Presentation on theme: "Chapter 9 Real Estate Appraisal This chapter introduces a central issue in real estate decision making, “What is the property worth?”"— Presentation transcript:
Chapter 9 Real Estate Appraisal This chapter introduces a central issue in real estate decision making, “What is the property worth?”
Understanding the Appraisal Profession: FIRREA State Requirements: Licensed appraisers Certified residential appraisers Certified general appraisers
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
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
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.
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
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)?
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
Application of the three approaches to valuation: Sales comparison approach Cost approach Income approach Reconciliation of value indications Report of defined value
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)
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)
Cost Approach to Value Subject Property: 155 Potter Dr. Land Valuation: Size 60' X 135' @$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.@$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
Income Approach: Gross Income Multiplier Net Income Capitalization Discounted Cash Flow (Table 10.3)
“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.
ESTIMATING NOI (Net Operating Income) Potential Gross Income - Vacancy and Collection Losses + Other Miscellaneous Income = Effective Gross Income - Operating Expenses = Net Operating Income
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) @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
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
Steps 1 Verify recent sales of similar properties (property use and location) 2 Determine gross income of these properties. 3 Calculate “market” GIM by sales price/gross income 4 Estimate subject property’s value by: gross income x GIM
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 GIM=8.42 Subject: Gross Income=$65,000 x 8.42 = $547,300 65,000 x 8 =$520,000- - - 65,000 x 8.75 = $568,750 (Range of Value)