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Chapter1Washington Real Estate Fundamentals

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WA Real Estate Fundamentals Copyright2009 Baenen/Corl Page 1

CHAPTER 1

1.01

Originally, brokerages represented the seller as their client, and sold homes to buyers as

customers. The post World War II baby boom triggered an unprecedented housing boom. The

small 'Mom and Pop' brokers (small family owned real estate firms) began sharing their

customers and clients with sales associates. The brokers remained responsible (and thereforeliable) for all aspects of the transactions.

But sometimes, brokers didn't have enough 'inventory' (houses for sale) to keep their sales

associates busy, so they decided to share lists of their inventory with each other. These

shared lists evolved into what became known as the MLS, or Multiple Listing Service.

Originally, the MLS was a series of printed cards containing descriptions (and later, photos) of

homes. The cards were printed and distributed to the MLS designated broker members and

sales associates. The system worked so well that it evolved into MLS books.

The creation of the MLS helped brokers to keep their sales associates working. It made good

business sense. After all, everyone benefited. Sellers homes were exposed to every buyer,and every buyer had access to the entire market - as did all brokers. From a Fair Housing

perspective it was great when it worked that is, sometimes real estate didnt make the

entire market available to prospective customers because of pre-conceived ideas based on

race, color, religion, etc. But the real estate industry and the various governmental agencies

have taken steps to correct these issues.

Of course, nowadays the market is available to everyone for a different reason the advent of

the internet. Many MLS organizations make their collective listings available on line (for a

fee), and quite a number of independent consumer oriented websites have evolved that bypass

the real estate professionals altogether.

New terminology developed over time in order to describe the changing face of brokerage.

The designated broker who 'listed' the seller's home for sale on the MLS was the Listing

Broker, and the broker that worked with the buyer who purchased the home was referred

to as the Selling Broker.

As time went on, the relationships between the real estate professionals and their clients and

customers became blurred. Brokers often found it easier to show homes to buyers via the MLS,

because it opened more housing choices to the buyers than perhaps their own brokerage had

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in his or her inventory. Consequently, many brokers unconsciously developed a greater

'loyalty' to the buyer they were working with, rather than to the seller they were working for.

Those two words, with and for, are the essence of representation, or agency (a topic we'll

discuss in greater detail in Chapter 13). A broker working for someone is actually engaged in arepresentation or agency relationship (through their designated broker), and the party they

represent is referred to as a client. In many states, a broker working with someone is actually

not engaged in any sort of representation, and therefore the party they are working with is a

customer. Although most state laws have addressed this relationship (customer) as still

requiring honest and fair dealing on the part of the broker, the customer is not really

represented.

It became apparent in the 1980s that buyers were often under the mistaken impression that

they were being 'represented' by the real estate sales associate and his or her broker. The

fact was that in most cases, the buyer was misinformed. Agents were supposed to explain to

every buyer (customer) that they and their designated brokerwere actually working for the

seller (as client), and that they were merely working with the buyer (as customer). But they

often failed to make this clear to the buyer, and sometimes never even brought it up. In fact,

agents often behaved as if they actually were representing the buyer, or worse, as if they

represented both seller and buyer, without making any disclosures at all.

The real estate industry began to take stock of itself and most states throughout the U.S.

began to enact laws which clarified these positions and required formal written disclosure.

Ultimately, this has been a benefit to everyone involved, and has reduced litigation liability

on these issues.

A simple way to understand the way things are now is that, in most jurisdictions, brokers used

to represent the seller, and now they can represent the buyer, or they can represent both in

the same transaction (provided both parties are made aware and agree in writing). All of this

applies to Landlords and Tenants as well. Real estate firms and brokers have had to rise to a

new level of professionalism and a higher standard of ethics, and that has been

beneficial to buyers, sellers, landlords, tenants, brokers and sales associates alike.

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1.02

Appraisal techniques will be discussed in Chapters 18 and 19. The following is from the

Appraisal Foundation Web Site (www.appraisalfoundation.org):

The Appraisal Foundation, a not-for-profit educational organization dedicated to the

advancement of professional valuation, was established by the appraisal profession in the

United States in 1987. Since its inception, the Foundation has worked to foster

professionalism in appraising by:

establishing, improving, and promoting the Uniform Standards of ProfessionalAppraisal Practice (USPAP);

establishing educational and experience qualification criteria for the licensing,certification and recertification of appraisers;

disseminating information on USPAP and the Appraiser Qualification Criteria to theappraisal profession, state and federal government agencies, users of appraisal

services, related industries and industry groups, and the general public and;

sponsoring appropriate activities relating to standards, qualifications and issues ofimportance to appraisers and users of appraisal services.

BACKGROUND

In the early 1980's, the crisis in the savings and loan industry highlighted the need to improveappraisal practices throughout the United States. The difficulties and losses experienced by

many lending institutions illustrated the importance of ensuring that appraisals are based

upon established, recognized standards, free from outside pressures.

In 1986, nine leading professional appraisal organizations in the United States and Canada

came together to form the Ad Hoc Committee on the Uniform Standards of Professional

Appraisal Practice. Agreeing upon a generally accepted set of standards, the eight United

States committee members adopted those standards and thereafter established The Appraisal

Foundation in 1987 to implement the Uniform Standards of Professional Appraisal Practice.

The Appraiser Qualifications Board was included in the Foundation structure to develop and

promote meaningful criteria by which the competence of appraisers could be measured. TheUniform Standards of Professional Appraisal Practice was adopted by the Appraisal Standards

Board of the Foundation on January 30, 1989 and is recognized throughout the United States

as the generally accepted standards of professional appraisal practice.

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The work of the Foundation is important to all disciplines of the appraisal profession as well

as to the consumer public. The work of the Foundation benefits the appraisal profession by

functioning to increase the quality of appraisals and by addressing issues critical to the

advancement professional valuation. Users of appraisal services and consumers can feelconfident that the Foundation is working to serve their needs and help protect their financial

well-being.

The Appraisal Foundation is composed of other organizations. There are no individual

members of the Foundation. Today, through Sponsoring Organizations and Advisory Councils,

over eighty organizations, corporations and government agencies are affiliated with The

Appraisal Foundation.

RESPONSIBILITIES :Headquartered in Washington, DC, the Foundation is directed by a Board of Trustees. TheBoard of Trustees appoints members to and provides financial support for the AQB and the

ASB.

With the 1989 enactment of the Financial Institutions Reform, Recovery, and Enforcement Act

(FIRREA), Congress gave these two Boards considerable responsibilities.

APPRAISERQUALIFICATIONSBOARD (AQB)The AQB establishes the qualification criteria for state licensing, certification and

recertification of appraisers. FIRREA mandates that all state certified appraisers must meet

the minimum education, experience and examination requirements promulgated by the AQB.The AQB has also developed voluntary criteria for personal property appraisers.

APPRAISALSTANDARDSBOARD (ASB)The ASB sets forth the rules for developing an appraisal and reporting its results. In addition,

it promotes the use, understanding and enforcement of the Uniform Standards of Professional

Appraisal Practice (USPAP).

FIRREA requires that real estate appraisals used in conjunction with federally-related

transactions be performed in accordance with USPAP. In 2006, (the last year available from

the Bureau of Labor Statistics), there were more than 100,000 state certified and licensed

appraisers including assessors. They are currently required to adhere to USPAP. USPAP

contains the recognized standards of practice for real estate, personal property and business

appraisal.

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The authority of USPAP extends beyond FIRREA. Since 1992, the Office of Management and

Budget (OMB) has required federal land acquisition and direct lending agencies to use

appraisals in conformance with USPAP.

1.03

Of the many societies and councils under the umbrella of the National Association of Realtors,

is the group known as Counselors of Real Estate. This group awards the Counselor of Real

Estate (CRE) designation. The web page for this group is www.cre.org . The site will more

fully describe the criteria to become a member and the activities associated with counseling

in the About Us section of this web site.

1.04

Real estate education is a relatively new phenomenon. A significant percentage of formal realestate educational offerings (including continuing education as well as degree and certificate

programs) have only been in existence for the last thirty years. Prior to that time, education

was unstructured and limited mostly to on the job training. But there's a vast difference

between sales training, and professional education. As laws were passed around the country

requiring those who engaged in the profession of marketing and selling real estate for hire be

licensed, the real estate industry began to change. But, if the real estate industry were ever

to rise above the level of mere sales, education was the only way to connect real estate

brokers and brokers with the term 'professional.'

Many of the first real estate educational courses came from some of the specializations in

real estate (commercial, investment, property management, etc.). In fact, one of the first

groups to organize and provide education was the property management sector of the

business (which will be discussed under property management further in this Chapter).

As the transferring of real estate became more complex, the need for real estate licensees to

have better education has grown. Initially, most pre-license education was offered through

the community colleges, universities, and a few professional organizations. Over the last 20

years or so, the pace of change in many areas that affect real estate transactions pointed

toward a growing need for post-license education as well. Consumer protection has become

an increasingly strong theme throughout all real estate education.

The trend for post license education (Continuing Education) is only 15-20 years old in most

states. Over this time period most states have adopted some form of mandatory continuing

education (MCE or CE for short) not only for real estate, but for many groups that provide

services to the public and hold themselves out as 'professionals.' While this has triggered a

proliferation of training and education programs, it has become increasingly necessary for

such groups as the Washington State Department of Licensing (DOL) to create and review ever

stronger standards for real estate education. At the national level, the Association of Real

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Estate License Law Officials (ARELLO - of which the WA, DOL is a member) provides a national

forum for license law officials to exchange ideas and solutions to the challenges of quality,

professional education for real estate professionals.

The recent revision of the Washington State Real Estate Licensing Laws (RCW 18.85, 18.86)

will be effective as of July 1, 2010. This course has been developed to meet all educational

requirements in the revised RCWs.

1.05

Financing is covered in four Chapters in Unit VII in the text book. We will discuss financing in

great detail in those Chapters. The Mortgage Bankers Association of America is one of the

major lending professional associations. Their web site is www.mbaa.org/about. A visit to

their web site should include a reading of the Mission Statement. It details how this

organization is devoted to furthering high ethical standards in the real estate lending field.

1.06

Developers are at the top of the real estate food chain, so to speak. Developers find new

properties to acquire for the development process, and then do as much of the process as

they can afford to, or are willing to invest their time and money toward, often selling the

project to a builder. The development process is arduous and involves going from raw ground,

to an approved subdivision (homes) or site (commercial, industrial, etc.), to improved

(streets, sewers, utilities, etc.) to the final stage of "improvement", that is, the actual homes,

buildings or other structures.

An ancillary organization in this process is the National Association of Home Builders (NAHB).

The NAHB has created an excellent course called the Certified New Home Sales Professional

course, or CSP for short (Certified Sales Professional). A 24 hour program, usually offered over

a four day period, this course is designed to promote harmony and understanding between

real estate professionals and the builders who belong to the local Home Builder's Associations

(HBAs - affiliates of NAHB). The course grants the professional designation CSP to its

graduates. For more information on availability in Washington State contact the Building

Industry Association of Washington (BIAW) on Capital Blvd., Olympia, Washington.

1.07

Property Management is covered in Chapter 24. Property Management is a major specialty

within the industry, along with appraising, sales, and investment analysis. The Institute of

Real Estate Management is a council within the National Association of Realtors supporting

the property management profession. Reading about the organization and the educational

offerings available at their web site provides an insight into the activities and knowledge

needed to successfully manage income producing property. www.irem.org

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1.08

The text gives a brief description of the National Association of Realtors history and activities.

The Realtors have one of the largest trade associations in the United States. Their website www.realtor.com gives a tremendous amount of information. The ability to perform

accurate research will be a key to your success as a real estate agent. This is a good place to

start to learn more about the real estate industry and the participants. You may find some of

the virtual tours of the Hot Properties section particularly interesting.

1.09

Remember there are five classes of real estate, residential, commercial, industrial,

agricultural and special purpose.

Residential is essentially any kind of dwelling where you might live (eat, sleep, etc.) for aperiod of time that is not a hotel or similar commercial venture.

Commercial real estate is virtually any real estate where business is conducted (where

'commerce' typically takes place).

Industrial real estate is the 'home' of industry, where manufacturing, storing, shipping and

transferring of products takes place.

Agricultural real estate is naturally first thought of as farmland, but agricultural can be a

much more varied definition. Agricultural can include anything that involves the 'growing' of

products, so the definition can include such things as fish hatcheries. Whether to includesome endeavors as agricultural or industrial can sometimes depend on the extent of such

things as mechanization and organization. There are many enormous farms in the United

States that wholly owned and operated by large corporations, and their operations can easily

be compared or combined with industrial pursuits. It may sometimes fall to the local

governing body, such as a zoning board to determine the use classification of such properties.

And, finally, there is the catch-all use, special purpose, which includes those properties that

defy description under the previous headings. Such properties include churches government

lands and facilities, hospitals, schools, etc.

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1.10

There is a list of pertinent Internet Sites beginning on Page 488 of the text. Several of the

web addresses are now inaccurate, but we suggest that you log onto www.google.com as anexcellent and uncluttered search engine that will make your research on any of these topics

much easier.

1.11

There are physical and economic characteristics that distinguish real estate from other

commodities.

The physical characteristics include immobility (land can't be moved to another location -

even if buildings sometimes can), indestructibility (in theory, land cannot be destroyed -

although in reality it sometimes can be - violently, in the case of a volcanic eruption, orgradually in the case of erosion by wind or water), and non-homogeneity (which simply means

that no two parcels of land can be exactly alike - even though homes can be exactly alike,

they still do not occupy the same ground, and never can).

Anyone who has ever begun to study real estate seriously has heard the old saying that the

three most important factors in valuing or selecting real estate are location, location,

location. This implies that the location of a property is its first and most crucial asset, above

all others when evaluating any parcel of real estate for a specific user. Matching the need or

intentions of a particular user of real estate with the location where that need or those

intentions will be best served, is the core of the real estate business.

An appraiser first bases the value of property on its location. The appraiser uses comparable

sales for estimating the value of property. Comparable sales are recent sales of property that

are as close to the subject property in all characteristics. The more characteristics that differ

between comparable sales and the subject, the less reliable the estimated value, or the

potential success of the property by the user.

You can't move real estate (immobility), so the analysis regarding location as related to the

expected use is vital. This is true for residential property as well as income producing. The

potential home user has many specific criteria or characteristics they are searching for, such

as proximity to work, schools, recreation, church, shopping, and other lifestyle preferences.

Another characteristic is the fact you cannot destroy land (indestructibility), at least in

theory. That is to say that land cannot generally be made to disappear. However, there are of

course, exceptions. Erosion, landslides, earthquakes and other acts of nature can sometimes

cause land to subside or move. Environmental disasters can also cause situations where land

needs to be removed, cleaned or restored. The question is, "what is the economic feasibility

of restoring land?" In some cases the cost may be too prohibitive, thereby rendering the land

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valueless. But, for our purposes here, the simple concept of indestructibility simply means

that land generally remains where it is, intact, and useful for generations.

Non-homogeneity is a slightly harder concept to understand. If you have two city lots or two

five acre parcels that are adjacent to each other, the first thought is that they are just the

same. No two pieces of property are identical, but the test for the real estate agent, user, or

appraiser to apply is, "do the slight differences affect value and/or marketability?" Many

times in these cases they might be priced the same, but external factors may cause a

potential buyer to perceive a difference in values. The properties being considered could

have lesser or greater distances to bring in utilities (electric, gas, water, sewer, etc.) to the

site, so the variance in potential development costs may affect the value. Sometimes a lot

may have easier access to the main road or better access to utilities, and such building sites

may therefore have lower construction costs and so the overall development costs could be

less.

1.12

Scarcity means the supply of land is limited. But to make that point a little more clearly,

consider the fact that the supply of useable land is limited. There may be vast quantities of

land, but it is not all useable for one reason or another. Some land is simply not available for

private use, whether because of zoning purposes, the fact that it is owned by the

government, or simply the fact that there is no water or other essential element to sustain

life, and therefore cannot be used.

Substitution is one of the theories used when evaluating real estate. Substitution can be

explained as follows: "The price someone will pay for a property is influenced by the cost ofacquiring a substitute or comparable property."

Let's imagine you have just completed building your new home and you have to move. You

have struggled for several months with architects, local planning and building departments,

and builders. Next, you add up all the costs. Then you stop and think, "I should be

compensated for all the work and stress I went through to have this home in place, ready to

move into." Maybe, maybe not. And, you ask how much would someone pay for all your work?

This is where the theories of substitution and scarcity can be applied. If you are situated in is

a very marketable location (location, location, location) and you have built on the last vacant

lot in the area, (useable land is scarce) you may be able to realize a very significant return onyour time for developing and constructing the house, because there are no readily available

substitutes in this location.

However, if you have built in an area where there is ample useable land available (no scarcity

of land) then you may not be able to recoup the building costs in such a short span of time.

This touches on the concept of appreciation (which will be covered in greater detail later).

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Appreciation is when a house goes up in value over time as demand increases and available

supply decreases. One key to appreciation is demand, but another is time. The market usually

needs to 'absorb' the newly constructed homes into the available housing stock in a given area

for some period of time before appreciation can take place. Only in a situation where supplyis extremely limited can a home owner benefit from the effects of nearly instant

appreciation.

CONSIDER THE FOLLOWING SITUATION:

Youhavebuiltyourdreamhomeatacostof$500,000 inanareawheremostofthehomesare$300,000.Youhavebuilton5acreswheretherearemany comparable5 acreparcelsfor saleand thebuildingprocess isnottoo cumbersome.What is the incentivefor someone to buyyour housewhen they can build their owndreamhome?Notmuch.Theywillmostlikely not spendmore onyour home than theymight have to spend tobuildoneoftheirownwiththeirowntastesaswell.Theymayalsowantadiscount if thefloorplans ofyour home are so specifically designedforyour use that the house does not meet the requirements of the otherpotentialpurchasers.Inaddition,ifyouhavebuiltahomethathasacostfarexceeding theaverage in themarketarea, thenumberofpeoplewhoarewillingorabletopaythepricewillbelimited.

1.13

Modification is another concept of valuing land. Typically, when appraising property, land is

evaluated as if it were vacant and available for building. If property is not utilized to its

"highest and best use" then the modification, will be a detriment (e.g. - suppose one was to

build a single family home on a lot zoned multi-family (apartment units)?

In an actual case, the owners of such a property decided to build a home on the back portion

of a three acre site, one block from a main traffic artery in a suburban community. The west

boundary of the parcel fronted on the main traffic artery. They separated the back (east)

acre from the original site, petitioned and received access from a side street, and built a

house that cost $300,000. The house bordered a school on the east boundary, older smaller

homes on the north, west, and south. Since the property was zoned for multi-family and theexisting houses were all small and poorly maintained, how long do you think it will be before

the houses will be torn down and the apartments will be built? Not long. This house will

become an island in the midst of apartment buildings and a busy urban school. The only view

will be the back side of apartments and a school. This is definitely not the "highest and best

use" of the land. Far from it. Why didn't the owner sell the lot and buy a lot in an area where

the house would be more homogeneous, thus increasing rather than decreasing the value of

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the cost to build? No one can say, but this was a mistake that the owner will pay for in the

end, because it will be nearly impossible to sell the property and to break even, let alone

make a profit. Building this house on this lot, within such surroundings, and without

considering the further deterioration of the value of the land for purely residential purposeswas a colossal mistake. The house has significant economic (or external) depreciation

(meaning that the value is lessened because of the location - things not in or on the property

itself!) before they even moved in. The owner modified the land to its detriment. If the

owner had built an apartment complex it would have maximized the value of the land.

1.14

Fixity is a theory most often covered in economic courses as the idea that real estate is not a

'liquid' asset. In other words, the ultimate liquid asset is cash, because it can be used

instantly (liquidity). The value of real estate cannot be instantly 'cashed in' such as one can

with stocks or bonds, therefore real estate is the least liquid of major assets. This non-

liquidity makes real estate a long-term investment by nature, and that is the concept of

fixity. The theory is addressed when comparing real estate as an investment as opposed to

having cash in the bank to make an advantageous investment in a timely manner. Simply put,

it takes longer to liquidate real estate, thus possibly missing an investment opportunity.

1.15

Area preference is just another way of saying "location, location, location," Area preference

has many levels, from which side of the country to which part of the county to which side of

the street. It's all area preference; it's just a matter of degree.

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