Chapter 9 Real Estate Appraisal

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Chapter 9Real Estate Appraisal

• This chapter introduces a central issue in real
  estate decision making, What is the property
  worth?

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Understanding the Appraisal Profession

• FIRREA
• State Requirements
• Licensed appraisers
• Certified residential appraisers
• Certified general appraisers

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What is Value

• Market Value
• Motivated Parties
• Informed Parties
• Market Exposure
• Payment in Cash
• No Special Circumstances
• Investment Value

• Price vs. Market Value
• Market Value vs. Cost of Production
• Other Types of Value
• Assessed Value
• Insurable Value

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Key Appraisal Principles

• Anticipation
• Change
• Substitution
• Contribution

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The Traditional Appraisal Process

• Definition of the problem
• Type of value-purpose
• Description of property
• Specific Property rights
• Effective Date
• Data Selection and Collection
• General market analysis
• Specific property analysis

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• Highest and Best Use Analysis
• As though vacant A
• Land with improvements B
• A Highest and best use of land as if vacant is
  defined as that use, from among reasonably
  probable and legal alternative uses, found to be
  physically possible, appropriately supported,
  financially feasible and which results in the
  highest land value.
• B The highest and best use of the site as
  improved is defined similarly except it is the
  use that results in the highest property value.

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• Highest and Best Use
• Definition
• That use of a parcel of land that results in the
  greatest long-term economic return to the owner.
• Reasonably Probable
• Legally Permissible
• Physically Possible
• Economically Feasible

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• HBU
• Vacant Land
• What is zoning?
• Utilities?
• Will site perk?
• Road access?
• Others?
• Which use could create the highest price for the
  site (i.e. highest and best use)?

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• HBU
• Land with improvements
• Analysis much more difficult
• Present use is Highest and Best Use unless
  improvement can be demolished and value of land
  is worth more than site and current improvement

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• Application of the three approaches to valuation
• Sales comparison approach
• Cost approach
• Income approach
• Reconciliation of value indications
• Report of defined value

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Sales Comparison Approach

• Comparable sales data
• Selection
• How many comparables
• Adjustment of sales data
• Elements of comparison
• Property rights conveyed
• Conditions of sale
• Financing terms
• Market conditions
• Locational Characteristics
• Physical Characteristics
• Applying the sales comparison approach (Table
  10.1)

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Cost Approach

• Estimating site value
• Estimating production cost
• Reproduction cost
• Replacement cost
• Estimating accrued depreciation
• Physical deterioration
• Functional obsolescence
• Economic obsolescence
• Applying the cost approach (Table 10.2)

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Cost Approach to Value Subject
Property 155 Potter Dr. Land Valuation Size
60' X 135' _at_450 per front foot

27,000 Plus site improvements driveway,
walks, landscaping, etc.
8,000 Total
35,000
Building Valuation Replacement Cost 1,500
sq.ft._at_65 per sq.ft. 97,500 Less
Depreciation Physical depreciation
Curable (items of deferred
maintenance) exterior painting 4,000
Incurable (structural deterioration)
9,750 Functional obsolescence
2,000 External depreciation
0 Total -15,750 Depreciated Value
of Building

81,750 Indicated Value by Cost Approach

116,750
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Income Approach

• Gross Income Multiplier
• Net Income Capitalization
• Discounted Cash Flow (Table 10.3)

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CAP RATES Capitalization Rates

• The capitalization rate is the ratio of
  first-year NOI to property value.
• NOI / Property Value Cap. Rate
• The Cap. Rate is the rate at which future income
  is converted into present value. This technique
  is referred to as capitalizing income, and is
  used to value income generating real estate.
• Value NOI / Cap. Rate
• The Cap. Rate implicitly reflects the projected
  future NOI. If Future NOI estimates are expected
  to be lower, the price paid for the property will
  be lower, and the cap rate for that property will
  be higher, which reflects less investor optimism.

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ESTIMATING NOI (Net Operating Income)

• Potential Gross Income
• - Vacancy and Collection Losses
• Other Miscellaneous Income
• Effective Gross Income
• Operating Expenses
• Net Operating Income

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Income Capitalization Approach to
Value Potential Gross Annual Income
60,000 Market Rent (100 Capacity) Income
from Other Sources
600 (Vending Machines and Pay Phones)
60,600 Less Vacancy and Collection
Losses(estimated) _at_4 -2,424 Effective
Gross Income 58,176 Expenses Real
Estate Taxes 9,000 Insurance
1,000 Heat 2,800 Maintenance
6,400 Utilities, Electricity, Water, Gas
800 Repairs 1,200 Decorating
1,400 Replacement of Equipment 800 Legal
and Accounting 600 Management 3,000
Total 27,000 Annual Net Operating
Income 31,176 Capitalization Rate
10 (Overall Rate) Capitalization of Annual Net
Income 31.176/.10 Indicated Value by Income
Approach 311,760
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GIM ANALYSIS

• GIM Analysis is useful when market
• derived capitalization rates are hard to
• verify. Gross incomes are much easier
• to estimate than net operating incomes.
• Beware, however, operating expenses
• can vary greatly, particularly on older
• buildings

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• Steps
• Verify recent sales of similar properties
  (property use and location)
• Determine gross income of these properties.
• Calculate market GIM by sales
  price/gross income
• Estimate subject propertys value by gross
  income x GIM

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Example

• Sales Price/Gross Income GIM
• Comp 1 500,000/62,500 8
• Comp 2 650,000/76,741 8.5
• Comp 3 700,000/80,000 8.75
• GIM Range 8-8.75 Avg GIM8.42
• Subject Gross Income65,000 x 8.42 547,300
• 65,000 x 8 520,000- - - 65,000 x 8.75
  568,750
• (Range of Value)

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