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
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.
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
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,
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
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
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
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
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
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.
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
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)
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
considering the useful life of the structure, it would pay to fix the specific item causing depreciation
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.
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.
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
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%.
boards that are nailed directly to the rafters
metal used to prevent water seepage
beams which are the roof structure
structural horizontal parts supporting floor or ceiling loads, sub floor is nailed to floor joists, and drywall is nailed to floor joists
protruding underpart of roof which overhangs exterior walls
bottom portion of frame for window or door
short stud above or below a window opening or above a doorway
crawl space –
space under the house
concrete base of the house
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
lining of doorway or window
vertical 2” x 4” framework of walls, usually spaced on 16” centers
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
a street closed at one end
board foot –
a piece of lumber 12” x 12” x 1” (144 cubic inches)
withstands the four seasons best
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
insects destructive to wood
slope of the roof
frame house life –
normally considered to be 40 years
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
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