Valuation and Appraisal

 

 

 

Appraiser – person who sets the value of a property

 

 

 

 

Two Kinds of Appraisers:

 

Staff Appraiser – salaried member of a government agency or lending institution

Fee Appraiser – appraises for a fee or per job basis

 

 

 

Appraiser Societies:

 

American Institute of Real Estate Appraisers includes Member Appraiser Institute (M.A.I) and Residential Member (R.M.)

 

Society of Real Estate Appraisers includes Senior Real Estate Appraiser (S.R.E.A.) and Senior Residential Appraiser (S.R.A.)

 

American Society of Appraisers is the A.S.A..

 

 

 

Appraisal – analysis of facts at a given time, used to determine the value of what the appraiser sees at this time, an estimate or opinion at that time, an opinion or estimate of value of an adequately described property for a specific date, after an analysis of factual and relevant data, judgment of science by a state licensed appraiser

 

 

Since the appraisal is someone’s opinion, you may ask for a change in the opinion.  The real estate agent has the opportunity to ask for a re-appraisal.

 

 

Appraisal Process:

 

1.     Define the problem

Identify the property, type of value needed, date of appraisal, consider “highest and best use”

 

 

2.     Make a plan

Preliminary survey to determine character, scope, and amount of work involved to solve problem

 

 

3.     Gather Data

 

 

4.     Analysis Data

 

 

5.     Correlation

Indications of value through various methods of appraisals are related to each other, the greatest weight is given to the most applicable appraisal method

 

 

6.     Issue appraisal report (Three Types of Reports)

Letter Form – brief description and analysis

Short Form – simple check sheets or spaces to be filled in

Narrative Report – complete description and discussion of all pertinent facts, reasons, and computations pertaining to the final estimate of value

 

 

 

 

 

 

 

 

 

 

Price – is what is paid for property, regardless of pressure, motives or

          intelligence of the seller or buyer

 

Value – present worth of all the rights to future benefits arising from

ownership (Example:  An individual can give away property but the

property still has value.)

 

Cost – what someone paid to create or acquire, measure of past expenditures

in money, time, labor and sacrifice to bring something into existence

(Experts say that cost has very little weight on value, because it has no

control over present or future worth)

 

Value and Cost don’t go together.

 

Valuation - procedure applied in determining value

 

 

 

 

 

**Four Basic Factors of Value: (D.U.S.T.)

 

Demand – has to be combined with purchasing power, need or desire to

          possess something along with the monetary power to do it (Example:

          demand for Krispy Creams is high)

 

Use – what you can use (utility), almost never is without restriction (this

          restriction is almost always the government), ability to be put to use 

          (Example:  land is already be decided on its use – residential,

          commercial, etc.)

 

Scarcity – is how rare something is, scarcity increases value and

          overabundance decreases value (the price goes up depending on

          rare/scarce the property it)

 

Transferability – something must be able to transfer ownership in order for

          something to have value, must be capable of being transferred or the

          property will have no value to a potential buyer (can’t sell what you

          don’t own)

 

Four Special Forces on Value:

 

1.     *Social Standards – personal desires get more (Example: Keep up with the Jones)

Kinds of Social Standards: marriage/divorce rates, birth/death rates, social atmosphere (quality of parks, schools, etc.), attitudes (toward law and order), social composition (people with similar interests)

 

 

2.     *Economic Trends – availability of money/cost of borrowing money (example: interest up/down)

Kinds of economic trends: job opportunities, wage levels, availability of money/credit, interest rates, inflation levels

 

 

3.     *Government/Political Regulation – when government decides the use of property, which in turn decides the value of the land (has a great influence on power)

Kinds of government/political regulation: building codes, zoning laws, rent control laws, mass transportation system, adequate fire/police protection, legislation

 

 

4.     Physical Characteristics – when the physical characteristics are an influence

Kinds of physical characteristics: proximity (to shopping, schools, etc.), climatic conditions, physical hazards, character of soil (farming), size (shape of lot), action of the sun (preference of light), and topography (level of land)

 

 

 

 

 

 

 

 

 

 

 

Nine Types of Value:

 

1.     *Market Value – objective and unemotional, what a property is currently worth on the open market (open market is a willing buyer and a willing seller concept – either are forced to buy or sell), a price for which a willing buyer and seller would act

 

2.     *Subjective Value – emotional value, value that is within the mind of the beholder, what it is worth to the owner that will satisfy the desires of the purchaser because of the amenities of the property, attractiveness and satisfaction of living on the property (Example: hot button, what a buyer dreams of)

 

3.     *Loan Value – what a lender will loan against a property being used as collateral (what has been pledged to the lender) as the amount that will be loaned

 

4.     *Insurance Value – the value should match with the replacement cost, money needed to recreate the property

 

5.     *Assessed Value – used for property tax purpose and is a percent (%) of market value, value of the property established for the purpose of computing real property taxes

 

6.     *Investment Value – what a property is worth to a particular investor (depending on what they like)

 

7.  Sub Values – various types of values in which clients hire appraisers

to find (Example: an appraiser is hired to appraise first for market

value and then adjusting for sub value)

 

8.  Book Value – not used in appraising, it is an accounting term, used in

     income tax calculations, amount at which an asset is carried on one’s

financial books, based on original cost, plus capital improvements,

minus depreciation taken for tax purposes

 

9.     Plottage Value – assembling several parcels that are presently owned

     by individual owners, under one single ownership thereby creating a

     “higher and better use” of the property and increasing its value

 

Twelve Principles of Valuation: (appraiser’s bible)

 

1.     Highest and Best Use –

that use which will produce the greatest net return (net income), the

most amount of money for the use, a consideration of the use of a

property that would bring the greatest profit return in terms of net

income, governed by zoning

 

2.     Supply and Demand –

capitalistic (Example: gas, beef, homes)

 

3.     Integration – (equilibrium and disintegration)

Life Cycle of a Neighborhood – all neighborhoods experience the

same cycle

First Stage – Stage of Integration – combining buildings with land, development stage, value is going up

Second Stage – Stage of Equilibrium – neighborhood never looked nicer, mature and built out, demand grows and value reaches it maximum or equilibrium state (static state)

Third Stage – Stage of Discinagration – bring in the dozers, decline and decay, value goes down

Start all over the Cycles

 

4.     Regression –

value of a better home is negatively affected by the presence of a

lesser home, where properties of dissimilar value are placed in the

same neighborhood, the worth of the better properties are affected

adversely and are pulled down by the value of the lower priced

properties (Example: John F. Long’s personal home)

 

5.     Progression –

 value of a lesser home is positively affected by being surrounded by

better homes, it’s the opposite of regression, placement of lower value

homes among homes of higher value will increase the value of the

lower value homes (Example: smallest home in a subdivision)

 

 

 

 

 

6.     Conformity –

maximum value is realized when there is uniformity in a

neighborhood, reasonable degree of conformity in an area in regard to

land use, type of construction, architecture, etc., it does not mean

absolute sameness which tends to depress market values (Example:

the houses are painted is similar colors)

 

7.     Anticipation –

a person doesn’t mind spending full price for a property, if he/she

believes that the property values will be going up, anticipated future

benefits to be derived from the property, in appraising property the

appraiser estimates the present worth of future benefits (faith in prices

going up)

 

8.     Substitution –

no one will pay more for a product than they will for a reasonable

 substitute, a property’s value tends to be set by the price that would

have to be paid for acquiring an equally desirable substitution (This

 principle underlies the market data approach to appraisal) (Example:

to this day there is not a builder that stands out heads or tails above

any other builders – all on equal playing field)

 

9.     Change –

things will change, nothing stays the same forever, economic and

social forces affect present and future value

 

10. Competition –

success breeds competition and competition breeds success, when

demand exceeds supply in a specific type of investment, it invites new

investors into the market which dissipates part and sometimes all of

the profit

 

11. Balance –

an unbalanced property destroys value  (Example: an owner keeps

adding onto a home, when the home is amongst homes that are similar

and in proportion

 

12. Continuity –

one should make an improvement to property, only if it increases its

overall value

Possible Test Questions:

 

 

What is an appraisal?

 

An appraisal is an estimate of value that was determined by an analysis of facts at a given time.

 

 

What is the difference between cost and value?

 

The difference between cost and value is value is the worth of ownership for future benefits and cost is what was paid to create or acquire.

 

 

What are the four basic factors of value?

 

The four basic factors of value are D.U.S.T., which is demand, utility, social trends, and transferability.  Demand is combined with purchasing power.  Use is what the property can be used for.  Scarcity is the rarity of the property. Transferability is the ability to transfer property (you own before you are able to sell).

 

 

Which most closely relates to the term market value?

 

Purchase price because full cash value has to do with tax assessment.           

What is assessed value?

 

 

Assessed value is used for property tax and is a percent of market value.

 

All appraisals start with what principle?

 

All appraisals start with the Highest and Best Use Principle.

 

 

What principle is foremost in an appraiser’s mind?

 

The Highest and Best Use is foremost in an appraiser’s mind.

Miscellaneous Words:

 

Appreciation –

things go up in value, an increased monetary value of a property due

to enhancing economic causes, improvement of the property or

elimination of former adverse conditions

 

 

Two Reasons for Appreciation:

 

          Earned Increment –

owner does something to the property to make the property worth

more money

 

          Unearned Increment –

value goes up, but not due to the efforts on the part of the owner, that

part of appreciation brought about through no effort on the part of the

 owner/user (Example: inflation)

 

 

Depreciation –

loss of value from any cause

 

 

Best Method of Estimating Depreciation:

 

          Observed Condition or cost-to-cure method = seeing what is wrong

          and estimating the cost of repairs

 

 

Accrued Depreciation –

total depreciation from all causes

 

 

Point of Diminishing Returns –

the point in which the profit begins to drop,  for a time production of

goods/services and the demand is such that each additional

good/service brings in profit, however as the demand is being met the

price begins to drop as does the return

 

Four Principles of Balance: (agents that produce income)

The ideal combination of these four agents in efficient production will return the highest profit.

          Labor – earns wages

          Capital (investment of buildings/equipment) – earn interest

          Coordination (contribution of management) – receives compensation

          Land – earns rent

 

Curable –

considering the useful life of the structure, it would pay to fix the specific item causing depreciation

 

Incurable –

a major fault, so that considering the short remaining useful life of the structure, it would cost too much to fix the specific item causing the depreciation

 

 

Three Reasons for Depreciation:

 

          Physical Deterioration –

worn out and run down, loss of value resulting in normal wear and tear or negligent care to the structure, (Example: worn carpet, broken windows, termite damage, cracks in plaster) deferred maintenance – almost always curable and the cure is rehabilitation

 

          Functional Obsolescence –

out dated, loss in value that is inherent to the structure due to functional inadequacies, often caused by age or poor design – sometimes curable and the cure is modernization (Example: outdated plumbing, inadequate closet space or 4 bedroom, 1 bath change by adding another bath or kitchen and master bedroom are next to one another can’t change flow)

 

          Social/Economic Obsolescence –

loss from causes outside the property, loss of value due to factors outside the property - almost always incurable (Example: smoke, dust, noxious fumes or locating a freeway or prison close to a property, building a better road causes value of property to go down because it is along an older road)

 

Depreciation for Tax Deductible Expense Justifications:

 

Income producing property is recognized by the IRS as losing value through physical deterioration and functional obsolescence.  Therefore the IRS, permits depreciation deduction for tax purposes (not on land, land does not depreciate).  The annual amount of tax depreciation results from an apportionment of the money invested in the building over its estimated economic life.  The shorter the economic life, the more deductions allowed.

 

For residential income property, depreciation is allowed over a 27.5 year period and commercial is allowed over a 39 year period, as indicated in the Tax Reform Act of 1986.

 

 

Economic Life – the useful time period in which an asset is expected to remain economically feasible to an owner

 

 

Method of Depreciation:

 

Straight Line Method – is the only method used in accordance with the Tax Reform Act of 1986.  Cost of the property is deducted in equal annual installments.  Then divide the number of years in economic life into 100% to arrive at the annual percentage rate allowed each year.  Next, apply the percentage rate to the depreciable base (net, after deducting salvage value) to arrive at the depreciated deduction.

                  

Example: 

 

1/50 = .02

 

$100,000 x .02 = $2,000

 

50 = economic life

.02 = annual percentage rate

$100,000 = depreciated basis

$2,000 = annual depreciation deducted

 

Appraisals (sometimes referred to as Approaches)

 

Three Kinds of Appraisals (Approaches) to Value:

 

1.     Market Data Approach (Comparison Approach)

Estimating the value of a property by comparing it to similar properties that have sold recently as close to the subject property as possible (but don’t have to be identical but similar)

Adjustments are made because recently sold properties frequently are not identical to the subject property because of physical characteristics, location, financial terms of sale, etc.

Formula: Comparable sales + or – adjustments = estimated value

Check recent sales that are close by

Used for single family homes, condos, and small vacant lots (under 40 acres)

 

2.     Income Approach (Capitalization Method)

Turns income into value or amount of money left at the end of the year is the value of the building

Value is the present worth of future income

Investor is trading a sum of money (buying the property) for the right stream of future dollars

Method of finding this out: estimate the potential gross annual income, then deduct the vacancy factor (based on market experience deduct an appropriate allowance for vacancy/rent loss to arrive at an effective gross annual income that can be counted on), then select an appropriate capitalization rate (fair rate of return considering the type of investment) and divide into net income to arrive at capitalized value

This capitalization rate must be adequate to cover the risk involved in the investment and to attract well informed investors

Formula: Net income = expenses – total income

Used for income producing property, such as apartments, office buildings, and small shopping centers (strip centers)

 

 

 

 

3.     Cost Approach (Cost Replacement Method or Summation Method)

It includes the current cost of parts on the property, oldness of the property (depreciation or how old it is), and the land value

Estimate replacement cost of the improvements (the building) based on today’s cost of building materials and today’s labor costs

Subtract accrued depreciation and add the value of the land

Formula: Value of depreciated improvements + value of land = estimated value

Four Methods to Calculate Cost Approach:

          Quantity Survey Method – estimate present price of all materials used and labor hours needed to build the structure with allowance for overhead, insurance, and profit (most accurate, however most time consuming method)

          Unit-in place Method – estimate cost of installing the various components of the building (walls, roof, etc.) on a square foot or cubic foot basis, it includes the cost of material, labor, and profit

          Square foot Method – measure number of square feet in entire building and multiply this by the cost factor per square foot to build structure derived from local contractors

          Cubic foot Method – same as square foot method except the cubic foot cost factor is used

Used for unique and one of kind buildings

Example: churches, bowling alleys, restaurants

 

 

 

Replacement Cost –

is the current cost of constructing a new improvement similar to the improvement being appraised having the same basic utility

 

 

Reproduction Cost –

is the current cost of reproducing an exact replica structure, to estimate reproduction cost, the building materials would still have to be available for construction use, if not replacement costs would be figured

 

 

Possible Test Questions:

 

 

Why is Income Approach true value?

 

The Income Approach is true value because it is the amount of money left over at the end of the year.  Net Income = expenses – total gross income  This approach does not include depreciation, which makes it true value. 

 

 

 

Which of the following should use the Cost Replacement Approach?

 

Single family home         Apartment Building        Brand New Building

 

 

The brand new building should use the cost replacement approach because it is one of a kind.  It is new and you should know the materials that have been used to create/build it.

 

 

 

What is a strip center?

 

A strip center is a small shopping center, usually on a corner.

 

 

 

Why is landed added in last when figuring in the Cost Approach?

 

Land is added in because there is no depreciation on land.  When you subtract out depreciation on the property, you need to add the land back into the approach.

 

 

 

 

 

 

 

Appraisal Terms:

 

 

100% location –

best location for a specific type of business

 

 

directional growth –

direction in which a city is tending to grow

 

 

commercial acre –

remaining portion of a full acre in a subdivision after allowance for dedicated streets and alleys

 

 

metropolitan area –

a county or contiguous counties with one or more cities of 50,000 or more population

 

 

megalopolis –

a large city or series of cites containing a million or more population

 

 

key lot –

a lot to which other lots back up to and adjoin, least desirable lot in a block

 

 

depth table –

a percentage table used to make adjustments for lot values due to differences in lot depth, shapes, and locations in a block.  The basic depth table established was the 4-3-2-1 rule (provides that the front quarter of the lot holds 40% of the value, second quarter 30%, third quarter 20%, and the fourth quarter 10%.

 

 

Sheathing –

boards that are nailed directly to the rafters

 

Flashing –

metal used to prevent water seepage

 

 

*rafters –

beams which are the roof structure

 

 

*joists –

structural horizontal parts supporting floor or ceiling loads, sub floor is nailed to floor joists, and drywall is nailed to floor joists

 

 

*eave –

protruding underpart of roof which overhangs exterior walls

 

 

sill –

bottom portion of frame for window or door

 

 

cripple –

short stud above or below a window opening or above a doorway

 

 

crawl space –

space under the house

 

 

foundation –

concrete base of the house

 

 

footing –

expanded portion of the concrete foundation

 

 

mud sill –

treated member (or redwood) bolted to the foundation

 

sole plate –

board on which the studs rest

 

 

*header (lintel) –

beam over a doorway or window

 

 

*jamb –

lining of doorway or window

 

 

*studs –

vertical 2” x 4” framework of walls, usually spaced on 16” centers

 

 

firestop –

blocking to resist fire from spreading through the walls

 

 

ridge board –

highest point of construction in a frame building

 

 

cross bracing –

board running diagonally across wall framing to prevent sway

 

 

*cul-de-sac –

a street closed at one end

 

 

board foot –

a piece of lumber 12” x 12” x 1” (144 cubic inches)

 

 

redwood –

withstands the four seasons best

 

 

drywall –

wall material but not in wet form as plaster is

 

 

*gable roof –

a roof with two sloping sides

 

 

*hip roof –

a four sided roof with sloping sides and ends

 

 

termites –

insects destructive to wood

 

 

pitch –

slope of the roof

 

 

frame house life –

normally considered to be 40 years

 

 

B.T.U. –

British Thermal Unit, a unit of heat measurement

 

 

Average Ceiling Height in Residential Dwelling –

96 inches (8 feet)

 

 

Soil Pipe –

carries waste from house to sewer

 

 

*Bearing wall –

supports the weight of roof or upper stories

 

 

*party wall –

a fence or wall between two properties

 

 

potable –

refers to water that is drinkable

 

 

*percolation test –

test conducted to determine if the soil is porous, frequently used before installing a septic tank

 

 

junction box –

metal box wherein electrical wiring is connected

 

 

monolithic slab –

concrete slab, such as the floor of the house

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Possible Test Questions:

 

 

 

What are rafters?

 

Rafters are beams which are the roof structure.

 

 

 

What are joists?

 

What are joists structural horizontal parts supporting floor or ceiling loads, sub floor is nailed to floor joists, and drywall is nailed to floor joists.

 

 

 

What is an eave?

 

An eave is a protruding underpart of roof which overhangs exterior walls.

 

 

 

What is a header (lintel)?

 

A header (lintel) is a beam over a doorway or window.

 

 

 

What is a jamb?

A jamb is the lining of doorway or window.

 

 

 

What are studs?

 

Studs are vertical 2” x 4” framework of walls, usually spaced on 16” centers.

 

 

 

What are bearing walls?

 

Bearing walls support the weight of roof or upper stories.

 

 

 

What is a party wall?

 

A party wall is fence or wall between two properties.

 

 

 

What is potable?

 

Potable refers to water that is drinkable.

 

 

 

What is a percolation test?

 

The percolation test conducted to determine if the soil is porous, frequently used before installing a septic tank.

 

 

 

What is a gable roof ?

 

A gable roof is a roof with two sloping sides.

 

 

 

What is a hip roof ?

 

A hip roof is a four sided roof with sloping sides and ends.

 

 

 

What is a cul-de-sac?

 

A cul-de-sac is a street closed at one end