Unit 1 Pre-License Real Estate Practices and Principles - A4 - Appraisal and Ethics
Terms in this set (69)
A real estate _____ does not establish value. An _____ is the supported estimate or opinion of value.
Purpose of an appraisal
Appraisal reports are relied upon in important decisions made by mortgage lenders, investors, public utilities, governmental agencies, and business.
Function of an Appraisal
Major function of an appraisal is to estimate the property's market value. The appraiser is an independent third party who has no interest in the final valuation of the property.
Typically a feasible price, estimated in the terms of money, which a property will bring on the market. _____ _____ is often described as the present worth of future benefits. The following are important concerning market value -
- Buyer and seller must be motivated and well informed.
- The property is on the market for a reasonable time.
- Payment is made in cash or its equivalent (i.e. financing available if required).
A property's monetary worth is based on desirability. _____ is not based on cost to produce, it is based on demand.
Price or Market Price
Exact dollar the property sells for is the market price. It may or may not be the same as the market value. When used for a comparable, this is called objective or factual value. Subjective value is when a perception based on personal use. Market price is determined by buyers, since a property's value cannot be known until a buyer buys it. The price at which the buyer buys it is the market price.
Comparative Market Analysis (CMA)
A report in which data is gathered from researching the marketplace, using comparable properties that have been sold. These are often prepared by a salesperson instead of a licensed appraiser; however, the salesperson must be educated on the essentials of valuation to amass the market statistics. A _____ is not as extensive or as precise as an appraisal and cannot be represented as an appraisal.
Essential Elements of Value
For property to have value in the real estate market, it must have four elements of value; they can be remembered by the first letter of each word (STUD).
If there is too much property, the value will be less. When an area sells most of its properties, the balance tends to increase in value.
We must be able to transfer ownership from one party to another party (example, not in trust, probate, or partnership).
The property must be useful. It must satisfy your wants and needs. If no one wants it, then it has no value. Also called subjective value.
There must be a _____ for the property and the ability to pay for the property.
Principles of Value
The most important economic principles are shown below.
- Supply and Demand
- Highest and Best Use
Supply and Demand
When supply is short and demand is heavy, prices of property tend to go up. When supply is high and demand is low, prices tend to go down. The availability and desire for property affects its value.
Highest and Best Use
The most profitable single use for a property is the one that results in the greatest net attributed to site.
We will normally substitute a lower price property for a higher price property if we get roughly what we are looking for. We normally buy a lower price property before a higher price property if it fills needs.
Do not spend money on property unless the expense contributes to its value or the income you will get from the property.
You assemble a number of parts to give greater value. If you have many smaller properties adjoining and can make them one under a single owner, they may have more value. The increase in value is called assemblage. The whole is worth more than its parts. The opposite of this theory would be sub-dividing where breaking it into smaller portions would be worth more than the whole.
When economic conditions change, the value of property will change. The number of foreclosed properties recently on the market caused prices to decline for all properties. Nothing remains the same so market information must be current as possible.
In a particular area, you do not want all of the homes to be exactly alike nor do you want them to be vastly different. We are looking for a reasonable degree of conformity.
It is said in an area of high price homes and low price homes that the lower price homes will go up in value toward the prices of the higher price homes.
It is also said that the higher price homes will go down in value toward the price of the lower price homes.
We may buy property anticipating that it is going up in value or maybe just that we are going to enjoy the property.
The principal of competition states that excess profits tend to attract competition.
Influences on Value
The following great forces affect or influence value to a huge extent (PEPS).
Size, shape, location, soil conditions, and exposure affect the value. Location in relationship to other uses is also an important physical factor.
If we have recession or depression it will affect the value of the property. The economy has a great effect on value.
Political unrest in an area affects the value of property in that area. Government regulations, such as zoning laws, also affect value.
Social unrest in an area will affect the value of the property in that area. Neighborhood cycles affect value. Neighborhood cycles deal with the growth, stability, and decline of the neighborhood based on social conformity.
Approaches to Valuation
There are three basic procedures that appraisers use to reach an exact estimate of value.
- Sales Comparison Approach
- Income Approach (Capitalization Rate)
- Cost Approach
Sales Comparison Approach
Sometimes referred to as the market data approach, takes properties that have been recently sold in the area and compares them to the one being appraised to come up with an estimate of value. This approach is an example of substitution.
Sales Comparison Approach Types of Properties
Most commonly used to appraise single-family homes or properties where similar property sold.
Sales Comparison Approach Market Comparison
The following information is used when making the comparison.
- Recent sales.
- Compare with similar subject.
- Verify data.
- Make adjustments.
Sales Comparison Approach Adjustments
Necessary because no two properties are the same. Sales prices of comparable properties are adjusted to the subject property (the one you are appraising) using the following features.
- Time of Sale - we must use properties that have sold recently preferably within six months, never more than one year.
- Location - properties we are comparing must be in roughly the same location.
- Physical Characteristics - if the properties are located near each other, you can add or subtract for such things as number of baths, number of bedrooms, etc. Adjust the value of the comparable properties up or down to conform to the subject property (the one you are appraising). Adjustments are made for age, square footage, features, conditions, views, and sometimes lot size and location.
- Sales Concessions - incentive issues like foreclosure, a sale between family members or financing concessions. The property that you are comparing must have sold under approximately the same conditions as the subject property. Appraisers generally do not use foreclosure sales, short sales, or other distress sales as comparables.
Income Approach (Capitalization Rate)
Assumes that the net income derived from the property will control value. We are not concerned with the gross income. The thing we are concerned with is net operating income (NOI), how much is left after all expenses are paid.
Income Approach Types of Properties
Most commonly used in valuation of income-producing properties.
- The formula (net operating income / value = capitalization rate)
- Determining NOI
- Capitalization Rate - the rate of return received on an investment. Cap rates, as interest rates, are annual unless otherwise stated. They are used to determine present value of future income.
Gross Rent Multiplier
The formula (sale price / gross rent = gross rent multiplier). This formula would be used to calculate less than 4 rental units. The gross rent multiplier can be calculated monthly or annually.
Gross Income Multiplier
The formula (sale price / gross income = gross income multiplier). This formula is used to calculate commercial and industrial properties that generate income from other sources besides rental income.
An approach to valuation, based on the principle of substitution, which states the maximum value of property tends to be set by the cost of acquiring an equally valuable substitute property. This is the best method for new or special use structures. For example, we may appraise churches by the cost approach.
Cost Approach Types of Properties
Most commonly used in appraising buildings that have unique uses like churches or schools.
Cost Approach Concept
Value is based on the concept of substitution.
Cost Approach Formula
-The Formula (value = cost to replace - accrued depreciation + land). This approach consists of five steps.
- Estimate the value of the land as it were vacant.
- Estimate the cost to construct a similar building today.
- Estimate the accrued depreciation resulting from physical forces, functional obsolescence, and/or locational obsolescence.
- Deduct the accrued depreciation.
- Add the land.
Where is the Cost Approach normally found?
The cost approach is usually found on a residential appraisal but it is used as a validation of the value arrived at in the Sales Comparison Approach. It is not to be used to determine insurable value for homeowner's insurance.
_____ cost is based on how much it would cost to build a similar property; however, it need not be an exact duplicate.
_____ cost is based on how much it would cost to build an exact duplicate of an identical property.
When appraising real estate, _____ refers to any circumstances that negatively influences the worth of property.
Deals with normal maintenance and wear and tear of property. Can be curable or incurable.
Deals with undesirable features in the design or physical features of the property that are outdated. Can be curable or incurable.
External (Economic) Obsolescence
Has to do with the location of the property and is caused by negative environmental, economic, or social factors usually outside the property line. Always incurable.
Curable and Incurable
With regards to appraisals and depreciation depends on whether the necessary repairs contribute to the value of the property or not.
- For Example, physical deterioration of fixing broken shutters (curable) versus replacing a missing roof (incurable).
- Functional obsolescence of not enough closets (curable) versus a 12 story building that needs an elevator and has bad plumbing (incurable).
- The external obsolescence of a property being located next to a chemical plant (incurable).
Methods to Estimate Cost
When an appraiser computes the replacement or reproduction cost using the cost approach method, he would use one of the following methods.
- Square Foot Comparison
- Quantity Survey Method
- Unit-in-Place Method
- Comparative Unit Method
Square Foot Comparison
To use this method, you would multiply the cost per square foot of a comparable property by the number of square feet in the property in question. This is the simplest method of cost estimation.
Quantity Survey Method
To use this method, estimate the quantity of all materials and apply current cost. We would also have to add labor, overhead, etc. Contractors might use this.
This method uses cost per unit, such as per room or bath. Here we would estimate how much it would cost to put so many square feet of floor in place, how much it would cost to put so many doors or electrical outlets in place, etc.
Comparative Unit Method
In this case, we just compare cost of the unit, price per square foot or cubic foot we desire, to the overall cost of units built recently.
Summary of the Appraisal Process
- State the problem - what is the purpose of the appraisal?
- Preliminary survey and appraisal plan.
- Gather, record, and verify data - info can change from day to day.
- Analyze and interpret data.
- Apply up to three value approaches.
- Reconcile or correlate data and estimate value (the last thing done). Giving different weights to each approach to value.
-Prepare the report which could be -
-Short-form report where you fill in blanks.
- Uniform Residential Appraisal Report (URAR) - which is required on government-backed loans. The most common format.
- Lengthy written narrative reports, which may include photos, plot plans, maps, etc. Usually done for commercial appraisals.
- Note - appraisal is good for the day it is given.
- Reconciliation and preparing the report usually done simultaneously.
- Must be state licensed.
- Cannot pay referral fee for business.
- Cannot charge a fee based on percentage of appraised value.
- May charge a flat fee based on the type and difficulty of the property being appraised.
- Note - there is no specific time period that an appraisal is good for; however, the information you obtain to do the appraisal can change from day to day. The appraisal will only guarantee the information for the date of appraisal. The date of appraisal is the day the appraiser inspected the property.
Comparative Market Analysis (CMA)
A report in which data is gathered from researching the marketplace, using comparable properties that have been sold. These are often prepared by a salesperson instead of the licensed appraiser; however, the salesperson must be educated on the essentials of valuation to gather the market statistics. A _____ is not as extensive or as precise as an appraisal and cannot be represented as an appraisal.
Broker Price Opinion (BPO) and Broker Opinion of Value (BOV)
CMAs done for an asset management company or a lender to determine a selling price for a foreclosed property. They are also used for refinance loans and for verification of property conditions. Most are done as "drive bys" where the agent drives by the property and takes a photo from the street. In this case, the agent has no contact with the home owner. Some require an interior inspection with interior photos, in which case, the owner would be contacted and an appointment would be set. Real estate agents are also sometimes asked to do a Property Condition Report (PCR) in which case all that is needed is a photo of the property and verification that it is in good condition. There would be no CMA needed for a PCR. This is so the lender can verify that the borrower is keeping his promise to maintain property.
A set of moral principles or values. Professional _____ are a set of moral values that conform to professional standards of conduct, as in the real estate profession.
Ethical standards are a higher standard than law.
- Law - establishes a baseline for acceptable behavior.
- Ethics - establishes a level of behavior, which exceeds the standards of the law.
- Personal subjective feelings.
- Internal to each individual (what is important to you).
- Prioritized based on order of importance.
- May or may not carry an obligation to act.
- Values are the building blocks for principles.
- Objective based truths or assumptions (what one believes to be true).
- Thought oriented.
- Provide a moral compass.
- Carry obligation to act.
Values + Principles =
Ethics + Self Control =
A situation when there is a conflict between one's self-interest and ethical behavior or when there is a conflict between legal obligations and ethical behavior. In the real estate business, this often occurs as a result of our agency duties to our clients.