BASIC PRINCIPLES OF REAL ESTATE APPRAISAL APPRAISAL is a supportable or defensible estimate of value as of a particular point in time. an act or process of estimating value An estimate expressed as a single peso amount, of the scarcity and utility, i.e., economic nature, of a specific property at a specified time and place, assuming a specific use. TYPES OF APPRAISAL 1. Oral Report 2. Letter Report 3. Narrative Report 4. Form Report PURPOSES OF APPRAISAL 1. Sale or Purchase 2. Mortgage loans/Lending 3. Insurance 4. Tax Assessment 5. Eminent Dormain (Condemnation) 6. Property Disputes 7. Inheritance/Partitioning of Estate 8. Options – right to renew/ to buy 9. Urban Renewal 10. Corporate Realty – mergers, etc 11. Foreclosure Real Estate Valuation Principles • 1. Anticipation • 2. Balance • 3. Conformity • 4. Contribution • 5. Increasing & Diminishing Returns • 6. Change • 7. Consistent Use • 8. Substitution • 9. Highest and Best Use • 10. Competition • 11. Economies of Scale • 12. Supply & Demand • 13. Externalities ANTICIPATION present worth of all present and future benefits arising from ownership and use of real estate. The value of a property may increase or decrease based on a potential purchaser’s belief that some future event will benefit or detract from the value of the property. BALANCE The principle of balance also relates to land use. Under the optimum land use concept, there would be a proper blend of single- family residences, apartments, complementary shopping centers, nearby employment centers, and reasonably accessible recreational facilities. Conversely, a neighborhood that features no convenient access to shopping, places of worship, or employment would be considered inferior and result in lower demand and in lower prices. CONFORMITY • The principle of conformity is similar to the principle of balance, but it relates more to real estate characteristics. • It holds that maximum value is achieved and maintained when there is reasonable conformity and not monotonous uniformity among properties. • maximum value when it conforms to the surrounding land usage. SURPLUS PRODUCTIVITY • The surplus productivity principle recognizes the four agents of production. The four agents /factors of production are as follows : 1. Labor 2. Capital 3. Entrepreneurship 4. Land • An example of surplus productivity would be a Hotel. Income is derived from room rents, telephone charges, restaurant sales, and other departmental sources. All of the hotel labor is paid first. After that, payments due on borrowed funds are made (Capital). The entrepreneur is usually paid last. CONTRIBUTION • The principle of contribution holds that the value of a component is a function of its contribution to the whole rather than as a separate component. The cost of an item does not necessarily equal its contributory value. • Value of an improvement is equal to its contribution to the added value of the property (positive contribution). INCREASING & DIMINISHING RETURNS • The principle of increasing and decreasing returns relates to the principle of balance as well as to the principle of contribution. • This principle holds that as capital units are added, a certain point is reached where the added units do not contribute value commensurate with their costs. • Decrease in Incremental (additional) output as one factor is increased & other remained constant “Ceteris Paribus” (all else being equal). CHANGE Real estate condition, both physical and economic, do not remain constant value. Physical change may be brought by normal wear and tear Economic change may be due to (1) land classification and zoning changes (residential to commercial, agricultural to residential), and (2) tax laws changes and (3) buyers preference. It may not be noticeable on a day-to-day basis, but can be seen overtime. CHANGE • The principle of change holds that as time and market conditions change, so does supply and demand for real estate, and thus, the value of real estate. All elements around us are constantly in a state of change, and a valuation represents a photograph at a certain point in time within its constantly changing environment. a. Growth b. Stability c. Decline and d. Renewal Real estate passes through a cycle of: REAL ESTATE LIFE CYCLE • • Growth • • Stability • • Decline • • Revitalization REAL ESTATE LIFE CYCLE Growth • Growth is typically the initial stage in a neighborhood or district’s life cycle. This refers to the period in which the neighborhood or district is expending and developing. Stability • After the growth stage, an area typically matures and grows at a slower rate. The stability stage in the life cycle may occur when it is no longer profitable to build, and/or the simply or vacant land is depleted. Decline • When neighborhood can no longer compete with other comparable neighborhoods, it usually enters the decline stage of its life cycle. Improvements may become functionally inadequate and lose market appeal, and maintenance levels frequently decrease. Revitalization • After decline, a neighborhood or district sometimes shows revitalization, that is, it regains momentum or sees rebirth. Often, this occurs because of an area’s proximity to employment or other conveniences. Many fringe areas around older downtown business districts are being revitalized. In a sense, a district or neighborhood such as this re-enters the “growth” stage of the life cycle. Sometimes, a neighborhood or district may go through a long, extended growth stage, then mature and stabilize, never going through the decline or revitalization stages. Stability may dominate the life cycle for many years, with the area never declining to the point the revitalization occurs. CONSISTENT USE • Consistent use theory involves the concept that land cannot be valued under one highest and best use while the improvements are valued based on another highest and best use. o Agri land to Agri-use o Industrial land to Industrial-use…etc. SUBSTITUTION • is the process of identifying alternatives that would satisfy the same need, want, or desire. • the maximum value of a property is equal to the cost of purchasing or constructing equally desirable property. • A prudent purchaser would pay no more for a home than it would cost him or her to build or buy another one. Substitution keeps the market in balance. • equally desirable property. HIGHEST & BEST USE • is defined as that logical, legal, and most probable use which will yield the greatest net income to the land over a sustained period of time. • Each property has one best legal use that gives its greatest value. • The four standard tests for highest and best use • Each property has one use that gives its greatest value. 1. Legally Permissible 2. Financially Sustainable 3. Physically Possible 4. Socially Feasible COMPETITION • The principle of competition holds that profits tend to spur competition • The more profitable a venture may appear, the more competition will be created. In other words, success breeds competition, and extremely high success breeds excess competition. • Better Quality (Value) and a more competitive Price. • Profit attracts competition, while competition favors the consumer, too much of it will ruins profit. ECONOMICS OF SCALE • This theory, economies of scale, is based on the idea that the greater the volume of an item, the less each incremental volume should cost. • For instance, which would cost less: a single can of cola or each can in a case of colas? Probably the latter, due to the quantity discount. The same holds true for real estate. Which is more expensive per square meter or per hectare? SUPPLY & DEMAND • When demand is equal to supply, price is normal; • When demand is greater than the supply, price rises; • When supply is greater than demand, price falls. Value (Price) increases if few supply and high demand Value (Price) decreases if abundant supply and few demand Types of Real Estate Properties • Raw Land • Subdivision Lots • House and Lots • Townhouses • Condominium Units • [Industrial] Warehouses • Commercial & Office Space • Memorial Lots • Agricultural land FORCES AFFECTING VALUE • Social • Economic • Governmental • Environmental FORCES THAT INFLUENCE VALUE Real Estate value fluctuates, remains stable at times on account of certain forces within and/or outside an identified real property. The appraiser and valuer, in his research for value, analyzes and evaluates those forces to arrive at the right figure on a specific date. These forces are designated as: 1. SOCIAL – forces relate to population growth, birth control measures and migration. 2. POLITICAL – forces are government-based. The degree of efficiency in the maintenance of peace and order and the effort of providing primary services such as electricity light, water, fuel and food. Zoning and land use ordinances, anti-squatting law, rent control. 3. ECONOMIC – forces include the nature of basic industry and business activity in the neighborhood, trend of employment and workers and expansion of the housing program. 4. ENVIRONMENTAL (PHYSICAL) – forces refer to the location and age of the neighborhood: size, shape and topography of land, type of improvements and architectural trends, and street pattern, sidewalks and underground drainage. DEPRECIATION - Loss of value from any cause. 1. Physical Deterioration 2. Functional Obsolescence 3. Economic obsolescence • Physical Deterioration – reflecting loss in value brought about by wear and tear. Ex. Cracks on walls and floors, roof, skylight, balconies are affected by heat and cold climates (action of the sun, wind and moisture). Elevators, motors, cables & other equipment-due to wear & tear. These can be corrected by repairs. • Functional Obsolescence – out of date or old model. Ex. Poor architectural design & appearance, bad room arrangement, inadequate light & ventilation, under/over-improvement of site, excess construction, high ceiling, waste space. • Economic Obsolescence – when there is rapid tempo of neighborhood changes. Ex. Changes in zoning ordinances, government restrictions, changes to supply & demand with regard to land usage, decrease in population, infiltration of squatters & lower living standards, reduced buying power, when good companies or business move to another location, shifting of business center to social center. (Ex. Ballroom Dancing) CONCEPTS OF VALUE: Types of Value: Market value, leasehold value, insurable value, value in use, intrinsic value, investment value, asset value, assessed or taxable value, zonal value. Definition of Market Value – “the estimated amount for which a property should exchange on the date of valuation between a willing buyer and willing seller in an arms-length transaction, after proper marketing and both acting knowledgeably, prudently and without compulsion.” Disequilibrium – periods of rapid changes in market conditions affecting prices or values. The 3 categories for non-market valuation : 1. Benefits that an owner inherently enjoys 2. Reasonable price agreed between two specific parties only 3. Value determined by statute or contract Other types of value: 1. Special value – an amount above the market value 2. Synergistic value – additional value created by combining two or more interests 3. Going concern value – when a business is transferred as an operating entity 4. Liquidation value – value following closure; includes forced sale. 5. Salvage value – value when asset has reached the end of its economic life; for recycling.
