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Chapter 21

Real Estate Appraisal

QuestionAnswer
What is TRANSFERABILITY? how readily or easily title or rights to real estate can be transferred.
What is ANTICIPATION? the benefits a buyer expects to derive from a property over a holding period.
What is the PRINCIPLE OF SUBSTITUTION? a buyer will pay no more for a property than the buyer would have to pay for an equally desirable and available substitute property.
What is the PRINCIPLE OF CONTRIBUTION? focuses on the degree to which a particular improvement affects market value of the overall property.
What is the PRINCIPLE OF HIGHEST AND BEST USE? there is, theoretically, a single use for a property that produces the greatest income and return. A property achieves its maximum value when this is put to use.
What is the PRINCIPLE OF CONFORMITY? a property's maximal value is attained when its form and use are in tune with surrounding properties and uses.
What is PROGRESSION? if a property is surrounded by properties with higher values, its value will tend to rise.
What is REGRESSION? if a property is surrounded by properties of lower values, its value will tend to fall.
What is ASSEMBLAGE? the conjoining of adjacent properties.
What is SUBDIVISION? the division of a single property into smaller properties (can result in a higher total value).
What is REPRODUCTION VALUE? the value based on the cost of constructing a precise duplicate of the subject's property improvements, assuming current construction costs.
What is REPLACEMENT VALUE? the value based on the costs of constructing a functional equivalent of the subject's property improvements, assuming current construction costs.
What is MARKET VALUE? an opinion of the price that a willing seller and willing buyer would probably agree on for a property at a given time.
What is an APPRAISAL? an opinion of value supported by data and performed by a professional, disinterested third party.
What is BROKER'S OPINION OF VALUE? resembling an appraisal, but it is not necessarily performed by a disinterested third party or licensed professional and generally uses only a limited form of one of the three appraisal approaches.
Real estate value in general is... the present monetary worth of benefits arising from the ownership of real estate.
The primary benefits that contribute to real estate value are: income, appreciation, use and tax benefits
Ownership of real estate produces income when... there are leases on the land, improvements, or on air, surface or subsurface rights.
Appreciation is a benefit that contributes to real estate value because... it is an increase in the market value of a parcel of land over time, usually resulting from a general rise in sale prices of real estate throughout a market area.
The way a property is used affects real estate value because... it determines the property's value.
Tax benefits contribute to real estate value because... they contribute to the income and potential sale price of a property through the forms of preferred treatment of capital gain, tax losses, depreciation, and deferrals of tax liability.
The contribution of the improvement is equal to... the change in market value that the addition of the improvement causes.
In economic principles underlying real estate value, what is supply and demand? the availability of certain properties interacts with the strength of demand for those properties to establish prices.
What is utility? The fact that a property has a use in a certain marketplace.
Use is not the same as _____. function.
When a property suffers from diminishing marginal return, what is happening? the cost to improve exceed contribution.
Change should be reflected in a property's _____. value.
What is plottage value? an estimate of the value that the process of assemblage adds to the combined values of the assembled properties.
What is salvage value? the nominal value of a property that has reached the end of its economic life. Also an estimate of the price at which a structure will sell if it is dismantled and moved.
What is assessed value? the value of a property as estimated by a taxing authority as the basis for ad valorem taxation.
What is condemned value? the value set by a county or municipal authority for a property which may be taken by eminent domain.
What is depreciated value? a value established by subtracting accumulated depreciation from the purchase price of a property.
What is reversionary value? the estimated selling price of a property at some time in the future.
What is appraised value? an appraiser's opinion of a property's value.
What is rental value? an estimate of the rental rate a property can command for a specific period of time.
What is leasehold value? an estimate of the market value of a lessee's interest in a property.
What is insured value? the face amount a casualty or hazard insurance policy will pay in case a property is rendered unusable.
What is book value? the value of the property as carried on the accounts of the owner.
Book value formula: acquisition price + capital improvements - accumulated depreciation = book value
What is market price? what a property actually sells for.
Appraisals are used in real estate decision-making to... estimate one or more types of value, depending on the kind of decision to be made.
Appraisal Process STEP 1: define the appraisal problem and the purpose of the appraisal.
Appraisal Process STEP 2: collect, organize and analyze relevant data about the subject property.
Appraisal Process STEP 3: analyze market conditions to identify the most profitable use for the subject property
Appraisal Process STEP 4: estimate the land value of the subject property
Appraisal Process STEP 5: apply the three basic approaches to value the subject: sales comparison approach, cost approach and income capitalization approach
Appraisal Process STEP 6: reconcile the value estimates produced by the three approaches to value into a final value estimate
Appraisal Process STEP 7: present the estimate of value in the format requested by the client (most commonly the Uniform Residential Appraisal Report)
The sales comparison approach is also known as the... market data approach.
The sales comparison approach is based on the principle of... substitution (buyer will pay no more for the subject property than would be sufficient to purchase a comparable property) and contribution (specific characteristics add value to a property)
What are the steps in the sales comparison approach? 1. identify comparable sales 2. compare comparables to the subject and make adjustments to comparables 3. weight values indicated by adjusted comparables for the final value estimate of the subject
To qualify as a comparable, a property must: resemble the subject in size, shape, design, utility and location; have sold recently, generally within six months of the appraisal; have sold in an arm's-length transaction
The time of sale criterion is important in the sales comparison approach because... transactions that occurred too far in the past will not reflect appreciation or recent changes in market conditions.
Principal sources of data for generating the sales comparison are... tax records, title records and the local multiple listing service
Adjustments can only be made to the _____'s prices, not to the ____'s. comparable; subject
If the comparable is better than the subject in some characteristic, an amount is _____ from the sale price of the comparable. deducted
If the comparable is inferior to the subject in some characteristic, an amount is _____ to the price of the comparable. added
The principle factors for comparison and adjustment are: time of sale, location, physical characteristics and transaction characteristics.
Adjustment criteria: time of sale: if market conditions, market prices, or financing availability have changed significantly since the date of the comparable's sale, an adjustment may be made
Adjustment criteria: location: if there are differences between the comparable's location and the subject's. an adjustment may be made.
Adjustment criteria: physical characteristics: an adjustment may be made for marketable difference between the comparable's and subject's... lot size, square feet of livable space (or other appropriate measure per property type), number of rooms, layout, age, condition, construction type and quality, landscaping and special ammenities.
Adjustment criteria: transaction characteristics: for such differences as mortgage loan terms, mortgage assumability, and owner financing, an adjustment may be made.
What are the three quantitative guidelines for selecting a value from within the range of all comparables analyzed? total number of adjustments, amount of a single adjustment, and the net value of all adjustments.
As a rule, the fewer the total number of adjustments made... and the less the total adjustment amount... the smaller the adjustment amounts the more reliable the comparable
A broker or salesperson who is attempting to establish a listing price or range of prices for a property uses a scaled-down version of the... appraiser's sales comparison approach called a comparative market analysis (CMA)
The cost approach is most often used for... recently built properties where the actual cost of development and construction are known.
What are the strengths of the cost approach? 1. provides an upper limit for the subject's value based on the undepreciated cost of reproducing the improvements 2. very accurate for a property with new improvements which are the highest and best use of the property
What are the limitations of the cost approach? 1. the cost to create improvements is not necessarily the same as the market value 2. depreciation is difficult to measure, especially for older buildings
The cost approach generally aims to estimate either the _____ cost or the _____ cost of the subject property. reproduction; replacement
What is reproduction cost? the cost of constructing, at current prices, a precise duplicate of the subject improvements
What is replacement cost? the cost of constructing, at current prices and using current materials and methods, a functional equivalent of the subject improvements
What is depreciation? the loss of value in an improvement over time
What is accrued depreciation? the sum of depreciation from all causes
An appraiser considers depreciation as having three causes: physical deterioration, functional obsolescence and economic obsolescence
Physical deterioration is: wear and tear from use, decay and structural deterioration. May be either curable or incurable.
Curable deterioration is when... the cost of repair of the item is less than or equal to the resulting increase in the property's value
Incurable deterioration is when... the repair will cost more than can be recovered by its contribution to the value of the building.
Functional obsolescence is: when a property has outmoded physical or design features which are no longer desirable to current users. Can be either incurable or curable.
Curable functional obsolescence is when... the cost of replacing or redesigning the outmoded feature will be offset by the contribution to overall value.
Incurable functional obsolescence is when... the cost of the cure would exceed the contribution to overall value.
Economic obsolescence is: the loss of value due to adverse changes in the surroundings of the subject property that make the subject less desirable. Is an incurable value loss.
The cost approach consists of... estimating the value of the land "as if vacant"
Steps 1-3 in the Cost Approach: 1. estimate land value 2. estimate reproduction or replacement cost of improvement 3. estimate accrued depreciation
Steps 4-5 in the Cost Approach: 4. subtract accrued depreciation from reproduction/replacement cost 5. add land value to depreciated reproduction/replacement cost
Estimating reproduction or replacement cost of improvements: unit comparison method: the appraiser examines one or more new structures that are similar to the subject's improvements, determines a cost per unit for the benchmark structures, and multiplies this cost per unit times the number of units in the subject
Estimating reproduction or replacement cost of improvements: unit-in-place method: the appraiser uses materials cost manuals and estimates of labor costs, overhead, and builder's profit to estimate the cost of constructing separate components of the subject (overall cost estimate is sum of estimated costs of individual components)
Estimating reproduction or replacement cost of improvements: quantity survey method: the appraiser considers in detail all materials, labor, supplies, overhead and profit to get an accurate estimate of the actual cost to build the improvement
Estimating reproduction or replacement cost of improvements: cost indexing method: the original cost of constructing the improvement is updated by applying a percentage increase factor to account for increase in nominal costs over time
The accrued depreciation is often estimated by the economic age-life method. What is the economic age-life method (or straight-line method)? method assumes that depreciation occurs at a steady rate over the economic life of the structure. therefore, a property suffers the same incremental loss of value each year.
What is the economic life? the period during which the structure is expected to remain useful in its original use.
The sum of accrued depreciation from all sources is... subtracted from the estimated cost of reproducing or replacing the structure
The estimate value of the land "as if vacant" is... added to the estimated value of the depreciated reproduction or replacement cost of the improvements.
The income capitalization approach (or income approach) is used for... income properties and sometimes for other properties in a rental market where the appraiser can find rental data.
The income capitalization approach is based on the principle of... and the principle of... anticipation: the expected future income stream of a property underlies what an investor will pay for the property. substitution: investor will pay no more for a subject property with a certain income stream than another property with similar stream
What is the strength of the income capitalization approach? it is used by investors themselves to determine how much they should pay for a property
What are the 2 limits of the income capitalization approach? 1. it is difficult to determine an appropriate capitalization rate 2. the approach relies on market information about income and expenses, which can be tough to find
Steps in the income capitalization approach: 1. estimate potential gross income 2. estimate effective gross income 3. estimate net operating income 4. select a capitalization rate 5. apply the capitalization rate
Potential gross income is: the scheduled rent if the subjects plus income from miscellaneous sources (like vending machines).
Scheduled rent is: the total rent a property will produce if fully leased at the established rental rates
Potential gross income formula: scheduled rent + other income = potential gross income
An appraiser may estimate potential gross rental income using... current market rental rates, the rent specified in leases in effect on the property or a combination of both
Effective gross income formula? potential gross income - vacancy and credit losses = effective gross income
Vacancy loss refers to? an amount of potential income lost because of unrented space
Credit loss refers to? An amount lost because of tenants' failure to pay rent for any reason
Net operating income formula? effective gross income - total operating expenses = net operating income
Operating expenses include? fixed expenses and variable expenses
Fixed expenses are? those that are incurred whether the property is occupied or vacant
Variable expenses are? those that relate to actual operation of the building
The capitalization rate is an estimate of... the rate of return an investor will demand on the investment of capital in a property such as the subject
Appraisers obtain an indication of value from the income capitalization method by the formula: net operating income / capitalization rate = value
The formula for value is? income / rate = value
The gross rent multiplier (GRM) and gross income multiplier (GIM) are... simplified income-based methods used primarily for properties that produce or might produce income but are not primarily income properties.
The advantage of the income multiplier is that it... offers a relatively quick indication of value using an informal methodology.
What are the two steps in the gross rent multiplier approach? 1. select a gross rent multiplier by examining the sale prices and monthly rents of comparable properties that have sold recently 2. estimate the value of the subject by multiplying the selected GRM by the subject's monthly income
What is the gross rent multiplier for a property? price / monthly rent = GRM
What is the estimated value of the subject in the gross rent multiplier approach? GRM x subject monthly rent = estimated value
What are the two steps in the gross income multiplier approach? 1. select a gross income multiplier by examining the sale prices and gross annual incomes of comparable properties which have sold recently 2. estimate the value of the subject by multiplying the selected GIM by the subject's gross annual income
What was the 1989 Financial Institutions Reform, Recovery, and Enforcement act in response to? the savings and loan crisis
What does Title XI of FIRREA require? That competent individuals whose professional conduct is properly supervised perform all appraisals used in federally-related transactions
A state-certified appraiser is one who has? passed the necessary examinations and competency standards as established by each state in conformance with the federal standards stated in FIRREA and USPAP
What is the Uniform Standards of Professional Appraisal Practice (USPAP) the set of standards, guidelines and provisions for the appraisal industry
The competence provision requires appraisers to? assess whether they have the necessary knowledge and competence to perform a specific assignment
The departure provision permits appraisers to? perform an appraisal that does not meet all the USPAP guidelines provided they have informed the client of the limitations of the incomplete appraisal and if the partial appraisal will not be misleading
The standards of the USPAP concern: recognized appraisal methods, definition of due diligence, how appraisal results are reported, disclosures and assumptions, appraisal reviews, real estate analysis, mass appraisals, personal property appraisals, business appraisals, compliance with USPAP
Created by: alli-bohanon
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