Transcript Real Estate Appraisal

The Appraisal of Real Estate
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
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.
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
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
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.
Typical Market Conditions
It depends!
Open and competitive market
Prudent buyer and seller
Typical motivation for buyer and seller
Adequate marketing effort
Cash equivalency
Other Types
Investment value
Use value
Book value
Rental value
Salvage value
Assessed value
Fundament Theory of
Appraisal
Supply and demand
Anticipation/Change
Competition reduces economic rents
Substitution
Opportunity cost
Contribution
Externalities/linkages
Value - Why do we care?
Ownership transfer
Financing
Litigation
Taxes
Consulting
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Rents, feasibility, zoning board, insurers,
etc.
The Appraisal Process
Step 1: Problem Definition
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Real estate identification
Property rights
Use of appraisal
Value definition
Date
The Appraisal Process
Step 2: Preliminary Analysis & Data
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Plan of attack
Information
 General – trends
 Specific – property and comparable
 Supply & Demand – future changes
The Appraisal Process
Step 3: Highest and Best Use Analysis
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1.
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“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.
Identify use with highest overall return
Helps identify comparable properties
The Appraisal Process
Step 4: Land Value Estimate
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Sales comparison
Allocation (ratio)
Extraction (less improvements)
Subdivision & development
Land residual technique (NOIland)
The Appraisal Process
Step 5: Application of Three Approaches
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Sales Comparison (VSC)
Cost (VC)
Income (VI)
The Appraisal Process
Step 6: Reconciliation
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Using various estimates of value under a
number of methods determine one
estimate of value.
How?
The Appraisal Process
Step 7: Report of Defined Value
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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.
The Income Approach
Should look familiar!
GI=GO (DCF model)
N
V0  
t 1
NOI t
1  y 
NOI
V0 
R
t

NSPN
1  y 
N
The Income Approach
Gross income multipliers
SP
IM  *
GI
Potential or effective gross income
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..
Sales Comparison
Procedure:
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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
Sales Comparison
Sequence of adjustments:
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Financing terms
Conditions of sale
Market conditions
Location
Physical characteristics
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.
Sales Comparison
Uses and limitations:
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Good data = good results
An easy “amateur” appraisal
Financing advantage
No data = no use
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..
Cost Approach
Procedure:
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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
Cost Approach
Site Value (previously discussed)
Reproduction vs. replacement cost
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Reproduction is exact replica
Replacement is a “newer” building of equal
utility (modern materials, designs, and
layout)
Cost Approach
Direct (hard) costs
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Building permits
Labor
Materials
Equipment
Security
Contractors profit
Cost Approach
Indirect (soft) costs:
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Consulting
Engineering and architecture
Cost of carry (fees, points, interest, leaseup)
Selling expenses
Leasing commissions
Cost Approach
Cost Data Collection
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Marshall & Swift
MEANS
Cost Approach
Comparative Unit Method:
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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.
Cost Approach
Unit in Place Method:
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Each category (section) of the building’s
cost is estimated.
Foundation, sprinkler, roof, framing, on a
square foot cost basis
Cost Approach
Quantity Survey Method
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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.
Cost Approach
Depreciation:
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Non-accounting sense
Three major types:
 Physical deterioration
 Functional obsolescence
 External obsolescence
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Economic life, effective (actual) age,
remaining economic life
Cost Approach
Market Extraction Method
(depreciation):
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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
Cost Approach
Age-Life Method (depreciation)
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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
Cost Approach
Breakdown Method (depreciation):
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Most complex and least used
Usually used with another method of
estimating depreciation
Each form of depreciation is estimated
separately
Cost Approach
In summary:
V0  Vland  Development Cost  Accrued Depreciation
Useful when there is not an active
market for the subject property type
Reconciliation
We have 3 (or more) estimates of
value.
V  SCVSC  CVC  IVI
where,
SC  C  I  1
Appraisal Method Summary
Comparable sales
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Like goods sell for like prices
Requires transaction data on “similar” properties
Income approach
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Value is PV(future benefits)
Most relevant for income producing real estate
Cost approach
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Buyers will not pay more than the cost
Utilizes industry cost estimators
Conclusion
A real estate appraisal is a professional
opinion of value as of a particular date
based on systematic analysis and
market data.