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COST APPROACH
MARKET ANALYSIS FEASIBILITY
HIGHEST & BEST USE
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Cost, Feasibility, Market & HBU – graded areas ! The cost approach:
Theory & concepts ! Land valuation ! External
obsolescence ! Market analysis:
Subdivision ! Market analysis ! Functional
obsolescence
! Reconciliation ! Market analysis:
Shopping centers ! Market analysis:
Office buildings ! Total & physical
depreciation ! HBU decisions ! HBU applications
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COST APPROACH: THEORY & CONCEPTS
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Why Do Appraisers Hate the Cost Approach? ! Do we have to do a breakdown method for
depreciation? ! Does the market consider cost? ! Can you add the value of the land to the
value of the improvements? ! Is it because it is not developed properly in
courses?
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Cost Approach Reliability
! The cost approach is applicable when the improvements are new & when the improvements are older!
Reliability
Age of Property
High
Low
New Old
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Cost Approach ! Reproduction Cost
! Exact copy ! Can it be done with
even a 5 year old house? What about HVAC?
! Does this relate to market value definition?
! Replacement Cost ! Same utility ! Only cost of functional
superadequate items are different than for reproduction cost. Therefore, it is a modified Reproduction cost.
! It does not build the building that is appraised 68 Cost
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Profit (Entrepreneurial Incentive) in the Cost Approach
! Sale price minus cost, excluding profit? ! Is it what it would take to build improvements
as one of the agents of production? ! Land ! Labor ! Capital ! Profit or coordination
! Is it only in the improvements? ! What about churches & owner-occupied
buildings? 69 Cost
Cost Approach Considerations ! The four agents of production are
land, labor, capital and coordination. This applies to any goods or services. The cost approach expresses the four agents. The value of the land + direct & indirect costs (labor & capital) and profit (coordination) are elements of cost. Profit, in the cost approach, is not the difference between cost and value, but is a cost, & should always be included.
! Newer texts set forth only three agents of production. Coordination or profit is a labor cost.
! The cost approach builds to the date of appraisal. The income approach discounts to the date of appraisal. The profit in the income approach is not the same as profit in the cost approach.
! Profit can be derived and even applied as a percentage of direct costs, direct & indirect costs, or direct, indirect costs and land value. However, the profit or coordination is only attributable to the improvements. If the improvements are destroyed, the profit is all lost.
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Misconceptions About the Cost Approach
! It sets the upper limit of value ! Investors do not consider the cost approach ! You cannot reflect leased fee or leasehold
valuations ! It should be independent of the income & sales
comparison approaches ! It is most useful for special purpose properties ! It is not useful for older properties
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Cost Approach Inconsistencies ! The cost does not
match with the quality of the improvements
! The multipliers and other adjustments are not properly applied
! Lease-up costs are not accounted for
! The cost is not as of the appraisal date
! The cost manuals do not reflect current costs from the local market (even after all adjustments)
! Soft costs are omitted because the owner built with a small loan or all cash
! Profit is not included
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Cost Approach Inconsistencies ! The age of the
improvements is not consistent with ! previous renovations ! the age of improvements
in the area ! the condition of the
improvements ! after considering all
curables
! Curables do not have profit or sufficient profit built into the estimate (when appropriate)
! Depreciation is inconsistent with highest & best use as vacant (and land value)
! Cost is not consistent with time line
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Cost Approach Inconsistencies ! Appraising on the time line - soft & hard costs reflect
stage of completion? Date correct?
As Is
As Complete, But Not Stable Occupancy
As Complete & Stable Occupancy
Could Be Land Value
The Shell Of a Building Occupied & Finished Building
Land value
Hard cost to shell
Soft cost to shell
Land value
Hard cost to shell & finish
Soft cost to shell & finish & lease-up (marketing, commissions, tenant improvements)
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Cost Approach Inconsistencies
! If leasehold estate or leased fee, is there a bottom-line or other adjustment?
! Are site improvements in the land and the cost?
! Overall, does the age of the improvements, the functionality and market justify the adjustment from cost expressed by the depreciation?
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Special Purpose Property ! Definition: Economically,
suitable for only one use ! Therefore, use value is
appropriate? ! Therefore, cost approach
the default?
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Bottom Line Adjustments ! A cost approach results in a fee simple value without
adjustments. If the appraisal is to estimate another interest such as leased fee or leasehold estate, then an adjustment is necessary.
! Use bottom-line adjustments for the present worth of
excess rent (add) or present worth of below market rent (subtract). This is a market rent equivalency adjustment.
! Use bottom-line adjustments for intangibles or personal
property. 77 Cost
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LAND VALUATION
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Land Valuation Four Acceptable Methods
! Sales Comparison ! Allocation ! Extraction ! Income Approach
! Ground Rent Capitalization
! Land Residual
! Subdivision 79 Cost
Unit v. Element of Comparison Unit of Comparison
! Convenient way to look at price
! Whole property ! Per square foot
! Of land area ! Of buildable area
! Per front foot ! Residential ! Lake front ! Other
Element of Comparison ! Factors that cause prices to
vary (our adjustments) ! At date of sale
! Property rights ! Financing ! Conditions of sale ! Expenditures made shortly
after time of sale ! Market conditions ! At date of appraisal
! Location ! Physical ! Use ! Economic ! Non-realty
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Allocation
! The percentage (%) of total value to land value ! Is common in residential lots ! Is useful as a rule of thumb
! Example: ! A house sold for $200,000 in a new neighborhood & the lot
was sold for $40,000. Therefore, the land value is 20% of a total house sale price.
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Extraction ! Is also called Abstraction. It is the sale
price less contributory building value to result in a dollar ($) value for the land. ! It is used in areas with older buildings or
buildings representing interim uses. ! Example:
! An older property sold for $500,000 & the buyer gave the building $50,000 in value. Therefore, the land is worth $450,000.
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Ground Rent Capitalization
! Is an income approach to valuing land. ! Is useful with leased land along highways, downtown areas, or
other commercial areas ! You should not state in a report: �Because the subject in vacant
land, an income approach is not applicable.�
! Example ! A site was leased for a restaurant for $5 PSF absolute net
for 25 years to a fast food chain. Rates of return for similar leases are 11% - 13%. The value of the site is approximately $45 PSF.
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Land Residual ! The following must be known for a land
residual ! Building value ! Building capitalization rate ! Land capitalization rate ! Estimated NOI
! Example: ! A drug store is to be constructed for $2,000,000, inclusive of
profit. The market requires a 9% return on investment for buildings and 8% for land. What can be paid for a site if the net operating income is expected to be $270,000/year?
! Answer: ($270,000 - $180,000)/.08 = $1,125,000 84
I R V B 9% 2,000,000 L 8% T 270,000
Cost
Subdivision ! To develop land value:
! Estimate retail sales ! Estimate absorption period ! Deduct expenses ! Deduct all development costs ! Discount at rate of return
! The above procedure results in how much one could pay for land.
! To value a subdivision, only costs to complete would be deducted. By deducting all costs above, vacant land value results.
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TOTAL & PHYSICAL DEPRECIATION
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Depreciation ! Some buildings depreciate significantly at first and
others at the end of the economic life
Vo = 100% of cost
Vo = 0% of cost
Vo as a % of cost
Age of property
A
B
C
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Depreciation for a Corporate Headquarters, Many Special Use Properties & Many Houses ! Vo is less than 100% of cost at construction
Vo = 100% of cost
Vo = 0% of cost
Vo as a % of Cost
Age of Property
Obsolescence due to �overimprovement� or due to use of market value definition
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Likely Depreciation of Improvements Over Time
! You must determine where an improvement is in relation to the deferred maintenance.
Vo = 100% of cost
Vo = 0% of cost
Vo as a % of Cost
Age of Property
If no $ is spent
Average over long period of time
Money spent on curables over time
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Depreciation With Renovation ! This assumes the renovation costs were
reasonable. Note the life is extended. Vo = 100% of cost
Vo = 0% of cost
Vo as a % of Cost
Age of Property
Average over a long period of time
Renovation
New depreciation line
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Depreciation Of Components ! Not all components of a building depreciate over the
same life
Vo = 100% of cost
Vo = 0% of cost
Vo as a % of Cost
Age of Property
�Skeletal Structure� or total physical life
Items that last 50% of total life
Items that last <50% of total life
Economic Life of all improvements
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Depreciation on the other Approaches – Income
! Curable ! (1) Run the income, vacancy, expenses and
develop the cap rate as though there is nothing that needs to be done. This overstates the value until the next step
! (2) Deduct the amount of curable from the indicated value. You bring over line 3A, not the depreciation estimate in the cost approach!
! Note: The curable depreciation may have a profit component. Also, you do this procedure because the economic test that determined the item or items considered were economically justified to cure, replace, etc. as of the appraisal date.
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Depreciation on the other Approaches – Income
! Incurable ! Run the income, vacancy, expenses and develop
the cap rate as the property is. It has already been determined that whatever may decrease rents, increase vacancy, increase expenses or raise the cap rate is not economically justified to spend money.
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Depreciation on the other Approaches – Sales
! Curable ! It depends…
" If you add all deferred maintenance or curables to your sales before adjusting, then you will conduct your adjustment process as though there is no deferred maintenance or curables with the subject. At the end after determining a value as though nothing needs to be done with the subject you would deduct all of line 3A.
" If you do not add all curable items to your sales, in the adjustment process you would adjust the difference between the curables in the comparables and the subject.
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Depreciation on the other Approaches – Sales
! Incurable ! You can adjust the comparables for the incurable
functional obsolescence (line 3B) ! You can analyze the sales as though there is no
functional obsolescence, then bottom-line line 3B ! Sometimes all the comparables have the same
functional obsolescence as the subject. In this case, you would not have to adjust any obsolescence.
! Sometimes the comparables have some degree of the same functional obsolescence. You deduct the difference.
! E.G. You are appraising an old warehouse with a low eave height. All your comps have the same eave height.
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Handling Depreciation in other Approaches
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Income Sales Incurable Do nothing. The income
approach will be conducted as though nothing will be cured. Incurable obsolescence shows up in 1. Decreased income 2. Decreased occupancy 3. Increased expenses 4. Increased Ro
Choices: 1. Run sales as though
there is no incurable obsolescence & deduct it as a line item.
2. If sales have the same incurable obsolescence, do nothing.
3. Adjust for the difference in incurable obsolescence
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Handling Depreciation in other Approaches
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Income Sales Curable Run the income approach as
if there is no deferred maintenance or curable items. (As though all is cured). Then deduct line 3A.
Two choices: 1. Add all deferred
maintenance & curable items in your sales & analyze the subject as though there are no curable items (the subject is without deferred maintenance, etc.). Then deduct line 3A.
2. Adjust for the difference in curables & deferred maintenance items
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FUNCTIONAL OBSOLESCENCE
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Format
! Line 1 Cost of item ! Line 2 Physical depreciation charged ! Line 3 [Go with lower & cross out larger]
! A If curable ! B If incurable
! Line 4 Value of correct item
100 Cost
Format ! Line 1 Zero if not in property ! Line 2 If line one is zero, so is this ! Line 3 Sometimes you don’t get a choice
! A If curable (Include profit) ! B If incurable
! Line 4 Use the value & not the cost unless that is all you have
If there is surplus land, put the value of the site in line one & the land value needed for the size of site in line 4 & subtract.
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Considerations ! Functional obsolescence is “in” the
buildings but is a result of poor layout, outdated fixtures, poor design, ugly colors, etc.
! Functional obsolescence is sometimes a rational expense… ! Corporate headquarters ! A swimming pool ! Tenant finish ! Etc.
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EXTERNAL OBSOLESCENCE
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External Obsolescence
! Two major categories of external obsolescence… ! Economic – Poor market
! This is typically short-term & discounted with a yield rate, not capitalized with a Ro
! Environmental – Next to something that causes loss ! This may be estimated using direct capitalization if the
loss will go on for an undetermined time
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External Obsolescence
! The total loss from external obsolescence must be allocated between land & building. The total external obsolescence is that attributable to the building. ! Total loss/Ro – loss to land ! Total loss from external reasons x building/value
ratio [This usually doesn’t work but if it is the only information you get, use it.]
! PV of loss from yield capitalization – loss to land
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External Obsolescence
! External obsolescence as a % is computed on physically & functionally depreciated cost ! Cost = $1,000,000 ! Physical depreciation = $100,000 ! Functional obsolescence = $200,000 ! External obsolescence = $350,000 ! % external obsolescence =
$350,000/($1,000,000 – 100,000 – 200,000) = 50%
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MARKET ANALYSIS - SUBDIVISIONS
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Subdivision Analysis
! Capture – The percentage of the market the subdivision is expected to achieve
! Absorption – Number of units sold per some time period, such as per month, per quarter, per year.
! Projecting Units – Population increase divided by average household size x % to category (owned or rental) x % in value range of subject x capture rate
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Subdivision Analysis
COMPONENTS OF AN AVERAGE LOT PRICE IN A SUBDIVISION Return to: "On" Capital Return on equity capital
Return on debt capital Ongoing Management expense or Management Profit Line (To make the investment a hands off investment) All Expenses Marketing expenses Commissions Closing expenses of sale Overhead Other expenses All Costs Costs of infrastructure Costs of offsite improvements Prorated cost of amenities Raw Land Cost Underlying raw land value THE SUM OF THE ABOVE IS THE AVERAGE LOT PRICE THAT RETURNS ALL EXPENSES, COSTS, RETURN ON CAPITAL, UNDERLYING LAND VALUE, COSTS OF AMENITIES AS WELL AS THE PRORATED LAND COSTS TO THE AMENITIES TO THE AVERAGE LOT. NOTE: THE RETURN "OF" IS IN THE RETURN OF EXPENSES, COSTS AND UNDERLYING LAND VALUE.
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Copyright Ted Whitmer. All rights reserved.
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Absorption
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Absorption A subdivision has 100 proposed lots that will sell for $40,000/lot. The lot represents approximately 25% of total home value. Qualify at 2 times household income with income ranging from $25,000 to $200,000 per family. Given a supply of 300 lots competing with the subject and 1,000 new families in the next year. How many months should it take to absorb the subject, assuming 20% of the families qualify for the subject price range, and the subject is in an average competitive position? Capture rate = % of total potential market absorbed in the subject = lots in subject sold per period ÷ total lots in market Absorption = total families per time period moving into area x % in subject price range x capture rate 100 families X 20% qualify = 200 lots per year 300 lots existing + 100 proposed = 400 lots Subject capture rate = 100/400 = 25% Absorption = 200 X 25% = 50 lots per year Sell Out = 100 lots/ 50 lots = 2 years
Calculation of Feasible Rents Feasible rents are a function of cost and rate of return. In its simplest form a project is feasible when the income generated produces the required return on cost. The cost includes direct, indirect and profit as well as land cost. The rate of return is either to a particular investor, class of investors or the market in general. Overall rates from sales of existing buildings can be used for indications of return rates. However, if the properties are older the range of rates may be on the higher end of the rates that should be used for analysis of a proposed project, unless there are indications of risk that make the project higher risk than with an existing property. There are two examples of feasible rent calculations following. One is for a property that leases 90% of gross building area and the other for a property that can lease 100% of gross building area. Another example of calculation of feasible rents with different rates of increase to various components is included.
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Copyright Ted Whitmer. All rights reserved.
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1,000
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Subdivision Analysis ! Qualifying
! Income = $100,000 ! % for PITI = 28% ! Income for housing =
100,000 x 28% = $28,000
! % for taxes & insurance = 25% of principal & interest. Therefore, 28,000/1.25 = $22,400
! There is $22,400/12 = $1,867 for principal & interest
! Mortgage: I = 6% & N = 360 months
! You would run this across income strata to see what expected growth in population would qualify in subdivision 111
N I PV PMT FV 360 6/12 [311,400] -1,867
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Subdivision Analysis – For vacant land
! Project sell out period ! Project retail values ! Project expenses ! Project all costs ! Discount to PV with
high Yo
! Relationships… ! Lot value to raw land value
per acre ! Lot value to projected home
value (allocation) ! Lot value = Land value per
acre/density per acre + cost per lot + profit per lot
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Subdivision Analysis – Across Phases ! As you move down
the time-line the Yo decreases
! When using the cost approach, build in costs that are spent
! When conducting an income approach, deduct costs not yet spent
! If you do rentals, use rental rates and qualify by % income to rentals instead of calculate payments
! If no capture rate is suggested and there are four competing subdivisions (including the subject), go with a 25% capture
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Time Line – Cost Approach
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Highest Yo Yo lower than vacant
Lowest Yo
Probably no direct costs spent. Could be on utilities to site.
Add direct costs spent to phase I for infrastructure, entry, etc.
Add costs spent to get to phase II
Soft costs spent on planning, approvals, marketing, etc.
Soft costs of approvals, marketing, etc.
Profit minimal Add profit down the time line
Most profit
Deduct lots sold over time if appraising an existing improved subdivision. If all the subdivision is proposed, you would not deduct lot sales.
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COMMON RATIOS & MULTIPLIERS - EXAMPLE Population in area 50,000 Employment in area 30,000 Basic employment in area 10,000 Employment in mining 3,600 Mining in country 5% Forecast basic employment change 5,000 e (Local employment % in industry) = 3,600 / 30,000 = 12% E (National employment % in industry) = 5% (given) Location quotient (mining) = 12% / 5% = 2.40 EB multiplier (Total employment / basic employment) = 30,000 / 10,000 = 3 % of basic employees in industry = (2.40 - 1) / 2.40 = 58.3% PE ratio (Population to employment) = 50,000 / 30,000 = 1.67
Forecasting: Total employment: 5,000 x 3 = 15,000 Total population: 15,000 x 1.67 = 25,050 Note: 1. Basic employment x EB multiplier x PE ratio = Population (This can be used for change in basic employment as well as point in time analysis). 2. Forecast population = Forecast employment growth x PE ratio
SUBDIVISION LOTS (Also homes, apartments, duplexes, mobile homes, timeshare, condos, etc.)
Keys: 1. Population change per year or quarter, etc. 2. % to live in property type (e.g. mobile homes, single-family, etc.) 3. Monthly payments (inclusive of taxes & insurance) 4. % of households that can afford 5. Factor in current supply 6. Factor in competitive position of subject 7. Capture rate
Problem: Population increase: 1997 to 2002 = 35,000 persons Median household income: $35,000
25% ± $5,000 of median ; 50% ± $15,000 of median ; 75% ± $25,000 of median Average household size: 2.75 persons % single-family units: 60% Existing supply homes: 500 units Existing supply of home under construction: 100 units Existing single-family lots: 750 lots Typical lot value as % of total value: 22% Capture of subject subdivision: 20% of the market Proposed subdivision: 400 lots from $20,000 to $35,000/lot Mortgage terms: i = 8%, n = 360 months, LTV = 90%, Qualify at 28% total PITI Taxes are based on $20 per 1,000 of value and insurance on .75% of total home value
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Copyright Ted Whitmer. All rights reserved.
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Solution Housing units demanded: 35,000 ÷ 2.75 x 60% = 7,636 single family units Housing units per year: 7,636 ÷ 5 years = 1,527 per year City wide supply: 500 + 100 + 750 = 1,350 lots & houses Duration of supply: 1,350 / 1,527 = .88 years, or 10.6 months Home prices in subject: 20,000 / .22 to 35,000 / .22 = $90,900 to $159,000 Incomes to qualify: [90,900 x 90% x .0881* + (90,900 x .0275**)] /.28 = $34,700 (R) [159,000 x 90% x .0881* + (159,000 x .0275**)] /.28 = $60,600(R) * Rm = 360 N, 8 ÷ 12 I, -1 PV, solve PMT x 12 (.0881) ** Taxes are 2% & insurance .75% of value = 2.75% % who qualify: The median income is $35,000 and 75% of the population is within $25,000 of the median income, or $10,000 to $60,000. Therefore, 1/2 of 75% is from $10,000 to $35,000 & 1/2 is from $35,000 to $60,000. This translates to 75% divided by 2, or 37.5% of the population is in the range of the subject home value. Lots/homes demanded: 1,527 per year x .375 = 572 units per year Capture rate: 20% Absorption: 572 x 20% = 114 lots per year Sellout: 400 lots ÷ 114 = 3.5 years Variations: 1. If the market study is for apartments, etc. (rental units), then instead of mortgage
payments, look at affordability and rental payments that will be made. 2. Also look for % owner vs. renter, & possibly further segmentation based upon type of
subject property (e.g. high amenity apartments, extended care facilities, etc. 3. The problem above gives the capture rate (20%) for the subject. You may be asked to
make a judgment call on the test based upon competitive supply.
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Copyright Ted Whitmer. All rights reserved.
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MARKET ANALYSIS
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Market Analysis – Urban Structures
! Concentric Zone ! 5 zones – ripple effect ! PVI – peak value intersection
! Sector or Wedge Model ! Multiple Nuclei ! Axial Growth (Radial corridor)
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Market Analysis – Levels of Market Study
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Market Analysis ! Productivity analysis What a site can be used for.
Look at physical, economic and functional characteristics. ! Situs – The sum total externalities as it relates to a specific
site. ! Linkages (1) transportation (2) utility
! Linkage components: (1) Route, (2) Access, (3) Travel mode, (bus, car, rail, etc.) (4) Route orientation (inward to subject, outward or dual directional)
! Externalities (1) Neighborhood (2) Linkage
! Employment (1) service (2) basic
! Economic base – brings $ into an area and exports goods or services. 120 Cost
Market Analysis 1. Local employment % in industry
e = Local employment in industry / Total local employment
2. National employment % in industry E = National employment in industry / Total national employment
3. Location quotient (If >1, then the industry is basic and
imports money & exports goods or services) LQ = e / E
4. Percentage of basic employees
(LQ - 1.0) / LQ = % of basic employees in industry
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Market Analysis
5. Number of basic employees Total employs in industry x % of basic
6. EB multiplier (Employment to basic employment)
Total employment / Basic employment Basic employment x EB multiplier = Total employment
7. Population/employment ratio (PE)
Total population / Total employment 8. To forecast total population
Forecast total employment x PE ratio
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Market Analysis 9. To forecast total employment
Forecast basic employment x EB multiplier = Forecast total employment
10. Total employment
Basic + non-basic = total employment 11. m = Number of jobs created by a basic job
Non-basic employment / Basic employment 12. Population multiplier = reciprocal of % population in
workforce
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Market Analysis – Demand
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When the Market Softens
! Feasible rent will exceed market rent & market rent will decline at a rapid rate
! Land values will dive & decrease at a faster rate than will buildings ! The highest & best use of land will change from �office� to �hold for future office development�
! Land will be a negative carry with a risky reversion pushed out. The mechanics of discounting can cause land to be worth 1/2 in one day what it was the day before.
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Market analysis – shopping centers
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Shopping Centers
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! Population change in area ! Population change/average household (HH) size =
households ! Income per household ! % of household income to retail sales ! Average sales PSF ! Income for retail divided by average sales PSF = Net
space ! Net space/(1 – frictional vacancy) = Space Needed for
population growth ! Residual demand is after accounting for existing supply
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Shopping Centers
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! Central place theory (CPT) – geographical concept that explains the number, size and location of retail of most goods and services relative to the local population.
! Threshold population – the minimum people needed ! Two main goods & services
! 1. Higher-order – (cars, jewelry, etc.) need high threshold ! 2. Lower-order – (food, clothes, etc.) need lower threshold
! Market standard ! Characteristics expected by local acceptance
! Property rating grid ! Site, parking, topography building improvements, tenant mix,
legal ! Purpose is to identify the competitive differential (subject vs.
competitors) Cost
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Shopping Centers
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! Retail market area – Area of consistent draw ! Primary – 70 to 80% of market ! Secondary – 15 to 20% of market ! Tertiary – Any remaining market share
! Leakage– Loss of retail to other areas ! Reilly’s gravitational model– Predicts where one will
likely shop between centers ! Distance has a greater affect than size ! MAB = T / (1 + √Sa / Sb)
! MAB = Market area boundary ! T = Travel time ! Sa = Size of store a ! Sb = Size of store b
Cost
Shopping Centers TYPE TENANT SIZE MARKET
Convenience Not anchored, convenience goods
< 30,000 Less than 5 minutes
Neighborhood Convenience + personal services
30,000 to 150,000 & 4-10 Acres
5-10 minutes & 1-1.5 miles with 5,000-40,000 people
Community Convenience + personal services + shopper goods
100,000 to 300,000 & 10-30 acres
10-20 minutes & 3-6 miles with 40,000-150,000people
Regional Convenience + personal services + shopper goods & general merchandise
300,000 to 1M & 30 acres & one or more dept stores
20 minutes & 5-10 miles with 150,000-400,000 people
Super Regional General merchandise + apparel + furniture + home furnishings + services
>800,000 & at least 3 dept stores of at least 100,000
30minutes & 10-35 miles with >500,000 people
Specialty/theme Boutiques, crafts, gourmet foods, etc.
Same as neighborhood & community
Same as regional
Lifestyle Upscale home furnishings, women’s fashion, restaurants, etc.
300,000 to 500,000 Same as regional
Power Minimum of 3, but usually 5+ anchors & few small
Open-air > 250,000 all large 15 miles & 20 minutes & 400,000-500,000 people
Off-price outlet & discount Name brand, wholesale, outlet 60,000 to 400,000 Same as super regional
Strip Convenience, quick-service restaurant, car, service
Varies Neighborhood
Highway Motels, restaurants, truck, etc. Varies Passing motorists 130 Cost
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8. To forecast total population Forecast total employment x PE ratio 9. To forecast total employment Forecast basic employment x EB multiplier = Forecast total employment 10. Total employment Basic + nonbasic employment = total employment 11. m = Number of jobs created by a basic job Nonbasic employment / Basic employment 12. Population multiplier = reciprocal of % population in workforce Estimating demand - future in an area
� Retail 1. � in households in market area 2. x average household income 3. x % of income for retail 4. divided by sales psf per year
� Office 1. � in office employees over given period 2. x sf of office per employee 3. x capture rate of submarket
� Housing 1. � in households in area (population divided by persons per household) 2. + demolitions 3. - (actual - normal vacancies) 4. - (actual - normal units under construction)
Existing buildings and demand
� Existing Shopping Center Market Analysis Process
Step 1 � in households in market area Step 2 Delineate the market area Step 3 Forecast demand A. 4cast households B. Est. mean/median income & total income C. % household income spent on retail D. % of retail in subject type property E. Repeat above for secondary market F. Determine total demand in market G. Est SF by dividing F by sales PSF H. Adjust for vacancy (add) Step 4 Measure competitive supply Step 5 Analyze market equilibrium/disequilibrium Step 6 Forecast subject capture
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Copyright Ted Whitmer. All rights reserved.
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Example
RETAIL Keys: 1. Households 2. Average household income 3. % income spent on retail 4. % spent in subject type 5. % retention 6. Sales required psf 7. Less existing supply 8. Less forecast supply 9. Residual demand
Problem Households: Change of 1000 over the next 5 years (Currently 10,000) Average household income: $35,000 % spent taxes 25% % spent on nonretail 45% (housing, medical, insurance & professional, services, recreation, savings) % of retail sales by subject type 20% % retention of sales in primary mkt 80% (Note: on the test this may be expressed as 20% leakage) % supportable in secondary mkt 15% (of primary) Sales required psf subject type $250 Frictional vacancy 5% Existing retail space 250,000 sf (20% in subject type) Under construction 50,000 sf (25% in subject type) Permitted 40,000 sf (15% in subject type)
Solution 1. Total income = 11,000 x $35,000 = $385,000,000 2. Retail sales potential = $385,000,000 x (1 - 25% - 45%) = $115,500,000 3. Retail sales by subject type = $115,500,000 x 20% = $23,100,000 4. Sales retention = $23,100,000 x 80% = $18,480,000 5. Primary sales sf required = $18,480,000 / $250 psf = 73,920 sf 6. Plus: Secondary sales = 73,920 x 1.15 = 85,008 sf 7. Plus: Frictional vacancy = 85,008 / (1 - 5%) = 89,482 sf 8. Less: Existing, U.C., proposed = 250,000x20% + 50,000x25% + 40,000x15% = 68,500 sf 9. Shortage of space (next 5 years) = 89,482 sf - 68,500 = 20,982 sf
OFFICE & INDUSTRIAL Keys: 1. Employment 2. % of employment in office 3. Average sf per employee 4. Capture by subject area 5. Capture by subject property class (A, B, etc.) 6. Add existing, under construction (U.C.), proposed 7. Calculate residual demand
Cost
Copyright Ted Whitmer. All rights reserved.
46 Cost
132 Cost
Example
133
RETAIL Keys: 1. Households 2. Average household income 3. % income spent on retail 4. % spent in subject type 5. % retention 6. Sales required psf 7. Less existing supply 8. Less forecast supply 9. Residual demand
Problem Households: Change of 1000 over the next 5 years (Currently 10,000) Average household income: $35,000 % spent taxes 25% % spent on nonretail 45% (housing, medical, insurance & professional, services, recreation, savings) % of retail sales by subject type 20% % retention of sales in primary mkt 80% (Note: on the test this may be expressed as 20% leakage) % supportable in secondary mkt 15% (of primary) Sales required psf subject type $250 Frictional vacancy 5% Existing retail space 250,000 sf (20% in subject type) Under construction 50,000 sf (25% in subject type) Permitted 40,000 sf (15% in subject type)
Solution 1. Total income = 11,000 x $35,000 = $385,000,000 2. Retail sales potential = $385,000,000 x (1 - 25% - 45%) = $115,500,000 3. Retail sales by subject type = $115,500,000 x 20% = $23,100,000 4. Sales retention = $23,100,000 x 80% = $18,480,000 5. Primary sales sf required = $18,480,000 / $250 psf = 73,920 sf 6. Plus: Secondary sales = 73,920 x 1.15 = 85,008 sf 7. Plus: Frictional vacancy = 85,008 / (1 - 5%) = 89,482 sf 8. Less: Existing, U.C., proposed = 250,000x20% + 50,000x25% + 40,000x15% = 68,500 sf 9. Shortage of space (next 5 years) = 89,482 sf - 68,500 = 20,982 sf
OFFICE & INDUSTRIAL Keys: 1. Employment 2. % of employment in office 3. Average sf per employee 4. Capture by subject area 5. Capture by subject property class (A, B, etc.) 6. Add existing, under construction (U.C.), proposed 7. Calculate residual demand
Cost
Copyright Ted Whitmer. All rights reserved.
46 Cost
Cost
Market analysis – office buildings
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Office & Industrial
135
! 1. Employment ! Basic ! Service
! 2. % employment in office translated to # in office ! 3. Office space per employee ! 4. Employees in office x office space per employee =
Space needed for growth ! 5. Line 4/(1- frictional vacancy) = Total space
needed ! 6. Residual demand is after accounting for supply
Cost
136
Problem: Employment Currently 50,000 Population Expected growth in population over next 4 years is 20,000 persons PE ratio 1.75 to 1 Percent of employees in office 20% Total office in city 1,000,000 sf Total Class B in city 550,000 sf Total office in submarket 100,000 Occupancy 75% in submarket Total Class B in submarket 50,000 sf Occupancy in Class B 80% Frictional vacancy 5% Average space per employee 225 sf Est. capture by subject area 25% Est. % class demand 50% Office U.C., proposed Class B 25,000 sf
Solution: 1. Total employment growth = 20,000 / 1.75 = 11,429 2. Total occupying office = 11,429 x 20% = 2,286 persons 3. Office demand = 2,286 persons x 225 sf per person = 514,350 sf 4. Capture in subject market = 514,350 x 25% = 128,588 sf 5. Total demand for Class B in market = 128,588 sf x 50% / (1-5%) = 67,678 sf 6. Less: Existing, UC, proposed = (50,000 sf x 20% vacant) + 25,000 sf = 35,000 sf 7. Residual demand = 67,678 - 35,000 = 32,678 sf needed Variations: 1. There may not be a frictional vacancy given. Compute demand without making up a vacancy.
Cost
Copyright Ted Whitmer. All rights reserved.
47 Cost
Cost
137
Problem: Employment Currently 50,000 Population Expected growth in population over next 4 years is 20,000 persons PE ratio 1.75 to 1 Percent of employees in office 20% Total office in city 1,000,000 sf Total Class B in city 550,000 sf Total office in submarket 100,000 Occupancy 75% in submarket Total Class B in submarket 50,000 sf Occupancy in Class B 80% Frictional vacancy 5% Average space per employee 225 sf Est. capture by subject area 25% Est. % class demand 50% Office U.C., proposed Class B 25,000 sf
Solution: 1. Total employment growth = 20,000 / 1.75 = 11,429 2. Total occupying office = 11,429 x 20% = 2,286 persons 3. Office demand = 2,286 persons x 225 sf per person = 514,350 sf 4. Capture in subject market = 514,350 x 25% = 128,588 sf 5. Total demand for Class B in market = 128,588 sf x 50% / (1-5%) = 67,678 sf 6. Less: Existing, UC, proposed = (50,000 sf x 20% vacant) + 25,000 sf = 35,000 sf 7. Residual demand = 67,678 - 35,000 = 32,678 sf needed Variations: 1. There may not be a frictional vacancy given. Compute demand without making up a vacancy.
Cost
Copyright Ted Whitmer. All rights reserved.
47 Cost
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HIGHEST & BEST USE DECISIONS
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How much building can you get on the site problem… ! Lot 500’ (frontage) x 400’ (depth) ! Building: 2-story ! Parking: Five spaces per 1,000 SF of rentable & need 350 SF per
space. Rentable to gross is 90%. ! Setbacks– Cannot build on the setbacks parking or building.
! 40’ front ! 20’ back ! 10’ one side & 15’ the other side
! Green areas – In addition to setback areas ! 10% of building size ! 15% of total site size
! Retention (detention) area – 10% of site area (total)
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Solution ! (475x340) – [(15% green +
10% retention) x 500x400] = 1/2x + (x.90/1000 x 5 x 350) + .10x
! 161,500 – 50,000 = .5x + 1.575x + .10x
! 111,500 = 2.175x
! X = 111,500/2.175 = 51,264 SF
! Parking: 51,264 x .90/1000 x 5 = 231spaces
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500’
400’
40’
20’
15’ 10’
475’
340’
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Highest & Best Use
! Tests – Measured in dollars not rate of return ! Physical ! Legal ! Financially feasible ! Maximally productive
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Highest & Best Use
! Can have negative values ! Must report your analysis of HBU,
not just summarize your HBU ! Value in use must be consistent.
You don�t predetermine the use, then value the site under HBU (churches may be an exception)
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Highest & Best Use
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HIGHEST & BEST USE APPLICATIONS
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Highest & Best Use Tests
! Demolish or not to demolish ! Steps
! Value of land if vacant ! Value of property if continue use & do not
demolish ! Subtract: If the cost to demolish is greater, then
do not demolish. If the cost to demolish is less, then demolish.
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Highest & Best Use Tests
! Renovate or not renovate ! Steps
! Value the property as though renovated ! Value of property if continue use & do not
renovate ! Subtract: If the cost to renovate is greater, then do
not renovate. If the cost to renovate is less, then renovate.
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Feasibility
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Breakeven point
! Point at which EGI = debt service + expenses ! To derive occupancy:
! BE occupancy = (OE + DS)/annual rent per unit ! �Unit� can be an apartment unit, SF, cubic ft,
etc.
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Breakeven ratio
! It is used to determine the margin of safety that exists until CF = 0 ! DCR = 1 ! Re = 0
! BER = (OE + DS) / PGI ! It results in a % occupancy to break even
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Feasible Rent Calculation
! Cost x Ro = Io needed ! Io + Expenses = EGI needed ! EGI divided by (1 – vacancy) = PGI needed
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Feasibility
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Feasibility
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Feasibility
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When Market Rent Exceeds Feasible Rent (Good Market Conditions for Building)
! If the rental rates in the market exceed the feasible rental rate, then one, two, three or all of the following will happen… ! land values will increase at a very rapid rate (land
owners will take their cut of the market) ! improvement costs will increase (subs will take their
cut) ! there will be continued construction (developers will be
smiling) ! rates could increase and this would cause costs to
increase, slowing building (the Federal Reserve gets involved)
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RECONCILIATION
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PROBLEMS
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Physical Depreciation
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! RCN = $2,000,000 ! Needs painted $25,000
! Age is 5 & remaining life is 45 years ! What is total physical depreciation?
Item Cost Age Life % Total Carpet 75,000 5 7 HVAC 100,000 5 12
Roof 200,000 5 15
Other 250,000 5 8
Total
Cost
Physical Depreciation
158
! RCN = $2,000,000 ! Needs painted $25,000
! Incurable LL: (2,000,000 – 25,000 – 625,000) (5/50) = $135,000
! Age is 5 & remaining life is 45 years ! What is total physical depreciation? ! $25,000 + 318,155 + 135,000 = $478,155
Item Cost Age Life % Total Carpet 75,000 5 7 71.43 $53,571 HVAC 100,000 5 12 41.67 41,667 Roof 200,000 5 15 33.33 66,667 Other 250,000 5 8 62.50 156,250 Total 625,000 318,155
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Reilly’s Gravitational Model
! There is a 13 minute travel time between two stores with Store A having 300,000 SF and store B having 250,000 SF. What is the market area boundary?
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Reilly’s Gravitational Model ! There is a 13 minute travel time between two stores with Store A having
300,000 SF and store B having 250,000 SF. What is the market area boundary? ! MAB = T / (1 + √Sa / Sb)
! MAB = Market area boundary ! T = Travel time ! Sa = Size of store a ! Sb = Size of store b
! MAB = 13/ (1 + √300/250) = 13/ (1 + 1.09545) = 6.204 minutes from store B.
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Problems 1. A parking lot will be built with concrete that will cost $1.50 PSF for labor, $75 per cubic yard for concrete, and $1.00 PSF for forms and rebar. Assume the parking lot is 200 feet by 150 feet and will be poured 5.5 inches thick. What is the cost of the parking lot per square foot? a. $2.50 PSF b. $3.25 PSF c. $3.75 PSF d. $4.00 PSF 2. A market has 100,000 SF of office available for lease, 150,000 SF being added, 20,000 scheduled to be demolished and total office space is 1,000,000. Assume stabilized vacancy at 5%, what is residual demand in this market? a. 0 SF b. 56,500 SF c. 180,000 SF d. Cannot determine from the information given
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Problems 3. NOI = $0. Taxes are $2,000, insurance is $1,000 and maintenance is $2,000 per year. The taxes are broken into $1,500 for the land and $500 per year for the building. Ro = .12. Assume the land is worth $125,000, but is not developable until a road is completed in the area in two years and a change of zoning form R-1 to C-2 is achieved. The change in zoning is likely prior to the road being completed. Demolition of the building will cost $15,000. What is the value of the improvements? a. $0 b. -$12,000 c. -$15,000 d. -$30,000 4. In the above example, what is the highest and best use of the property? a. Commercial b. Residential c. To hold for future commercial development d. Research and development
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Problems 5. What has the most affect on apartment leasing? a. Household size b. Population change c. Employment change d. Students 6. There is an announcement that a company will employ 150 employees and sell computer keyboards to a distributor located in another state. The company will build a building of 50,000 SF of office, manufacturing and storage area. The expectations are that 400 more jobs will result because this company. Assume that the growth will result in a need for more office with a market that has 5,000 SF in excess of what is needed for typical frictional vacancy. Average employment in office is 180 SF per employee and 18% of the growth is expected to be in employment that needs office. What is the residual office demand after the company locates in the market? a. 7,960 SF b. 12,960 SF c. 15,820 SF d. 17,820 SF
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Problems 7. What is the likely growth in population from the company locating in this market? a. 550 persons b. 1,100 persons c. 2,200 persons d. 3,300 persons 8. What is the classification of the 150, 400 and 550 employees in problem 6? a. Basic, ancillary, total b. Basic, service, total c. Service, basic, total d. Service, additional, speculative 9. A property has above market leases. How would you adjust for this feature in the cost approach? a. You would not, the cost approach values fee simple interests b. You would add the present value of the excess rent as a bottom-line item c. You would subtract the present value of the excess rent as a bottom-line item d. You would add the difference between the leasehold and leased fee values as a bottom-line item
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Problems Answer questions 10 – 13 based upon the following information. Office building 1: Built within the last two years for $1,000,000 total construction costs and with a land value of $275,000. The building is 13,000 SF and the land is 52,000 SF. Office building 2: Built within the last year for $1,200,000 total construction costs and with a land value of $380,000. The building is 15,100 SF and the land area is 75,000 SF. Office building 3: Built within the last three years for $1,400,000 total construction costs and with a land value of $380,000. The building is 19,000 SF and the land area is 78,000 SF. Office building 4:Built within the last year for $1,150,000 total construction costs and with a land value of $375,000. The building is 15,000 SF and the land area is 63,000 SF. Assume all sites have a highest and best use with office development.
10. Which of the above is likely to have an irregular site? a. Office building 1 b. Office building 2 c. Office building 3 d. Office building 4
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Problems 11. Which building is likely to have the highest rent PSF? a. Office building 1 b. Office building 2 c. Office building 3 d. Office building 4 12. If all leased for the same rental PSF, which building likely has functional obsolescence? a. Office building 1 b. Office building 2 c. Office building 3 d. Office building 4 13. What is the increase in land value in the above office sites? a. 4% per year b. 7% per year c. 9% per year d. 11% per year 166 Cost
Problems
14. A building has a component that cost $125,000 if in new construction and is 10% depreciated. A high quality component would cost $150,000 in new construction and $275,000 to add. There is no salvage value to the existing component. The expenses increase $11,000 per year because of the inferior component and the rate to the building is .11. What is the amount of functional obsolescence? a. $0 b. $50,000 c. $62,500 d. $175,000 15. Which of the following is true? a. The cost approach sets the upper limit of value. b. The cost approach is used for fee simple valuations only. c. The cost approach is the best approach for special purpose properties. d. The cost approach is best used with very old properties.
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Problems 16. A retail property leases in a strip center for $25 PSF and percentage rents of
6% with a natural break. Vacancy in the retail center is overall at 5%. What would the rent be PSF if sales were $400 PSF per year? a. $24 PSF b. $25 PSF c. $25 + $24 PSF d. $25 / (1 - .05) PSF 17. Of the following, which is likely to have the highest sales PSF? a. Restaurants b. Jewelry c. Footwear d. Apparel 18. Which of the following is likely to have the highest turn ratio? a. Grocery b. Jewelry c. Footwear d. Gifts
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Problems
19. If the footprint coverage on the site is 1 to 4 and a 3-story building has a footprint of 15,000 SF, what is the FAR? a. 45,000/60,000 b. 60,000/45,000 c. 15,000/60,000 d. 60,000/15,000
20. A property has land worth $500,000. The improvements will be demolished in one year for $25,000. The improvements are being used for storage and generate enough income to off-set expenses. The NOI is zero. Assume the property would be developed today except the lease for the storage encumbers the property. What is the value of the property including the improvements. a. $450,000 b. $475,000 c. $500,000 d. $525,000 169 Cost
Problem Solutions
1. A parking lot will be built with concrete that will cost $1.50 PSF for labor, $75 per cubic yard for concrete, and $1.00 PSF for forms and rebar. Assume the parking lot is 200 feet by 150 feet and will be poured 5.5 inches thick. What is the cost of the parking lot per square foot? a. $2.50 PSF b. $3.25 PSF c. $3.75 PSF d. $4.00 PSF (1.50 + 1.00) x 200 x 150 = $75,000.00 75 x 200/3 x 150/3 x 5.5/36 = 38,194.44 Total Cost $113,194.44 Cost PSF: $113,194.44/(200 x 150) $3.77
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Problem Solutions
2. A market has 100,000 SF of office available for lease, 150,000 SF being added, 20,000 scheduled to be demolished and total office space is 1,000,000. Assume stabilized vacancy at 5%, what is residual demand in this market? a. 0 SF b. 56,500 SF c. 180,000 SF d. Cannot determine from the information given
Frictional vacancy needed: (1,000,000 + 150,000 – 20,000) x 5% = 56,500 SF Vacancy in market = 100,000, therefore there is no residual demand, but excess space of 43,500 SF. 171 Cost
Problem Solutions 3. NOI = $0. Taxes are $2,000, insurance is $1,000 and maintenance is $2,000 per
year. The taxes are broken into $1,500 for the land and $500 per year for the building. Ro = .12. Assume the land is worth $125,000, but is not developable until a road is completed in the area in two years and a change of zoning form R-1 to C-2 is achieved. The change in zoning is likely prior to the road being completed. Demolition of the building will cost $15,000. What is the value of the improvements? a. $0 b. -$12,000 c. -$15,000 d. -$30,000 When NOI is $0 and there is an interim use, the improvements are at least offsetting taxes, some insurance and some property upkeep (mowing, etc.). Therefore, the improvements would not be demolished until the new improvements can be built. The improvements contribute $1,500 x 2 years, but cost $15,000 to remove. Therefore, the improvements are worth at least a -$12,000. Note the property would be more valuable as totally vacant.
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Problem Solutions 4. In the above example, what is the highest and best use of the property?
a. Commercial b. Residential c. To hold for future commercial development d. Research and development
The highest and best use is not necessarily what is currently zoned. Many appraisers use the zoning of a property as the highest & best use and ignore the possibility of change of zoning that would result in a higher value. The market can pay a premium for the possibility of a zoning change even if it is remote so long as the potential higher value is considerably greater than the value as currently zoned.
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Problem Solutions 5. What has the most affect on apartment leasing?
a. Household size b. Population change c. Employment change d. Students
The major components of housing demand study are population, household size and income levels. Population change is the best answer.
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Problem Solutions 6. There is an announcement that a company will employ 150 employees and sell computer
keyboards to a distributor located in another state. The company will build a building of 50,000 SF of office, manufacturing and storage area. The expectations are that 400 additional jobs will result over the 150 employees because this company. Assume that the growth will result in a need for more office with a market that has 5,000 SF in excess of what is needed for typical frictional vacancy. Average employment in office is 180 SF per employee and 18% of the growth is expected to be in employment that needs office. What is the residual office demand after the company locates in the market? a. 7,960 SF b. 12,960 SF c. 15,820 SF d. 17,820 SF
Note that the basic employer of 150 employees will build their own building. The problem requires translating the 400 jobs into potential residual demand. The office need is (400 x 18% x 180)/(1 – frictional vacancy). Note that frictional vacancy is not given. Ignoring the frictional vacancy there will be a need for 12,960 SF. There is a need for 12,960 less the 5,000 in excess, or 7,960 plus what would be needed for the frictional vacancy. Answer (a) is the best answer.
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Problem Solutions 7. What is the likely growth in population from the company locating in this market?
a. 550 persons b.1,100 persons c. 2,200 persons d. 3,300 persons Approximately 48% of Americans are employed. There are one working spouse families, children and retired that do not work. Therefore, the ratio is about 2:1 population to employment. 8. What is the classification of the 150, 400 and 550 employees in problem 6? a. Basic, ancillary, total b. Basic, service, total [All employment is basic + service] c. Service, basic, total d. Service, additional, speculative
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Problem Solutions 9. A property has above market leases. How would you adjust for this feature in the
cost approach? a. You would not, the cost approach values fee simple interests b. You would add the present value of the excess rent as a bottom-line item c. You would subtract the present value of the excess rent as a bottom-line item d. You would add the difference between the leasehold and leased fee values as a bottom-line item There are many bottom-line items that may be deducted or added for a cost approach to reflect the problem that is a appraised. If the problem is to appraise a business, the appraiser may add the value of personal property and business value to the cost approach. This is a possible USPAP problem. An appraiser cannot simply add the component parts of a value together. An appraiser may reflect a value that is not market value in fee simple by making adjustments to the cost approach. Theoretically, the cost approach without adjustment reflects a fee simple value. Any difference in fee simple would be a bottom-line addition or deduction.
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Problem Solutions
10. Which of the above is likely to have an irregular site? a. Office building 1 b. Office building 2 c. Office building 3 d. Office building 4 The land-to-building ratio is highest with building 2. 11. Which building is likely to have the highest rent
PSF? a. Office building 1 b. Office building 2 c. Office building 3 d. Office building 4 The newest and highest cost PSF is building 2.
! 12. If all leased for the same rental PSF, which building
likely has functional obsolescence? a. Office building 1 b. Office building 2 c. Office building 3 d. Office building 4 If all had the same rental rate PSF, the highest cost
would most likely have the functional obsolescence.
13. What is the increase in land value in the above office
sites? a. 4% per year b. 7% per year c. 9% per year d.11% per year The oldest building site was $20 PSF of building area,
then the next $21.15 and the newer buildings site cost was about $25 PSF. The prices went up $5 over 2 years or 25%/2 = 12.5%. Therefore, (d) is the best answer.
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Building LTB Ratio Cost PSF Land PSF (of Building)
Total Cost
1 (2 years) 4.00:1 $76.93 $21.15 $98.08 2 (1 year) 4.97:1 $79.47 $25.16 $104.63 3 (3 years) 4.11:1 $73.68 $20.00 $93.68 4 (1 year) 4.20:1 $76.67 $25.00 $101.67
Cost
Problem Solutions
14. A building has a component that cost $125,000 if in new construction and is 10% depreciated. The correct component would cost $150,000 in new construction and $275,000 to add. There is no salvage value to the existing component. Because of the existing component, the expenses increase $11,000 per year and the rate to the building is .11. What is the amount of functional obsolescence? a. $0 b. $50,000 c. $62,500 d. $175,000 3B. $11,000/.11 = $100,000 15. Which of the following is true? a. The cost approach sets the upper limit of value. b. The cost approach is used for fee simple valuations only. c. The cost approach is the best approach for special purpose properties. d. The cost approach is best used with very old properties. This represents the best answer. Answer (d) could also be correct because a property with a large land value to total value ratio would result in a cost approach that is useful.
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1 $125,000
2 (-) ($12,500)
3A (+) $275,000
3B (+) $100,000
4 (-) ($150,000)
TOTAL $62,500
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Problem Solutions 16. A retail property leases in a strip center for $25 PSF and percentage rents of 6% with a
natural break. Vacancy in the retail center is overall at 5%. What would the rent be PSF if sales were $400 PSF per year? a. $24 PSF b. $25 PSF c. $25 + $24 PSF d. $25 / (1 - .05) PSF
Natural break: $25/.06 = $416.67 PSF of sales. At $400, the tenant would pay the base rate. 17. Of the following, which is likely to have the highest sales PSF? a. Restaurants b. Jewelry c. Footwear d. Apparel 18. Which of the following is likely to have the highest turn ratio? a. Grocery b. Jewelry c. Footwear d. Gifts
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It would either be jewelry or food. Regional malls report jewelry as the highest sales PSF.
Grocery has the highest turn because of perishable items and because the average good is the least.
Cost
Problem Solutions
19. If the footprint coverage on the site is 1 to 4 and a 3-story building has a footprint of 15,000 SF, what is the FAR? a. 45,000/60,000 b. 60,000/45,000 c. 15,000/60,000 d. 60,000/15.000 If is (3 x 15,000)/(4 x 15,000), or 45,000/60,000 Note: The footprint ratio has to have the building being the smaller of the two numbers in the ratio. There is 4 parts land for 1 part building footprint.
20. A property has land worth $500,000. The improvements will be demolished in one year for $25,000. The improvements are being used for storage and generate enough income to off-set expenses. The NOI is zero. Assume the property would be developed today except the lease for the storage encumbers the property. What is the value of the property including the improvements. a. $450,000 b. $475,000 c. $500,000 d. $525,000 $500,000 – 25,000 + offset for carrying some land costs – delay for development because of the encumbrance of the lease. Therefore, either $450,000 or $475,000. Because of risk and delay, (a) is the best answer.
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Depreciation Problems
182
Reproduction Cost $1,000,000 Physical Curable: Paint $10,000 & Appliance replacements = $20,000 Short-lived items Total cost = $100,000 Depreciation = $45,000 Actual age =10 years & remaining physical life = 40 years Obsolescence concerns: (Assume all items below are in physical incurable long-lived) 1. Curable, requiring an addition. Example - Needs a sprinkler system (new fire code), cost to add =$45,000. Cost in new construction if the building was being built new = $25,000. 2. Curable, requiring substitution. Example - A playground area needs to be replaced with a volleyball court area. (Change of tenant mix). The playground cost $10,000. It will cost $2,000 to take away, there is $500 in salvage value for the equipment, and the volleyball court area will cost $1,000 to build. Net rents will increase enough to justify. 3. Curable, super adequacy. Example - A swimming pool cost $30,000 in new construction, would cost $4,000 to fill and landscape over it, adds $500 to expenses each year (Ro = 11%), and adds nothing to rents or occupancy. There is $250 in salvage value to the pool equipment.
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Depreciation Problems
183
4. No functional, but there is a rent loss - Net income could be increased $4,000 if a recreation building were built for a cost of $50,000, including exercise equipment. The building would have cost $48,000 if built during original construction, as of the date of the appraisal. (This is the example of no functional obsolescence, see calculations following). 5. Incurable, deficiency (item not in the building) - The apartment could use an elevator for the second floor. Rents are affected, net $5,000 per year. The elevator would have cost $30,000 if the property was being built, but would cost $70,000 to add to the existing structure. 6. Incurable, deficiency (item in the building) - The club room has inadequate air-conditioning and therefore does not rent for parties as much as other rec rooms in the area. The lost income is $600 per year, the existing A/C unit cost $3,000 in new construction and would currently cost $10,000 to replace and redo the duct system. The proper A/C unit in new construction would have cost $5,000. 7. Incurable, superadequacy - The apartments have covered parking that cost $34,000 in new construction. The income is affected, net $2,000 per year (positively). The cost to tear down the covered parking would be $10,000.
Cost
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184
8. Incurable, superadequacy - The apartments also have hallways that are too large, compared to market standards and cost $5,000 more in new construction than smaller hallways. In addition, the extra utility bills and maintenance contribute $1,100 in expenses per year over and above what smaller hallways would cost. 9. External - The market is soft and net income is depressed $20,000. The market is expected to recover fully in 5 years. The Ro = 10% and Y = 14%. Assume a land-to-value ratio of 20% and that the land value is depressed $40,000 because of the poor market. 10. External - The apartments are next to an industrial plant and the net rents are affected $3,500 per year. The land is losing $35,000 in value because of its proximity to the plant.
Cost
Depreciation Problem Solutions
185
Physical curable = $30,000 Physical incurable short-lived = $45,000 Physical incurable long-lived ($1,000,000 - 30,000 - 100,000) x 10/50 = $174,000
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Depreciation Problem Solutions
186
1. Functional curable, requiring an addition Line Description Notes $
1 Cost of existing item
There is no sprinkler in the cost approach, so there is no cost in line 1
$0
2 (-) Less: Physical Depreciation
When line 1 is $0, then line 2 will be zero.
$0
3A (+) or
Cost to Cure This is the cost of adding a sprinkler system to an existing building.
$45,000
3B (+) Cost if Incurable There is no information given but the system will be installed.
No info
4 (-) Value of “correct” item
This is the cost to install the sprinkler in a new building being built as of the date of the appraisal.
- $25,000
Depreciation This turns out to be the excess cost to add a sprinkler system in an existing building versus building it into a new building.
$20,000
Cost
Depreciation Problem Solutions
187
2. Functional curable, requiring an substitution - Playground Line Description Notes $
1 Cost of existing item
Cost of playground, but there is a change of tenant mix.
$10,000
2 (-) Less: Physical Depreciation
$10,000 x 10/50 - $2,000
3A (+) or
Cost to Cure $2,000 to remove the playground - $500 salvage costs + $1,000 to add a volleyball court
$2,500
3B (+) Cost if Incurable No info
4 (-) Value of “correct” item
The cost (value?) of a volleyball court if being built in new construction. It probably would not be much different than the $1,000 given. If it was, I would use less than the $1,000.
- $1,000
Depreciation $9,500 Cost
Depreciation Problem Solutions
188
3. Curable, superadequacy - Pool Line Description Notes $
1 Cost of existing item
$30,000
2 (-) Less: Physical Depreciation
$30,000 x 10/50 - $6,000
3A (+) or
Cost to Cure $4,000 to fill - $250 salvage for equipment
$3,750
3B (+) Cost if Incurable $500/.11 = $4,545 PV of expenses if not filled in
$4,545
4 (-) Value of “correct” item
- $0
Depreciation $27,750
Cost
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Depreciation Problem Solutions
189
4. No obsolescence. Recreational Building? (This problem exists when an item that is being considered is not in the building and the added value is less than the cost.) Line Description Notes $
1 Cost of existing item
No item in cost. There is no recreational building
$0
2 (-) Less: Physical Depreciation
-$0
3A (+) or
Cost to Cure The cost to build a recreational building
$50,000
3B (+) Cost if Incurable This is the lost income if no building is built ($4,000/.11 = $36,364)
$36,364
4 (-) Value of “correct” item
This is the cost of a recreational building if being built in new construction
- $48,000
Depreciation It is easy to see that the rec building would be a poor decision if built even in new construction. The value is less than the cost.
Negative
Cost
Depreciation Problem Solutions
190
5. Functional Incurable Deficiency, not in building. Elevator Line Description Notes $
1 Cost of existing item
There is no elevator and thus no cost in RCN
$0
2 (-) Less: Physical Depreciation
-$0
3A (+) or
Cost to Cure $70,000
3B (+) Cost if Incurable $5,000/.11 = $45,455 $45,455
4 (-) Value of “correct” item
This is the cost of putting in an elevator while a building is being built.
- $30,000
Depreciation This is what the rest of the building is losing because there is no elevator to serve it.
$15,455
Cost
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191
6. Functional Incurable Deficiency, in building. HVAC Line Description Notes $
1 Cost of existing item
$3,000
2 (-) Less: Physical Depreciation
$3,000 x 10/50 = $600 -$600
3A (+) or
Cost to Cure This is the cost to put in the proper unit in an existing building.
$10,000
3B (+) Cost if Incurable $600/.11 = $5,455 $5,455
4 (-) Value of “correct” item
This is the value of the correct item. Sometimes, costs are cut during construction & the rest of the building loses without the proper component.
- $5,000
Depreciation $2,855
Cost
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Depreciation Problem Solutions
192
7. Functional Incurable Superadequacy. Covered Parking.
Line Description Notes $ 1 Cost of existing
item $34,000
2 (-) Less: Physical Depreciation
$34,000 x 10/50 = $6,800 -$6,800
3A (+) or
Cost to Cure This is the cost to remove the covered parking. One would not remove items that contribute to value.
$10,000
3B (+) Cost if Incurable $2,000/.11 = $18,182. This is not a loss but a gain. Note, however the value is less than the cost. Also notice this is a negative depreciation (a negative negative is a positive.
-$18,182
4 (-) Value of “correct” item
The $18,182 could go in line 4 as opposed to line 3B. The math would be the same.
Depreciation $9,018 Cost
Depreciation Problem Solutions
193
8. Functional Incurable Superadequacy. Large Hallways.
Line Description Notes $ 1 Cost of existing
item Note that here we are using the excess cost of the item, not the total hallway cost.
$5,000
2 (-) Less: Physical Depreciation
$5,000 x 10/50 = $1,000 -$1,000
3A (+) or
Cost to Cure No information, but it seems likely one would not narrow hallways.
3B (+) Cost if Incurable $1,100/.11 = $10,000 $10,000
4 (-) Value of “correct” item Depreciation $14,000
Cost
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9. External Obsolescence. Soft Market. The rent loss in one year is $20,000. Even if the loss stays at $20,000 for 5 years, the most the loss would be is 5 x $20,000 = $100,000 to the total property, including the land. The loss to land is $40,000, so the most the loss could be is $100,000 - $40,000 = $60,000 to the improvements. If the loss declines as the market recovers the loss will be less than $60,000. If the loss is as follows: $20,000; $17,500; $15,000; $10,000; $5,000 the PV is approximately $60,000, and $60,000 - $40,000 is $20,000. Therefore, there is not much loss to the improvements. Moral of the Story: Don’t capitalize a short-term loss or gain (e.g. tax abatement) with a Ro.
Cost
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Depreciation Problem Solutions
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10. External Obsolescence. Environmental Problem? The rent loss, total, is $3,500/.10 = $35,000. The loss to the land is $35,000. Therefore, the loss to the building is $35,000 – 35,000 = $0. This is common. Sites have different values in the same Highest & Best Use categories because the higher valued sites produce higher rents and the lower valued sites produce lower rents.
Cost
Problem – Also, which would cost the least to build?
196
25. Which neighborhood is primarily industrial? a. 1 b. 2 c. 3 d. 4 26. Which neighborhood has a regional shopping center? a. 1 b. 2 c. 3 d. 4 27. Which neighborhood is a downtown CBD? a. 1 b. 2 c. 3
d. 4 Answer 28 & 29 based upon the following: Assume the following have the same area in square feet. A B C D 28. Which of the following would have the least perimeter? a. A b. B c. C
d. D 29. Which of the following would have the most perimeter? a. A b. B c. C
d. D 30. A property that is 50 years old has a remaining economic life of 5 years. There is sufficient data to establish
a reliable land value. Which of the following statements is most true? a. A cost approach is not reliable because of significant depreciation. b. A cost approach would be reliable because of the well established land value. c. An income approach would appear to be most useful. d. Only the sales comparison approach is applicable to this appraisal. 31. Land that is not salable but is in excess of what is needed for a particular building size is which of the
following? a. excess b. surplus c. outside storage d. industrial
Cost
Copyright Ted Whitmer. All rights reserved.
112 Cost
Cost
Problem – Also, which would cost the least to build?
197
25. Which neighborhood is primarily industrial? a. 1 b. 2 c. 3 d. 4 26. Which neighborhood has a regional shopping center? a. 1 b. 2 c. 3 d. 4 27. Which neighborhood is a downtown CBD? a. 1 b. 2 c. 3
d. 4 Answer 28 & 29 based upon the following: Assume the following have the same area in square feet. A B C D 28. Which of the following would have the least perimeter? a. A b. B c. C
d. D 29. Which of the following would have the most perimeter? a. A b. B c. C
d. D 30. A property that is 50 years old has a remaining economic life of 5 years. There is sufficient data to establish
a reliable land value. Which of the following statements is most true? a. A cost approach is not reliable because of significant depreciation. b. A cost approach would be reliable because of the well established land value. c. An income approach would appear to be most useful. d. Only the sales comparison approach is applicable to this appraisal. 31. Land that is not salable but is in excess of what is needed for a particular building size is which of the
following? a. excess b. surplus c. outside storage d. industrial
Cost
Copyright Ted Whitmer. All rights reserved.
112 Cost
A has the least perimeter.
D would have the most perimeter.
A would probably cost the most to build and C the least. Note that houses are often built as rectangles. A square house would have greater load requirements in the roof.
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11. Refer to problem 10. What would the functional obsolescence be if the cost to cure was $90,000 instead of the $150,000?
a. $115,385 b. $145,000 c. $170,385
d. $295,385 e.
Answer 12 - 14 based on the following graph: The subject is a 10 year old office building with functional obsolescence in a soft market. LINE C REPRESENTS THE RELATIONSHIP OF % OF VALUE AND AGE CONSIDERING A SOFT MARKET.
EITHER LINE A OR B REPRESENTS JUST PHYSICAL DEPRECIATION, AND EITHER LINE A OR B REPRESENTS FUNCTIONAL OBSOLESCENCE IN A BUILDING.
Value 100%
90% A
80%
70% B
60%
50% C
40%
30%
20%
10%
0% 0 5 10 15 20 25 30 35 40 45 Age 12. What does line A represent? a. Depreciation from cost new (time 0) to the end of the life of the building b. Physical depreciation from cost new (time 0) to the end of the life of the building c. Functional obsolescence from cost new (time 0) to the end of the life of the building d. External obsolescence from cost new (time 0) to the end of the life of the building 13. What does line B represent? a. Depreciation from cost new (time 0) to the end of the life of the building b. Physical depreciation from cost new (time 0) to the end of the life of the building c. Functional obsolescence from cost new (time 0) to the end of the life of the building d. External obsolescence from cost new (time 0) to the end of the life of the building
Cost
Copyright Ted Whitmer. All rights reserved.
109 Cost
198
What percentage functional, physical & external obsolescence does a 20 year old building have?
Cost
11. Refer to problem 10. What would the functional obsolescence be if the cost to cure was $90,000 instead of the $150,000?
a. $115,385 b. $145,000 c. $170,385
d. $295,385 e.
Answer 12 - 14 based on the following graph: The subject is a 10 year old office building with functional obsolescence in a soft market. LINE C REPRESENTS THE RELATIONSHIP OF % OF VALUE AND AGE CONSIDERING A SOFT MARKET.
EITHER LINE A OR B REPRESENTS JUST PHYSICAL DEPRECIATION, AND EITHER LINE A OR B REPRESENTS FUNCTIONAL OBSOLESCENCE IN A BUILDING.
Value 100%
90% A
80%
70% B
60%
50% C
40%
30%
20%
10%
0% 0 5 10 15 20 25 30 35 40 45 Age 12. What does line A represent? a. Depreciation from cost new (time 0) to the end of the life of the building b. Physical depreciation from cost new (time 0) to the end of the life of the building c. Functional obsolescence from cost new (time 0) to the end of the life of the building d. External obsolescence from cost new (time 0) to the end of the life of the building 13. What does line B represent? a. Depreciation from cost new (time 0) to the end of the life of the building b. Physical depreciation from cost new (time 0) to the end of the life of the building c. Functional obsolescence from cost new (time 0) to the end of the life of the building d. External obsolescence from cost new (time 0) to the end of the life of the building
Cost
Copyright Ted Whitmer. All rights reserved.
109 Cost
199
What percentage functional, physical & external obsolescence does a 20 year old building have?
Physical = 50% Physical & functional = 60%, therefore functional is 10% of cost new. All depreciation is about 75%. (The good is 25%) External as a % is after physical & functional. The loss is 15%/40% = 37.5% of physically & functionally depreciated cost.
Cost
END OF THE COST APPROACH
200 Cost