the appraisal of real estate. what is appraisal? simply put, appraisal is the act or process of...
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The Appraisal of Real Estate
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What is appraisal?Simply put, appraisal is the act or process of estimating value.More precisely: “The term appraisal means a written statement independently and impartially prepared by a qualified appraiser setting forth an opinion of defined value of adequately described property as of a specific date, supported by the presentation and analysis of relevant market information”
- Real Estate Valuation, Lusht, 1997
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What is value?
Value is the worth of an item.Human behavior determines value because no item has inherent value.Value in exchange is the quantity of one thing that can be obtained in exchange for another good. This relationship is determined by the market.Value is subjective due to personal preferences, but market value is objective due to market behavior.
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Market Value
"The most probably selling price in terms of money which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buy and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.”
- Appraising Real Property Boyce & Kinnard, 1984
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Market Price
“The amount actually paid, or to be paid, for a property in a particular transaction, which differs from market value in that it is an accomplished or historic fact, whereas market value is and remains an estimate……”
- Appraising Real Property Boyce & Kinnard, 1984
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Market Value vs. Market Price(the skinny)
Value and price are identical in a theoretical, perfectly competitive market.We live in a real world! Market value is the “most probably selling price” under typical market conditions.Price is an agreed upon amount or a historical figure.
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Typical Market Conditions
It depends!Open and competitive marketPrudent buyer and sellerTypical motivation for buyer and sellerAdequate marketing effortCash equivalency
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Other Types
Investment valueUse valueBook valueRental valueSalvage valueAssessed value
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Fundament Theory of Appraisal
Supply and demandAnticipation/ChangeCompetition reduces economic rentsSubstitutionOpportunity costContributionExternalities/linkages
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Value - Why do we care?
Ownership transferFinancingLitigationTaxesConsulting Rents, feasibility, zoning board,
insurers, etc.
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The Appraisal Process
Step 1: Problem Definition Real estate identification Property rights Use of appraisal Value definition Date
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The Appraisal Process
Step 2: Preliminary Analysis & Data Plan of attack Information
General – trends Specific – property and comparable Supply & Demand – future changes
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The Appraisal Process
Step 3: Highest and Best Use Analysis“the reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value”
Vacant vs. improved Vacant may be highest and best use.1. Identify use with highest overall return2. Helps identify comparable properties
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The Appraisal Process
Step 4: Land Value Estimate Sales comparison Allocation (ratio) Extraction (less improvements) Subdivision & development Land residual technique (NOIland)
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The Appraisal Process
Step 5: Application of Three Approaches Sales Comparison (VSC) Cost (VC) Income (VI)
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The Appraisal Process
Step 6: Reconciliation Using various estimates of value
under a number of methods determine one estimate of value.
How?
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The Appraisal Process
Step 7: Report of Defined Value Conclusion communicating the final value
estimate written. It presents the data, assumptions, and
analyses in a manner so that an intelligent reader should comprehend the logical process and come up with a similar answer to the problem.
It should also explain how and why particular steps were taken.
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The Income Approach
Should look familiar!GI=GO (DCF model)
01
0
1 1
Nt Nt N
t
NOI NSPV
y y
NOIV
R
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The Income Approach
Gross income multipliers
Potential or effective gross income
*
SPIM
GI
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The Sales Comparison Approach
Underlying economic theory: Similar goods sell for similar prices.Applicable to all property types but works best for property types with frequent transactions.Data, data, data..
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Sales Comparison
Procedure: Research market/gather data Verify information Select units of comparison (ft^2, apt. unit,
etc) Develop comparable analysis Compare comps to subject with respect to
elements of comparison & make adjustments
Reconcile
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Sales Comparison
Sequence of adjustments: Financing terms Conditions of sale Market conditions Location Physical characteristics
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Sales Comparison
A(n) _________ adjustment will be made to the comparable price when the comparable property is superior to the subject property.Net adjustments lead to the adjusted sales price.
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Sales Comparison
Uses and limitations: Good data = good results An easy “amateur” appraisal Financing advantage No data = no use
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The Cost Approach
Underlying economic theory: No prudent buyer would pay more than it would cost to purchase the land and develop.Applicable to all property types but does not have the ease of sales comparison.Data, data, data..
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Cost Approach
Procedure: Estimate site value Estimate hard and soft costs of
improvements including reasonable profit
Estimate accrued depreciation in the structure
Add site value to improvement depreciated cost
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Cost Approach
Site Value (previously discussed)Reproduction vs. replacement cost Reproduction is exact replica Replacement is a “newer” building of
equal utility (modern materials, designs, and layout)
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Cost Approach
Direct (hard) costs Building permits Labor Materials Equipment Security Contractors profit
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Cost Approach
Indirect (soft) costs: Consulting Engineering and architecture Cost of carry (fees, points, interest,
lease-up) Selling expenses Leasing commissions
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Cost Approach
Cost Data Collection Marshall & Swift MEANS
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Cost Approach
Comparative Unit Method: Determine (find) estimate of cost per
unit of area Aggregate cost per unit Size matters Use of benchmark building
Adjust for size, finish quality, time, etc.
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Cost Approach
Unit in Place Method: Each category (section) of the
building’s cost is estimated. Foundation, sprinkler, roof, framing,
on a square foot cost basis
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Cost Approach
Quantity Survey Method Most complex and time consuming No aggregation of data according to
size Number of labor hours, direct cost
supplies are estimated and the cost of each is applied.
Rarely used.
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Cost Approach
Depreciation: Non-accounting sense Three major types:
Physical deterioration Functional obsolescence External obsolescence
Economic life, effective (actual) age, remaining economic life
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Cost Approach
Market Extraction Method (depreciation): Transaction prices of similar properties
with respect to age/depreciation Sale price minus land = depreciable
cost (1) Estimate the replacement cost (2) (2)-(1) = total depreciation
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Cost Approach
Age-Life Method (depreciation) Estimate total economic life of similar
properties Estimate effective age Compute ratio of effective age
(subject) to total economic life Apply ratio to development cost
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Cost Approach
Breakdown Method (depreciation): Most complex and least used Usually used with another method of
estimating depreciation Each form of depreciation is
estimated separately
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Cost Approach
In summary:
Useful when there is not an active market for the subject property type
0 landV V Development Cost Accrued Depreciation
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Reconciliation
We have 3 (or more) estimates of value.
,
1
SC SC C C I I
SC C I
V V V V
where
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Appraisal Method Summary
Comparable sales Like goods sell for like prices Requires transaction data on “similar”
properties
Income approach Value is PV(future benefits) Most relevant for income producing real estate
Cost approach Buyers will not pay more than the cost Utilizes industry cost estimators
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Conclusion
A real estate appraisal is a professional opinion of value as of a particular date based on systematic analysis and market data.