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Chapter 7 Valuation Using the Sales Comparison and Cost Approaches

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Presentation on theme: "Chapter 7 Valuation Using the Sales Comparison and Cost Approaches"— Presentation transcript:

1 Chapter 7 Valuation Using the Sales Comparison and Cost Approaches
Real Estate FIN 331 Fall 2013

2 Market Value, Investment Value, and Transaction Prices
Appraisals An unbiased written estimate of the fair market value of a property Appraiser’s final estimate of property value Data upon which the estimate is based Assumptions and calculations used to arrive at the particular estimate Why Do We Have To Estimate Market Value? To get an estimate of the probable selling price under current market conditions Lenders require an estimate of market value to make a reasonable mortgage decision Real estate markets are assumed to reflect near perfect competition; the implication is that transaction occur at or very near true (or intrinsic) values Question: Are we all price takers?

3 Market Value, Investment Value, and Transaction Prices
The Appraisal Process: Uniform Standards of Professional Appraisal Practice (USPAP) Identify the appraisal problem Client & intended uses of appraisal Date of valuation Rights to be valued (fee simple, etc.) Type of value to be estimated: market, insurance, or taxable value? Important assumptions or conditions Determine the required scope of work Time & personal requirements Outline of proposed appraisal report Data & procedures used to complete required tasks

4 Market Value, Investment Value, and Transaction Prices
Perform data analysis Market analysis: Effects of demand & supply Highest & best use; use which is legally/physically/financially permissible Highest & best use as though vacant: considers any possible use Highest & best use as improved: must consider any cost of demolition Determine value of land: Important to value separately from improvements Apply 3 Approaches to Valuation Sales comparison approach Cost approach Income approach

5 Market Value, Investment Value, and Transaction Prices
Reconcile indicated values from 3 approaches Weight based on relative reliability of the three approaches Report final value estimate Report writing is an extremely important function Must meet requirements of 1 of 3 reporting options Self-contained report: full narrative description of process Summary report: summary of conclusions, principal points of process Restricted report: minimal discussion, limited to use by client

6 Sales Comparison Approach to Estimating Market Value
Basic Idea: Value of RE can be determined by analyzing the sale prices of similar properties Why? In a competitive market, close substitutes should sell for similar prices Major difficulty? How many truly close substitutes exist & how many of these have sold recently? Selecting Comparable Sales Must be properties that prospective buyers would consider substitutes Should be arms-length transactions Fairly negotiated prices that occurred under “normal” conditions For example, not a distressed sale Select to minimize required physical and locational adjustments

7 Sales Comparison Approach to Estimating Market Value
Data Sources Public records (e.g., county property tax assessor) Multiple listing service Private vendors (title companies, others): CoStar for commercial properties Adjustments to Comparable Sale Prices Convert characteristics of each comparable to an approximation of subject Sequence of adjustments Transactional adjustments: nature of the deal (see list top of page 171) Property adjustments: unique feature of property (ditto) Recent price trends

8 Cost Approach to Estimating Market Value
Procedure Estimated reproduction cost of improvements − Estimated accrued depreciation = Depreciated cost of building improvements + Estimated value of site = Indicated value by the cost approach The Major Assumption?: Cost of creating a property is related to its market value Two concepts of cost: Replacement cost: Cost to create something of equal utility (functionality) Reproduction cost: Cost of an exact physical replica Complication in application? Methods to estimate replacement cost Quantity survey method Cost per square foot or cubic foot Unit in place

9 Cost Approach to Estimating Market Value
Sources replacement cost estimates R.S. Means Marshall and Swift Consulting firms Builders/contractors Special Issue of Accrued Depreciation – Commercial Property Difference between replacement cost & market value of improvements Types of accrued depreciation that must be considered: Physical deterioration: Loss in market value due to aging, decay & ordinary use Functional obsolescence: Loss in value due to changes in tastes, preferences, technological innovations, or market standards External (economic) obsolescence: loss of value due to neighborhood changes

10 Homework Assignment Key terms: Accrued depreciation, Appraisal, Comparable properties, Market value, Property adjustments, Replacement cost, Reproduction cost, Restricted appraisal report, Transactional adjustments Study questions: 2, 3, 4, 7, 8, 12

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