Chapter 19: Appraising Real Estate

General Nature of Appraisal

*   Unbiased estimation of "value"

*   market (most probable sales price)

*   insurance

*   liquidation

*   Compensation to firm usually based upon fee per job

*   Residential fees

*   Commercial fees

*   Junior appraisers split fees with firm

*   Work out of appraisal "shop"

Real Estate Counseling

*   Assists with real estate decision making

*   Investment value

*   Market analysis and/or feasibility

*   Economic impact studies

*   Location studies

*   Counselors usually academics, appraisers, or accountants

Professional Designations

*   MAI, SRA (Appraisal Institute)

*   ASA (American Society of Appraisers)

Appraisal Regulation

*   Appraisal Foundation

*   FIRREA (Financial Institutions Reform, Recovery, and Enforcement Act of 1989)

*   State Certifications (state dependent)

*   Registered

*   Licensed appraiser

*   Certified Residential

*   Certified General

The Appraisal Business

Function and Uses of Appraisals

*   Purchase or selling decisions (market value)

*   Lending decisions (market or quick sale value)

*   Investment decisions (investment value)

*   Insurance decisions (insurance value; reproduction value)

Forms of Appraisals

*   Letter

*   Form

*   Narrative

The Value Decision

Types of Value

*   Market Value

*   Investment Value

*   Insurance Value

Assumptions for Market Value

*   Typically informed parties to the transaction

*   Utility maximization

*   Adequate market exposure

*   Normal motivation

*   Normal financing

Investment Value vs. Market Value

*   Value in use

*   Value in exchange

Cost vs. Price vs. Value

*   Cost--historic amount paid

*   Asking price--amount desired by seller

*   Value--the most probable sales price

Economic principles

*   Increasing and decreasing returns--adding another bath to a 6 bedroom, one bath home is probably and increasing return to scale. Adding another bath to a three bedroom, three bath home is probably a decreasing return to scale.

*   Opportunity cost (principal of substitution)--Will pay no more thanů

Economic principles (cont.)

*   Marginal productivity (contribution)--value is the price of the last unit produced

*   Balance

*   Internal balance--components must be in balance--The six bedroom one bath home will sell for less than a six bedroom two bath home less the cost of the additional bathroom.

*   External balance--The market must be in equilibrium for the value of an additional property to be equivalent to the values of preexisting properties.

Economic principles (cont.)

*   Conformity--The property must generally conform to the norm demanded by the market for the value to be based upon that norm.

*   External economies and diseconomies (externalities)

*   Plottage--increase in value due to combining multiple parcels into one.

*   Assemblage--the process of merging multiple adjacent lots into one ownership

Economic principles (cont.)

*   Change

*   Progression

*   Regression

*   Supply and demand

Highest and best use

*   Highest and Best Use of a Property as Vacant

*   Highest and Best Use of a Property as Improved--Itemizing curable depreciation.

*   Purpose of Highest and Best Use Analysis

*   Sample Highest and Best Use Statements

*   Residential

*   Commercial

Approaches to Value Estimation

*   Cost-depreciation approach

*   Sales-comparison approach

*   Income capitalization approach

The Appraisal Process

*   Definition of the process

*   Preliminary analysis

*   Data selection and collection

*   Land value estimate

*   Application of the appropriate approaches to value

*   Reconciliation of value indications and final estimate

*   Reporting of value

Sales-Comparable Approach

*   Based upon the theory that a knowledgeable purchaser would pay no more for a property than the cost of acquiring an acceptable substitute.

*   Identifying comparables                                        

*   Adjustments

*   Time of sale

*   Conditions of sale

*   Location

*   Physical attributes

*   Reconciliation

Comparable Sales Example

*   Subj.: 3 bdrm, 2 bath, 1-car gar., 2100 s.f.

*   Sale 1: Sales Price = $98,000
3 bedroom, two bath, 1-car garage, 2000 s.f.

*   Sale 2: Sales Price = $108,000
3 bedroom, two bath, 2-car garage, 2200 s.f.

*   Sale 3: Sales Price = $101,000
3 bedroom, one bath, 1-car garage, 2200 s.f.

*   Sale 4: Sales Price = $93,000
3 bedroom, one bath, 1-car garage, 2000 s.f.

Sales Comparison Adjustments

*   Adjustment for Bathrooms: Compare Sale 1 and Sale 4; $5,000 difference for bath.

*   Adjustment for Size: Compare Sale 1 and Sale 3; If Sale three had 2 baths, it would have sold for $106,000, so the extra 200 s.f. cost an extra $8,000 or $40 per s.f.

*   Adjustment for extra garage stall: Compare Sale 1 and Sale 2; If sale 2 had 2000 s.f. it would have sold for $100,000, so the extra garage cost $2,000.

Sales Comparison Adjustment Grid

*   Sale1 Sale2 Sale3 Sale4

*   Price $98,000 $108,000 $101,000 $93,000

*   Garages $0 -$2,000 $0 $0

*   Baths $0 $0 +$5,000 +$5,000

*   Size +$4,0000 -$4,000 -$4,000 +$4,000

*   Adjusted Price
$102,000 $102,000 $102,000 $102,000

*   Indicated Sales Price is then $102,000

Cost-Depreciation Approach

*   Based upon the theory that a knowledgeable purchaser would pay no more for a property than the cost of building an acceptable substitute.

*   Site value

*   Plus Improvement value

*   Less Depreciation

Estimating Improvement Value

*   Quantity survey--quantity take-off

*   Materials

*   Labor

*   Unit-in-place--structural components

*   Quantity-in-place--Square feet or cubic feet

Depreciation

*   Physical

*   Functional

*   External

*   Economic

*   Locational

*   Curable vs incurable

Cost Depreciation Example

*   Given a 2,000 s.f. 5 year old home with 5 bedrooms and one bath. Lots cost $30,000 and new construction costs $40 / s.f. and an extra bathroom would cost $12,000 to add. Homes are expected to last for 50 years

*   Land Cost = $30,000

*   Building Cost = $40 * 2,000 = $80,000

*   Less Physical Depreciation = 5/50*$80,000= $8,000

*   Less Functional Obsolescence = $12,000

*   Cost Depreciation Value = $90,000

Income-Capitalization

*   Based upon the theory that a knowledgeable purchaser would pay no more for a property than the present value of the anticipated future benefits.

*   Estimation of income

*   Estimation of multipliers

*   Value = Income / Rate
$10,500/.09 = $116,667

Reconciliation

*   Cost-Depreciation Value=$120,000
Income Approach Value=$105,000
Sales-Comparison Value=$98,000

*   Straight Average
($120,000+$105,000+$98,000)/3=$107,667

*   Weighted Average
20% New, 50% Rentals, 30% Resales
.2*$120,000+.5*$105,000+.3*98,000
= $105,900