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Real Estate Basics: Real Property Appraisal

Terms in this set (70)

Square footage method: Involves calculating the cost of construction by multiplying the square footage of the structure by the construction cost for that particular type of building. For example, you'd multiply a $ 100 per square foot cost to build the kind of house you're appraising by the 2,000 square foot total area of the house to arrive at a cost estimate of $ 200,000 to replace the structure. The square footage method is the one more commonly used by appraisers to estimate replacement or reproduction cost

Unit-in-place method: Provides the cost to construct a building by estimating the installation costs, including materials, of the individual components of the structure. So if you know you need 1,000 square feet of sheet rock to cover the walls, you need to find out the cost of buying, installing, and finishing the sheet rock on a per-square-foot basis and then multiply by 1,000 square feet. Another approach to this method is to estimate the four main steps (units) to building a house. For instance, cost of foundation, cost of roof and framing, cost of mechanicals, and cost of walls and finish work. Each step is estimated separately and then all are added together

Quantity survey method: More detailed than the previous method, it requires you to break down all the components of a building and estimate the cost of the material and installation separately. So in the sheet rock example, you estimate so many dollars each to buy the sheet rock, screws, and tape, and to pay for the installation

Index method: Requires you to know the original construction cost (without land) of the subject building. You then multiply that original cost by a number that takes into account the increase in construction costs since the building was built. National companies that do this kind of research publish these numbers. If a building cost $ 20,000 to build originally, and the current index in that area for this type of structure is 1.80, the calculation is $ 100,000 × 1.80 = $ 180,000, or the cost to construct the same building today
Square-foot method - The cost per square foot of a recently built comparable structure is multiplied by the number of square feet (using exterior dimensions) in the subject building. This is the most common and easiest method of cost estimation. For some (usually nonresidential) properties, the cost per cubic foot of a recently built comparable structure is multiplied by the number of cubic feet in the subject structure

Unit-in-place method - In the unit-in-place method, the replacement cost of a structure is estimated based on the construction cost per unit of measure of individual building components, including material, labor, overhead and builder's profit. Most components are measured in square feet, although items such as plumbing fixtures are estimated by cost. The sum of the components is the cost of the new structure

Quantity-survey method - The quantity and quality of all materials (such as lumber, brick and plaster) and the labor are estimated on a unit cost basis. These factors are added to indirect costs (for example, building permit, survey, payroll, taxes and builder's profit) to arrive at the total cost of the structure. Because it is so detailed and time consuming, this method is usually used only in appraising historical properties. It is, however, the most accurate method of appraising new construction

Index method. A factor representing the percentage increase of construction costs up to the present time is applied to the original cost of the subject property. Because it fails to take into account individual property variables, this method is useful only as a check of the estimate reached by one of the other methods
1. Estimate annual potential gross income. An estimate of economic rental income must be made based on market studies. Current rental income may not reflect the current market rental rates, especially in the case of short-term leases or leases about to terminate. Potential income includes other income to the property from such sources as vending machines, parking fees and laundry machines.
2. Deduct an appropriate allowance for vacancy and rent loss, based on the appraiser's experience, and arrive at effective gross income.
3. Deduct the annual operating expenses, from the effective gross income to arrive at the annual net operating income (NOI). Management costs are always included, even if the current owner manages the property. Mortgage payments (principal and interest) are debt service and not considered operating expenses.
4. Estimate the price a typical investor would pay for the income produced by this particular type and class of property. This is done by estimating the rate of return (or yield) than an investor will demand for the investment of capital in this type of building. This rate of return is called the capitalization rate (or "cap" rate) and is determined by comparing the relationship of net operating income with the sales prices of similar properties that have sold in the current market. For example, a comparable property that is producing an annual net income of $15,000 is sold for $187,500. The capitalization rate is equal to $15,000 divided by $187,500, or 8 percent. If other comparable properties sold at prices that yielded substantially the same rate, it may be concluded that 8 percent is the rate that the appraiser should apply to the subject property.
5. Apply the capitalization rate to the subject property's annual net operating income to arrive at the estimate of the property's value.