Valuation & Market Analysis, Summaries of Acting

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PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 1

TOPIC 6

Appraisal:

Valuation & Market Analysis

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EXAM TOPICS:

A. Appraisals

1. Purpose and use of appraisals for valuation (pp. 6 - 1~ 6 - 2)
2. General steps in appraisal process (pp. 6- 9 ~ 6- 10 ) (pp. 6-17~6-18)
3. Situations requiring appraisal by certified appraiser (pp. 6- 2 ~ 6- 3 ) B. Estimating Value (pp. 6- 3 )
4. Effect of economic principles and property characteristics (pp. 6- 3 ~ 6- 4 )
5. Sales or market comparison approach (pp. 6- 10 ~ 6- 1 2)
6. Cost approach (pp. 6- 12 ~ 6- 14 )
7. Income analysis approach (pp. 6- 14 ~ 6- 15 ) C. Competitive/Comparative Market Analysis (pp. 6 - 25 )
8. Selecting comparables (pp. 6- 25 )
9. Adjusting comparables (pp. 6-25)

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Appraisal Industry

A. Property appraisals came into question and were in part causation of unsound real estate investments surrounding the Savings and Loan Association crisis collapse. The 1989 1,000+ Savings and Loan Bank Crisis and failures were one of the most significant collapses since the 1929 Great Depression and the FSLIC (Federal Savings & Loan Insurance Corporation) paid S&L’s some $20 billion to depositors before going bankrupt. This S&L collapse contributed to the unsound home investments and questionable real property appraisals. B. Appraisal regulation was introduced by Congress via passing FIRREA, the Financial Institutions Reform Recovery and Enforcement Act of 1989 in the wake of the savings and loan crisis which also established the Resolution Trust Corporation (RTC) and closing hundreds of insolvent S&Ls funding payout insurance to depositors.

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 2 C. Appraisals performed as part of a federally related transaction must comply with state standards and must be performed by a state-certified or state-licensed appraiser. D. State appraiser licensing requirements and appraisal standards must meet minimu levels set by the Appraisal Standards Board and Appraisal Qualifications Board of the Appraisal Foundation, a national group of representatives of major appraisal and related organizations. E. Appraisal Foundation , a national group of representatives of major appraisal and related organizations.

Appraisal Industry

• The collapse of many savings and loan associations as a result of the surge into unsound investments were at least partly the consequence of questionable property appraisals.
• Congress introduced appraisal regulation by passing FIRREA in 1989.
• Appraisals performed as part of a federally related transaction must comply with state standards and must be performed by a state-certified or state-licensed appraiser.
• State appraiser licensing requirements and appraisal standards must meet minimum levels set by the Appraisal Standards Board and Appraisal Qualifications Board of the
• Appraisal Foundation , a national group of representatives of major appraisal and related organizations.

Appraisal Purpose & Use of Appraisals for Valuation

A. The collapse of many savings and loan associations as a result of the surge into unsound investments was at least partly the consequence of questionable property appraisals. B. Congress introduced appraisal regulation by passing FIRREA in 1989. C. Appraisals performed as part of a federally related transaction must comply with state standards and must be performed by a state-certified or state-licensed appraiser. D. State appraiser licensing requirements and appraisal standards must meet minimum levels set by the Appraisal Standards Board and Appraisal Qualifications Board of the Appraisal Foundation, a national group of representatives of major appraisal and related organizations.

Situations Requiring Appraisal via Certified Appraiser (Residential | General)

A. All transactions of $ 1,000,000 or more B. Non-residential and residential (other than one- to four-family) trans- actions of $250,000 or more C. Complex residential transactions of $250,000 or more

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 4 very hard to bargain on the price because of scarcity. Had it been the other way around, for example, if only 50 units were sold and there were 150 units left on the market, there will be some room for bargaining and the price may go down.

3. UTILITY: The type of use that the subject property is most suitable for, and whether or not it satisfies the needs of a certain buyer. Example: a small town known for its large retirement community has a new subdivision being built with mostly one-story Ranch homes. This design will probably prove to be popular with the majority of people in the city, because those of a retirement age may have issues with climbing too many stairs, therefore they will be able to ―utilizeǁ this type of design much better than a two-story home, especially with bedrooms located upstairs.
4. TRANSFERABILITY: The ability to sell, lease, will property to another person. The more the restrictions on the sale, lease or transfer of property, the less the value. Example: Property may be the subject of a dispute between partners, or certain action taken by a government entity such as the IRS or DEA, therefore, unless these restrictions are lifted, property will either have a lower value or no value at all.

Appraisal Definition

Real estate appraisal, property valuation or land valuation is the process of developing an opinion of value, for property (usually market value) by a state licensed appraiser. Real estate transactions often require appraisals because they occur infrequently and every property is unique (especially their condition, a key factor in valuation), unlike corporate stocks, which are traded daily and are identical. The location also plays a key role in valuation. However, since property cannot change location, it is often the upgrades or improvements to the home that can change its value. Appraisal market valuation reports form the basis for mortgage loans, settling estates and divorces, taxation, and so on. Sometimes an appraisal report is used to establish a sale price for a property.

D. Value

1. Definition - the present worth of future benefits arising from the ownership of real property. 2.Characteristics necessary for a property to have value in the real estate market include “DUST”: a.Demand—need supported by purchasing power. b. Utility—capacity to satisfy human wants and needs. c. Scarcity— finite supply. d. Transferability—transfer of ownership rights with relative ease.

E. Market value

1. Most probable price a property will bring in a competitive market, allowing for

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 5 reasonable time to find a knowledgeable purchaser. a. The buyer and seller are not under pressure to act. b. Payment is made in cash or equivalent.

2. Typical goal of an appraiser, although a property may have different values at the same time.
3. Estimated price (compare to market price, which is the actual selling price).

A. Market value and market price

1. Market value a. Most probable price a property will bring in a competitive market, allowing for reasonable time to find a knowledgeable purchaser. 1. The buyer and seller are not under pressure to act. 2. Payment is made in cash or equivalent. b. Typical goal of an appraiser, although a property may have dif- ferent values at the same time c. Estimated price (compare to market price, which is the actual selling price)
2. Market price a. Market price is the “last price the property sold for” which may be recent or serveral years in the past. b. Market price would be the same if the property was recently sold (last 6months ~1year) and is most relevant whereas properties sold 5~30 years ago would have a less relevant market price meaning, use and value. MARKET VALUE or OMV ( Open Market Valuation ) is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with open market value, fair value or fair market value, although these terms have distinct definitions in different standards, and may or may not differ in some circumstances. Search Results Open Market Value is the estimated amount that a property would exchange contracts at (sell for) between a willing buyer and a willing buyer on the date of the valuation. In the opinion of the valuer, it is the probable price which a property would be expected to achieve on the day in a open fair sale environment. Market value or OMV (Open Market Valuation) is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with open market value, fair value or fair market value, although these terms have distinct definitions in different standards, and may or may not differ in some circumstances. Market value is the most commonly used type of value in real estate appraisal in the United States because it is required for all federally regulated mortgage transactions, and because it

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 7

• Refinancing a home loan —the bank will typically use an appraisal of a home's current market value as a measure of the home value to determine refinancing terms for a mortgage.
• Estate sales —if the homeowner has died and a relative wants to purchase the property, the court will look at home value appraisal to determine a price for the sale.
• If the government wants to "buy out" a homeowner to use that land to, say, build a highway or school, the owner is typically entitled to be compensated at fair market value so that she will sell.
• Short sale —this is when a home is worth less than the owners owe on their mortgage. In this case, the owners must persuade the lender to let them sell the home for some amount that is less than the balance of the home loan they still owe. "When a bank does allow this, the bank wants to make sure that the short- selling purchase price is at least FMV for the property," says Pellegrini. Because, of course, no one likes a total loss on a home value!

FAIR MARKET VALUE DEFINITION AND USE

• The fair market value is the price an asset would sell for on the open market when certain conditions are met.
• The conditions are: the parties involved are aware of all the facts, are acting in their own interest, are free of any pressure to buy or sell, and have ample time to make the decision.
• Fair market value is different than market value and appraised value.
• Tax settings and the real estate market are two areas that commonly use fair market value.
• Insurance companies use fair market value in determining certain claim payouts.

ARM’S LENGTH TRANSACTION: A transaction that occurs in a competitive market that

leads to a fair sale involving a willing buyer and seller, both acting with knowledge of the property under no duress and with no other intervening factors such as selling to a relative or friend. An arm's length transaction, also known as the arm's length principle (ALP), indicates a transaction between two independent parties in which both parties are acting in their own self-interest. ... In contract law, from the opposing party, and are acting in their own self- interest to attain the most beneficial deal.

• The parties involved in an arm's length sale usually have no pre-existing relationship with each other.
• These types of deals in real estate help ensure that properties are priced at their fair market value.

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 8

• Deals between family members or companies with related shareholders are not considered arm's length transactions.

Types of Appraisals (Broker | Agents and Appraisers)

A. Appraisal —an opinion of value; a detailed estimate of a property’s value by a professional appraiser. B. Competitive/Comparable market analysis (CMA)— used by the broker or the salesperson to help the seller determine a listing price for the property; basically, a comparison of prices of recently sold and currently for sale properties that are similar in location, style, and amenities to the property of the listing seller. CMA will generally estimate market value as likely to fall within a range of figures. CMAs can also guide a purchaser in formulating an offer. C. Broker Price Opinion (BPO)— similar to a CMA but different in that it is usually more detailed because it is used by a third party (e.g., a relocation company) to provide a basis for negotiation of a purchase price or a buyout in the case of a company employee being transferred to another city. The BPO is generally more detailed because the third party knows very little about the neighborhood in which the property is located. Real estate brokers are paid to complete BPOs.

CMA – Comparable or Competitive Market Analysis - A comparative market analysis

is an examination of the prices at which similar properties in the same area recently sold. Real estate agents perform a comparative market analysis for their clients to help them determine a price to list when selling a home or a price to offer when buying a home. Since no two properties are identical, agents make adjustments for the differences between the sold properties and the one that is about to be purchased or listed to determine a fair offer or sale price. Essentially, a comparative market analysis is a less-sophisticated version of a formal, professional appraisal. BPO – Broker Price Opinion - + When doing a BPO, the real estate pro researches the ‘subject property,’ they take pictures of it, they also scope out the neighborhood as well as pull 6 comparable properties (3 Active Comps and 3 Sold Comps) in their MLS (Multiple Listing Service). They then take all of this information, the pictures they took of the subject and their knowledge of the local real estate market and they input it into a BPO form. The final BPO is used to support their professional opinion that will help determine the potential selling price[1] or estimated value[2] of a real estate property.

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 10 approach ", the " cost approach ", and the " income capitalization approach ". In the process of buying or selling a home, you may hear some strange and vaguely familiar terms. One of these terms is the “real estate appraisal report.” This is a written report that estimates the current fair market value of the property that you are buying or selling. What Information Determines the Report? The price given in the appraisal is determined by several factors:

• Recent sales of similar properties in the area
• Current condition of the property
• The neighborhood and its impact on future value These terms are just vague enough to be difficult for many buyers and sellers to understand. Recent Sales An appraiser will review the records of nearby properties sold from the last few weeks or months to find three or four that are similar in size, style and layout. The selling prices of those homes will help determine the value of the home being appraised. Many buyers and sellers want to know how recently the comparable homes were sold, and what is defined as “within the same area.” The parameters vary between homes in a metropolitan area and in a rural community. In a larger city, the appraiser could find similar homes that sold in the last month and within one mile of the home that is for sale. In a small town or rural community, that appraiser may have to consider sales over several months or widen the perimeter to encompass the entire town or several miles. Current Condition An appraiser must evaluate the current condition of the selling property to determine its value. He or she will inspect the home for any health and safety issues. Any violations or risks will be noted in the final report. These may include old wiring, a lack of railing along stairs and many other conditions. In addition, the appraiser will evaluate the overall design of the home. Is it comparable to others in the neighborhood or is it above or below them? A home that needs serious updating will have a lower appraisal value than one that has recently been renovated. The Neighborhood The surrounding neighborhood also plays a part in the appraisal. The appraiser must determine the current state of the neighborhood and where it is headed in the future. For instance, a home in a new or up-and-coming subdivision will have a higher value today, because it is expected to increase in the future. On the other hand, a home in a tired-looking neighborhood that is declining instead of growing doesn’t have the same potential for value.

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 11

SALES COMPARISON APPROACH METHOD

The " SALES COMPARISON " real estate appraisal approach is more typically performed on residential type properties. This approach compares the price per unit area of similar properties in the surrounding area. The price variations are generally averaged to create a fair market value for the property being appraised. This type of real estate appraisal is considered to be the most accurate appraisal as it utilizes recent market values on comparable properties. B. Market/data approach (sales comparison or direct sales)

1. A value estimate is obtained by comparing the subject property with recent sales of comparable properties through adjustment of sales prices of comparables. Comparable properties used in an analysis should be “arm’s length” or a normal market transaction involving willing buyers and willing sellers, as opposed to a foreclosure sale, an auction, or a sale to a relative.
2. Four areas of adjustment: a. Date of sale b. Location c. Physical characteristics d. Terms of the sale
3. The adjustment process involves three basic steps: a. Adjust the price of the comparable for any difference between the comparable and the subject property (the property being appraised). With your dollar adjustments remember to always mirror your subject property. b. C.B.S. - Comparable better subtract from the comparable the difference between the comparable and the subject property. c. S.B.A. - Subject better add to the comparable the difference between the comparable and the subject property.
4. Considered the most reliable of the three approaches in appraising residential property.

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SALES OR MARKET COMPARISON APPROACH A. Also known as THE MARKET DATA APPROACH B. Most suitable for PRE-OCCUPIED HOUSES AND VACANT LAND. C. Value is estimated by using other comparable property that has been recently sold in the same general area. If the sold comparable has a superior feature in comparison to the subject property, then it is adjusted downwards, but if it has an inferior feature then it is adjusted upwards. D. Appraiser gives emphasis to normal inflation, age of improvements, square footage, any good or bad features such as a garage, basement, bathrooms, fireplace, cracked foundation, evidence of termite infestation, etc.

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 13 a. Physical deterioration (wear, tear, poor maintenance)—may be curable b. or incurable. c. Functional obsolescence —may be curable or incurable (outdated d. items, poor design). e. External obsolescence (economic, environmental, or locational)—loss f. of value due to factors outside the property: is always incurable. g. Most reliable approach for special-purpose buildings such as churches h. and schools. Most suitable for new property and property with little or no comparables, such as a museum, library, school, etc. In this method, the appraiser takes the following steps to appraise the property: A. Land is appraised without the building, using the market comparison approach. B. The cost of reconstructing the building as a new unit is estimated. C. The value of the land is then added to the value of the building. D. REPRODUCTION COST - Is the cost to reproduce an exact duplicate of the same building using current materials and methods to produce a functional equivalent of the subject property. E. REPLACEMENT COST - The cost of replacing a building with another that functions in a similar way but not a duplicate. This method is more suitable for appraising older structures since it may not be possible to find discontinued building material that would be used at the present time such as asbestos insulation or plumbing fixtures of a certain type. F. DEFERRED MAINTENANCE - Existing maintenance and repair requirements that were due but put off. G. ACCRUED DEPRECIATION - The amount of depreciation that has occurred between the time the improvement was built and the effective date of the appraisal. F. ECONOMIC LIFE - Is the period of time during which the structure is expected to remain useful in its original function. This period is essential to calculating accrued depreciation.

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 14

METHODS OF DEPRECIATION (FOR MAN-MADE IMPROVEMENTS)

1. PHYSICAL DETERIORATION: Ordinary wear-and-tear such as roof leaks, problem with plumbing, electrical wiring, basement cracks, etc.
2. FUNCTIONAL OBSOLESCENCE: Outdated design and layout inadequacy, property may have served its purpose in the past but does not meet modern requirements such as commercial building that lacks parking, 4-bedroom house with one bathroom, etc.
3. EXTERNAL (economic, environmental) OBSOLESCENCE : Loss of value due to changes in society and the surrounding area such as presence of crime in neighborhood, pollution from factories, noise from airport, high unemployment, etc. CURABLE OBSOLESCENCE: Can be corrected. Example, a house with no garage may have a large enough lot to add a two-car garage. INCURABLE OBSOLESCENCE: Cannot be or not economically feasible to be corrected or modified. External obsolescence is considered to be the hardest to cure.

INCOME ANALYSIS APPROACH METHOD

CAPITALIZATION METHOD (BROKER ONLY)

The " income capitalization approach " to real estate is primarily used for commercial properties and to a lesser extent industrial, mixed properties and is based on the expectation of future benefits. This appraisal method type utilizes models to predict the behavior of market participants, in particular with regard to income-producing commercial

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 16 B. CAPITALIZATION (CAP) RATE: The rate of return an investor would receive on investment. Example (1): What is the NOI if the gross rent for the year was $55,000 and the following expenses were considered: Taxes: $4000/year, Insurance: $3000/year, Utilities: 500/month? Answer: UTILITIES: $500 X 12 = $6000/YEAR $55000 - $4000 - $3000 - $6000 = $42,000 NOI Example (2): An investor is looking at a rate of return of 12% annually on his/her investment. The property has a gross income of $26,000/yr. with estimated expenses of 40% of gross/yr. How much should this investor pay for this property? Answer: NOI = $26,000 - 40% = $15, $15,600 ÷ 12% = $130, Example (3): In the previous example, if the appraiser estimates that the Cap Rate in that market should be 10%, what would the value? Answer: $15,600 ÷ 10% = $156, Example (4): in the previous example, if the appraiser estimates the Cap Rate to be 8%, what would the value be? Answer: $15,600 ÷ 8% = $195, APPRAISAL PROCESS A systematic procedure enables an appraiser to collect, organize and analyze the necessary data to produce an appraisal report.

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 17

Steps in the Appraisal Process

Purpose. The first step in the process is to define the appraisal problem and the purpose of the appraisal. This involves

• identifying the subject property by legal description
• specifying the interest to be appraised
• specifying the purpose of the appraisal, for example, to identify market value for a purchase, identify rental levels, or establish a value as collateral for a loan
• specifying the date for which the appraisal is valid
• identifying the type of value to be estimated Data Collection. The second step is to collect, organize and analyze relevant data about the subject property. Information relevant to the property includes notes and drawings from physical inspection of the subject, public tax and title records, and reproduction costs. Relevant information about the market includes environmental, demographic, and economic reports concerning the neighborhood, community, and region. Highest and best use. The third step is to analyze market conditions to identify the most profitable use for the subject property. This use may or may not be the existing use. Land value. The fourth step is to estimate the land value of the subject. An appraiser does this by comparing the subject site, but not its buildings, with similar sites in the area, and making adjustments for significant differences. Three approaches. The fifth step is to apply the three basic approaches to value to the subject: the sales comparison approach, the cost approach, and the income capitalization approach. Using multiple methods serves to guard against errors and to set a range of values for the final estimate. Reconciliation. The sixth step is to reconcile the value estimates produced by the three approaches to value into a final value estimate. To do this, an appraiser must:
• weigh the appropriateness of a particular approach to the type of property being appraised
• take into account the quality and quantity of data obtained in each method Summary Report. The final step is to present the estimate of value in the format requested by the client. Types of Appraisers There are three (3) types of real property appraisers which are Provisional, Residential and General Appraiser. Provisional Appraiser is an apprentice and must work directly under supervision of the Residential or General Appraiser. This type of appraiser has only a four(4) year term and

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 19

Typical Terms and definitions:

Market Price is the last price the real property has sold for which could be several years. When a real property has recently sold, the Market Price and the Selling price are the same. When a property is for sale, the Market Price is the price the property last sold for. When the property sells, the Selling Price is the recent sales price and at that time matches the Market price. Selling Price is the price that a real property as most recently sold for. This term refers more exclusively the recent sale price of the real property. The previous sale price (generally 2- 40 years) is the Market Price. Asking Price is the price that a seller wishes to sell the real property for. This often differs from the actual ‘list price’ that is found on the listing, MLS ( Multiple Listing Service ) or fair open market listed price. The seller in many cases has a more sentimental and higher value opinion and this sometimes is referred to as the ‘ dream price’. List Price is the price of a real property for sale set by the seller and licensed real estate listing agent. The List Price is the agreed price between what the seller and CMA (comparative/comparable market analysis) price provides. Comparative Market Analysis is an examination of the prices at which similar properties in the same area recently sold. Real estate agents perform a comparative/comparable market analysis for their clients (signed to listing agreement) to help them determine a price to list when selling a home or a price to offer when buying a home. Selling Price is the price that a real property as most recently sold for. This term refers more exclusively the recent sale price of the real property. The previous sale price (generally 2- 40 years) is the Market Price.

PSI Real Estate License Prep Study Notes 2020 - Steve Fuller INSTRUCTOR TOPIC 6- 20

TYPES OF VALUE

The purpose of an appraisal influences an estimate of the value of a parcel of real estate. This is because there are different types of value related to different appraisal purposes. Some of the possibilities are listed below.

Types of Real Estate Value

• • market
• reproduction
• replacement
• salvage
• plottage
• assessed
• condemned
• reversionary
• appraised
  • rental
  • leasehold
  • insured
  • reversionary
  • appraised
  • rental
  • leasehold
  • insured
  • book value Market value. Market value is an estimate of the price at which a property will sell at a particular time. This type of value is the one generally sought in appraisals and used in brokers' estimates of value. Reproduction value. Reproduction value is the value based on the cost of constructing a precise duplicate of the subject property's improvements, assuming current construction costs. Replacement value. Replacement value is the value based on the cost of constructing a functional equivalent of the subject property's improvements, assuming current construction costs. Salvage value. Salvage value refers to the nominal value of a property that has reached the end of its economic life. Salvage value is also an estimate of the price at which a structure will sell if it is dismantled and moved. Plottage value. Plottage value is an estimate of the value that the process of assemblage adds to the combined values of the assembled properties. This concept presupposes that two typc Assessed value. Assessed value is the value of a property as estimated by a taxing authority as the basis for ad valorem taxation. Condemned value. Condemned value is the value set by a county or municipal authority for a property which may be taken by eminent domain. Depreciated value is a value established by subtracting accumulated depreciation from the purchase price of a property. Reversionary value. Reversionary value is the estimated selling price of a property at some time in the future. This value is used most commonly in a pro-forma investment analysis where, at the end of a holding period, the property is sold and the investor's capital reverts to the investor.