Week 5 Final Paper
RES450: Real Estate Appraisal
Valuation of Varying Property Types
An appraisal is simply one man’s unbiased opinion based on gathered data/facts collected about the property and like properties. This essay will explain the appraisal process for four property types (Single Family, Condominium, Commercial Retail, and Land), comparing the data used in each approach, by comparing each approach to value as well as discuss how Uniform Standards of Professional Appraisal Practice (USPAP) standards apply to the valuation of each property type. The purpose of an appraisal is to estimate, or opinion of value based on supportable evidence and approved methods.
The licensed or certified appraiser, by reason of professional training, experience, and ethics is responsible for furnishing clients with an objective third party opinion of value, arrived at without pressures or prejudices from the parties involved with the property, such as an owner or lender. The appraiser has a heavy personal and professional responsibility to be correct and accurate in opinions of value. Otherwise, the appraiser’s clients may easily suffer loss and the appraiser’s professional reputation may also suffer.
The appraisal process has several steps to complete it correctly. These steps may seem simple in theory. The first of these steps is to state the problem. The second step is to list and collect the data from reliable sources and document those sources. The third step is to determine the “highest and best use.” The fourth step is estimating the land value (usually by sales analysis). The fifth step is deciding which approach to use for proper execution and reconciling the estimated values for a final estimate. The sixth and final step is to compile the report with the final value estimate. It is the appraiser obligation to recognize what drives prices. Every appraiser should ask themselves are they driving the price or is the market. (Allen, 2015)
There are many approaches to assist in determining the value of a property. There is the cost approached, which is used when appraising newer or unique use buildings such as public buildings, schools, and churches. You should also consider in “cost approach” is reproduction cost versus replacement cost. Reproduction cost is the current cost of a replica of the subject property, including both negative and positive features of the property.
Moreover, replacement cost is the current cost of improvements with similar utility or function to the subject property (Betts, 351). There are four steps to the cost approach. 1. Estimate the value of the land as if it was vacant. 2. Find its highest and best use 3. Estimate the current cost of constructing the building. 4. Add the estimated land value to the depreciated cost of the building(s) and site improvements to arrive at the total property value (Betts, 346).
The income approach is based on the present value of the rights to the future income, such as rent or lease. The steps in the income approach to value include estimating the annual potential gross income (income from all sources, including rent, concessions, and vending), making deductions for vacancies and rent loss to obtain the effective gross income. Deductions of annual operating expenses to obtain the annual net operating income must be taken into account. This does not include debt service (principal and interest payments or capital expenditures/capital improvements) (Bettis, 402).
The next step in the income approach is estimating the price an investor is willing to pay for the income produced by this particular class/type of property. For this step, you need to compare the annual net operating income of similar properties that recently sold. The annual net operating income is divided by the sales price, thus giving you the capitalization (“cap”) rate. The final step is applying the capitalization rate to the subject property’s annual net operating income (NOI) to obtain an estimated value (Betts, 403).
Gross rent multipliers (GRM) and gross income multipliers (GIM) are informal surrogates for income capitalization. GRM is used four residential properties that have up to four units. And, is based on the total monthly rent of newly sold (typically within the last 6mos.) comparable properties (the sales price divided by the gross monthly rent results in the gross rent multiplier) (Betts 410).
Gross income multiplier (GIM) is used for residential properties that have five or more residential unit as well as for commercial properties. It is based on the gross annual income of newly sold (typically within the last 6mos.) comparable properties (the sales price divided by the gross annual income results in the gross income multiplier). In most cases, multipliers are limited to practical use (Betts, 413)
Then they are reconciled to obtain the final value estimate. This is done by analyzing and weighing the findings from the three approaches. The three approaches will most commonly produce three different indications of value. Depending on the type of property, one approach would be given more weight than others.
The sales comparison approach is the most commonly used in residential appraisals and is the estimate of value obtained by comparing the subject property with like properties within the same neighborhood commonly referred to as “Comps.” The property under appraisal is compared with recently sold comparable properties (properties similar to the subject). However, some adjustments may be considered (Betts, 265).
The adjustments that are made are typically for minor difference between the subject property and its comparables. Often comparables may have small differences like a half bath or a larger footprint, or a pool or better curb appeal. All these things affect what someone is willing to pay for a property. i.e. if the subject property is selling for $250k and the house down the street just sold for $240k and it came with a pool, and you see a pool as a bonus you would most likely not be willing to pay more for a house that didn’t have a pool.
The condition of a sale is a driving factor, such as foreclosure, or a sale between family members, market conditions since the date of sale, changes in economic, conditions between the date of the sale of the comparable property and the date of the appraisal, location or neighborhood differences, physical features and amenities (Swago, 2014). The final step is “dollar value.” This consists of indicating each “difference” between the subject property and the comparable properties and assigning an appropriate dollar amount based on the area.
Similar Size: Compare similar-sized properties to the one you are trying to value. The market might look at larger and smaller properties differently, so if you want the proper adjustment, you’ve got to stick with comparing apples to apples so to speak.
Condition: Remember to consider upgrades and condition in your analysis. An upgraded property might sell for substantially more than a fixer. This is why properties in the most similar condition will be your best comparisons when trying to extract a reasonable adjustment for square footage.
Know the Market: Sometimes, smaller homes can sell for more than larger homes. It is easy to assume a larger home will sell for more, but at times, certain smaller models may carry a value premium for whatever reason, which causes them to sell for more. This is where knowing the neighborhood market comes in handy.
Data Sample: Use more than just one comparison to substantiate how much extra square footage is worth. More data helps build a stronger case.
The Internet has become a hub for data providers and information. Such data incorporate information on organizations, market situations and performance info such as listing prices, sold prices, rents, vacancies, property and submarket characteristics, transaction volume and terms, demographic and socioeconomic conditions in the market, broader economic indicators, portfolio characteristics, historical returns, and underlying mortgage characteristics (Betts, 496).
Because consumers want to be more informed about all things, companies like Zillow, Trulia, Realtor.com, Homes.com, Redfin, Zip Realty, and Ownerly just to name a few provide a list similar to MLS (Multiple Listing Service). This service used to be an exclusive list that was only available to industry insiders such as Real Estate Agents, Brokers, and Appraisers. However, thanks to these companies, a lot of the same information that a few were privy to is now on display for just about any consumer to see, often free of charge but can be more detailed at a nominal fee.
This could also be a big part of the problem for appraiser holding on to their integrity. Consumers take these numbers they have gathered from various sites very literal and expect the appraisals to reflect that same value. Even though the appraiser has more things to consider, then the basic information provided on these sites.
As part of the regulation of appraisal activities, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), requires appraisals performed as part of a federally related transaction be performed by a state-licensed or state-certified appraiser. Licensed or certified appraisers need not perform appraisals of residential property valued at $250,000 or less. Nonresidential properties valued at above $250,000 require a certified appraiser.
Allen, Marcus T.1, Cadena, Anjelita2, Rutherford, Jessica3, Rutherford, Ronald C.4, Effects of Real Estate Brokers’ Marketing Strategies: Public Open Houses, Broker Open Houses, Journal of Real Estate Research. 2015, Vol. 37, Issue 3, p343-369. 27p.
Bettis, R. (2013). Real Estate Appraisal. Manson, Ohio: Cengage learning
Swango D. (2014). Information, Knowledge, and Awareness: Resources for Real Estate Analysts and Valuers. Appraisal Journal (Summer,2014), [cited January 17, 2016]; 82(3): 256-258. Available from: Business Source Elite.