Real Estate Principles: Appraisal Methods

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Automated valuation models

AVM

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is a mathematical average to estimate the homes in a neighborhood

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Note

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In order to make a loan, lenders need an accurate appraisal by a California licensed real estate appraiser

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market data method

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is a method of appraising real property by comparing the current selling prices of recently sold similar properties and adjusting those prices for any differences

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Note

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the usual adjustments are made for differences in location, age, lot size, building size, condition of the property etc

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section 2

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cost approach

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cost approach

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is the process of calculating the cost of the land, buildings as if they were new today and then subtracting the accrued depreciation to arrive at the current value

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note

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the cost approach objective is to determine the land value plus the cost to replace the improvements

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Direct costs

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are expenditures for labor and materials used in the construction of improvements

A contractors overhead and profit are generally treated as direct costs

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Indirect costs

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are expenditures other than material and labor cost

examples are administrative cost, professional fees, financing cost, insurance, and taxes

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Note

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sales comparison method is considered the most reliable, it relies on sales of similar parcels to determine the value of the subject land, or site.

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replacement cost

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is the cost of building a similar new structure today of equal utility using modern construction methods

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replication cost

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is the cost of reproducing a structure usually destroyed, but at current prices using identical older style materials and methods as used in the original structure

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notes

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as construction cost increase for new homes,

the replacement cost of existing homes also increase

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comparative-unit method

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is used to derive cost estimate in terms of dollars per square foot or per cubic foot, based on known costs of similar structures and adjusted for time and physical differences

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unit-in-place method

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employs unit costs for the various building components such as foundations, floors, walls, windows, and roofs as installed and uses square foot, linear foot, or other appropriate units of measurement to estimate each component part.

these estimates include labor and overhead

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quantity survey method

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involves detailed estimates of the quantities of raw materials used, such as brick, lumber, cement, the price of such materials, and the labor costs

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square feet

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length times width

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depreciation

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is a reduction in the value of a property due to any cause.

the difference between replacement cost of a property and its market value is depreciation

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accrued depreciation

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is the loss in value of improvements from any cause at the date of appraisal.

accrued depreciation is what happened in the past, whereas the accrual for depreciation is the amount of future depreciation

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five methods of estimating accrued depreciation

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1) capitalized income

2) market

3) straight-line ( most common )

4) engineering

5) breakdown

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straight-line method (age life)

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assumes the value decline in equal amounts of depreciation each year, until it reaches zero.

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actual age

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is the current age, real age of the building

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effective age

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is determined by the condition of the building rather than the actual age.

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economic life

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is the estimate number of years of anticipated financial return from the improvements

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accrual for depreciation

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is the concept of estimating the amount of depreciation there will be in the future

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physical deterioration

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is the loss in value due to wear and tear

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curable depreciation

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are repairs that add more to a buildings value than they cost

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incurable depreciation

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refers to repairs that be so expensive they are not economically feasible

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note

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obsolescence is not a method of calculating depreciation, but is a term meaning a "major cause" of depreciation

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functional obsolescence

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is the loss in value due to outmoded style or non-usable space

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economic obsolescence

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is the loss in value due to changes in the neighborhood and is external to the property itself, it is always uncurable

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section 3

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capitalization approach

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Note

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the income approach determines the "present worth of future benefits"

capitalization is the process of converting income into value.

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income approach

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is the process of analyzing the future net income from the property to determine its current market value. another word for this process is capitalization, cap rate

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Math

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net income divided by capitalization rate = market value

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steps in the income approach

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1) calculate the annual effective gross income

2) complete an operating expense statement

3) deduct related operating expenses from effective gross income to get net income.

4) divide net income by the appropriate cap rate

5) total value

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effective gross income

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is the gross income minus any vacancies or rental losses

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vacancy factor

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is the loss in rents due to any cause

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operating expenses statement

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1) property taxes

2) insurance and licenses

3) manager fees

4) utilities

5) maintenance, repairs, and services, garderners etc

6) replacement reserves

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note

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review 2 to 3 years of income and expenses for the subject property then for date of value

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replacement reserves

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consists of funds set aside for the purposes of replacing items in the future.

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variable costs

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are operating expenses that can vary with occupancy, utilities and repairs as for example

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fixed costs

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remain constant, such as property taxes and fire insurance

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note

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the capitalization rate is composed of two parts, 1) a rate of return on the money invested and 2) a return of original investment of money (recapture rate)

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gross rent multiplier, GRM

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is the multiplication rule of thumb used to convert the rental income into value.

the annual gross income multiplier varies from times 5, times12, depending on the location of the property and the condition of the individual buildings.

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Math

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sales price divided by annual rent = GRM

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Math

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Annual rent times GRM = market value

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section 4

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reconciliation of value

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reconciliation

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is the process of selecting the most appropriate approach for a particular appraisal job and giving it the most consideration in pinpointing the final value.

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note

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in general, the "market comparison approach" is best for single-family homes or lots; the "cost approach" is best for new, unique or unusual structures; and the "income approach" is best for properties that can be used to generate income.

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USAPAP

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uniform standards of appraisal practice

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narrative report

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Is the most comprehensive and complete and is generally used for commercial properties and for use by government agencies

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fee appraisers

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is an independent , self-employed appraiser