Real Property Valuation

The Nature of Value

Foundations of Appraisal

Wayne Foss, MBA, MAI, CREFoss Consulting GroupEmail: wfoss@fossconsult.com

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Land is Unique

In Location and it’s CompositionPhysically ImmobileDurableSupply is finiteUseful to People

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Concepts

Governmental and Legal– the focus of law is on ownership rights

Legal Definition– Land… includes not only the ground, or soil, but everything that

is attached to the earth, whether by course of nature, as are trees and herbage, or by the hand of man, as are houses and other buildings. It includes not only the surface of the earth but everything under it and over it. Thus in legal theory, the surface of the earth is just part of an inverted pyramid having its tip, or apex at the center of the earth, extending outward through the surface of the earth at the boundary lines of the tract, and continuing upward to the heavens.

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Concepts, con’t...

Geographic– Diverse physical characteristics– May be used for many purposes– Use influenced by geographic considerations

Legal– Individuals hold private rights to own and use land– public rights to shared use– Land: “The earth’s surface, both land and water, and anything

that is attached to it whether by the course of nature of human hands.”

• Subsurface rights• Surface rights• Suprasurface rights

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Concepts, con’t...

Social– resource that all individuals share

– marketable commodity

– Conflicts between groups with different views on land use

– Environmental and Historic preservation concerns

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Concepts con’t...

Economic– Major source of wealth

– Can be used for multiple purposes

Restrictions– Public right to use of the nation’s airspace

Highest and Best Use– Physical Characteristics

– Locational Characteristics

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DefinitionsReal Estate

– Physical Land and Appurtenances affixed to the land (e.g.,

structures)

Real Property– all interests, benefits and rights inherent in the ownership

of real estate

– bundle of rights

Personal Property– Moveable items not permanently affixed to, or part of, the

real estate

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Real Estate, Personal Property and Real Property

1. Schaefer owns land with a grove of trees that are prized for their wood. The trees would be classified as:

2. Schaefer cuts down several of the trees and stacks the wood on this land.

3. Schaefer sends the wood to a woodworker to be made into cabinets. The finished cabinets are delivered and placed in Schaefer’s house.

Real Estate

Personal Property

Personal Property

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Real Estate, Personal Property and Real Property

4. Schaefer secures the cabinets to a wall in the family room of the house.

5. Years later Schaefer remodels the home and removes the cabinets and places them in the attached garage.

6. Schaefer’s marriage falls apart, and a judge orders that Schaefer’s spouse receive one-half the wholesale timber value of the tree grove. The interest in the tree grove represents

Real Estate

Personal Property

Real Property

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Types of Real Property Fee Simple Estate

– all interests, benefits, and rights inherent in the ownership Leased Fee Estate

– an ownership interest held by a landlord Leasehold Estate

– an ownership interest held by the lessee Life Estate

– Total rights of use, occupancy and control limited to the lifetime of a designated party.

Easement

– A conveyance of use, but not ownership

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Types of Real Property, con’t...

Partial Interest

– divided or undivided rights in real estate that represent less than the whole

Specialized fractional ownership

– Condominium

– Cooperative

– Timesharing Vertical Interest

– Subsurface and air rights

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Limitations on Ownership Public: Four Powers of Government that restrict private ownership

– Police Power• the right of government under which property is regulated to

protect public safety (e.g. zoning, building codes)

– Escheat• Property reverts to the state when its owner dies without a

will or any ascertainable heirs

– Taxation• right of government to raise revenue through assessments

(e.g. property tax, special assessments)

– Eminent domain• right of government to take private property for public use

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Limitations on Ownership, con’t... Private

– Deed Restriction• limitation that passes with the land regardless of the owner

– Easement• access, drainage, view

– Encroachment• trespassing on the domain of another

– Lease

– Mortgage

– Lien

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Bundle of Rights

Contains all of the interests in Real Property– Use and/or improve

– Sell

– Lease

– Enter

– Give it Away

– or do nothing

Each interest can be separated and traded from the bundle

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The Practice of Appraisal

Appraisal– an opinion of value

Appraisal Consulting (Evaluation)– an analysis, recommendation, or opinion to solve

a problem

Appraisal Review– an opinion about the quality of another

appraiser’s work

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Purpose and Intended Use

The purpose establishes the foundation for the final value opinion. Some examples are:– Market Value

• Definitions of market value

– Insurable Value

– Assessed Value

– Use Value

– Investment Value

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Definition of Market ValueThe most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:

1. Buyer and seller are typically motivated;

2. Both parties are well informed or well advised, and acting in what they consider their best interests;

3. A reasonable time is allowed for exposure in the open market;

4. Payment is made in terms of cash in United States Dollars or in terms of financial arrangements comparable thereto; and

5. The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

Source: Federal Register vol. 55, no. 163, August 22, 1990 pages 34228 and 34229

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InternationalDefinition of Market Value

Market value is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction after property marketing wherein the parties had each acted knowledgeably, prudently, and without compulsion.

Source: International Valuation Standards 2000, (London, 2000), 92-93

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Intended UseThe intended use

– the manner in which the client will employ the information contained in the appraisal.

• Transfer of Ownership

• Financing and Credit

• Legal Claims

• Tax Matters– Real Estate Taxes

– Estate Planning and Taxes

• Investment Counseling– Rental Surveys

– Feasibility Analysis

– Supply and Demand Analysis

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Factors of Value

Utility– ability of a product to satisfy a human want, need or

desire

Scarcity– supply relative to demand

Desire– wish to satisfy a human need

Effective Purchasing Power– ability of an individual or group to purchase

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Value, Price and Cost

Value– The monetary worth of a property, good or service to buyers

and sellers at a given time. The present worth of future benefits that accrue to real property ownership.

Price– The amount a particular purchaser agrees to pay and a

particular seller agrees to accept under the circumstances surrounding their transaction.

Cost– The total dollar expenditure for an improvement (structure).

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Agents of Production Land

– Cost of acquisition

Labor– direct and indirect cost to construct and market

the product. • Land or land and improvements

Capital– cost of capital on borrowed and equity capital

invested in the project

Entrepreneurial coordination– incentive or profit (reward for the investment of

time and expertise)

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Economic Principles

Anticipation– The perception that value is created by the

expectation of benefits to be derived in the future.• Residential: amenities and pleasures of ownership• Income: the income it will produce in the future

Change– The result of the cause and effect relationship

among the forces that influence real property value.

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Economic Principles, con’t...

Supply and Demand– the price of real property varies directly, but not

necessarily proportionately, with demand and inversely, but not necessarily proportionately, with supply.

• Supply:– usually values vary inversely with changes in supply

– quantity of space supplied is slow to adjust to changes in demand

• Demand:– supported by effective purchasing power results in effective

demand

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Economic Principles, con’t...Competition

– profit encourages competitionSubstitution

– when several similar commodities, goods, or services are available, the one with the lowest price will attract the greatest demand and widest distribution.

• Basis for data selection in the approaches to value

Balance– property value is created and sustained when

contrasting, opposing or interacting elements are in a state of equilibrium.

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Economic Principles, con’t...

Increasing and decreasing returns– successive increments of one or more agents of

production added to fixed amounts of the other agents will enhance income, … until a maximum return is reached.

Contribution– value of a component is measured in terms of its

contribution to the value of the whole property.• Basis of adjustments in the sales comparison approach

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Economic Principles, con’t...

Conformity– real property value is created and sustained when

the characteristics of a property conform to the demands of the market.

• Basis for under or over improvement of a site

Externalities– economies outside a property have a positive

effect on its value, while diseconomies outside a property have a negative effect on its value.

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Highest and Best UseThe reasonably probable and legal use of vacant land or improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.

Two types:

•H&BU of land or a site as vacant

•H&BU of property, as improved

Interim Use: The temporary use to which a site or improved property is put until it is ready to be put to its future highest and best use.

Consistent Use: Land can not be valued on the basis of one use while improvements are valued on the basis of another.

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So That’s An Introduction to Real Estate Valuation

Wayne Foss, MBA, MAI, CRE, Fullerton, CA USAPhone: (714) 871-3585 Fax: (714) 871-8123 Email: wfoss@fossconsult.com