Chapter 10
Valuation Fundamentals
Market Value:
The most probable price which a property should
bring in a competitive and open market under all
conditions requisite to a fair sale, the buyer and
seller each acting prudently and knowledgeably,
and assuming the price is not affected by undue
stimulus.
Implicit in this definition:
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buyer and seller are typically motivated;
both parties are well-informed or well-advised,
and acting in what they consider their best
interests;
a reasonable time is allowed for exposure in the
open market;
payment is made in terms of cash in United States
dollars or in terms of financial arrangements
comparable thereto; and
the price represents the normal consideration for
the property sold unaffected by special or
creative financing or sales concessions granted
by anyone associated with the sale.
What is Value:
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Market Value
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Motivated Parties
Informed Parties
Market Exposure
Payment in Cash
No Special
Circumstances
Investment Value
Price vs. Market Value
 Market Value vs. Cost
of Production
 Other Types of Value
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Assessed Value
Insurable Value
The Appraisal Process:
 Physical/Legal identification
 ID property rights being valued
 Purpose of Appraisal
 Date of value estimate
 Gather/analyze data
 Apply techniques to establish value
 Reconcile estimates to find final value
estimate of subject
APPRAISAL
COST APPROACH
Replacement - Depreciation + Land = Estimate of Value Cost
 Physical (Wear and Tear) ---- Curable/Incurable
 Functional (Design, etc.) ---- Curable/Incurable
 External (Location)
INCOME APPROACH
Income = Estimate of Value
Rate
Sales Comparison Approach
Sales Price (Comparables) +/- Adjustments = Est. of Value
or
Gross Income Multipliers (GIM) = Sales Price/Gross Income
Cost Approach:
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Many techniques can be used in conjunction with
the cost approach to value. The technique chosen
to estimate replacement (or reproduction) value
will generally depend on (1)the age of the
structure being valued, (2)whether the structure
is highly specialized in design or function, (3)the
availability of data to be used for cost estimating.
Generally if a project is in the proposal stage, cost
data will be developed by an appraiser or
estimator. Cost estimation services are available
for appraisers from the Marshall and Swift
company and the Boeckh Division of the American
Appraisal Company.
Sales Comparison Approach:
 Estimating value by the direct sales
comparison approach is accomplished
 by comparing sales of similar properties
with the subject by using either a price per
physical unit basis or income ratios.
Typical units of comparison on a physical
unit basis include:
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price per square foot of gross building area
price per square foot of net building area
price per unit (apartments, miniwarehouses,
hotels, healthcare)
price per seat (restaurants and theaters)
Elements of Comparison:
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On identification and calculation of the appropriate unit
of comparison, each is compared to the subject
property and adjusted for differences. Potentially the
typical adjustment could be for one or more of the
following elements of comparison :
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Ownership interest
Nonmarket financing (cash equivalency)
Conditions of sale (buyer and seller motivation)
Change in market conditions (sometimes referred to as
time)
Locational characteristics
Physical characteristics
Economic characteristics
Use
Nonrealty components of value
 The important consideration for an appraiser
is to properly identify the units of comparison
used for the different property types in the
marketplace and to calculate the unit value
correctly for the comparable property.
Without accurate information, the direct sales
comparison approach is difficult to use. The
common units of comparison on an income
unit basis include:
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potential gross income multiplier (PGIM) (value
divided by potential gross income)
effective gross income multiplier (EGIM) (value
divided by effective gross income)
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The multipliers represent relationships between
various levels of income and the sales price of a
comparable property. Once the factors are
properly extracted from each sale, they are
compared with the subject and an appropriate
multiplier is selected to estimate the value of the
subject property. Differences in factors for
comparable properties may be caused by one or
more of the following:
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differences in ownership interests
noncash equivalent sales prices
excess land
possible differences in lease terms, market condition
and expense treatment in leases
differences in occupancy levels
Income Capitalization:
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There is a relationship between income and
value. In appraisal, the term capitalization refers
to the conversion of income into an estimate of
value. Because the income capitalization
approach does involve estimates of income,
utilizing the approach relies heavily on the
operating statement that must be developed for
any property being appraised. Items excluded in
developing net operating income include:
Federal or State income taxes, interest expense,
mortgage payments, and depreciation.
R = NOI1 , and V = NOI
V
R
“CAP RATES”: Capitalization Rates
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The capitalization rate is the ratio of first-year NOI to
property value.
NOI / Property Value = Cap. Rate
The Cap. Rate is the rate at which future income is
converted into present value. This technique is
referred to as capitalizing income, and is used to
value income generating real estate.
Value = NOI / Cap. Rate
The Cap. Rate implicitly reflects the projected future
NOI. If Future NOI estimates are expected to be lower,
the price paid for the property will be lower, and the
cap rate for that property will be higher, which
reflects less investor optimism.
Discounted Cash Flow (DCF) Valuation Approach:
Cash Flows from operations (NOI’s) and resale are
forecasted into the future. These cash flows are then
discounted to reflect the requires rate of return on
similar properties. The result is a Present Value that
reflects the estimated value of the property.
V = CF1 + CF2 + . . . . . CFn
(1+R) (1+R)2
(1+R)n
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Separating Property Value into
Mortgage and Equity Interest
Value of Property =
Present Value of NOI
Value of Mortgage =
Value of Equity =
Present Value of Payment
Present Value of NOI-Payment
NOI
NOI represents cash available from operations to
pay suppliers of capital - lenders and investors.
NOI - Debt Service = BTCF
 The value of a property at any given point in time
is equal to the present value of the expected NOI
over the economic life of the property.
 The value of the equity investor’s ownership
position is equal to the difference between the
value of the entire property and the value of the
loan.
Property Value = Value of Debt + Value of Equity
and
Equity = Property Value - Debt
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