1. Florida Real Estate Principles, Practices & Law 38th Edition Linda L. Crawford Copyright © 2015 Kaplan, Inc. All rights reserved.

2. Chapter 15 Estimating Real Property Value

3. ©2015 Kaplan, Inc. Appraisal Regulation Licensees may perform appraisals for compensation –Appraisals must comply with USPAP –Cannot perform appraisals for federally related transactions CMAs and BPOs –Do not have to comply with USPAP –Cannot be referred to as appraisals

4. Federally Related Transaction Involves federal financial regulatory agency –Office of Thrift Supervision, Office of Comptroller of Currency, the FED, FDIC, or National Credit Union Administration Real estate-related financial transaction –Sale, lease, exchange, financing, etc. Requires an appraisal Transaction value exceeds $250,000 Appraisal must be completed by state- certified or licensed appraiser ©2015 Kaplan, Inc.

5. Note Fannie Mae, Freddie Mac, HUD, and VA require appraisals be completed by state- certified or licensed appraisers, regardless of transaction value ©2015 Kaplan, Inc.

6. Types of Value Assessed value Insurance value Investment value Liquidation value Going-concern value Salvage value ©2015 Kaplan, Inc.

7. Market Value Fannie Mae and Freddie Mac’s definition of market value –The most probable price which 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 and knowledgeably, and assuming the price is not affected by undue stimulus. ©2015 Kaplan, Inc.

8. Assumptions in Market Value Value applies to a specific date Seller is able to convey marketable title Buyer and seller are typically motivated Both parties are well informed or well advised, acting in their own best interests A reasonable time is allowed in the open market Payment is made in cash in U.S. dollars or in comparable financial arrangements Price is not affected by special financing or seller concessions ©2015 Kaplan, Inc.

9. Cost, Price, Value Cost Expenditure to create an improvement (labor, materials, and land) Price Amount paid; the contract price Value Ability to command goods and services in exchange ©2015 Kaplan, Inc.

10. Overimprovement Sometimes owners invest more money in a structure than they can reasonably expect to recapture ©2015 Kaplan, Inc.

11. Characteristics of Value Demand Utility Scarcity Transferability ©2015 Kaplan, Inc.

12. Highest and Best Use The most profitable use of a property, that is –Legally permissible (zoning) –Physically possible –Financially feasible ©2015 Kaplan, Inc.

13. Highest and Best Use As Though Vacant Legal use of a site that would produce the greatest value Potential highest and best use of a site determines its value As Improved How a site that has improvements on it can best be utilized Should improvements be demolished, renovated, or retained in present condition ©2015 Kaplan, Inc.

14. Approaches to Estimating Real Property Value USPAP requires appraisers to use and reconcile all three approaches to estimate value if sufficient data are available ©2015 Kaplan, Inc. Sales comparison approach Cost depreciation approach Income approach

15. Principle of Substitution A prudent buyer or investor will pay no more for a property than the cost of acquiring, through purchase or construction, an equally desirable alternative property Sets upper limit of value ©2015 Kaplan, Inc.

16. Sales Comparison Approach Value is estimated by reviewing recent sales of properties (comps) similar to the subject property –Sales must have occurred recently in the same market –Comparable properties must be similar to the subject property Adjustments are made –Transactional differences (changes in market conditions since the date of sale) –Property differences (location, square footage, and so forth) ©2015 Kaplan, Inc.

17. Adjustments for Property Differences Adjustments are made to each comparable property for differences between the comp and the subject CBS Comp Better = Subtract CIA Comp Inferior = Add ©2015 Kaplan, Inc.

18. Adjustment Example A comparable lot sold for $30,000. The comparable is in a better location but is smaller than the subject. The appraiser estimates the difference in location to be $5,000 and the difference in size to be $4,000. Sale Price$30,000 Location (CBS) -5,000 Size (CIA) +4,000 Adjusted sale price$29,000 ©2015 Kaplan, Inc.

19. Adjustments for Transactional Differences Financing terms –Appraiser adjusts each comparable for special financing terms like seller-paid points Conditions of sale –Appraiser must research for abnormal pressure on the buyer or seller Market conditions –Appraiser adjusts sale price of each comparable if market has changed since the comparable sold ©2015 Kaplan, Inc.

20. Market Conditions Adjustment Example A comparable sold 6 months ago for $210,000. During the past 6 months, sale prices have increased 5% in that neighborhood. $210,000 x 5% = $10,500 $210,000 + $10,500 = $220,500 Comparable sale price adjusted for market conditions is $220,500 ©2015 Kaplan, Inc.

21. Reconciliation Each comp’s sale price is adjusted for differences between the comp compared with the subject Each comp is rated in terms of its similarity to subject property Rating is reflected in giving weight to each comparable The weighed comps determine the indicated value using the sales comparison approach ©2015 Kaplan, Inc.

22. Reconciliation Example CompAdjusted Sale PriceWeight A$255,000 35% B$262,000 20% C$250,000 45% Solution: $255,000 ×.35=$89,250 $262,000 ×.20=$52,400 $250,000 ×.45= $112,500 $254,150 Weighted Average ©2015 Kaplan, Inc.

23. Cost-Depreciation Approach A knowledgeable purchaser will pay no more for a property than the cost of acquiring a similar site and constructing an acceptable substitute structure (principle of substitution) The upper limit of value can be measured by determining the cost to acquire an equivalent site and to reproduce a structure as if new, and subtract for depreciation ©2015 Kaplan, Inc.

24. Cost-Depreciation Approach Formula  Estimate cost to reproduce building  Subtract accrued depreciation  Equals depreciated value of building  Add value of the site  Equals value of the property ©2015 Kaplan, Inc.

25. Estimating Cost Reproduction cost –Cost to duplicate a structure exactly Replacement cost –Cost to build structure with same use and function but not exact copy Three methods to estimate reproduction cost new –Quantity survey –Unit-in place –Comparative square-foot Comparative unit or unit comparison Cost estimation handbook Cost estimate based on current cost to construct a building of same size, design and quality ©2015 Kaplan, Inc.

26. Estimating Cost Example: Comparative Unit Method Main structure2100 sq. ft. × $85 per sq. ft. = $178,500 Garage 440 sq. ft. × $55 per sq. ft. = $24,200 Lanai 200 sq. ft. × $25 per sq. ft. = $5,000 Total Estimated Reproduction Cost New: $207,700 ©2015 Kaplan, Inc.

27. Depreciation Accrued depreciation represents the loss in value between the subject and an exact new replica A defect is curable if it is cost-effective to correct ©2015 Kaplan, Inc.

28. Types of Depreciation Physical deterioration –Loss in value due to ordinary wear and tear –Caused by use, lack of maintenance, exposure to elements Functional obsolescence –Loss due to operational inadequacies, poor design, or changing tastes –Overimprovement is also functional obsolescence External obsolescence –Loss in value due to something outside of property lines ©2015 Kaplan, Inc.

29. Lump-Sum Age-Life Method Majority of appraisers take into account the observed condition of the subject property Based on a ratio of property’s effective age (age indicated by structure’s condition and utility) to its economic life (total years a structure is profitably useful) ©2015 Kaplan, Inc.

30. Accrued Depreciation Formula Effective age ÷ Total economic life × Reproduction cost new = Estimated total accrued depreciation Alternative method Reproduction cost new ÷ Total economic life × Effective age = Estimated total accrued depreciation ©2015 Kaplan, Inc.

31. Accrued Depreciation Example A house with an estimated reproduction cost of $207,700 has an effective age of four years. The economic life of the house is 60 years. Solution: 4 years ÷ 60 years x $207,700 = $13,847 (rounded) Alternate Solution: $207,700 ÷ 60 years x 4 years = $13,847 (rounded) Accrued Depreciation = $13,847 ©2015 Kaplan, Inc.

32. Final Steps in Cost-Depreciation Approach Estimate site value using sales comparison approach (include non-structural site improvements) Add site value to depreciated value of structure to arrive at a final value ©2015 Kaplan, Inc.

33. Income Approach Measures a flow of income projected into the future Market value is estimated based on the present worth of future income ©2015 Kaplan, Inc.

34. Types of Income Potential gross income –Annual income if fully rented, no collection loss Effective gross income –PGI less vacancy and collection losses (plus other income) Net operating income –EGI less operating expenses ©2015 Kaplan, Inc.

35. Operating Expenses Expenses that contribute to operation of property –Fixed expenses Property taxes & hazard insurance –Variable expenses Maintenance, utilities, supplies, etc. –Reserve for replacements Allowance for future replacement of building components ©2015 Kaplan, Inc.

36. Operating Expenses NOT included in operating expenses −Depreciation −Costs of financing −Personal expenses −Income taxes −Any expense that does not contribute to the operation of the property ©2015 Kaplan, Inc.

37. Formulas Potential Gross Income (PGI) Minus Vacancy and Collection Losses Plus Other (non-rental) Income Equals Effective Gross Income (EGI) Effective Gross Income (EGI) Minus Operating Expenses Equals Net Operating Income (NOI) ©2015 Kaplan, Inc.

38. IRV Formula IRxVIRxV I = Net Operating Income (NOI) R = Capitalization Rate V = Value (or sale price) ©2015 Kaplan, Inc.

39. Using IRV to Find Value I (NOI) ÷ R (Capitalization Rate) = V (Value) What is the value of a property with a net operating income of $60,000 if the market capitalization rate is 10%? $60,000 ÷ 10% = $600,000 Value ©2015 Kaplan, Inc.

40. Using IRV to Find Capitalization Rate I (NOI) ÷ V (Value) = R (Capitalization Rate) What is the capitalization rate for a property with a Net Operating Income of $57,600 and a value of $720,000? $57,600 ÷ $720,000 =.08 (8%) Capitalization Rate ©2015 Kaplan, Inc.

41. Using IRV to Find Net Operating Income R (Capitalization Rate) × V (Value) = I (NOI) What is the Net Operating Income for a property with a value of $1,200,000 located in an area with a capitalization rate of 12%? 12% × $1,200,000 = $144,000 NOI ©2015 Kaplan, Inc.

42. Gross Multipliers GRM (gross rent multiplier) is the ratio between a property’s gross monthly rent and its selling price GIM (gross income multiplier) uses annual income; includes income from rent and other sources ©2015 Kaplan, Inc.

43. GRM Steps 1.Estimate gross monthly rent for subject property 2.Calculate a market-derived GRM by taking sale price of comparable properties and dividing by gross monthly rent, then calculate average market-area GRM 3.Multiply gross monthly rent of subject by GRM to estimate value of subject property ©2015 Kaplan, Inc.

44. GRM Example Subject property rents for $1,200 a month ComparableSale Price ÷ Monthly Rent = GRM 1$120,400 ÷ $1,225 = 98.29 2$126,000 ÷$1,275 = 98.82 3$132,000 ÷$1,350 = 97.78 294.89 294.89 ÷ 3 = 98.3 market GRM $1,200 × 98.3 = $117,960 Estimated Market Value ©2015 Kaplan, Inc.

45. Additional Appraisal Terms Assemblage - combining of two or more adjoining properties into one Plottage - added value that results from assemblage Progression - the value of an inferior property is enhanced by association with superior properties Regression –the value of a superior property is adversely affected by association with inferior properties Situs – people’s preferences for a certain area ©2015 Kaplan, Inc.

46. Comparative Market Analysis (CMA) Licensees prepare CMAs to help buyers and sellers make informed decisions NOT appraisal reports Based on properties –Recently sold –Currently on the market –Recently expired listings ©2015 Kaplan, Inc.