These are the most important points for you to remember in this unit.
Regulation of Appraising – FIRREA
- Appraisal Foundation—the source of appraisal standards and appraiser qualifications.
- Federally-Related Transaction— any real estate-related financial transaction which a federal regulatory agency regulates that requires the services of an appraiser.
- To prepare an appraisal that will be used in a federally related transaction, a person must be a state-certified appraiser.
- State-certified residential appraisers are qualified to appraise one to four residential units without regard to value or complexity.
- State-certified general appraisers are qualified to appraise all types of real property.
- The Uniform Standards of Professional Appraisal Practice (USPAP) sets the standards and requirements for the valuation of real property.
- The Ethics Rule of USPAP is to promote and preserve public trust, and requires that appraisers
- perform assignments with impartiality, objectivity, and independence, and without accommodation of personal interest, and
- must not accept an assignment that is contingent on the value of the property.
- Real estate licensees may perform appraisals for a fee. There are several requirements for real estate licensees performing appraisals, including
- the appraisal may not involve a federally related transaction,
- licensees may not represent themselves as certified or licensed appraisers unless they are licensed or certified under Chapter 475, Part II, and
- licensees who prepare appraisals must comply with the USPAP.
- Sales associates should not prepare appraisals without the express consent and supervision of the broker. Fees for preparing appraisals can be collected only by a broker.
- The Comparative Market Analysis (CMA) helps sellers to set listing prices and buyers to decide on the amount to offer for a property.
- The CMA may not be called an appraisal. It is an opinion of value.
- Licensees are permitted to charge a fee for preparation of a CMA. The fee must be paid to the broker.
- Licensees need not conform to USPAP when preparing a CMA.
- Broker Price Opinion (BPO)
- The BPO cannot be called an appraisal.
- The licensee may charge a fee for preparing a BPO. The fee must be paid to the broker.
- The licensee need not comply with the USPAP when preparing a BPO.
Concept of Value
- Value is the most probable price that a property should bring in the market in a fair sale.
- Price is the consideration paid from a buyer to a seller in an actual transaction.
- Cost is the amount of money required to improve a parcel of real estate.
- Appraisers may be asked to estimate:
- Assessed value—used for property tax purposes. County property appraisers regularly appraise property to be used as the basis for taxes.
- Insurance value—generally an estimate using the cost approach that insurance companies may use to measure replacement cost.
- Going-concern value—the value of a business that is profitable.
- Liquidation value—assumes a quicker than normal sale. The liquidation value of a business that has failed is usually lower.
- Investment value—the amount an income property is worth to a particular investor based on that investor’s required rate of return. It is a subjective value and not considered as market value.
- Salvage value—the value of an improvement at the end of its useful life.
- Market value—the value most often sought by an appraiser.
- Market Value is “the most probable price that 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, knowledgeably and assuming the price is not affected by undue stimulus.”
- Characteristics of Value—there are four essential factors for a parcel or real estate to have value.
- Demand – Desire along with the economic means to purchase.
- Utility – Must be useful and able to fill a need.
- Scarcity – If there is excess supply on the market, the value falls.
- Transferability – The legal ability to convey title.
Principles of Value
- Principle of substitution–establishes that the value of a property is set by the cost to obtain another property that is comparable, either by purchasing it or by building it.
- Highest and best use of a parcel of land is the use which produces the greatest return to the land.
- Increasing returns—demonstrates that improving a property may add more value than it costs to improve it.
- Decreasing returns—demonstrates that improving a property may cost more than the value added, also called an over-improvement.
- Progression and Regression—related to increasing and decreasing returns.
- Progression says that the value of a modest home in a neighborhood of larger, expensive homes will be higher than if the home were in an area of more modest homes.
- Regression says, “Don’t build your fancy, large home in a neighborhood of smaller homes.” Its value will be less than if you built it in a more prestigious neighborhood.
- The principle of conformity says that improvements that are dissimilar to other properties in the area will have less contributory value than the typical house in the area.
- Assemblage and Plottage:
- Assemblage involves combining two or more parcels of land in order to increase the overall value.
- Plottage is the increased value of the property after assemblage.
Introduction to the Three Approaches to Value
- There are three principal methods used in estimating real property value:
- sales comparison approach,
- cost approach, and
- income approach.
Sales Comparison Approach
- This approach is based on the theory of substitution. If a buyer can purchase a similar property for a lower price, the buyer will buy that property.
- The approach used by the appraiser is to value the subject property based on recent sales of similar (comparable) properties in the neighborhood.
- Differences in the sold properties from the subject property are accounted for by adjusting the sale price of the comparable property, not to the subject property.
- Adjust the comparable using the acronyms “CIA / CBS.”
- If the Comparable is Inferior, Add, If the Comparable is Better, Subtract.
- The sales comparison approach to value lets the market tell the appraiser what prices buyers are paying in the market for similar homes.
- Steps in the approach:
- Locate the most recent sales in the neighborhood.
- Review each sale to determine that it is like the subject.
- The age of the comparable should be roughly the same as the subject property.
- A 30-year-old home is not like the subject property if it is two years old.
- Prepare an adjustment grid, listing each of the properties on the grid.
- Adjust each of the comparable sales so that they reflect that characteristic of the subject property.
- Adjustments are made to the comparable property only, never to the subject property.
- The types of property best suited for this approach are in an active market with several recent sales.
- The cost-depreciation approach is based on the premise that the value of a property can be estimated by the land value and the investment required to reproduce the building new, less depreciation.
- It is used as a check on the other approaches, and is used as the primary approach for special-purpose buildings, such as hospitals, or schools.
- Steps in the Approach
- Estimate the current cost to reproduce the building new.
- Estimate the total depreciation of the building and subtract it from the cost to reproduce the building.
- Estimate the value of the land as if the land were vacant.
- Add the value of the land to the depreciated value of the structures.
- Reproduction vs. replacement cost
- Reproduction cost is the cost to exactly reproduce the improvements as of the date of the appraisal.
- Replacement cost is the cost required to build a substitute property having the same use as the subject property using modern, updated materials.
Steps in the Cost Approach
- Step 1: Estimate the current cost to reproduce the building new.
- Quantity survey method is a detailed inventory of every item in the building, plus the labor, financing, and builder’s profit.
- Unit-in-place method is the cost of each item plus the labor cost to install the item.
- Comparative square foot method, also called the “unit comparison method” is the most used.
- Cost estimating manuals show typical costs of reproduction for many types of structures.
- Index method: find the original cost of building the subject property and apply an index to that cost.
- Step 2: Estimate loss from depreciation—an estimate of the loss of value from all causes.
- Land is not depreciated. Only the improvements are depreciated.
- Depreciation can be classified as either curable or incurable.
- Curable depreciation is a loss of value that can be corrected at a cost less than the resulting increase in property value.
- Incurable depreciation either cannot be corrected or would cost more than the increase in property value.
- The three types of depreciation are:
- Physical deterioration -ordinary wear and tear and physical damage.
- It is curable depreciation if fixing the defect will add at least as much value as it costs.
- It is incurable depreciation if fixing a defect will not add at least as much value as it costs.
- Functional obsolescence is anything which is inferior to a new structure of the same type. It may be curable or incurable.
- External obsolescence is a loss in value which is caused by problems outside the property. The loss is usually incurable.
- Step 3: Estimate the value of the land as if vacant
- The value of the land is normally estimated using the comparable sales approach.
- Step 4: Add the value of the land to the depreciated value of the structure.
- Application of approach
- Most appropriate for properties that are not typically sold or rented, such as schools, libraries, and town halls.
- The value estimated by the cost approach sets the maximum value for a property.
Income approach-There are six steps in the approach.
- Step 1: Estimate potential gross income (PGI)—the amount of income the owner would receive if the property were 100% rented.
- Step 2: Estimate effective gross income (EGI)—the typical amount a property would bring in from rentals, less vacancies and collection losses.
- Vacancies mean that an apartment is ready for rent, but is vacant.
- Collection losses occur when the apartment is occupied, but the owner can’t collect the rent.
- Step 3: Estimate property expenses—three types:
- Fixed expenses are those costs that don’t vary based on the occupancy rate. Property taxes and insurance are fixed expenses.
- Variable expenses fluctuate with the rises and falls in the occupancy rate. Examples would be management expense (part of this is commissions on rentals), supplies, maintenance, and garbage collection.
- Reserves for replacement is an amount charged against the income (but not usually set up in a reserve bank account). It is for component parts of the improvements like the roof, HVAC (heating, ventilation, and cooling), and carpeting which wear out faster than the structure itself.
- Step 4: Find net operating income by subtracting expenses from the effective gross income.
- Step 5: Estimate the appropriate capitalization rate.
- Dividing the net operating income of similar income properties that have sold recently by the sale price results in a capitalization rate that can be applied to the subject property’s net income.
- Step 6: Find value by dividing the NOI by the capitalization rate.
- To estimate value with this approach, use the basic formula:
I = Income (annual net operating income)
R = Rate (of interest). The capitalization rate represents the relationship between net income and sale price
V = Value (of property)
To find the formula you need, cover the item you are solving for.
- Gross rent multiplier (GRM) is a multiple of the potential gross rent of a property.
- GRM is derived from the comparable sales approach, using sales of similar rental properties.
- Gross income multiplier (GIM) is used to estimate the value of larger income properties. It is based on the annual income of the property.
Preparing a Comparative Market Analysis (CMA)
- Most real estate licensees use a comparative market analysis to help show a seller the best offering price for a property.
- Buyers also make use of the CMA to help set the offering price when preparing an offer.
- Find comparable properties that are currently listed, have sold recently, or the listing has expired.
- Recently sold—the properties that have sold recently help to show what value buyers and sellers agree on. The adjusted value is the best estimate of what an appraisal will show.
- Currently on the market—the properties currently on the market show the competition to the seller’s property.
- Recently expired listings—show the market’s resistance to overpriced listings.