual remaining economic life. Maintaining the property.

Engineering Method

The engineering method is sometimes called the observed condition method or the breakdown method. It requires the appraiser to inspect the building and make judgments about the extent of the actual depreciation.

While this method of estimating depreciation requires the most skill on the part of the appraiser, it is also considered to be the most reliable method.

Fixed Expenses

- Real estate taxes

- Hazard insurance

- Salaries

Variable Expenses

- Tenant services

- Utilities

- Supplies

- Cleaning

- Repairs

- Administrative

- Management fees

Reserves for Replacement

- Funds set aside on a regular basis for:

- Replacement of structures

- Equipment that wears out

Overall Rate

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 interest (return on the investment).

A capitalization rate that provides for both interest and recapture is called an overall rate.

Direct Comparison Method

appraiser analyzes recent sales of comparable income-producing properties and decides on a capitalization rate based on the rates indicated by those comparable sales.

Band of Investment Method

In the band of investment method, the appraiser considers prevailing mortgage interest rates (which would apply to an investor's loan to purchase the property), in addition to the rate of return required on the investor's equity investment.

Summation Method

The summation method starts with the interest rate paid by a safe investment (such as bonds). It then adds enough interest to cover management costs, the lack of liquidity of real estate, and other risk factors.

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.

Land Residual Technique

Method of ESTIMATING Land Value in which the Net Operating Income attributable to the land is capitalized to produce an indication of the land's contribution to the Total Property

Property Residual Technique

Used in the income approach to find the value of the property, both land and building.

Gross Income Multiplier (GIM)

A method of appraising income-producing property based on a multiple of the annual gross income; also called a gross rent multiplier.

Distribution Method

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 was due to land costs.

Development 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 developed lots and subtracts the costs of development to calculate the current value of the land.