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Real Estate Economics
Unit 16 Valuation Process
Terms in this set (41)
Characteristics Of Real Estate
Unlike other commodities, real estate has unique characteristics that affect its value. These fall into two categories: (1) economic characteristics and (2) physical characteristics.
There are four basic economic characteristics of land that will influence its value:
-Permanence of investment
The total supply of land is fixed—they aren't making any more! Scarcity applies to the principle of value known as supply and demand. In total, there are seven basic principles of value. Let's briefly discuss how the principle of supply and demand relates to scarcity.
The availability of property for sale or for rent at various pricing levels creates the marketplace. When product availability exceeds the demand for that product, this economic force drives market pricing down. Of course, in the reverse, when the demand for a product exceeds the available inventory stock, this economic force drives prices up. It is, therefore, safe to conclude that the pricing of a parcel of property reflects the current scarcity of that parcel at that moment in time.
The building of an improvement on one parcel of land has an effect on the value of neighboring parcels or on whole communities. For example, the construction of a shopping mall or the selection of a site for a landfill can influence values in a large area.
Although all land ownership comes with the right to improve, the nature of improvements is greatly restricted by local zoning. Improvements must always be
-in compliance with zoning ordinances; and
-built in compliance with local building codes.
Permanence of investment
As the characteristic of scarcity suggests, land cannot be made or destroyed. Within this category of economic characteristics, permanence becomes the sole factor behind purchasers' willingness to invest large amounts of capital to improve property. The result of improvement generally leads to the supply side. Although improvements generally apply to new construction, existing structures may also be gutted and renovated. Even if older buildings are torn down, improvements such as drainage, electricity, water, and sewerage remain; so, generally speaking, prior improvements may be salvageable when the previous infrastructure remains.
This economic characteristic, often called situs, refers to people's choices and preferences for a given area. It is what makes one house sell for twice as much as an almost identical one on the other side of town. As the old expression goes, the three most important factors in determining the value of real estate are location, location, and location. For example, an older property located in an area alongside newer properties will enjoy price appreciation merely as a result of its being near these newer properties.
There are three basic physical characteristics of land:
-Immobility (land is nonmovable)
-Indestructibility (land is permanent)
-Nonhomogeneity (each parcel of land is unique)
While the physical characteristics of any parcel of land will apply only to that land itself, the economic characteristics discussed previously are used to compare the value of one parcel of land in relation to another.
Land is immobile. Even if soil is removed, that part of the Earth's surface always remains. The geographic location can never be changed. Because land is immobile, real estate laws and markets tend to be local in character.
Just as land is immobile, it is durable and indestructible. Land may diminish as a result of erosion or increase as a result of accretion; however, land cannot be made or destroyed.
No two parcels of land are ever exactly the same. Although there may be substantial similarity, all parcels differ geographically because each has its own location.
Real Estate-the Business Of Value
Value is not the same as price, nor is it the same as cost. Value can be defined as the amount of goods or services that will be offered in the marketplace in exchange for any given product. It also has been described as the present worth of future benefits attributable to a property.
In real estate, the concept of cost (the price or purchase or production) generally relates to the past, while price (the amount of consideration, usually currency, that a buyer agrees to pay for an item and a seller agrees to sell that item for) relates to the present, and value (the worth of an item to one party or another) relates to the future.
basic principles that constitute value:
There are seven basic principles that constitute value:
1. The principle of supply and demand emphasizes pricing's direct relationship to the availability and demand for a product.
2. Substitution refers to the reality that any informed investor would not pay more for a property than it would cost to purchase a substitute property of equal utility. For example, let's say you are shopping for a suit at Armani. The suit sells for $1,000. Later, you find the same suit at Bloomingdale's for $800. The principle of substitution suggests that in all likelihood, you will purchase the suit at Bloomingdale's rather than at Armani.
The principle of substitution is the primary foundation for all three approaches to appraisal valuation:
-The sales comparison approach, which uses comparable sales, that is, the cost of acquiring a substitute property, to indicate how much an informed investor/buyer will pay for a particular property.
-The cost approach is based on single use/purpose property for which sales of comparable properties are few or nonexistent. These properties are valued by establishing the cost to reproduce or replace the property—combining land value with the cost of constructing the improvement (new) and then taking into account the accrued depreciation of existing improvements to the property. The final result will determine for the investor whether the subject property or a substitute is feasible.
-The income capitalization approach regards the property's value as being directly related to the income attributable from that property once a capitalization rate is applied. The principle of substitution applies in that the subject property is always measured against substitute investment alternatives bearing equal cash flow returns and risks.
3. Anticipation refers to the expectation that today's purchase will increase in value tomorrow.
4. Highest and best use is defined as the use that is most likely, legal, and desirable when measured against alternative likely, legal, and desirable uses and that conveys to its owner the greatest income and subsequent value attributable to the land. The highest and best use approach values sites in two ways:
-Highest and best use as vacant.
This approach answers the question, Which use or improvement would most likely result in the greatest value attributable to the land if the land is (or were) vacant? Someone viewing a property as a development site is likely to disregard improvements made to the property. Given this example, one would view this site analysis "as vacant."
-Highest and best use as improved.
This approach is identical to the "as vacant" method, with one exception: it requires including in the analysis the costs of demolition of the existing improvement. These demolition costs would not appear had the site already been vacant, and they are in addition to the costs of constructing the new improvement.
Normally, the current use of a property tends to be the highest and best use of that site; however, that is not always the case. For example, changes in zoning might allow for a project of greater bulk (the total legal and buildable square footage of a project) to be built in place of the existing structure. Once the zoning increase takes effect, the existing use of the property ceases to be the highest and best use of that site since it conforms to a lower standard. See Unit 21 for more on zoning.
5. External property influences refer to the features outside of the property line that affect value.
Economies are a direct result of the addition of area amenities by a municipality. Some of these amenities may include new highways, transportation systems, and water and sewer facilities.
Diseconomies—the reverse of economies—are usually (but not always) the result of nonlocal reasons or events. Examples might include crime and pollution.
6. Conformity exists where there is uniformed use and a consistent construction style of properties in a given subdivision. Property values tend to remain stable or increase where conformity exists. A subdivision in which housing is all Tudor-style and the houses are similar in size would be an example of conformity.
7. Increasing and decreasing returns. Increasing returns occur when improvement(s) made to a property that cause the overall value of that property to increase as a result of that improvement's overall utility. This can also be referred to as an underimprovement. Decreasing returns occur when a property owner improves a property beyond the point of capital recapture (the return of the original principal investment) on a sale; in such an instance, the property is said to be overimproved. Usually, the result is that neighboring property owners experience increased property values, while the subject property remains limited in its value potential. From a resale point of view, it is not always wise to be the biggest or best house on the street.
Supply And Demand
The forces of supply and demand continually interact in the market to establish price levels. Usually when supply goes up, prices drop; when demand increases, prices rise.
When supply exceeds demand (buyer's market); when demand exceeds supply (a seller's market).
Supply and Demand in the Real Estate Market
Because real estate is fixed (immobile), the real estate market is relatively slow to adjust to changes in the factors that influence supply and demand. The product cannot be removed from the market or transferred elsewhere, so an oversupply usually results in lower price levels. But because development of and construction on real estate take considerable time, increases in demand may not be met immediately. Thus, when demand is high, prices rise.
Some of the factors affecting supply include:
-Product availability. Inventory or lack thereof; vacancy and/or absorption rates
-Potential for new inventory. New construction; renovations or conversions of existing product (for example, conversion from an antiquated office building to a new residential building)
-Labor supply and construction costs:
Increase or decrease in availability of raw materials or construction materials
Abundance or shortage of labor in the skilled building trades
Increase in the cost of building materials
High interest rates or scarce loans
-Governmental controls and financial policies:
Local property taxation
National interest rates
The government can greatly influence the amount of money available for real estate investment through its monetary policies.
At the local level, policies on taxation of real estate can have either positive or negative effects. Community amenities such as churches, schools, parks, and efficient governmental policies all affect the real estate market.
The basic human need for shelter grows or declines as the population changes. At any given time, some areas are gaining population while others are losing. In recent years, New York state's population has dropped. The makeup of the population, or demographics, also must be taken into account. For example, an increasing number of homes have been bought by single persons, one-parent families, and retirees.
Employment and wage levels
Employment levels in the community (the opening or closing of a large company, for example) have a major effect on the real estate market. Generally speaking, bullish real estate markets occur when unemployment rates are low. Income levels coupled by employment can spark the bull market. In these times, the working, income-earning consumer feels better about the prospect of taking on long-term debt. Often, the driving force behind this debt assumption is the desire to become a first-time homeowner or to upgrade or improve one's home.
These are factors that constitute demand in any market. However, future planning becomes critical since nothing lasts forever. The good times may become lean times. Economies are cyclical and as a result, leaner times, when they come, can ultimately punish the same party they rewarded when times were good.
Vacancy levels in a community provide a good indication of the demand for housing:
A growing shortage of housing (a decrease in vacancies) will result in increasing rents.
An overabundance of housing (an increase in vacancies) will force rents down.
Generally speaking, when rentals in housing are soft, sales markets are strong; and when sales markets are soft, rental markets are strong. However, if the demand within the sales markets exceeds the amount of available supply, the rental market can be strong. At the present time, this is the case in New York City where the supply is limited.
When mortgage interest rates fall, more buyers come into the market, which tends to drive prices up.
Interest rates and sales prices work in opposite directions:
-Lower interest rates lead to increases in a property's pricing. Sellers are aware of the liquidity in the market and, as a result, strive to achieve higher sales prices.
-High interest rates lead to a decrease in a property's pricing. Buyers are aware of the illiquidity in the market and as a result strive to achieve lower purchase prices.
An appraisal is a supported and defended estimate or opinion of value, while an
- evaluation is an analysis of a property and its attributes in which a value estimate is not required. The study may consider any aspect of the property including the nature, quality, and utility of an interest in the real estate.
-Valuation is the process of estimating value for a specific set of interests as of a specific point in time or specific date for a real estate property. It could be market value, assessed value, insurance value, liquidation value, value in use or investment value. The process is to investigate the property, not only the physical property itself but also all of the aspects of the property such as zoning, taxes, building code, type of construction, and its design.
-In the real estate business, the highest level of appraisal activity is conducted by professional real estate appraisers who are recognized for their knowledge, training, skill, and integrity in this field and who are licensed or certified by New York State. Within the appraisal industry, appraisers are governed by the Uniform Standards of Professional Appraisal Practice (USPAP). The Financial Institutions Reform Recovery and Enforcement Act of 1989 (FIRREA) requires that any appraisal to be conducted involving a federally related transaction must utilize either a licensed certified or general appraiser.
-A federally related transaction is defined as any transaction in which a loan is originated by any financial institution or lender regulated by the federal government. This would include institutions or lenders regulated by the Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of Currency (OCC), National Credit Union Administration (NCUA), and Office of Thrift Supervision (OTS).
Formal appraisal reports are relied on in important decisions made by mortgage lenders, investors, public utilities, government agencies, businesses, and individuals.
Not all estimates of value are made by professional appraisers. Often, the real estate licensee must help a seller arrive at a market value for his or her property without the aid of a formal appraisal report. Such assistance is known as an opinion of value or a comparative market analysis (CMA).
License law prohibits calling any opinion of value or CMA an "appraisal" unless it is prepared by a licensed, certified, or general appraiser. The usual penalty for doing so is the revocation of your real estate license.
- An evaluation is a study of nature, quality and utility of property. Evaluation establishes value essence. It may not be for a specific date it might be an arrange. You might say: "I want to evaluate what one family homes would go for in a specific market or a specific submarket between 1,200 and 1,800 sq ft". In an evaluation you would gather the data about that 1,200 to 1,800 sq ft homes, you arrive at a market range for that and that would be typical of an evaluation as opposed to the data of an estimate value for a specific property.
- An evaluation is primarily used to analyze a specific market. If you wanted to find out the cost of condominiums in Lower Manhattan, you may have an evaluation of 1 bdr condos, 2 bdr condos, etc so that you could get a market range of what that particular product in that particular market or submarket is. It's property specific as opposed to being a general analysis of a market.
- is a price that is expressed in terms of cash as distinguished from a price expressed totally or partly in terms of face amount of notes or other securities that cannot be sold at their face amounts. They are readily convertible into cash, such as money market holdings, short-term government bonds or Treasury bills, marketable securities and commercial paper.Calculating cash equivalency price, an appraiser must compare the transaction with typical financing. If there is favorable financing or unfavorable financing you will have to make a cash equivalent adjustment to the analysis.
Specific rights in an appraisal
- The 'right of use' in real estate is a bundle of rights and when you win the complete bundle of rights, you own the real estate completely. If you give up some of those rights, you are changing the value of that property. Fee simple which is the full bundle of rights gives you a bundle of use, the right of exclusion, the right to lease the property, the right of escheat, the right to leave it to an heir, or just selling the property. Those are all rights in realty.
- When you give up the right of use and you lease the property to another individual you have now a lease fee interest in a property. If you have a leasehold interest in a property, you as a tenant are in a position of subleasing that property to someone else.
A salesperson may sometimes be approached, however, to furnish a simple paid appraisal to help in division of property during divorce proceedings or to settle an estate. Such a determination of current value does not require any special license, but it should be performed under the supervision of the managing broker. This provides guidance and education in the process, and, of course, only the broker may charge the public for services.
Appraisals may be required in the following situations, among others:
-Estate purposes, to establish taxable value or facilitate fair division among heirs
-Divorce proceedings, where real estate forms part of property to be shared
-Financing, when the amount to be lent depends on the value of the property
-Taxation, to furnish documentation for a taxpayer's protest of assessment figures
-Relocation, establishing the amount to be guaranteed to a transferred employee
-Condemnation, arriving at fair compensation for property taken by government
-Insurance, estimating possible replacement expense in cases of loss
-Damage loss, used to support income tax deductions
-Feasibility, to study possible consequences of a particular use for property
-Fair market value determinations, often occurring in commercial lease transactions when the subject of rental value pertains to options to extend lease terms.
A fee appraiser works as an independent contractor, offering services to a number of different clients. A staff appraiser is an in-house employee of an organization such as the FHA, a lending institution, or a large corporation. A fee appraiser's fees are generally based on time and expenses; fees are never based on a percentage of the appraised value.
Types of Value
An appraiser may be asked to estimate one of several different types of value:
Some of the different types of value are as follows:
-Market value is the most common subject of the valuation process.
-Assessed value applies specifically to the process of real property taxation. It should be noted that assessed valuation may or may not resemble the property's actual market value. Assessed value is value that is placed on a property by a municipality to gain revenue for that municipality. It may be equal to market value, it may be a percentage of market value. It will have a relationship to other values on the market but it will not necessarily reflect current market value.
- In New York State for example we have what we call a 'state equalization war' where properties are assessed for a specific percentage of market value:
- Class 1 properties (which are residential) are assessed at 6% of the market value
- Class 2 property (residential properties) or Class 4 property (commercial properties) are assessed at 45% of the estimated market value.
-Liquidation value is usually obtained via a forced or hurried transaction. It can also be referred to as book value. This is the value that lenders will most often look to when providing financing to a business entity. It's a value typically used for bankruptcy or a discharge of a property where you would value a property for a fast sale unlike market value where the property is properly exposed, no one is forced to buy, no one is force to sell, usually in a liquidation value someone is forced to sell, so it is an aberration in the market.
-Insurable value is used for insurance purposes. The insured value is used to determine the amount of insurance carried on the property. As insurance only covers improvements that are made to the land, segregating the land value from the improvement value is essential in the determination of the improvement's insurable value. For tax purposes, the IRS always values the land at 20% of the overall value of the property as improved. It should also be noted that insurable value uses the cost approach to valuation. It could be based on either replacement or reproduction cost. 'Replacement cost new' is the cost of creating something 'like kind' in quality whereas 'reproduction cost' is an actual replica.
- Value-in-Use is a value for a property for a specific user. A property is typically purchased by an owner occupier to run their business such as a warehouse, not purchased to rent or create an income stream. It is purchased so someone runs their business out of it. Value in use is the value derived from a property when its current use is not the property's highest and best use. An example might be land that is a potential development site but that the current owner utilizes as a farm. The land is valued based on its use (as a farm) and not on its highest and best use (as a development site).
-Investment value is the value to an investor when some of the following items are taken into consideration: risk of investment and capital loss; rate of return on invested capital; return of invested capital; and management involvement. An 'investment value' is a value to a particular investor of what that property would yield under a certain economic scenario to a specific investor looking for a specific rate of return.
-Salvage value is what components of property or a business may be sold for (at the end of their useful life).
-Mortgage value is normally established by appraisal. It represents the amount or value that the lender is willing to commit to the loan. It is also the difference between the buyer's initial equity investment (down payment); and the purchase price or appraised value of the property, whichever is less.
The most frequently sought type is market value.
Market value is an important concept defined as the probable price a property will bring in a competitive and open market, offered by an informed seller, and allowing a reasonable time to find a purchaser who buys the property with knowledge of all the uses to which it is adapted, neither buyer nor seller being under duress. It is the most probable price that someone would pay for a property as of a specified date where a buyer is not forced to buy, a seller is not forced to sell.
Market value also presupposes an arm's-length transaction. This is defined as a transaction between relative strangers, each trying to do the best for himself or herself. In essence, the parties are unrelated and are dealing from equal positions of bargaining. A sale between mother and son, for example, is not likely to be an arm's-length transaction and may not yield full market value for the property.
Included in the definition of market value are the following key points:
-Market value is the most probable price a property will bring.
-Payment must be made in cash or its equivalent.
-Both buyer and seller must act without undue pressure.
-A reasonable length of time must be allowed for the property to be exposed in the open market.
-Both buyer and seller must be well informed about the property's assets, defects, and potential.
-Market value presupposes an arm's-length transaction.
Market value versus market price
Market value is an estimate based on an analysis of comparable sales and other pertinent market data. Market price, on the other hand, is what a property actually sells for—its selling price. Theoretically, the ideal market price would be the same as the market value.
-Price is the particular amount that an individual pays for a property which may be equal to or less than, or more than cost.
There are circumstances under which a property may be sold below market value, such as a seller who is forced to sell quickly or a sale arranged between relatives.
- Price does NOT equal Value!
- Real estate is an inefficient market. Most markets have balance and equilibrium. If you are going to buy a pretzel there is certain demand that is more or less established and there is certain cost that is more or less established. You could rapidly fill that need and you can cut back on that need.
With real estate, that's not the case. Very rarely is the real estate market in balance because of how slow it takes to develop RE. However, the market conditions can change rapidly. Real estate many times will have pent up demand and not enough product to meet that demand or vice-versa having too much product for the demand.
Market value versus cost
One of the most common errors made in valuing property is to assume that cost to build represents market value.
-Cost is the cost of building the property; including the cost of labor, materials, legal services, architectural design, financing, holding cost such as taxes and insurance during construction, interest on instruction loans, contractor's overhead and profit as well as developer's overhead and profit.
Cost and market value are most often equal when a newly constructed house is being appraised. Once the last house in the new subdivision has been sold, however, market value may go up because those who want to live in that particular neighborhood have to compete for whatever houses become available. On the other hand, construction of an expressway nearby may make the houses less desirable, and market value might drop. Cost hasn't changed; value has.
It is important to note that cost consists of two components:
1.) Hard costs or direct costs that include
-cost of land,
-cost of brick and mortar, and
-cost of labor to produce the improvement.
2.) Soft costs or indirect costs that consist of
-architectural and engineering fees,
-professional fees (appraiser),
-lease-up costs (commissions),
Approaches To Appraisal
Real estate is usually appraised in one of three ways:
-Sales comparison approach (m/c)
-Income capitalization approach
Each approach is appropriate for solving different valuation problems. All appraisals study the subject property (the parcel being evaluated) through all three methods while weighting the approaches appropriately and reconciling the results for a final estimate of value.
Sales Comparison Approach
The sales comparison (market data) approach evaluates property through careful study of similar parcels recently sold. These recently sold properties are referred to as comparable properties, or comps. Adjustments are made upward or downward to the comparables' sales price figures depending on whether their various components exist in the property being appraised. The minimum number of comparable sales you could use is three. However you are not limited to three comparable sales. You have to use as many sales as it is necessary to justify your market value estimate.
There are three categories of adjustments that an appraiser will study:
-Transactional differences—financing at the time of the comparable's sale, conditions at the time of sale, and market conditions adjustment from the date of sale to present
- Is it typical market financing? or is it atypical financing? Any conditions of sale, conditions in the market, is it arm's length? Is not arm's length? If it's not arm's length you cannot use it, you adjust for market trends.
-Physical characteristics: If you are out in a rural area of let's say Suffolk county the value of that garage, its contributory value may be very little other than keeping a car protected from the elements, or as storage, it may have little contributory value. However if you are in Brooklyn Heights or Manhattan and you have a garage, that garage can be very valuable. So the market determines how valuable that item that is contributing
- However, the first thing that you adjust for are the rights conveyed.
When making adjustments, the appraiser identifies the differences between the comparable properties and the subject property:
-When the comparable property is superior to the subject property in an area of comparison, the appraiser subtracts that amount from the sales price of the comparable.
-When the comparable property is inferior to the subject property in an area of comparison, the appraiser adds that amount to the sales price of the comparable.
- If you have two homes that are 6 rooms, 3 bedrooms, 1.5 baths and they are 1,400 sq ft. One has a garage and one doesn't. The property that has the garage sells for $550,000. The property that doesn't have a garage sells for $525,000. Then that $25,000 difference is attributed to the difference in having a garage and not having a garage.
The appraiser never adjusts the subject property. He or she will only adjust the sales price of the comparables to reflect and arrive at a range of value. Appraisals will always fall into a range of value since they are opinions of value. The appraised value can be any value that falls within the actual range of value determined through this process.
The sales comparison approach is based on research and study of the data gathered. It is most appropriate for valuation of residential one- to four-family residences.
The cost approach estimates the amount needed to reproduce or replace the property being studied. This approach is most appropriate for non-income-producing buildings that cannot easily be compared with others such as hospitals, schools, libraries, houses of worship, and fire stations. It also is the primary and only approach used for insurance purposes.
The cost approach to appraisal is used when:
-the subject of an appraisal is a single-purpose property and
-where comparable sales are nonexistent b/c the property is new or a special purpose property.
The cost approach considers not only the cost of reconstructing improvements but also the amount of depreciation that already has subtracted value from the property.
Depreciation falls into three categories:
-Functional obsolescence (undesirable or outmoded features)
-External obsolescence (economic obsolescence or locational obsolescence), defined as undesirable factors located beyond the property lines.
Since physical deterioration exists within the property line, it is considered to be a curable event by the property owner (i.e. a broken window). Functional obsolescence also occurs within the property line and can also be either a curable or noncurable event (i.e. a house only has 1 bathroom= functionally obsolete b/c the standard is that a house should have 2 bathrooms).
- An item is said to be curable when the cost to repair or replace it is equal to or less than the overall value that it will add to the property. An item is said to be noncurable when the cost to remediate it is greater than the overall value that the remediated item will add to the property (i.e. like a boiler).
Unlike physical deterioration and functional obsolescence (which are events that occur within the property line and can be curable or noncurable events), external obsolescence occurs from forces outside the property line that are not in the control of the property owner (i.e. It could be locational such as you are on a street with a heavy traffic pattern or you are next door to a gasoline service station). As a result, external obsolescence is considered to be a noncurable event.
Cost Approach cont'd
Reproduction cost is defined as the cost to create an exact replica of the subject property, while replacement cost is defined as the amount of capital necessary to construct the improvement using modern-day materials when a reproduction of the improvement is unachievable. This will not result in an exact replica of the improvement.
When calculating reproduction or replacement cost (new), direct and indirect costs must be taken into consideration. Direct costs are the expenditures necessary for the labor and materials used in the construction of a new improvement, including contractor's overhead and profit, while indirect costs are construction expenses for items other than labor and materials (e.g., financing costs, taxes, administrative costs, contractor's overhead and profit, legal fees, interest payments, insurance costs during construction, and lease-up costs).
The process of reproduction or replacement (particularly in the absence of an active sales market for similar properties) ultimately creates a comparable property exactly like the subject. The difference is that the replacement is looked at as new, while the subject suffers from depreciation (a loss of value attributable to any one or a combination of three events—physical deterioration, functional obsolescence and external obsolescence) of its aged components.
Using the cost approach, the following are the three steps that are used for calculating the appraised value:
Determine the reproduction/replacement cost (new). This is accomplished by using one of three cost estimating methods:
1.) The quantity survey method entails a detailed costing process of all construction materials, cost of labor to construct the improvement, builders' return on the invested capital, and soft costs associated with the completion of the finished product such as architectural and engineering costs. The items of consideration are multiplied by the cost per item.
2.) With the unit-in-place method, each component required to construct the improvement is studied. The appraiser then calculates the costs related to each of the components of the improvement to derive an amount. Components consist of items such as foundations, walls, floors, roofing, and paving.
3.) The comparative-unit method (also known as the square-foot or cubic-foot method) multiplies the cost per square or per cubic foot to construct an improvement by the square feet of living area contained in the subject property. This method is more widely used than the quantity survey method and the unit-in-place method.
Determine the amount of accrued depreciation (total loss in value due to physical deterioration, functional obsolescence, and external obsolescence) attributable to the subject property and subtract that from the figure calculated in Step One. This new figure, representing accrued depreciation, can be determined by utilizing any of the three methods for determining accrued depreciation:
The breakdown method is used to appraise older single-family homes and income-producing properties. In each case, depreciation categories are analyzed separately.
The market extraction method includes the study of comparable properties that have experienced the same or similar degrees of depreciation.
The lump-sum age-life method is the most popular method for appraisers using the cost approach to appraise residential property. The basis of this method is a measure or ratio of the property's economic or useful life as it relates to the property's effective age. Effective age is defined as the age of a property as a result of the condition of the improvement and the utility of the improvement.
The formula for calculating accrued depreciation using the lump-sum age-life method is as follows:
(Effective age ÷ Economic life) × Reproduction/replacement cost new = Accrued depreciation
Determine the site value (land value) and add it to the figure calculated in Step Two. Site values can always be derived through studying comparable sales. Each property that sells, regardless of property type, has underlying land as one of its components. Land comps are identified by separating land and improvement values.
The cost approach in formula form:
Reproduction/replacement cost (new) - Accrued depreciation + Site value = Appraised value
(See document for ex)
Income Capitalization Approach
The income capitalization approach to appraisal estimates value by analyzing the income generated by the property being considered. It is most appropriate and effective for the valuation of rental property. The income approach utilizes three types of ratios:
-Gross income multiplier (GIM), a measure of annual income
-Gross rent multiplier (GRM), a measure of monthly income
-Overall capitalization rate (OAR), a measure of income and value as it relates to an investor's return on invested capital
The gross income multiplier (GIM) is the ratio of the property's sales price to the annual gross income of the property.
For example, a property sells for $1,200,000 and has an annual gross income of $100,000. This will produce a GIM of 12 ($1,200,000 ÷ $100,000 = 12). In simple terms, this property sold for 12 times the gross income attributable to the property. While this method offers a quick calculation of property value, it is unreliable because the property has expenses attributable to operations. This method views the income only, without considering the property's expenses.
The gross rent multiplier (GRM) is the ratio of the property's sales price to the monthly rental income. (GRM = Sales price ÷ Monthly rental income) The following table shows some examples of GRM comparisons.
(See document for ex)
Valuation using the overall capitalization rate (OAR) estimates value by comparing capitalization rates to the income attributable to the property.
Income Capitalization Approach cont'd
This is not a simple process, as it is truly up to the investor to determine the actual net operating income (NOI) of the subject property. In order to understand this method, we must examine the three events in real property ownership:
1.) As part of the acquisition, the investor analyzes the income and expenses of the subject purchase to calculate the net operating income.
2.) During the holding period, the property owner analyzes income and expenses of the subject purchase to calculate the net operating income. Next, the property owner will use this information to create a discounted cash flow analysis, which indicates when to sell, when to refinance, and whether to continue to hold the property.
3.) The reversion process is merely the sale of the property, when the investor reverts back to his or her original investment of cash.
Only a holder of the property (see #2 above) can provide an accurate picture of the property's operating expense history. Therefore, any investor or appraiser appraising a property for acquisition purposes should be knowledgeable enough to estimate the expenses accurately in order to ensure a more accurate calculation of the NOI. The importance of generating an accurate figure is primarily due to the relationship between the NOI of a property and the property's value to another.
Let's examine the steps in estimating value using the income capitalization approach.
Step one (income analysis)
This step begins with an examination of the potential gross income (PGI). This figure represents the gross rent roll or gross receipts attributable through rental activities if the property were 100 percent leased. Determination of this figure is as a direct result of adding contract rents and projected rents. Contract rent is income derived from current rent-paying tenants (better known as actual income), while projected rent is predicated on market conditions. It is extremely rare that any building is ever truly 100 percent rented. Step Two addresses this reality.
Step two (income analysis)
This step calculates the vacancy and collection loss (V&C) by examining the leasing and vacancy history. On existing property, you must determine average vacancy rates; on new construction, this figure is determined by analyzing market condition studies in conjunction with neighboring property vacancy rates. This step also involves an examination of the property tenants, which will determine the quality of tenancy as well as the ability of the occupants to pay the rent.
The anticipated sum of the V&C is deducted from the PGI.
This rate is always calculated as a percentage figure. Since it represents a percentage of loss attributable to vacancy/collections, it is subtracted from the PGI figure.
Next, establish whether any other income (OI) is attributable to the property. Other income can be defined as income that is not derived from the main activity of the property. For example, a highrise apartment building may contain commercial spaces such as a garage, retail space, and/or commercial space. Income derived through these activities is deemed other income.
Any other income is then added to the difference between the PGI and the V&C. This will give the appraiser or investor a figure that represents the effective gross income. In essence, effective gross income is the income attributable to a property, after deducting vacancy and collection losses, while adding in any other income derived from that property.
Summary of Steps One and Two (income analysis):
Potential gross income (PGI) - Vacancy and collection loss (V&C) + Other income (OI) = Effective gross income (EGI)
Now that we have examined the income side of a property, let's examine the expense side.
Step three (expense analysis)
There are operating expenses associated with running all income-producing properties. These expenses can be broken down into three categories:
Reserves for replacements
Fixed expenses are expenses that do not vary as a result of a property's occupancy rate. Regardless of the property's leasing activities, these expenses remain constant for the year of analysis. Fixed expenses consist of only two items: property taxes and property insurance.
Variable expenses are expenses that will fluctuate up or down with the property's leasing activities. Variable expenses consist of the following:
Reserves for replacements is available cash on hand meant to pay for any anticipated or unanticipated major capital improvement to the property. Examples might include a new roof, new mechanical equipment, or façade restoration.
Once the appraiser identifies the three categories of property expenses, the three are added together. This amount is subtracted from the EGI to calculate the property's NOI.
The NOI represents the cash flow attributable to the property after deducting all property-related expenses but before deducting any debt service (mortgage payments) or federal income taxes, which would include items such as mortgage interest, depreciation allowances, and carryover and suspended losses brought forward from previous years.
Generally, an appraiser obtains the information for income and expenses from a reconstructed income and expense (operating) statement. A simplified version of the income approach is illustrated in the table below.
Step Three (expense analysis) at a glance:
Effective gross income (EGI) - Operating expense (OE) = Net operating income (NOI)
Steps In The Appraisal Process
The appraiser derives value through the systematic observation of appropriate market data selection and the application of a variety of value methods, which allow him or her to make a conclusion regarding the property's value.
Let's examine the steps and procedures that guide a real property appraisal.
There are seven steps within the appraisal process:
-Definition of the assignment
-Analysis of highest and best use
-Estimation of land value
-Application of the three approaches to appraisal
-Reconciliation of the values toward a final estimate of value
Defining the assignment
This requires that the appraiser understand the legal description of the property being appraised, know what property rights are being valued, and determine the appropriate "effective date" or "as of date" to be used. Remember, appraisals are only good for one day—the date of preparation. The reason for this is that conditions inside and outside the property line can change at any time and any such change can directly affect the property value.
This step includes the selection and collection of appropriate data necessary for the observation of market and environment conditions.
Analysis of highest and best use
This analysis involves the comparison of alternative legal and financially viable uses that may exist on the property. As previously discussed in this unit, the purpose is to make a determination as to which legally permissible use would contribute to securing the highest value for the land.
Estimation of land value
The site is valued through a careful review and comparison of other comparable land sales. Any property that sells has land underneath it; therefore, comps are always available for valuing land.
Application of the three approaches to appraisal
These three approaches are the sales comparison approach, the cost approach, and the income capitalization approach discussed previously.
Reconciliation of the values toward a final estimate of value
This process requires the appraiser to determine through careful "weighting" which of the value indications derived from the three appraisal methods best solves the appraisal problem. Although an appraisal report will contain value indications derived from all three approaches, the appraiser ultimately selects the one value indication that will best represent the solution to the assignment. If more than one approach to value is used, different indications of value may result. Reconciliation is the art of analyzing and weighing the findings from the approaches used.
Whenever possible, all three approaches should be used as a check on the final estimate of value. The process of reconciliation is more complicated than simply averaging the estimates. With certain kinds of properties, one approach will be more valid and reliable than the others.
For example, the income approach is rarely used when appraising a single-family residence, and the cost approach is of limited value unless the home is relatively new; therefore, appraisers generally give the greatest weight to the direct sales comparison approach. In appraising income or investment property, the income capitalization approach is normally given the greatest weight. The cost approach is usually assigned the greatest weight in appraising churches, libraries, museums, schools, and other special-use properties where there is little or no income or sales revenue. From this analysis, or reconciliation, a single estimate of market value is produced.
There are various types of reports that appraisers commonly deal with. They include oral reports, form reports, and narrative reports.
Oral reports are delivered to the client or appropriate party orally. The appraiser (as required by USPAP) must support and defend his or her estimate of value. At the least within this type of report, the appraiser is required to include at minimum a property description, details on any assumptions made and any conditions affecting valuation conclusion, and the value conclusion and reasoning behind that conclusion.
Form reports are typically used in appraisals involving financing through financial institutional lending. They generally consist of three to five pages. In order for secondary market players such as Fannie Mae, Ginnie Mae, and Freddie Mac to purchase these loans, it is necessary that the indication of value be in this report format.
Narrative reports apply to large commercial projects.
There are three types of narrative reports that are recognized in this category of reporting by USPAP: summary reports, self-contained reports, and restricted reports.
Summary reports include some but not all of the information necessary to support and defend the estimate of value. Regardless of information submitted and/or reported, the appraiser is always required to maintain within his or her files all information used in deriving the estimate of value.
Self-contained reports are very in-depth and detailed appraisal reports. They generally consist of all supporting information contained within the appraiser's files. This would include supporting data, data description, appraiser's reasoning, and valuation analysis.
Restricted reports are reports that are intended only for the client.
Comparative Market Analysis
"Real estate properly priced is half sold." The seller determines the listing price for the property. Because the average seller usually does not have the background to make an informed decision about a fair market price, the real estate agent should be prepared to offer knowledge, information, and expertise in this area.
A broker or salesperson can help the seller by furnishing a comparative market analysis (CMA). This study compares the prices of recently sold homes that are similar in location, style, and condition to the home being put on the market (the subject property).
A CMA differs from a direct sales comparison appraisal in several ways. It is usually offered as a free service by a salesperson or broker and is used merely as a market tool to establish a listing for sales price, whereas the paid appraisal rendered by a fee appraiser focuses on value. Both studies analyze recent sales of similar properties, but the CMA does so differently. It includes material not usually considered in regular appraisals, such as information on nearby properties that failed to sell, for example, and a list of competing properties currently on the market. It also includes significant DOM (days on the market before the sale) information. Broker license law and ethics dictate that unless one is a licensed state-certified or general appraiser, a CMA may never be called or referred to as an "appraisal."
Once the broker has information on the subject property, he or she must select properties with the same general characteristics from the neighborhood (or a similar neighborhood) that have sold recently, that are listed, and that have recently failed to sell. The broker then uses the information about these comparable properties ("comps") to arrive at an informal estimate of value of the subject property.
The broker generally uses a comparative market analysis form, similar to the one illustrated in the following figure, to prepare a written CMA to present to the property owner. A well-researched and well-prepared CMA will help the broker explain that the eventual selling price is set by the buying public through the operation of supply and demand in the open market. The CMA gives the seller an effective way to judge the market and choose a reasonable listing price.
Residential Market Analysis
- When we are performing a residential market analysis we have to collect data from the market. We collect data of recently sold properties that tells us what happened in the recent past, any expired offerings. That gives us information. Perhaps a certain property type is not as desirable as other property types. The expired offerings could be too high or they could be property specific that doesn't make that particular offering acceptable in the market.
You are looking at current listings in the market as well as contracts of sale. You examine the subject property in terms of its buyer appeal: Is there a certain presence to the property? Is it located on a hill? Does it have beautiful landscape? is it brick? is it frame? what is popular in that particular market? What is the specific property's market position? Is it on the lower end of the market or the higher end of the market, middle of the market? Is it a starter home? is it something for a family? Is it a home for a couple being retired? What are the assets of the property? What amenities does it have? Does it have a swimming pool? Does it have parking? Is it in a school district? Has it been well maintained? Has it been modernized?
What are the specific drawback of the property? Was it kept well? If it wasn't kept well that would be a drawback. Is it in a high tax zone? Is the school district inferior? Is it on a heavily traffic street? Is it next to or near a commercial property or across the street from a school or a park that may be too noisy in the evening or have a lot of children or older people hanging around disposing garbage in front of the property so you always have to clean it up?
Buyer Appeal aka curb appeal
Buyer appeal applies to the initial impression that any buyer feels or has about a particular property that is under consideration. This usually relates to the appearance of the property as viewed from the curb, also referred to as curb appeal.
Market positioning compares the amount of similar properties that are available to that of the subject property. The purpose of this analysis is to determine how the subject property can be differentiated from competing properties that are simultaneously up for sale, while providing potential solutions to successful marketing procedures.
Assets and Drawbacks
Depending on the property in question, most properties can be compared to other availabilities through a close investigation as to the property's assets and drawbacks. When completing a CMA, this process of determining a property's assets or drawbacks may include but not be limited to items of comparison, such as
-accessibility to alternate means of public transportation,
-buyer appeal, and
Area Market Conditions
Area market conditions will vary from time to time due to the cyclical nature of the real estate market. Issues such as supply and demand, availability of credit, and competing properties will dictate any area market conditions. When conditions are good, properties tend to sell relatively quickly. When conditions are poor, the opposite occurs. Careful consideration should be given to the market conditions when preparing a CMA. This will avoid overpricing or underpricing a property. When conducting a CMA, a licensee is charged with the duty of giving a fair estimate or opinion of the property's value. Failure to do so will result in disciplinary action by the DOS.
- You have to understand the specific market and the sub market. Is the market active right now? is it inactive? What are the current typical market terms? Is it typical financing that individuals in that market would go to a financial institution and be able to get financing at standard rates and standard down payments? Or is it a market that financing is unavailable and the sellers of the property typically may have to hold the paper or may be an extremely long marketing times. What is a specific value range in that particular market? Is it high value area, low value area, is it what we call high end or low end?
It is no secret that a sales transaction offering favorable terms of sale will sell faster than one with unfavorable terms. For example, seller financing is viewed as a favorable condition. The buyer saves money on closing costs for which he or she would normally pay more in any institutional financing transaction. Immediate occupancy creates another favorable condition that will aid in the favorable and quick disposition of the property. When obtaining a listing, a licensee should always inquire as to the potential for obtaining favorable terms from the seller. This will always assist the licensee in bringing about a successful sale.
Market Value Range
A market value range is always achieved when comparing similar sold properties. This is referred to as the range of value. For example, after comparing three to six comparable sold properties, a licensee discovers that the comparable sales indicate the range of value to be $250,000-$265,000 for the subject property. At this point, depending on the condition of the property and the desire on the part of the seller to effectuate a quick sale, the licensee may recommend the middle range as the target price. Of course, the final decision concerning offering price will always be that of the property owner; the licensee's role is to present all the facts to his or her principal.
The Real Estate Agent's Role
In valuing property and presenting the owner with a CMA, the real estate agent must be careful to act competently and with due diligence. The agent should keep a copy of the CMA presented to the owner and also copies of any documentation used to complete the CMA. Agents should make sure that owners understand the estimates of value, how those estimates were determined, and what they mean to the owner.
- They should contact listing agents, get feedback from prospective purchasers, & communicate with buyers and sellers. They should be able to keep sellers informed about the activity in the market of both their own property as well as those properties that are competitive. They should keep good documentation, keep records of agents who showed the property and individuals of people that they showed the property to. They should keep lists of people who appeared at open house. They should keep notes: what a particular buyer is interested in, etc. They should also be able to effectively communicate with the buyer or with the seller, provide them information in a professional manner, keep the sellers informed and communicate with other agents.
Basic Principles of Value
A number of economic principles affect the value of real estate. The most important are defined in the following paragraphs.
The principle of plottage holds that the merging of adjacent lots into one larger parcel may produce a higher total value than the sum of the two sites valued separately. For example, if two adjacent lots are valued at $35,000 each, their total value if consolidated into one larger lot might be $90,000. The process of merging the two lots under one owner is known as assemblage.
The value of any component of a property is what its addition contributes to the value of the whole. For example, the cost of installing an air-conditioning system and remodeling an older office building must be analyzed to see if it would be worth doing for the anticipated increase it would bring in rental income.
This principle states that excess profits tend to attract competition. For example, the outstanding success of one fast-food outlet may attract investors to open others in the area. This could mean less profit for all. That would be taken into consideration in the type of appraisal known as a feasibility study.
No physical or economic condition remains constant. Real estate is subject to natural phenomena such as tornadoes, fires, and routine wear and tear of the elements. Also, like any business, the real estate business is subject to the demands of its market. An appraiser takes into account the past and possible future effects of natural phenomena and the behavior of the marketplace.
The following figure outlines the seven steps an appraiser takes in carrying out an assignment. (See document)
Highest & Best Use , Site Valuation
- There are 4 tests for higher and best use. Higher and best use always refers to the site as if unencumbered or as improved. Unencumbered is as if the site were vacant and ready to be improved to its higher and best use. It must be legally permissible, it must be physically possible, it must be economically feasible, and it should be an appropriate use for the site. You don't have all warehouses and then build a residential home in the middle of it.
- As vacant, the higher and best use is the value that provides the greatest return to the site. As improved, if the improvement is still contributing value to the site and it is not economically feasible to knock down that improvement and rebuild something other than the existing improvement then the existing improvement is the highest and best use of the site.
- A site is always valued as if it is unimproved and ready to be built upon. When you value a site, you have to see what the possible improvements are that you can make to that site according to zoning. This site's value is as if it is vacant, it can be brought to its highest and best use. You will look at common units of comparison, you can be priced per square foot, price per buildable foot, price per acre, if you are valuing plottage which is an assemblage of land to be developed you may do it price per lot, a buildable lot.
- Land cannot be created or destroyed but it can have a negative value. How can land have a negative value? Land is encumbered with environmental hazard. Cleaning a site may make the land valueless and be a true detriment.
The Profession Of Appraising
Until the early 1990s, when the federal government directed each state to license and certify appraisers, professional designation was made through membership in appraisal societies. Different designations require varying levels of education, specific courses in appraisal, examinations, demonstration appraisals, experience, and continuing education. The Appraisal Institute, the largest private society, offers the prestigious designations MAI (Member, Appraisal Institute) and SRA (Senior Residential Appraiser).
Some professional appraisers belong to more than one society. Those along the Niagara frontier, for example, may join an international society, FIABCI. Where expert testimony is provided for court proceedings or before a public body such as a zoning board, specific credentials (MAI, SRA, or state licensing or certification) may be required.
Licensing and Certification
Federal and state governments suggest licensing or certification for all appraisals, but they require it only for federally related appraisal assignments with a transaction value of at least $250,000. (An appraisal is federally related if there is federal government tie-in, such as if the appraisal is used for lending purposes and the lender is a federally chartered bank or savings and loan.)
New York's appraisal licensing and certification process provides for four types of appraiser licenses or certifications:
-Appraiser assistant license. An appraiser assistant must work under the supervision of a state licensed or certified appraiser, who must cosign all the appraisal reports. An appraiser assistant license is good for two years and may be renewed once.
-Licensed residential appraiser. A licensed real estate appraiser may appraise noncomplex one- to four-unit residential real property with a transaction value of less than $1,000,000, and complex ones up to $250,000.
-Certified residential appraiser. A certified residential appraiser may appraise any residential property up to four units.
-Certified general appraiser. A certified general appraiser may appraise any real property.
Various appraisal courses must be completed, depending on the type of license or certification the applicant is seeking.
The following is a brief overview of the new education requirements that became effective January 1, 2008:
Licensed appraiser assistant
-150 classroom hours of approved courses
-No previous experience necessary
-No exam required, but the applicant is only eligible to take the state exam for the category of education that has been completed
Licensed residential appraiser
-150 classroom hours of approved qualifying courses
-2,000 hours accumulated experience in no less than 24 months
-Sit for and pass a new state exam based on the 2008 qualifying courses
Certified residential appraiser
-200 classroom hours of approved qualifying courses
-Associate degree (or higher) or 21 college semester hours in specific courses
-2,500 hours accumulated experience in no less than 24 months
-Sit for and pass a new state exam based on the 2008 qualifying courses
Certified general appraiser
-300 classroom hours of approved qualifying courses
-Bachelor's degree (or higher) or 30 college semester hours in specific courses
-3,000 hours accumulated experience in no less than 30 months
-Sit for and pass a new state exam based on the 2008 qualifying courses
Note: The criteria does not affect appraisers licensed before January 2008; however, if the appraiser seeks an upgrade from current standing, he or she will be required to conform and meet with the requirements of these standards.
The law also prescribes the following: "No state certified real estate appraiser or state licensed real estate appraiser shall supervise more than three (3) licensed real estate appraiser assistants."
Furthermore, there are three components for licensure/certification:
In conjunction with the aforementioned, the New York State Real Estate Appraisal Board has now adopted the "segmented approach" toward the implementation of the aforementioned new requirements that took effect January 1, 2008. This means that any aspect or component requirement of education, experience, or exam that has been completed prior to January 1, 2008, will have served to satisfy that one component.
For example, if an applicant for a license as a certified general appraiser has completed the required 180 hours of education and fulfilled his or her experience requirement as was prescribed under the laws prior to January 1, 2008, but not passed the New York State exam, the DOS will accept the previous education and experience toward fulfillment of current requirements, but the applicant will still be required to complete and pass the new New York State exam.
Examination and experience
Licensed assistants are qualified to work at entry-level assignments, assisting under supervision. All other applicants must have at least two years' full-time appraisal experience and pass state examinations of increasing difficulty for various types of license or certification. In addition, they must present evidence of varying numbers of required hours appraising different types of property.
License and certification applications and information are available on the Division of Licensing Services Web site at www.dos.state.ny.us/licensing/.
As applicable fees do change from time to time, the applicant is always advised to check as to the appropriate fee at the time of application. However, at the present time a $300 nonrefundable fee must accompany completed applications. If the application is in order, the applicant will receive an admission card to a scheduled walk-in examination (there is a $50 exam fee). The applicant must score 75 percent or higher on the exam. Renewals require 28 hours of continuing education and a 7-hour USPAP update course.
-Appraisal - An estimate of a property's value by an appraiser who is usually presumed to be expert in his work.
-Valuation - The process of estimating market value, investment value, insurable value, or other properly defined value of an identified interest or interests in a specific parcel or parcels of real property as of a given date.
-Assessed Value - A valuation placed upon property by a public officer or a board, as a basis for taxation.
-Insured Value - The value of an asset or asset group that is covered by an insurance policy; can be estimated by deducting cost of non-insurable items (e.g. land value) from market value.
-Value-in-Use - The net present value (NPV) of a cash flow or other benefits that an asset (real property) generates for a specific owner under a specific use.
-Investment Value - The specific value of an investment to a particular investor or class of investors based on individual investment requirements; distinguished from market value, which is impersonal and detached.
-Evaluation - a study of the nature, quality, or utility of certain property interests in which a value estimate is not necessarily required, e.g. highest and best use, feasibility, market supply and demand, etc.
-Market Value - The most probable price that a property should bring if exposed for sale in the open market for a reasonable period of time, with both the buyer and seller aware of current market conditions, neither being under duress.
- Mortgage Value - The estimate worth of a particular asset which is established for the purposes of obtaining financing secured against that asset.
- Plottage - Increment in unity value of a plot of land created by assembling smaller ownerships into one ownership.
-Price - The amount a purchaser agrees to pay and a seller agrees to accept in an arms length transaction.
-Cost - The total dollar expenditure for labor, materials, legal services, architectural design, financing, taxes during construction, interest, contractor's overhead and profit, and entrepreneurial overhead and profit (may or may not equal value).
- Direct Cost - The cost of labor and materials.
- Comparative Market Analysis - A property evaluation that determines property value by comparing similar properties sold within the last year.
-Sales Comparison Approach - Valuation method which compares a subject property's characteristics with those of comparable properties which have recently sold in similar transactions.
- Income Approach - An appraisal technique whereby the value of an income producing property is estimating by capitalizing its net operating income using an appropriate capitalization rate. Value = Income / Rate. (tax.ny.gov - glossary)
-Cost Approach - A method of estimating the value of real property by calculating a current construction cost, subtracting accrued depreciation and adding a land value obtained from the market. This method works best when the improvements are relatively new and estimates of depreciation are thus more likely to be accurate.
-Depreciation - A loss of utility and thus value caused by physical deterioration, functional obsolescence or economic obsolescence or any combination thereof.
- Obsolescence - One of the causes of depreciation. It is the loss of desirability and usefulness caused by new inventions, changes in design, and improved processes for production, or from the influence of external factors. Obsolescence may be either economic or functional.
- Functional Obsolescence - Impairment of useful capacity or efficiency; loss of value caused by super adequacy, inadequacy or changes in the art inherent in the property itself. Not to be confused with external effects of economic obsolescence. Curable if the cost to cure is justified by the resulting increase in value of the property; otherwise incurable.
- Economic Obsolescence - A loss in value caused by influences external to the property such as increasing industrial activity near a residential neighborhood. These are incurable.
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