Chapter 18RE Appraisal

Terms Appraisal:Estimate of Value of Something Capitalize: Convert Future Income into PV Valuation:Appraisers’ Step by Step Process Highest & Best Use: Use of land which will

produce the greatest Current Value 4-3-2-1 Rule: Land @ the back of a lot is

worth < front: [e.g. 50’x100’ >25’x200’] CMA Estimate price via sales & prospects

Competitive Market Analysis

Market Value aka Fair Market Value

Most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale the buyer and seller each acting prudently knowledgeable and assuming the price is not affected by undue stimulus

Terms

Principle of Anticipation: Price = f(Anticipated Benefits to Buyer/Seller)

Principle of Substitution: Price = f(Cost of Equally Desirable Substitute)

Principle of Competition: Profits encourages Competition ... Supply

Plottage Value=Total > Sum(Small Lots)

Terms

Define the Appraisal Problem Conduct a Preliminary Analysis Formulate Appraisal Plan& Collect data Estimate Highest and Best Use Estimate Land Value & Improvements Reconcile Results =Defined Value Estimate Report Conclusion of Value

Uniform StandardsPro-Appraisal Practice

Transfer of ownership Financing or credit Compensation/Condemnation proceeding RE decision making Taxation Lease provisions Corporation to purchase employee home

Reasons for the Appraisal

Highest price definition The highest price in terms of money which a

property will bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus

Principles of Appraisal

Sales Comparison (Market): Residential

Cost (Replacement Value) Residential (if < 3 sites) /Income

Income Capitalization Income/Commercial Properties

Three Approaches

Steps Identify all comparable sales Gather & verify data on these sales Select the most appropriate (3 is magic #) Adjust comparables for time and comparability Reconcile differ. values & Produce Best Est

Enhancements: Matched pair: Find 2 properties that differ in one

characteristic & calculate the difference OLS: P=a+b(baths)+c(closets)+d(appliances)

Sales Comparison

1) You want to figure the price of a house: These are its characteristics:Sale Date MaySite (View) Inside LotConstruction Quality GoodAge of the Structure 5 YearsDesign/Appeal GoodLocation of Building Quiet StreetCondition of Building FairGarage or # Cars 2 CarGross Living Area 2300SqFtAir Condition Central

Sales Comparison: Subject House

Three Comps & their characteristics:Item Comp 1 Comp 2 Comp 3

SalePrice 275,000$ 185,000$ 235,000$

Sale Date 12 Mos ago Current Sale 14 Mos ago

Site(View) Apt Com p Odd Shape Larger Lot

QualCons t Excellent Excellent Fair

Age 10 Yrs 1 Yr 10 Yrs

Des/App Fair Good Good

Condition Fair Good Poor

Garage 2-Car 3-Car 2-Car

GLA 2600 SqFt 2000 SqFt 2000 SqFt

Air Cond Central Room Central

Sales Comparison: 3 Comparables

Item Subj.Prop Com p 1 % Diff Com p 2 % Diff Com p 3 % Diff

Sales Price 275,000$ 185,000$ 235,000$

Sale Date May-98 May-97 5% May-98 0% May-97 5%

Site (View ) Inside Lot Apt Complex 5% Odd Shape 5% Larger Lot -5%

QualCons Good Excellent -5% Excellent -5% Fair 5%

Age 5 Yrs 10 Yrs 5% 1 Yr -5% 10 Yrs 5%

Des&App Good Fair 5% Similar 0% Similar 0%

Condition Fair Similar 0% Good -5% Poor 5%

Garage 2-Car Similar 0% 3-Car -5% Similar 0%

GLA 2300 2600 -5% 2000 5% 2000 5%

Air Cond Central Similar 0% Room 5% Similar 0%

Price /Sq Ft 105.77$ 92.50$ 117.50$

Net Difference 10% -5% 20%

Adjusted Price 250,000 194,737 195,833

Adjusted P/SqFt 96.15$ 97.37$ 97.92$

E(Price /Sq') 97.15$

E(Pr SbjProp) 223,437$

Sales Comparison: Final Adjustment

Reproduction Cost: The current cost of constructing an exact replica (Ideal)

Replacement cost: Cost of constructing similar utility using current standard of material, skill, etc. (Reality)

Cost Approach

Direct Construction of

improvements (labor, contractor fees & materials)

Indirect Appraiser, lawyers,

accountants, financing, architect, etc

Quantity survey: Add estimates of direct & indirect

Unit in place: Estimate

cost of putting components together (e.g.. all drywall, painting, etc

Per square foot: Cost/Sq’

Types of Costs Methods

Cost Approach EstimatingCosts

Types of Depreciation Physical Depreciation: Wearing out Functional Obsolescence: Technology (halls, floors,etc) Economic Obsolescence: Neighborhood or highway moves

Estimating Reproduction to market value:

Value now=100K, Reproduce then =120K 20/120 = 17% deterioration

Actual to Effective Life: Effective life=40yrs but 20 in actual=50% deprec.

Cost Approach

SubtractDepreciation

Hard Costs: Soft CostsExcavation 21,500$ Archictecture, Attorneys & Accounting150,000$ Foundation 42,000$ Construction Loan 65,000$ Exterior & Framing 350,000$ Builder Profit 125,000$ Interior 230,000$ Physical Deterioration (Repairable):Interior Finish 5,000$ Floor Covering 10,000$ Physical Deterioration (Nonrepairable):Age (Years) 20Economic Life (Years) 50Annual Expense for machinery, etc. inadequacies. 6,000$ Annual Expense for environmental changes: 3,000$

Cost Approach: Example

Const: Cost Bldg:Hard Costs:

Excav/Foundation 63,500$ Exterior & Framing 350,000$ Interior 230,000$

Total 643,500$ Soft Costs:

Arch.Att.Acct 150,000$ ConstLoan&Bldr 190,000$

Total 340,000$ Replacement @ Current Prices: 983,500$

Cost Approach: Example

Deterioration:Pys:Rep: Interior finish 5,000$

Floor Covering 10,000$ 15,000$

Subtotal 968,500$ Nonrepairable:

Pys:NRep: Age/EcLife=(20/50) 40%LessNR% 387,400$

Subtotal 581,100$ FnctObsol: Ann Exp Eff Loss: 6,000$

Less:PV 30Yr@10% $56,561Subtotal 524,539$

ExtObsol: AnnExp Rent Loss: 3,000$ Less:PV 30Yr@10% $28,281

Subtotal 496,258$ Land Value by Comparison: 75,000$

Value per Cost Approach: 571,258$

Cost Approach: Example

Gross Rent Multiplier Estimate economic rents on complex

What they should rent for now Note: Some rents may be grandfather’d

Check GRMs in the area GRM=Sales Prices(SPs)/Gross Rents (GERs)

Use E[GRM] to get E(Price) for propertyeg.AvgSPs= $120K & AvgGERs=$10K : E[GRM]=12

Sbj=GER=$130 Therefore: Price=12*130=$1,560K

Income Capitalization Approach

Capitalization= Conversion of NOI into estimate of PV or MV: MV=NOI/CR

Cap rates=Relationship: Income & Value Techniques to determine Cap Rate:

Estimate cap rates for comparables Check other investors: What do you expect?

Bands of Investment: Like RE WACC Return on property must be enough to pay all

financial claims & still give Equity E(ROR) BOI=WM*RM +WE *RE

Income Capitalization Approach

Gross Annual Income 175,000.00$ Vacancy Allowance (as % of GAI) 5%Property taxes 14,583$ Hazard insurance 4,375$ Property Mgt(5% of GAI) 8,750$ Maintenance 15,729$ Utilities 8,209$ Other 2,771$

E(Cost) Deprec YearsFurn/App 22,500$ 6Heat/Wat/Elect 31,250$ 10Roof/Paint 68,740$ 20

Capitalization Rate: 12.356%

Income Cap Approach: e.g.

Gross Annual Income 175,000$ Vacancy Allowance 8,750$ Effective Gross Income 166,250$ Operating expenses

Property taxes 14,583$ Hazard insurance 4,375$ Property Mgt(5% of GAI) 8,750$ Maintenance 15,729$ Utilities 8,209$ Other 2,771$

ReservesFurn/App 3,750$ Heat/Wat/Elect 3,125$ Roof/Paint 3,437$

Total Op Expenses 64,730$ Net Op Inc 101,520$ Operating Expense Ratio:TOE/EGI 38.94%Value = Income/CapRate 821,628.48$

Income Cap Approach: e.g.

Information: Income Properties Apart/Condo: Income&Expense Analysis:Apts,

Condos, Coops (Chi:Inst. or RE Mgt)

Office Bldgs Office Building Experience Exchange Report(WashDC:Bldg

Owners&MgsA)

ShopCtrs Dollars & Cents of Shopping Centers(Wash DC: Urban

Land Inst)

IndusPark Site Selection Hndbk (Atlnta: Conway)

Hotels/Leis. Trends in Hotel Industry (Houston: Pannell, Kerr & Foster)

The Report

Letter: 1-5 pages-When detail not important

Form: Preprinted Forms:Govt & Institutions

Narrative: Longest & Formal: When Clients

need to know complete details & methods