Chapter 7–10 Notes: Valuation, CMA, Business Valuation, and Brokerage
Chapter 7 – Three Approaches to Value
Objective: Describe, apply, and reconcile the three approaches (sales comparison, cost, income) to estimate market value.
Three approaches: Sales Comparison, Cost Approach, Income Approach.
Key idea: The appraiser applies the approaches appropriately and reconciles to a single value conclusion.
The Sales Comparison Approach
Also called market, market data, comparable sales, direct sales comparison.
Principle: Substitution — a buyer won’t pay more for a property than for an equally desirable comparable.
Three steps:
Step 1: Locate comparable sales
Qualifying comparables: similar in size, shape, design, location; arm's-length; sold recently.
Sources: Local brokers, appraisers, MLS, county assessor, public records.
Data for each comp: date of sale, sale price, financing terms, location, physical characteristics, terms of sale.
Step 2: Adjust for dissimilarities
Use 3–5 comparables; adjust each price toward the subject.
Adjustments are market-based (not cost-based).
If subject is better, adjust comp upward; if worse, adjust downward.
Temporal adjustments use market conditions; adjustments can be expressed via TANSP (time-adjusted normal sale price).
Major factors of adjustment: transactional characteristics, market conditions, location, physical characteristics.
Sequence: transactional characteristics first, then location, then physical characteristics (T-L-P).
Step 3: Reconcile the value
Adjusted sale prices of comparables are reconciled (not simply averaged) to arrive at the subject’s value.
Major concepts:
Normal sale price = Transaction price + Financing terms + Condition of sale + Sales concessions.
Market conditions adjusted normal sale price = Normal sale price + Market conditions adjustment.
Final adjusted sale price = Market conditions adjusted normal sale price + Location adjustment + Physical characteristics adjustment.
Factors and data quality:
Location, site size, view, age, design, condition, quality, garage vs. carport, pools, etc.
Uniform Appraisal Dataset (UAD) descriptors for federally related transactions (C/Q ratings for Condition/Quality).
USPAP reference: “relevant characteristics” affecting value.
Pros/Cons:
Pros: market reflection, widely understood, courts rely on it, best for residential.
Cons: active market required; no two properties are identical; difficult for special-use properties.
Reconciliation: A judgment-based correlation of comparables to determine value.
The Cost Approach
When used: for special-purpose buildings (schools, jails, churches, civic centers) and for new or near-new properties; reflects the upper limit of value for highest and best use on the land.
Six steps:
Step 1: Estimate replacement cost (today’s prices, modern construction) or reproduction cost (exact replica).
Replacement cost reflects current methods/tools; reproduction cost is a replica.
Data sources: cost services (e.g., Marshall & Swift).
Step 2: Estimate accrued depreciation (loss in value due to age, use, deterioration, obsolescence).
Major components: roof, floors, walls, electrical, hvac, plumbing, etc.
Types of depreciation: physical deterioration, functional obsolescence, external obsolescence.
Effective age vs. actual age; observed condition guides depreciation.
Step 3: Subtract accrued depreciation from replacement cost to get present depreciated cost of the building.
Step 4: Estimate land (site) value (via market data, independent of building).
Step 5: Depreciate site improvements (if any).
Step 6: Add present depreciated building cost + depreciated site improvements + land value to obtain final value.
Methods to determine replacement cost:
Quantity Survey Cost Method
Unit-in-Place Cost Method
Unit-of-Comparison Cost Method
Economic Age-Life Method (depreciation calculation):
If total economic life is EL and effective age is EA, depreciation percentage = EA/EL.
Accrued depreciation = Replacement cost × (EA/EL).
Example: If RC new = $1,875,000, EL = 30 yrs, EA = 18 yrs, then
Present depreciated cost = RC new − Depreciation.
Land and site: value estimated via market comparison; site improvements depreciated; final value equals
the sum of: present depreciated building cost + depreciated site improvements + land value.Cost Approach: Advantages – often most accurate for public buildings and new tract housing; disadvantages – hard to measure accrued depreciation precisely; can diverge from market value for older or uniquely valued properties.
Example structure: A problem using unit-of-comparison cost yields a replacement cost; compute depreciation; derive final value as shown in problems in the material.
The Income Approach
Purpose: estimate value of income-producing real estate as the present value of its future income stream.
Two main methods:
Income Method (direct capitalization) – suitable for larger or stable income properties; used for listing prices, investment advice, and fee appraisals.
Gross Income Method (GRM/GIM) – uses gross income multipliers for smaller properties.
Five-step process (Income Method):
Step 1: Estimate annual potential gross income (PGI).
Use contract rent, market rent, or both.
Step 2: Estimate effective gross income (EGI) by deducting vacancy and collection losses (VCL) from PGI, and adding other income.
VCL is a percentage of PGI (or EGI).
Step 3: Estimate net operating income (NOI) by deducting operating expenses (OE) from EGI.
OE includes fixed expenses (FE), variable expenses (VE), and reserves for replacements (RR).
NOI = EGI − (FE + VE + RR).
Step 4: Select a capitalization rate (R).
Often market-derived; reflects return requirements, interest rates, risk, etc.
Step 5: Apply the cap rate: Value V = NOI ÷ R.
IRV (three-variable) framework:
I = R × V
R = I ÷ V
V = I ÷ R
If two of the three are known, the third can be solved.
GRM and GIM (gross methods):
GRM (monthly): GRM = Selling price ÷ Monthly rent; Value = GRM × Subject monthly rent.
GIM (annual): GIM = Selling price ÷ Annual gross income; Value = GIM × Subject annual gross income.
Reconciliation: Weigh the applicability and reliability of each approach; a final value conclusion is reconciled (not averaged) across approaches.
Sample problems (brief): Provided problems illustrate deriving value from direct capitalization and from GRM/GIM analyses.
Comparative Market Analysis (CMA) vs Appraisal (Chapter 8)
CMA/BPO are licensee-produced value estimates, not formal appraisals; CMA uses the Sales Comparison Approach.
Purpose: help sellers and buyers estimate market value; used in listing or offer decisions.
Comparables (comps):
Sold within the last 12 months (or less)
Currently on the market
Expired within the last 12 months without selling
Data for CMA: physical characteristics (size, rooms, age, construction), terms, time, market conditions, etc.; sources include MLS, tax rolls, courthouses, etc.
Adjustment basics: compare subject to comparables and adjust comparables toward subject for differences in: square footage, beds/baths, garages, pools, lot size, etc.
Four factors of adjustment (transactional, location, physical characteristics, etc.) with T-L-P sequence.
Square footage: living area must be measured as defined by ANSI standards; include guidance on what counts as living area and what to exclude (e.g., garages, unfinished spaces).
Practice floor plans and square footage calculations illustrate how to compute living area and overall value indications.
Reporting: CMA reports typically include an adjustment grid, final value indications, and a range of values; supported by cost-per-square-foot benchmarks.
Summary of Key CMA Concepts
The CMA uses adjusted sale prices of comparables to estimate market value for a subject; adjustments are market-derived.
The final listing price is a professional judgment based on the adjustment grid, comparables, and market data; a CMA often provides a price range rather than a single point value.
Four common data elements in CMAs: location, living area (sq ft), lot size, and sale terms.
Business Valuation (Chapter 9)
Four approaches to value a business: Sales Comparison, Cost, Income, and Liquidation Value.
Going concern value vs. asset-based value; business valuation often includes real estate and intangible assets (goodwill, licenses, trademarks, etc.).
Business entities: sole proprietorship, partnership (general/limited), corporation, S-Corp, trusts.
Why value a business: sale/purchase, allocation, divorce, condemnation, financial reporting, mergers, etc.
Six-step business valuation process:
Step 1: Define the problem (interests/assets, purpose, type of value).
Step 2: Establish the date of valuation and collect data (financial statements, market data).
Step 3: Analyze data (income statements, comparable sales, pro forma analyses).
Step 4: Develop informed judgment; formulate value conclusion.
Step 5: Prepare the report (scope, data, assumptions, limitations).
Step 6: Communicate results.
Financial statements concepts:
Balance sheet vs. income statement; cash vs. accrual accounting; assets vs. liabilities vs. equity.
Key ratios: quick ratio, current ratio, inventory turnover, debt-to-worth, net profit on owner capital.
Adjusted statements for comparability (adjusted balance sheet, economic balance sheet, pro forma income statement).
Intangible assets and residual methods:
Types: business goodwill, personal goodwill, separable intangibles (franchises, licenses, trademarks, copyrights, leaseholds).
Excess profits approach and market residual approach used to value intangibles.
Practical notes:
GAAP distortions can affect business valuations; cash vs. accrual accounting differences matter for comparables.
Listing and Selling Real Property (Chapter 10)
Brokerage relationships: four forms
Single Agent (fiduciary duties to one party)
Transaction Broker (limited representation to both parties; no fiduciary duties)
No Brokerage Relationship (non-representation; limited duties)
Designated Sales Associate (one agent represents seller, another represents buyer in some nonresidential or high-asset cases)
Fiduciary duties owed in single-agent relations: loyalty, confidentiality, obedience, full disclosure, accounting, skill/care/diligence, presenting all offers in a timely manner.
Non-fiduciary duties: honesty, accounting for funds, fair dealing, etc.
No Brokerage Relationship: duties include honesty, disclosure of known material facts, and accounting for funds; no agency relationship.
Mandatory disclosures/forms:
Notice of No Brokerage Relationship
Single Agent Disclosure Form
Consent to Transition to Transaction Broker (when moving from single agent to transaction broker)
Transition forms must be signed; transition to designated sales associate in certain nonresidential cases requires explicit consent.
Transition rules:
A licensee may transition from single agency to transaction broker with prior written consent; transition to other forms can also occur with proper disclosures.
Arm’s-length concept: dealings between unrelated parties; caveat emptor generally applies in ordinary transactions.
Recordkeeping: notices must be retained for five years.
Summary of duties by relationship: presented in a tabular format in the text (p. 165–177 in the material), showing which duties apply under which relationship.
Quick Reference Formulas and Concepts
Sales Comparison: NSP, TANSP, final price adjustments; Transactional, Location, Physical adjustments (T-L-P).
Cost Approach: RC (replacement cost) and/or reproduction cost; Depreciation via EA/EL; Final value = Depreciated cost + Land + Depreciated site improvements.
Income Approach: PGI, VCL, EGI, OE (FE + VE + RR), NOI; Cap rate R; Value V = NOI / R; IRV (I = R × V; R = I / V; V = I / R).
GRM: GRM = Selling price ÷ Monthly rent; Value = GRM × Subject monthly rent.
GIM: GIM = Selling price ÷ Annual gross income; Value = GIM × Subject annual gross income.
CMA adjustments: use market-derived adjustments; square footage adjustments typically $ per sq ft; full baths, half baths, pools, garages, and site size adjustments all standard elements.
Key Definitions to Remember
Highest and best use: the most profitable legal use of the land.
UAD (Uniform Appraisal Dataset): standardized property descriptors for federally related transactions.
Going concern value: value of a business as an operating entity (including goodwill).
Residual methods: techniques for valuing intangibles (excess profits and market residual).
Four brokerage relationship options: single agent, transaction broker, designated sales associate, no brokerage relationship.