Basic Appraisal Principles
PC100GRCHN
about the appraisal institute
T
he Appraisal Institute is the nation’s largest professional association of real estate appraisers.
Its mission is to advance professionalism and ethics, global standards, methodologies, and
practices through the professional development of property economics worldwide. Organized
in 1932, the Appraisal Institute advocates equal opportunity and nondiscrimination in the
appraisal profession and conducts its activities in accordance with applicable federal, state
and local laws. Individuals of the Appraisal Institute benefit from an array of professional
education and advocacy programs, and may hold the prestigious MAI, SRPA, SRA,
AI-GRS and AI-RRS designations. Learn more at www.appraisalinstitute.org.
For Educational Purposes Only
The materials presented in this course represent the opinions and views of the developers and/or reviewers. Although these materials
may have been reviewed, the American Society of Appraisers, and the American Society of Farm Managers and Rural Appraisers, the
views and opinions expressed herein are not endorsed or approved by these organizations as policy unless adopted by the Board of
Directors of the organizations pursuant to the Bylaws of the organizations. While substantial care has been taken to provide accurate
and current data and information, the Appraisal Institute, the American Society of Appraisers, and the American Society of Farm
Managers and Rural Appraisers do not warrant the accuracy or timeliness of the data and information contained herein. Further, any
principles and conclusions presented in this course are subject to court decisions and to local, state, and federal laws and regulations
and any revisions of such laws and regulations.
This course is presented for educational and informational purposes only with the understanding that the Appraisal Institute, the
American Society of Appraisers, and the American Society of Farm Managers and Rural Appraisers are not engaged in rendering legal,
accounting, or any other professional advice or services. Nothing in these materials is to be construed as the offering of such advice
or services. If expert advice or services are required, readers are responsible for obtaining such advice or services from appropriate
professionals.
Nondiscrimination Policy
The Appraisal Institute, the American Society of Appraisers, and the American Society of Farm Managers and Rural Appraisers advocate
equal opportunity and nondiscrimination in the appraisal profession and conduct their activities in accordance with applicable federal,
state, and local laws.
Copyright © 2004, 2009, minor updates 2022, Appraisal Institute, American Society of Appraisers, American Society of Farm
Managers and Rural Appraisers. All rights reserved. No part of this publication may be reproduced, modified, rewritten, or distributed,
electronically or by any other means, without the express written permission of the Appraisal Institute, the American Society of
Appraisers, and the American Society of Farm Managers and Rural Appraisers.
HIGHER
DID YOU KNOW THE APPRAISAL INSTITUTE PROVIDES MORE
THAN QUALITY EDUCATION TO THE VALUATION PROFESSION?
The Appraisal Institute…
XX Develops peer-reviewed continuing and qualifying education taught by practicing appraisers
and offered across the U.S., internationally, and online.
XX Is the leading publisher of more than 70 world-renowned valuation books, used by valuation
professionals and universities in the U.S. and abroad.
XX Offers 24/7 access to its world-class research library—the Y.T. & Louise Lee Lum Library.
XX Maintains the strongest presence of any valuation organization in Washington, DC, and
state capitals.
XX Publishes The Appraisal Journal, Valuation magazine, and Appraiser News Online.
XX Sponsors annual education and leadership development conferences.
XX Provides local, national, and international networking and volunteer opportunities through
its chapters and national organization.
XX Offers highly respected designations in commercial, residential, and review (MAI, SRA,
AI-GRS, AI-RRS), which are recognized as marks of excellence in the field of real estate
valuation and analysis.
XX Has led the valuation profession in its quest to provide knowledge, experience, and integrity
to the valuation profession for more than 85 years.
When looking for valuation education, you have choices. The Appraisal Institute offers an extensive body of appraisal
knowledge PLUS business connections, networking opportunities, exclusive discounts, indispensable research and
resources, complimentary subscriptions, and much more.
Our Mission
www.appraisalinstitute.org/ai-affiliation
Our mission is to advance professionalism and
ethics, global standards, methodologies, and
practices through the professional development
of property economics worldwide.
Our History
The Appraisal Institute was established when the American Institute of Real Estate Appraisers (AIREA) and
the Society of Real Estate Appraisers (Society) unified in January 1991. AIREA and the Society, founded
in 1932 and 1935, respectively, were created to help standardize the appraisal process by promoting
professional education and upholding high ethical standards.
1932 AIREA is formed as an affiliate of the National Association of
Realtors. The Appraisal Journal is launched. The Metro New
Jersey Chapter becomes the first chartered chapter.
1935
The U.S. Building and Loan League sponsors the Society,
which establishes appraisal guidelines and standards. After
completing education and experience requirements, the first
SRA designation is conferred.
1945
The MAI designation program is introduced (AIREA’s MAI
designation dates back to the 1930s)
1951
The first edition of The Appraisal of Real Estate is published.
1961
The Society opens a Washington, DC, office to
establish a voice among the leaders of Congress and the
federal government.
1969
The Society initiates the Young Advisory Council (YAC),
a series of roundtable discussions on topics of interest to
appraisers and analysts, now known as LDAC.
1981
The Appraisal of Real Estate is translated and published
in German. 14 additional international editions have been
published since then.
1987
AIREA and the Society are founding sponsors
of The Appraisal Foundation, which is established
to work with the government to create a selfregulatory system.
1989
Congress passes the Financial Institutions Reform, Recovery and
Enforcement Act (FIRREA), which establishes state appraisal
certification/licensing for federally related transactions.
1992
The Y. T. and Louise Lee Lum Library
is established.
2000
The Appraisal Institute introduces
Appraiser News Online (ANO).
1991
AIREA and the Society formally merge into the
Appraisal Institute.
1996
The first quarterly issue of Valuation Insights & Perspectives
(now Valuation) is introduced.
2003
The first MAI designations are conferred upon
Korean appraisers.
2014
The Appraisal Institute begins issuing two review
designations: the AI-GRS and AI-RRS.
With more than 85 years of history, the Appraisal Institute continues to serve as the nation’s largest
professional organization of real estate appraisers. Through its designation programs, educational offerings,
advocacy efforts and publishing endeavors, the Appraisal Institute maintains its leadership position within
the real estate industry and continues to be a leader in the global valuation profession.
200 W. Madison, Suite 1500, Chicago, IL 60606
888-7JOINAI (756-4624) | https://www.appraisalinstitute.org
The Appraiser Qualifications Board (AQB) has reviewed and approved
Basic Appraisal Principles
30-hours Qualifying Education (QE)
30-hours Continuing Education/Education (CE/E)
28-hours Continuing Education (CE)
Classroom version
Basic Appraisal Principles
Topics
Hours
Real Property Concepts & Characteristics
ƒ
ƒ
ƒ
1.25
Real Property Characteristics
1.75
Legal Description
1.25
1.00
Public and Private Controls
1.25
Real Estate Contracts
1.00
Leases
0.50
Valuation Bias, Fair Housing, and/or Equal Opportunity
Types of Value
ƒ
ƒ
0.25
0.25
1.50
Other Value Types
1.25
0.25
Classical Economic Principles
1.50
Application and Illustrations of the Economic Principles
8.50
Overview of Real Estate Markets and Analysis
ƒ
1.25
Market Value
Economic Principles
ƒ
ƒ
0.25
Forms of Ownership
Influences on Real Estate Values
ƒ
0.25
Basic Real Property Concepts
Legal Considerations
ƒ
ƒ
ƒ
ƒ
30 hours
Market Fundamentals, Characteristics and Definitions
1.25
1.25
Ethics and How They Apply in Appraisal Theory and Practice
2.25
Examination
2.00
The content of this course has been approved under the Course Approval Program of the Appraiser
Qualifications Board (AQB) of The Appraisal Foundation. Qualifying and Continuing Education were
both approved through April 10, 2024.
The Course Approval Program is a voluntary national system for the approval of courses of
instruction that satisfy the education criteria established by the AQB for licensure and certification
of real estate appraisers pursuant to Title XI of the Financial Institutions Reform, Recovery and
Enforcement Act (FIRREA).
All states require students to provide proof of education. Students must track their education on
a matrix. The above breakdown of hours has been fulfilled for the Basic Appraisal Principles core
curriculum subtopic.
Acknowledgments
The following contributors deserve recognition for their efforts in developing this material:
Course developer:
Craig M. Harrington, SRA, AI-RRS
Development team:
Margaret A. Hambleton, SRA
Ron D. DeVries, MAI, SRA
Joseph C. Magdziarz, MAI, SRA, AI-GRS, AI-RRS
Scott Seely, ARA, MAI
David Lewis, ASA, SR/WA
Reviewer:
Dawn M. Molitor-Gennrich, SRA, AI-RRS
The following Education Resources staff of the Appraisal Institute also contributed to
the completion of these materials: Sue Siradas, Director, Education Resources; Anne
Calek, Senior Manager, Classroom Education; Dawn Martin, Managing Editor, Classroom
& Technology-Based Education; Linda Willet, Editor; Classroom & Technology-Based
Education; Jeanie Yu, Senior Production Specialist, Classroom Education; Michael Brooks,
Production Specialist, Classroom Education; Mallory Whaley, Education Development
Coordinator; and Kristine Cesario-Price, Senior Classroom Education Specialist.
Contributions were also made by Nancy Hardiman, Director of Education, Certification and
Strategic Alliances, American Society of Farm Managers and Rural Appraisers; and Patrick
Christoff, Director of Education, American Society of Appraisers.
Unless otherwise noted, all graphic artwork was created by Craig Harrington, the
course developer.
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
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Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Table of Contents
Overview.................................................................................................................. ix
Course Schedule....................................................................................................xiii
SECTION 1
Introduction
What Is an Appraiser?..................................................................................... 1
Appraisal Practice............................................................................................ 1
The Valuation Process..................................................................................... 3
Career Perspective.......................................................................................... 5
Career Planning............................................................................................... 5
Part 1. The Appraiser and Public Trust
Preview Part 1................................................................................................. 7
Ethical and Competent Practice........................................................................ 9
Exercising Sufficient Diligence........................................................................ 13
Problem Identification and Scope of Work........................................................ 14
Review Part 1................................................................................................ 17
Review Quiz.................................................................................................. 18
Part 2. The Nature of Real Estate
Preview Part 2............................................................................................... 19
Land Basics.................................................................................................. 21
Fundamental Land Rights............................................................................... 22
Real Estate, Personal Property, and Real Property............................................ 26
Review Part 2................................................................................................ 31
Review Quiz.................................................................................................. 32
Part 3. Rights and Interests in Real Estate
Preview Part 3���������������������������������������������������������������������������������������������� 33
Estates in Land............................................................................................. 35
Encumbrances.............................................................................................. 41
Review Part 3................................................................................................ 47
Practice Test Section 1.................................................................................. 49
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SECTION 2
Part 4. Legal Description of Real Estate
Preview Part 4............................................................................................... 53
Metes and Bounds........................................................................................ 55
Rectangular (Government) Survey System....................................................... 57
Lot and Block System.................................................................................... 62
Other Methods for Legal Description............................................................... 64
Review Part 4................................................................................................ 65
Review Quiz.................................................................................................. 66
Part 5. Forms of Property Ownership
Preview Part 5............................................................................................... 67
Introduction.................................................................................................. 69
Ownership in Severalty................................................................................... 69
Co-Ownership................................................................................................ 71
Trusts........................................................................................................... 74
Condominiums, Cooperatives, and Timeshares................................................ 76
Planned Unit Developments (PUDs)................................................................ 79
Review Part 5................................................................................................ 81
Review Quiz.................................................................................................. 82
Part 6. Controls on Ownership
Preview Part 6............................................................................................... 83
Four Government Controls on Ownership......................................................... 85
Lien Encumbrances....................................................................................... 93
Review Part 6................................................................................................ 99
Practice Test Section 2................................................................................ 101
SECTION 3
Part 7. Contracts, Leases, and Deeds
Preview Part 7............................................................................................. 105
Contract Fundamentals................................................................................ 107
Types of Contracts....................................................................................... 109
Leases....................................................................................................... 115
Deeds........................................................................................................ 117
Review Part 7.............................................................................................. 121
Review Quiz................................................................................................ 122
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Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Part 8. The Nature of Value
Preview Part 8............................................................................................. 123
Overview of Cost, Price, and Value................................................................ 125
Four Factors of Value................................................................................... 128
Types of Value............................................................................................. 130
Review Part 8.............................................................................................. 133
Review Quiz................................................................................................ 134
Part 9. Market Value
Preview Part 9............................................................................................. 135
Market Value Fundamentals......................................................................... 137
Market Value in Appraisal Practice................................................................ 145
Review Part 9.............................................................................................. 147
Practice Test Section 3................................................................................ 149
SECTION 4
Part 10. Influences on Real Estate Values
Preview Part 10........................................................................................... 153
Factors of Production................................................................................... 155
Four Forces that Influence Value................................................................... 156
Review Part 10............................................................................................ 163
Review Quiz................................................................................................ 164
Part 11. Economic Principles
Preview Part 11........................................................................................... 165
Economic Principles in Real Estate............................................................... 167
Introduction to the Concept of Highest and Best Use..................................... 176
Review Part 11............................................................................................ 179
Review Quiz................................................................................................ 181
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Part 12. Applied Economics in Real Estate
Preview Part 12........................................................................................... 183
12.1 Problem.............................................................................................. 185
12.2 Problem.............................................................................................. 186
12.3 Problem.............................................................................................. 187
12.4 Problem.............................................................................................. 187
12.5 Problem.............................................................................................. 188
12.6 Problem.............................................................................................. 189
12.7 Problem.............................................................................................. 190
Review Part 12............................................................................................ 191
Practice Test Section 4................................................................................ 193
SECTION 5
Part 13. Market Fundamentals
Preview Part 13........................................................................................... 197
Market Competition..................................................................................... 200
Money Markets, Capital Markets, and Real Estate Markets............................. 202
Monetary and Fiscal Policy........................................................................... 206
Sources of Capital for Real Estate................................................................ 209
Review Part 13............................................................................................ 211
Review Quiz................................................................................................ 213
Part 14. Real Estate Math Basics
Preview Part 14........................................................................................... 215
Math as an Appraisal Tool............................................................................ 217
Solving Basic Appraisal Problems................................................................. 218
Review Part 14............................................................................................ 223
Review Quiz................................................................................................ 224
Part 15. Math Applications in Real Estate
Preview Part 15........................................................................................... 227
Percentage Problems .................................................................................. 229
Tax Rate Calculations.................................................................................. 233
Mortgage Calculations................................................................................. 236
Floor Area Ratio and Land-to-Building Ratio.................................................... 239
Review Part 15............................................................................................ 243
Practice Test Section 5................................................................................ 245
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Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
SECTION 6
Part 16. Measurement and Statistics
Preview Part 16........................................................................................... 249
Measurement Basics................................................................................... 251
Statistical Concepts for Appraisers............................................................... 256
Review Part 16............................................................................................ 261
Review Quiz................................................................................................ 262
Part 17. Introduction to Financial Calculations
Preview Part 17........................................................................................... 265
Getting Started........................................................................................... 267
Financial Calculations.................................................................................. 269
Review Part 17............................................................................................ 275
Review Quiz................................................................................................ 276
Part 18. Time Value of Money Concepts
Preview Part 18........................................................................................... 277
Understanding Cash Flow............................................................................. 279
Time Value of Money................................................................................... 284
Review Part 18............................................................................................ 295
Practice Test Section 6................................................................................ 299
SECTION 7
Part 19. Analyzing Market Areas
Preview Part 19........................................................................................... 301
Understanding Market Areas........................................................................ 303
Characteristics of Market Areas.................................................................... 305
Value Influences on Market Areas................................................................. 308
District Types.............................................................................................. 311
Review Part 19............................................................................................ 315
Review Quiz................................................................................................ 316
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Part 20. The Nature of Appraisals
Preview Part 20........................................................................................... 317
Valuation Services and Appraisal Practice..................................................... 319
Scope of Work............................................................................................. 322
Review Part 20............................................................................................ 327
Review Quiz................................................................................................ 328
Part 21. Appraisal Principles in Practice
Preview Part 21........................................................................................... 329
Problem Solving.......................................................................................... 331
Problems for Scope of Work Decisions.......................................................... 333
Review Part 21............................................................................................ 341
Practice Test Section 7................................................................................ 343
SECTION 8
Part 22. Exam Content Review
Preparing for the Exam................................................................................. 347
Content Covered in the Course..................................................................... 348
Appendix
Part 1......................................................................................................... 349
Part 2......................................................................................................... 351
Part 3......................................................................................................... 353
Part 4......................................................................................................... 355
Part 14....................................................................................................... 357
Part 15....................................................................................................... 359
Part 17....................................................................................................... 361
Residential Green and Energy-Efficient Addendum
Commercial Green and Energy-Efficient Addendum
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Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Overview
Course Description
Basic Appraisal Principles is designed as an introductory course for individuals preparing
for a career as a valuation professional. The course provides the first 30 hours of
qualifying prelicensure education, which is commonly required by states for individuals
seeking appraisal licensure.
The course uses experienced instructors to guide participants through introductory
economic concepts. Participants learn the basic appraisal principles that can be used
to build a solid foundation for an ethical and competent appraisal practice. Concepts
such as highest and best use, the time value of money, and the nature of value are
explored through instructor-led discussion. Real-world type problems are introduced to aid
participants in developing their problem-solving skills.
Learning Enhancements
The course has been designed with a variety of elements to enhance your learning experience.
ƒ Preview. To give you a taste of what is to come, you will find a preview page that
begins each part. Included on the preview page is a brief overview of the content,
learning objectives to consider as you move through the content, and learning tips
that will assist you in understanding the information you’re about to learn.
ƒ Learning Objectives. Each learning objective covers essential information you
need to know to fully understand the concepts in the course. Look them over
before the part begins so that you have a frame of reference as you move through
the material. At the end of each part, reread the objectives. Are you able to do
what is stated? If not, this is the time to ask your instructor for help. Or, review
the concepts that you do not understand.
ƒ Examples & Problems. Supplementing the discussions, we’ve included examples
and problems to help you visualize and practice what you are learning.
ƒ Fill-in-the-Blanks. It is a proven fact that when you write something down, you
are more apt to remember it. The course handbook has “missing” content in the
outline that you will need to add in the space provided in your handbook as the
instructor goes over the content.
Basic Appraisal Principles
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ƒ
Review. Each part concludes with a review. Included in the review are the learning
objectives and key terms and concepts that have been covered. Also, we’ve
provided recommended readings from textbooks that will reinforce what you have
learned in class.
ƒ
Review Quizzes and Section Practice Tests. Short quizzes are included at the end
of some parts, and practice tests are included at the end of each section in the
review. The questions are similar to the types of questions you might find on the
exam. By answering the true/false questions, fill-in-the-blanks, or multiple-choice
questions, etc., you will find out whether or not you really know the information
that was covered in that part. The review quizzes and practice tests are intended
for self-study, and answers are found in the solutions booklet.
ƒ
Digging Deeper. Digging Deeper information goes beyond the scope of the
course and is not intended to be covered in class. It is not tested on the course
exam; however, appraisers preparing for the comprehensive exam should be
familiar with it, as well as all other material contained in the course handbook,
whether or not it is presented in class.
Classroom Guidelines
To make the classroom environment a positive experience for everyone attending, please
follow these guidelines:
ƒ 100% attendance is required. No exceptions.
ƒ Limit use of laptops to classroom projects.
ƒ Communicate with business associates during break time instead of class time.
ƒ Put away reading materials such as newspapers and books that are not used
in class.
ƒ Silence cell phones.
ƒ Use recording devices only if prior permission has been granted.
ƒ Refrain from ongoing conversations with those seated near you and other
distracting behavior.
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Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
General Information
ƒ Calculators. A financial calculator is required. The accepted model used in the
course is the HP 12C.
ƒ No class time will be used to cover the operation of other calculators.
For additional help, go to the “Using a Financial Calculator” section of the
Appraisal Institute’s website:
https://www.appraisalinstitute.org/education/education-resources/using-afinancial-calculator/
Important Note. Laptops, cellular phones, tablets, iPads, wearable technology
(smart watch, Apple Watch, Google Glass, etc.) and other devices that can store
data or connect to the Internet are NOT permitted during the exam. In addition,
all watches, wallets, bags, and purses must be removed and stored out of reach
prior to taking the exam.
ƒ Breaks. There will be two 10-minute breaks during each half-day session unless
noted otherwise by the course sponsor. The lunch break is one hour.
ƒ Attendance sheets will be distributed during class to verify your attendance during
each session.
ƒ Certificates of completion will may be downloaded after completion of the course,
and attendance during the entire course is required.
USPAP References in This Handbook
All references to the Uniform Standards of Professional Appraisal Practice (USPAP) are
taken from the 2020-2021 edition (Washington, D.C.: The Appraisal Foundation).
Recommended Texts
ƒ The Appraisal of Real Estate, 15th ed.
ƒ The Dictionary of Real Estate Appraisal, 7th ed.
Basic Appraisal Principles
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Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Schedule
Course Schedule
SECTION 1
Introduction
Registration
Classroom Rules and Procedures
Introduction
Part 1. The Appraiser and Public Trust
Ethical and Competent Practice
Exercising Sufficient Diligence
Problem Identification and Scope of Work
Questions and Review
Break
Part 2. The Nature of Real Estate
Land Basics
Fundamental Land Rights
Real Estate, Personal Property, and Real Property
Questions and Review
Break
Part 3. Rights and Interests in Real Estate
Estates in Land
Encumbrances
Questions and Review—Self-Study Practice Test (Section 1)
Lunch
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SECTION 2
Part 4. Legal Description of Real Estate
Metes and Bounds
Rectangular (Government) Survey System
Lot and Block System
Other Methods for Legal Description
Questions and Review
Break
Part 5. Forms of Property Ownership
Introduction
Ownership in Severalty
Co-ownership
Trusts
Condominiums, Cooperatives, and Timeshares
Planned Unit Developments (PUDs)
Questions and Review
Break
Part 6. Controls on Ownership
Four Government Controls on Ownership
Lien Encumbrances
Questions and Review—Self-Study Practice Test (Section 2)
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Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
SECTION 3
Part 7. Contracts, Leases, and Deeds
Contract Fundamentals
Types of Contracts
Leases
Deeds
Questions and Review
Break
Part 8. The Nature of Value
Overview of Cost, Price, and Value
Four Factors of Value
Types of Value
Questions and Review
Break
Part 9. Market Value
Market Value Fundamentals
Market Value in Appraisal Practice
Questions and Review—Self-Study Practice Test (Section 3)
Lunch
SECTION 4
Part 10. Influences on Real Estate Values
Factors of Production
Four Forces that Influence Value
Questions and Review
Break
Part 11. Economic Principles
Economic Principles in Real Estate
Introduction to the Concept of Highest and Best Use
Questions and Review
Break
Part 12. Applied Economics in Real Estate
Practice Problems
Questions and Review—Self-Study Practice Test (Section 4)
Basic Appraisal Principles
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SECTION 5
Part 13. Market Fundamentals
13.1 and 13.2 Dilemmas
Market Competition
Money Markets, Capital Markets, and Real Estate Markets
Monetary and Fiscal Policy
Sources of Capital for Real Estate
Questions and Review
Break
Part 14. Real Estate Math Basics
Math as an Appraisal Tool
Solving Basic Appraisal Problems
Questions and Review
Break
Part 15. Math Applications in Real Estate
Percentage Problems in Practice
Tax Rate Calculations
Mortgage Calculations
Floor Area Ratio and Land to Building Ratio
Questions and Review—Self-Study Practice Test (Section 5)
Lunch
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Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
SECTION 6
Part 16. Measurement and Statistics
Measurement Basics
Statistical Concepts for Appraisers
Questions and Review
Break
Part 17. Introduction to Financial Calculations
Getting Started
Financial Calculations
Questions and Review
Break
Part 18. Time Value of Money Concepts
Understanding Cash Flow
Time Value of Money
Questions and Review—Self-Study Practice Test (Section 6)
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SECTION 7
Part 19. Analyzing Market Areas
Review of Financial Problems and Practice Test
Understanding Market Areas
Characteristics of Market Areas
Value Influences on Market Areas
District Types
Questions and Review
Break
Part 20. The Nature of Appraisals
Valuation Services and Appraisal Practice
Scope of Work
Questions and Review
Break
Part 21. Appraisal Principles in Practice
Problem Solving
Problems for Scope of Work Decisions
Questions and Review—Self-Study Practice Test (Section 7)
Lunch
SECTION 8
Part 22. Exam Content Review
Instructor’s Course Review—Preparing for the Exam
Participant’s Course Review—Self-Study
Break
Instructions
Exam
Exam
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Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Section 1
1
Introduction
Part 1. The Appraiser and Public Trust
Part 2. The Nature of Real Estate
Part 3. Rights and Interests in Real Estate
Introduction
I.
What is an Appraiser?
Later in the course, we’ll formally define the term appraiser, but we want your
thoughts for now. Use the space below to write down some of your ideas.
Instructor note: The blank lines are for participant notes, and there is
no preset answer to this question.
Suggestion: The class discussion can address the important concept
that appraisers provide independent, impartial, and objective value opinions.
An appraiser’s opinion can involve all types of real property and can also
include personal property and intangible business assets.
II. Appraisal Practice
A. Appraisal practice is a valuation service performed by an individual acting as an
appraiser.
B. Professional services that come under appraisal practice include
1. Appraisal
2. Appraisal review
3. Other services while acting as an appraiser
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Introduction – 1
C. What is an appraisal?
1. An appraisal is “the act or process of developing an opinion of value; an
opinion of value.” (USPAP, Definitions)1
2. An appraiser can provide the client with an opinion of value on real property,
personal property, or intangible business assets.
3. Appraisals are commonly used in the following types of assignments:
a. Transfer of ownership
An appraisal
ƒ
Aids buyers and sellers in their decision-making process. It states
an opinion of value.
ƒ
Is used as a starting point in negotiations involving real property
exchanges.
ƒ
Can facilitate negotiations in the reorganization or consolidation of
ownership involving multiple properties.
b. Financing and credit
Appraisals provide
ƒ
Essential information for borrowers and creditors working through
mortgage loan processing.
ƒ
Guidance to financial investors considering the purchase of real
estate mortgages or other mortgage-backed securities.
c. Litigation
Appraisals are used
1.
ƒ
By the courts to establish just compensation (that is, monetary
award) in eminent domain proceedings (for example, when private
property is taken for public use).
ƒ
In cases that involve contract disputes and the dissolution of a
marriage or a business partnership holding real estate.
Also see the Standards of Valuation Practice (SVP), Chicago: Appraisal Institute, 2020.
Introduction – 2
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
ƒ
In lawsuits where expert testimony is required to identify damages
resulting from a diminution in property value. These can include
construction defects and property contamination issues.
ƒ
To assist clients in bankruptcy and/or foreclosure proceedings.
d. Tax matters
Appraisals are used
ƒ
In property tax assessment work.
ƒ
To establish a basis for depreciation.
ƒ
To determine gift or inheritance taxes.
e. Investment decisions
Appraisals are used to
ƒ
Establish a basis (or a starting point) for setting rent schedules
and lease provisions.
ƒ
Aid in determining the feasibility of proposed construction or a
renovation program.
ƒ
Serve specific needs for insurance companies and policyholders in
regard to damage claims.
ƒ
Determine value for corporations and third parties to purchase
homes of transferred employees.
ƒ
Facilitate corporate mergers, issuance of stock, or the revision of
book value.
ƒ
Analyze market supply and demand trends.
The lists under each assignment type indicate some, but not all, of the ways
appraisals can be used by clients to solve their valuation problems.
III. The Valuation Process
The valuation process is a systematic procedure that an appraiser employs to provide
the answer to a client’s question about the value of real property. The next course in
this series, Basic Appraisal Procedures, is dedicated to addressing the eight steps in
the valuation process, which are shown in the diagram on the next page.
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Introduction – 3
The Valuation Process
Identification of the Problem
Identify the
client and
intended users
Identify
the intended
use
Identify the type
and definition
of value
Identify the
effective date
of the opinion
Identify the relevant
characteristics of
the property
Identify any
assignment
conditions
Scope of Work Determination
Data Collection and Property Description
Market Area Data
Subject Property Data
Comparable Property Data
General characteristics
of region, city, and
neighborhood
Subject characteristics of
land use and improvements,
personal property,
business assets, etc.
Sales, listings, offers,
vacancies, cost and depreciation,
income and expenses,
capitalization rates, etc.
Data Analysis
Market Analysis
Highest and Best Use Analysis
Demand studies
Supply studies
Marketability studies
Land as though vacant
Ideal improvement
Property as improved
Land Value Opinion
Application of the Approaches to Value
Sales comparison approach
Income capitalization approach
Cost approach
Reconciliation of Value Indications and Final Opinion of Value
Report of Defined Value
Source: The Appraisal of Real Estate, 15th ed., Chapter 4, P. 31.
Introduction – 4
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IV. Career Perspective
If you were to picture your career as a high-rise building with each floor representing one
year of experience, what kind of foundation would you need to support 30 stories?
Career pinnacle
Enhanced skill sets
Experience
Knowledge
Education
Competent practice
Ethical principles
V. Career Planning
Think long range while planning your career. Participants are often surprised by the
breadth of information they must assimilate just to attain the first level license from
their state. That’s only the starting point. Begin seeing your career in five- and 10-year
increments, and you won’t get overwhelmed. Developing competency is a career-long
process, and today is simply the point where you begin.
We’re going to take you on a journey of learning unlike anything you’ve experienced
before. You will need to study hard, but take time to enjoy this experience. There’s no
need to be anxious. This course and the others that follow will cover the essential
content you need to prepare for appraisal licensure. But we also want to prepare you
for something more—your career in appraisal practice.
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Introduction – 5
Introduction – 6
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Preview
Part 1
The Appraiser and Public Trust
We begin Part 1 with a disquieting glimpse of what can happen when appraisers lose
track of their ethical boundaries. The result of such behavior is that public trust in
appraisal practice is damaged, and sometimes the entire appraisal profession suffers
due to the actions of a few. We will look at three fundamental areas that define the
boundaries for appraisers to perform ethically and competently in their appraisal
assignments.
Learning Objectives
To prepare for Part 1, read the following learning objectives, and refer to them as you
study this part of the handbook.
† Recognize components of ethical appraisal practice.
† Recognize components of competent appraisal practice.
† Recognize components of sufficient diligence in appraisal practice.
† Identify six assignment elements in the problem identification process.
† Define scope of work.
Learning Tips
The essential terms are found in the review section at the end of Part 1. You will see
many of these terms again in a course that specifically covers appraisal standards and
ethics. This course provides an overview of ethical practice. What you learn here will help
you digest the material in the standards and ethics course, which comes later in this
introductory series. Don’t be too concerned if all the concepts don’t tie together right
away. Many of these concepts will be reviewed and amplified in Part 20 of this course.
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Part 1 – 7
Self-study tip. Each day after class concludes, we encourage you to thoroughly review
the day’s contents. The course handbook contains much more information than can be
covered by the instructor during the classroom sessions. In some instances, you will
find additional background information or examples in the appendix that will assist you
in understanding specific concepts and principles. While the instructor might highlight a
particular issue, the course handbook often provides additional definitions and details on
that same topic. By carefully reviewing the day’s contents in the course handbook after
each class (such as during an evening study time), you will be building the foundation for
the content you will learn the next day.
Solutions booklet. Your course materials include a booklet that contains solutions to the
review quizzes and practice tests. The booklet provides additional examples to round out
your review of specific topics addressed in the course handbook.
Please use the solutions booklet for its intended purpose. The quizzes, practice tests,
and problems provided in the course handbook will help you to comprehend and review
content necessary to pass the final exam. It is in your best interest to check solutions
only after you have challenged the questions. The review quizzes and practice tests are
intended as aids in your personal study time.
Digging Deeper
Throughout the course, you will notice content that is designated with a book and pencil
graphic. You’ll see it for the first time in Part 3. Treat this material as a resource tool. In
some cases, we wanted to provide additional terms related to the topic. However, you will
not be tested on these additional terms.
In some parts of the course, you may find a problem or quiz question that is labeled
as Digging Deeper. That means the question is more advanced, and you’re welcome to
challenge it, but don’t get discouraged if you can’t solve it. Answers and solutions to
problems are provided in the solutions booklet.
End Digging Deeper
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Part 1.
The Appraiser and Public Trust
I.
Ethical and Competent Practice
A. Contemporary perspective
The following are actual newspaper headlines describing the fate of two
separate appraisers:
“Appraiser Gets Two Years in Prison for Role in Flipping Ring”
“Appraiser Sentenced in Federal Flipping Investigation”
Illegal property flipping is a mortgage scam used to deceive banks. The scheme often involves
properties in fair condition purchased at a low price and then quickly resold at an inflated price to a
naive buyer. To carry out the scam, a licensed appraiser is used (often as an unwitting participant)
to provide an appraisal that supports a fraudulent sale contract.
1. An appraiser begins a career with hope and aspirations to succeed as a
valuation professional. This hope includes a genuine desire to be ethical in
appraisal services. To maintain integrity, an appraiser needs to be alert to
unethical practices that might lead to illegal or criminal acts.
2. A short history lesson. Corrupt practices are not isolated to the appraisal
profession. For example, the accounting profession was thrown into a crisis
when the unethical practices of a large accounting firm were exposed in
connection to work it performed for an energy-trading company. Here are some
thoughts to keep in mind.
a. The accounting firm in question was a respected international company.
b. Only a small group of accountants engaged in unethical behavior or
criminal acts.
c. The unethical activities of a small group resulted in significant damage to
the public’s perception of the company and the accounting profession.
3. In order to preserve public trust, appraisers must carry out their professional
services in a manner that maintains a high level of ethical and competent
practice. In the pages that follow, we will look at the components of appraisal
practice that will foster public trust and help you avoid actions that are unethical.
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Part 1 – 9
B. Ethical appraisal practice
1. Appraisers have an obligation to protect public trust as they perform
valuation services for their clients.
2. Appraisers must develop and communicate their work in a manner that is
meaningful and does not misrepresent their services to intended users.
3. When an individual is acting in the role of an appraiser, he or she must
perform assignments ethically and competently. The appraiser must not
engage in criminal behavior and must perform the assignments by being
a. Impartial or neutral;
b. Objective or fair-minded;
c. Independent or autonomous; and
d. Free of self-interest
1.1 Dilemma
Two parties involved in a real property valuation dispute are seeking to hire one
appraiser to help resolve the matter.
Is it ethical for an appraiser to perform this type of assignment when the parties have
conflicting interests?
Instructor guidance: An appraiser does not “represent” or advocate a
client’s position. Since an appraiser is impartial and independent, it is ethical
to perform a valuation service for both parties in this dispute assuming
they agree to abide by the results.
4. An appraiser must not influence or promote the goal of any person or group.
An appraiser must defend his or her opinions and conclusions and must
perform assignments with impartiality with respect to any party or cause.
Part 1 – 10
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1.2 Dilemma
I completed an appraisal assignment for a bank last week with a $250,000 value
conclusion. The bank called today and said they need another $5,000 to put the deal
together; otherwise, they won’t pay me. That’s a 2% difference, and I guess it’s not
worth arguing about. This is my sole client, and I can’t afford to lose the business.
What should I do?
What advice do you have for this appraiser?
Instructor guidance: Changing the appraisal would favor the cause of the
client and alter the impartial and objective nature of the appraiser-client
relationship.
C. Competent appraisal practice
1.3 Discussion Question. In the Real World
An appraiser discovers during the course of the assignment that he
lacks the required knowledge and experience to complete the
assignment competently.
What should the appraiser do?
Instructions: Before attempting to answer this question, read the content on the next
page of the handbook and then discuss the issues with those seated at your table area.
Instructor guidance: Inform the client and satisfy the competency issue or
withdraw from the assignment. The appraiser’s obligation to address competency
applies even if the issue is discovered during the course of the assignment due
to previously unknown facts or conditions.
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Part 1 – 11
1. When a client engages an appraiser, the individual must
a. Be proficient to complete the assigned work; or
b. Attain the needed proficiency to complete the work competently; or
c. Turn down the engagement or stop the assignment if already underway
Note: Secondary mortgage market guidelines (Fannie Mae/Freddie Mac)
and FHA require appraisers to have requisite knowledge and experience in
the property type prior to accepting the assignment. This guideline exceeds
appraisal standards.
2. Being competent requires that an appraiser assess his or her own proficiency
to complete the job competently before accepting an assignment. Thus
competency requires
a. Being able to correctly identify the problem to be solved; and
b. Having the training, information, and work experience to complete the
assigned work in a competent manner; and
c. Being aware of and observing laws, regulations, and requirements relating
to the appraiser or the assigned work
Competence. The state of having the requisite or adequate ability
or qualities to perform the specific assignment and produce credible
assignment results.2
3. Competency may apply to a number of factors that connect with an
appraiser’s familiarity with
a. A property type and the interest to be appraised
b. A market and the market’s participants
c. A geographic location
d. An intended use
e. Laws, regulations, and client requirements that may apply
f.
2.
Analytical methods and procedures
Unless otherwise noted, all definitions that are not italicized are course-specific definitions.
Part 1 – 12
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4. Before being engaged, an appraiser must determine his or her own competency
to undertake the work. If not competent, the appraiser has three obligations.
a. Inform the client about the identified competency issues prior to taking
the assignment, which may include insufficient knowledge and/or
experience.
b. Complete all tasks and procedures essential for the assignment in a
competent manner. Competency can be fulfilled in various ways, such as
personal study, association with another appraiser, or retaining others who
possess the required knowledge, skills, and/or experience.
In regards to geographic competency, an appraiser working in an
unfamiliar location must acquire an understanding of the market and
property type to ensure credible assignment results. Thus the appraiser
must spend sufficient time to understand the nuances of the local market
or work with (or retain) someone who has expertise in the locality.
c. Disclose competency issues in the written report and identify the steps
taken to satisfy the appraiser’s lack of knowledge and/or experience in
that particular assignment.
5. When an appraiser is working on an existing assignment and determines
he or she cannot complete the assignment competently, the appraiser must
cease work and inform the client of that determination.
II. Exercising Sufficient Diligence
A. An appraiser must be sufficiently diligent and exercise due care while performing
valuation services for clients to ensure the assignment results are credible.
Standard A of the Standards of Valuation Practice is similar to Standards Rules
1-1 (a-c) in USPAP, which provides the following information:
In developing an appraisal, a valuer must:
1. be aware of and understand methods and techniques that are necessary to
produce credible assignment results (SR A-1(a))
2. not commit a substantial error of omission or commission that significantly
affects the assignment results (SR A-1(b))
3. not make a series of errors that, considered individually, may not significantly
affect the assignment results but which, when considered in the aggregate,
establish that the appraisal is being rendered in a careless or negligent
manner (SR A-1(c))
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Part 1 – 13
B. The Competency Rule in USPAP requires an appraiser to use due diligence and
due care, which does not require perfection and is impossible to attain. However,
an appraiser must not render appraisal services in a careless or negligent
manner.
C. It is the appraiser who makes the decision on how to solve a particular valuation
problem for a client. Thus the appraiser must be prepared to demonstrate that the
type and extent of research and analyses performed in the appraisal is sufficient
to produce credible assignment results.
III. Problem Identification and Scope of Work
Clients retain appraisers to solve valuation problems. The first step in the valuation
process is identification of the problem. The second step is to determine the scope of
work for the assignment. Going back to the first step, the appraiser must identify six
assignment elements, so let’s take a closer look at them (a definition of “assignment
elements” is provided in USPAP).
A. Identification of the problem
1. Client3 and any other intended users
2. Intended use
3. Type and definition of value (also known as the purpose of the assignment)
4. Effective date of the valuer’s opinions and conclusions
5. Subject of the assignment and its relevant characteristics
6. Assignment conditions
B. What is scope of work?
Scope of work. 1. “The type and extent of research and analyses in an
appraisal or appraisal review assignment.” (USPAP, DEFINITIONS)
2. The type of data and the extent of research and analyses. (SVP,
Definitions section)
1. Once the appraiser has properly identified the problem to be solved, the next
step is to decide upon an acceptable scope of work.
3.
USPAP defines “client” as “the party or parties (i.e., individual, group, or entity) who engage an appraiser by
employment or contract in a specific assignment, whether directly or through an agent.
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2. The valuer must determine the scope of work necessary to develop an
appraisal that is credible given its intended use (SVP, SR A-3).
3. The appraiser must disclose the scope of work in the appraisal report and it
must be appropriate for the intended use.
4. The scope of work decision is an exercise in judgment the appraiser
undertakes in the process to solve the client’s problem.
C. Issues such as what constitutes an acceptable scope of work are addressed in
the national course on standards and ethics.
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Part 1 – 15
Part 1 – 16
Basic Appraisal Principles
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Review
Part 1
Learning Objectives
Now that you’ve completed Part 1, you should be able to
; Recognize components of ethical appraisal practice.
; Recognize components of competent appraisal practice.
; Recognize components of sufficient diligence in appraisal practice.
; Identify six assignment elements in the problem identification process.
; Define scope of work.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 1, pp. 1–3, and Appendix A, pp. 1–9.
Terms and Concepts to Remember
Appraiser
Ethical appraisal practice
Scope of work
Competency
Identification of the problem
Sufficient diligence
Competent appraisal
practice
Public trust
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Part 1 – 17
Review Quiz
Fill in the missing content for the following questions.
1.
Appraisers must develop and communicate their work in a manner that is
meaningful and that does not misrepresent their services to intended users.
2.
An appraiser must not advocate the cause or interest of any
3.
At what point must an appraiser be competent regarding an appraisal
assignment? At completion of the assignment .
4.
The appraiser must be prepared to demonstrate that the type and extent of
research and analyses performed in the appraisal is sufficient to produce
credible assignment results.
5.
An appraiser performing an assignment in an unfamiliar geographic location must
spend sufficient time to understand the nuances of the local market.
party or issue .
Check the appropriate box for each question.
6.
A series of errors in an appraisal is acceptable as long as
it does not significantly affect the value conclusion.
7.
An appraiser must inform a client prior to accepting the
assignment if he or she lacks the requisite training,
information, and/or work experience to complete the
assignment competently.
8.
A fee arrangement contingent on an appraiser’s value
conclusion will help the appraiser to maintain impartiality
and independence.
9.
In an assignment that involves a dispute between two parties,
it is the appraiser’s duty to represent his client’s position.
TRUE
FALSE
10. The unethical practices of a few can sometimes damage
public trust for an entire profession.
Review quizzes and practice tests are intended to be taken during your personal study
time. Suggested answers are found in the solutions booklet.
Part 1 – 18
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Preview
Part 2
The Nature of Real Estate
Part 2 introduces the fundamental concepts of land and the rights people have in land.
Real estate and real property are definitely connected to each other, but these terms
also have distinctive differences. The focus is to identify the terms used to describe real
estate and learn why it is important for appraisers to distinguish among the various ways
we look at real estate.
Learning Objectives
To prepare for Part 2, read the following learning objectives and refer to them as you
study this part of the handbook.
† Recognize the distinctive differences among land, real property, real estate, and
personal property.
† Identify significant characteristics of land.
† Identify three major divisions of land rights: air, surface, and subsurface.
† Identify five major rights in the real estate bundle of rights.
Learning Tips
Your instructor will introduce many new terms—most of which will be foreign to you. The
list in the review section of Part 2 contains the essential terms and concepts. That doesn’t
mean that other terms mentioned by your instructor or found in the handbook aren’t
important. We’ve simply prioritized the ones that you should concentrate on for now.
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Part 2 – 19
Part 2 – 20
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Part 2.
The Nature of Real Estate
Now that you’re excited about starting your career on a solid ethical foundation, it brings
to mind another kind of foundation called terra firma. Appraisers call it land, or perhaps
we should call it real estate … or is it real property?
I.
Land Basics
A. People refer to land, real estate, and real property as if they are the same. In one
way, they are right. These three terms offer different perspectives on how we view
the same economic concept, yet these terms have distinct meanings. Moreover,
there is a fourth term called personal property that adds to the confusion.
2.1 Example—Real Estate or Personal Property––In the Real World
A group of property owners located near an international airport filed a
class-action lawsuit against the airport’s management alleging loss in
property value attributed to air traffic noise.
In the subsequent trial, a lawyer for the owners tried to illustrate the loss
in property value by arguing that if the owners’ properties were relocated to
a comparable location far away from the air traffic noise, the values would
be higher. While we can appreciate the lawyer’s argument, the flaw is that
real estate is inseparable from its location. Once real estate is moved, it is
no longer real estate; it becomes personal property.
B. Land characteristics
1. Land is immobile, and each parcel is unique in its location and composition.
2. Land is durable as a long-term asset, but the supply of land is finite.
3. Land is not only an economic concept but also a valued commodity to people.
C. Land defined
Land. In law, the solid surface on the earth, as distinguished from water.4
4.
Unless otherwise noted, all definitions in italics are taken from The Dictionary of Real Estate Appraisal, 7th ed.
Chicago: Appraisal Institute, 2021.
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Part 2 – 21
II. Fundamental Land Rights
Certain rights accompany land such as air rights, water rights, mineral rights, and oil
and gas rights. These land rights together with all the other rights in real property
(comprehensively known as the bundle of rights) are the interests that appraisers
analyze and evaluate. For now, we’ll focus on fundamental land rights.
A. The inverted pyramid
Land theory suggests that ownership in land includes complete possession from
the center of the earth to the ends of the universe. Of course, in real practice,
land ownership has limitations due to governmental controls.
1. Suprasurface rights
2. Surface rights
3. Subsurface rights
B. Air rights (suprasurface rights)
Air rights. The right to undisturbed use and control of designated air space
above a specific land area within stated elevations.
1. Right to construct buildings in the air space over the land
2. Right to control view/solar access
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3. Right to lease or sell these rights
4. Limitations to air rights
a. Congress enacted laws in the 1920s and 1930s that gave the federal
government complete control over the nation’s airspace.
b. A landowner still has the right to use the airspace above the property as
long as that use does not interfere with air traffic.
5. A landowner can seek damages if a public or private party uses the airspace
over the property in a manner that is detrimental to, or interferes with, the
landowner’s rights.
C. Surface rights
1. Rights include land, water, and anything attached to the land—either naturally
or placed by human hands.
2. Water rights
a.
Riparian rights
These are rights pertaining to properties
touching a body of water or a waterway such as a river or stream
(generally interpreted as flowing waters) with an emphasis on the benefit
and useful purpose to which the flowing water may be applied.
b.
Littoral rights
These are rights pertaining to properties
abutting an ocean, lake, or pond (generally interpreted as nonflowing
waters) with an emphasis on the use and enjoyment of the shore (the
area between high and low water levels).
c. Landowners with water rights generally have an unrestricted right to use
the water that adjoins their property. However, they cannot interrupt or
divert the flow of water (or contaminate it). Riparian and littoral owners
cannot impair the rights of other riparian or littoral landowners. This often
involves agricultural issues of farming and irrigation.
d. Riparian and littoral rights are appurtenant (that is, attached) to the land
and cannot be retained by the seller after the property is sold.
e. Prior appropriation water rights. This system of allocating water rights is
different from riparian and littoral rights. Water law in the western United
States generally follows the appropriation doctrine (sometimes referred to
as the Colorado Doctrine), which came about due to the scarcity of water
in that area of the country. This water right can be summed up as “first in
time is first in line,” and the rights are unconnected to land ownership.
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Part 2 – 23
D. Subsurface rights
1. Rights to the use and profits of the underground portion of a designated property.
2. Right to extract coal, minerals, oil, gas, and water.
3. Right to construct and maintain tunnels, subways, sewers, and basements.
4. Solid mineral rights
a. Minerals are part of the real estate until they are extracted from the
earth. Once removed, the minerals become personal property.
b. A landowner may sell mineral rights separately from the land.
c. Some states have reserved the mineral rights within a property at the time
of the original conveyance (that is, when the land was initially platted).
5. Oil and gas rights
a. A landowner has the right to drill for oil or gas.
ƒ
The landowner owns the oil or gas produced from wells on the
property but not until the oil or gas is brought to the surface.
ƒ
Questions can arise regarding ownership because oil and gas are
not solid and can flow to the point where the underground reservoir
is tapped by the landowner’s well.
b. Oil and gas becomes personal property once it is brought to the surface.
c. Landowners often don’t have the required equipment or skills for oil and
gas drilling. Therefore, they might enter into lease agreements with oil or
gas companies to extract oil or gas under their land.
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E. Land rights in perspective
Land plays a critical role in many disciplines, including law, economics, sociology,
and geography. Each of these disciplines views land from its unique perspective.
1. Governmental and legal
a. Under a free market economy, land use is regulated within a framework
of laws.
b. The law does not focus on the physical characteristics of land but on the
rights and obligations associated with various interests in land.
c. The law recognizes the potential conflict between private ownership and
public use.
2. Economic
a. Land is a major source of wealth, which can be measured monetarily.
b. The economic concept of land incorporates modern value theory.
3. Social
a. Land is a resource that all individuals share.
ƒ
Environmental preservation concerns
ƒ
Historic preservation concerns
ƒ
Private development versus public interest concerns
b. Land is a marketable commodity.
4. Environmental and geographic
a. Land has diverse physical characteristics.
b. Land can be used for multiple purposes.
ƒ
Agriculture
ƒ
Industry
ƒ
Commerce
ƒ
Habitation
ƒ
Recreation
ƒ
Open space
c. Decisions on land use are influenced by geographic considerations.
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Part 2 – 25
III. Real Estate, Personal Property, and Real Property
Knowledge Preview. Choose real estate, personal property or real property for 1–6.
1.
Schaefer owns land with a grove of trees
that are prized for their wood. The trees
would be classified as
Real estate 2.
Schaefer cuts down several of the trees
and stacks the wood on his land.
Personal property 3.
Schaefer sends the wood to a
woodworker to be made into cabinets.
The finished cabinets are delivered and
placed in Schaefer’s house.
Personal property 4.
Schaefer secures the cabinets to a wall in
the family room of the house.
Real estate 5.
Years later, Schaefer remodels the home
and removes the cabinets and places
them in the attached garage.
Personal property Schaefer’s marriage falls apart, and a
judge orders that Schaefer’s spouse
receive one-half the wholesale timber
value of the tree grove. The interest in the
tree grove represents
Real property 6.
A. Real estate
1. Real estate is land (physical raw land) and all things that are a natural part of
the land such as trees and minerals.
2. Real estate includes appurtenances.
All real estate improvements were once personal property; when attached to
the land, they become real estate.
Appurtenance. Something added or appended to a property that then
becomes an inherent part of the property; … usually passes with the
property when title is transferred.
Part 2 – 26
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B. Personal property
Personal property. “Any tangible or intangible article that is subject
to ownership and not classified as real property, including identifiable
tangible or intangible objects that are considered by the general public
as being ‘personal,’ such as furnishings, artwork, antiques, gems and
jewelry, collectibles, machinery and equipment; and intangible property
that is created and stored electronically such as plans for installation art,
choreography, emails, or designs for digital tokens.” (USPAP, Definitions).
1. In the broader sense, personal property is a legal interest in anything (tangible
and intangible) that is subject to ownership and not classified as real estate.
2. Tangible, moveable items of property not permanently affixed to, or part of,
the real estate. Personal property is also known as chattel and personalty.
a. Furniture and furnishings not built into the structure such as freestanding
refrigerators, artwork, collectibles, machinery, and equipment.
b. Items such as bookshelves and window treatments installed by a tenant
that under specific lease terms may be removed at the termination of the
lease. These are also known as trade fixtures (see the next page).
c. Leased solar photovoltaic systems and power purchase agreements are
often attached to the rooftop but do not have the continuity of ownership.
The solar photovoltaic system remains in the name of the leasing
company, and the lease identifies the system as personal property.
3. Intangible items of personal property developed and stored electronically.
ƒ
Created plans for installation art, choreography, emails, or designs of
digital tokens.
4. Personal property is not endowed with the rights of real property ownership.
5. Sometimes there is confusion about whether manufactured housing is
real estate or personal property due in part to its former identification with
mobile homes (and mobile home parks). Dwellings that are not affixed to a
permanent foundation are generally treated as personal property.
6. Trees and cultivated crops
a. Perennial plantings such as trees, shrubbery, and grasses that do not
require annual cultivation are considered real estate.
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Part 2 – 27
b. Annual crops and plantings such as corn, wheat, and vegetables are
known as emblements and are personal property.
ƒ
In a land sale, the issue of emblements is typically addressed
in the land purchase contract to avoid confusion regarding
harvesting rights.
ƒ
Generally, crops planted by a tenant farmer are treated as
emblements.
C. Fixtures
A fixture is an appurtenance (that is, treated as real estate) when permanently
attached to a property. However, some fixtures can be easily removed without
damaging the property and are treated as personal property. These differences
can cause disputes about whether a fixture is real estate or personal property.
Fixture. An article that was once personal property but has since been
installed or attached to the land or building in a rather permanent manner so
that it is regarded in law as part of the real estate.
1. Intent is a primary factor in determining whether an item is a fixture. In a
residence, fixtures might include plumbing, lighting, or a built-in dishwasher.
2. Tests of fixtures
Attachment (or annexation)
The manner (permanence) in which the item is affixed
Adaptation
Character of the item (for example, custom-made) and its adjustment (or modification) to the real estate
Agreement
The intention of the party who attached the item
3. Trade fixtures may be subject to laws and customs of the area but generally
a. Trade fixtures are articles placed in or attached to rented buildings by a
tenant to help carry out the trade or business of the tenant.
b. These fixtures are personal property regardless of how they are affixed.
Part 2 – 28
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c. These fixtures are removable by the tenant when the lease expires unless
this right has been surrendered in the lease.
D. Real property
Real property. “The interests, benefits, and rights inherent in the ownership
of real estate.” (USPAP, Definitions)
1. In some jurisdictions, the terms real estate and real property are used
interchangeably. For appraisal purposes, there is a distinct difference. Real
estate is an identified land parcel (including appurtenances), whereas real
property is the interests and rights in the identified tract of land.
2. A right or interest in real estate is also referred to as an estate.
3. Ownership interests have been compared to a bundle of sticks with each stick
representing a specific right of ownership.
Bundle of rights. Total range of ownership interests in real property. An
owner that possesses all the interests in the bundle of rights has the
most complete form of ownership.5
Rights in Real Property
Transfer
Possession
Lease
Mortgag e
Improve
4. Other rights attached to real property ownership include the right of enjoyment
(use the property in a legal manner), the right of exclusion (keep others from
entering or using the property), and the right to do all or none of these things.
5.
Definitions that are not referenced are definitions written by the developer. Such definitions may address only one
aspect of the term.
Basic Appraisal Principles
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Part 2 – 29
E. Partial interests (see Part 5 for more information on this topic)
Partial interest. Divided or undivided rights in real estate that represent less
than the whole, i.e., a fractional interest.
The removal of one or more rights in real property can affect value. Appraisers are
sometimes asked to value a partial interest in real property.
Part 2 – 30
Basic Appraisal Principles
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Review
Part 2
Learning Objectives
Now that you’ve completed Part 2, you should be able to
; Recognize the distinctive differences among land, real property, real estate, and
personal property.
; Identify significant characteristics of land.
; Identify three major divisions of land rights: air, surface, and subsurface.
; Identify five major rights in the real estate bundle of rights.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 1, pp. 3–5, Chapter 2, pp. 9–14, and
Chapter 7, pp. 59–66.
Terms and Concepts to Remember
Air rights (a.k.a., suprasurface rights)
Land
Real property
Appurtenance
Littoral rights
Riparian rights
Bundle of rights
Partial interests
Subsurface rights
Emblements
Personal property
Surface rights
Fixtures
Real estate
Trade fixtures
Improvements
Basic Appraisal Principles
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Part 2 – 31
Review Quiz
Write a number on the line opposite each item below to indicate whether the item is
best described as
1. Real estate
2. Real property
3. Personal property
4. Fixture
5. Trade fixture
Note. Permanently attached fixtures are also real estate. Choose “fixture” rather than
“real estate” if the test of fixtures applies to the personal property item. Trade fixtures
are also personal property, but choose the best answer that fits the description.
5
Photographic
printing equipment owned and used by a one-hour photo
business that rents space in a mall
1
Chain link fence
2
An estate
3
Portable dishwasher
2
Condominium
1
Swimming pool in the ground
3
Swimming pool above the ground
5
Air-handling
systems and filters owned and installed by a tenant in leased
space of an industrial park
4
Room air conditioner permanently mounted in a wall opening
2
Right to occupy
4
Portable hot tub permanently enclosed in a deck with underground plumbing
1
Shrubbery
3
Emails
Suggested answers for this quiz are found in the solutions booklet.
Part 2 – 32
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Preview
Part 3
Rights and Interests in Real Estate
This part looks at two related areas—estates in land and encumbrances—that can
have an impact on estates, particularly from a value standpoint. The first half of Part 3
concentrates on the two major types of estates—freehold and leasehold. The second half
addresses encumbrances that are not liens. Lien encumbrances are examined in Part 6.
Learning Objectives
To prepare for Part 3, read the following learning objectives and refer to them as you
study this part of the handbook.
† Identify distinctions between freehold and leasehold estates.
† Recognize distinctions between liens and other types of encumbrances.
† Distinguish types of non-lien encumbrances.
Learning Tips
As you’re beginning to discover, an introductory course contains a lot of new terms. By
the end of the day, you may feel a little overwhelmed by terms, but that’s pretty normal.
Just try to concentrate on the major terms. To bring order to these terms, make use of
the two primary chart diagrams that are labeled “Estates” and “Encumbrances.”
You will notice extra material labeled as Digging Deeper for “Other types of easements.”
This content is provided as additional information, and you don’t need to know those
particular terms for this course.
Overall, try to focus on the big picture. Let the detailed information filter in as you review
during your personal study time, but concentrate your efforts on terms and concepts that
are listed in the review section. When you’ve finished Part 3, review the three objectives,
which will reinforce the big picture focus.
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Part 3 – 33
Part 3 – 34
Basic Appraisal Principles
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Part 3.
Rights and Interests in Real Estate
A number of legal rights (that is, a bundle of rights) belong to the owner of real estate. In
Part 3, we’re going to take a closer look at the rights and interests that run with real estate.
I.
Estates in Land
Estate. An owner’s degree, quantity, nature, and extent of interest or interests in
property.
Estate in land. The degree, nature, and extent of interest that a person has in land.
There are many types of estates, but not all interests in real estate are defined as
estates in land. To be an estate in land, the legal right(s) or interest(s) must allow
possession—now or in the future—and specify duration. Estates are distinguished by
their duration and fall into two legal categories—freehold and leasehold estates.
Estates
E
states
Indeterminate
D u r a t io n
Freehold
F
ree
eeh
hold
Defined
D u r a t io n
Leasehold
L
eas
ea
sehold
Estate
E
stat
tate
e fo
forr Y
Years
ears
ear
s
Life
Lif
e
Estat
tate
e
Estate
Fee Simple
Sim
Si
mple
Est
Es
tate
Estate
Includes a Future
I n t e r e s t o r P o s s e s s io n
E
Estate
state fr
fro
from
om
P
eri
rio
od to
to Period
Per
eriiod
Period
Estate
E
stat
tate
e at
at Will
Willl
Wi
Fee Sim
Simp
Simple
ple
A
bsollute
bso
Absolute
Fee Sim
Simp
Simple
ple
Deffea
De
eas
sible
Defeasible
Leased Fee
Fee
Interest
Interest
Estate
Est
Es
tate a
att
Sufffera
Su
eran
nce
Sufferance
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Part 3 – 35
FREEHOLD ESTATES
A. Characteristics of a freehold estate
1. Present or future possession
2. Indeterminate duration
3. Ownership
F
reeh
eho
old Estates
Estates
Freehold
Fee Sim
Simp
Simple
ple Estate
Esttate
Es
Inherritabl
Inhe
table
e
Inheritable
LLife
ife E
Estate
state
Noninher
Noninhe
rita
itab
ble
Noninheritable
B. Types of freehold estates
1. Fee simple estate
a. Fee simple absolute is the most complete form of ownership with
unlimited duration and subject only to governmental powers.
b. Fee simple defeasible is subject to the occurrence or non-occurrence of
a specific event. The two types are an estate 1) qualified by a special
limitation and 2) subject to a condition subsequent (see the appendix for
expanded definitions of these two types of estates).
c. Leased fee interest is an ownership interest held by a landlord with the
rights of use and occupancy conveyed by lease to others. The rights of
the lessor (the leased fee owner) and the lessee are specified by contract
terms contained within the lease.
Fee Simple
Simple
Est
Es
tate
Estate
Fee Simple
Simp
Sim
ple
A
bsolute
Absolute
Part 3 – 36
Fee Simple
Simple
D
efe
fea
asible
Defeasible
LLeased
eased
ease
d Fee
Fee
IInterest
nter
tere
est
Basic Appraisal Principles
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2. Life estate
Life estate. Rights of use, occupancy, and control, limited to the lifetime
of a designated party, sometimes referred to as the life tenant.
Life tenant. One who owns an estate in real estate for his or her
lifetime, the lifetime of another person, or an indefinite period limited by
a lifetime.
a. Conventional life estate
ƒ
Ordinary life estate with remainder or reversion. In some states,
the identifying labels of reversionary interest and remainder interest
are used interchangeably for the same party or entity.
ƒ
A pur autre vie (pronounced pùr ówtra vίy) estate is also with
remainder or reversion, but the duration of this estate is based on
the life of someone other than the life tenant.
Example of an Ordinary Life Estate
Grants Life Esta
Grants
Estat
te
Estate
G
ranttee
ran
Grantee
Life
Lif
Li
fe Tenant
Tenant
Grantor
Gr
rant
anto
or
Reversion
Reversio
n
Reversionary
Interest
or
Remainder
Remainder
Interest
Inte
Int
eres
restt
Remainderman
Remainder interest. A future possessory interest in property that is
given to a third party and matures upon the termination of a limited or
determinable fee.
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Part 3 – 37
b. A life estate may function differently (from that of an ordinary life estate),
depending on the type (retained life estate, life estate trust, etc.) and also
how individual state laws might apply to life estates.
c. Legal life estate
Digging Deeper
ƒ A legal life estate is established by state law rather than created by an owner. It is
automatically effective upon the occurrence of certain events.
ƒ Legal life estates currently in use by some states are dower, curtesy, and
homestead.
ƒ Many states have eliminated dower and curtesy in favor of the Uniform Probate
Code (UPC).
ƒ A homestead provides protection for a property occupied as a family home for
the life of the owner, thus it is a life estate. In states with homestead laws, a
bankruptcy filing would not jeopardize an owner’s private residence. If the real
estate is a homestead, it is exempt from creditors for the life of the owner.
There are limitations as to how much land of the homestead is exempt, and the
exemption doesn’t apply to property taxes or mortgage liens associated with the
real estate.
End Digging Deeper
LEASEHOLD ESTATES
C. Characteristics of leasehold estates
1. Possessory
2. Defined period of time or specified conditions
3. Reversion of possessory rights (that is, reverts back to the owner)
Part 3 – 38
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4. A leasehold estate begins with an agreement called a lease. There are two
primary participants to a lease.
Lessor (the landlord). The property owner holding a fee simple estate
with a leased fee interest (this is a future interest).
Lessee (the tenant). The party with a leasehold interest.
D. Types of leasehold estates (also referred to as tenancies)
1. Estate (tenancy) for years
a. Tenancy is for a definite or fixed period of time, not necessarily in years.
b. Lease automatically terminates on the expiration of the rental period. No
notice by either party is required; it simply ends at the specified time.
c. Consent is required if either party to the lease wants to terminate before
the end of the contracted term. Termination of a lease by mutual consent
is called surrender.
d. Unless prohibited in the lease agreement, an estate for years is
assignable by the tenant. The tenant can sublease or assign to
another party.
e. An estate for years does not terminate upon the death of the landlord.
Leasehold
Lea
Le
asehold
Estate
E
state for
for Years
Years
Estate
Est
Es
tate at Wil
Willl
Estate from
Estate
Est
Period
P
eriod tto
o Perio
Period
d
Estate a
Estate
Est
att
Sufferance
Sufffera
Su
eran
nce
Basic Appraisal Principles
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Part 3 – 39
2. Estate (tenancy) from period to period
a. Tenancy is for an indefinite period of time with no specific expiration date.
Notice must be given to terminate the lease.
b. This type of tenancy typically comes about as an extension or holdover
from a tenancy for years. The original lease term was likely set as monthto-month or some other period of time.
c. For this type of extended tenancy, the periodic renewals are automatic.
3. Estate (tenancy) at will
a. Tenancy is for an unspecified period of time and similar to a tenancy from
period to period except that it never originated with any specific term.
b. The estate automatically renews itself unless a notice of termination is
given by one of the parties. For example, Becker agrees to pay a stated
amount of rent each month to a property owner, but no time period was
ever specified in the agreement. As long as Becker pays the rent each
month, the lease continues indefinitely.
c. Estate at will terminates upon the death of the landlord or tenant.
4. Estate (tenancy) at sufferance
a. The estate is created when a tenant lawfully takes possession but stays
after the lease expires without the consent of the property owner.
b. It is used to distinguish between a tenant who lawfully entered into
possession but holds over without consent and a trespasser who never
had permission to enter the land.
c. The tenant has no current rights to possess the property, but the property
owner must follow legal procedures for eviction.
Part 3 – 40
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II. Encumbrances
Encumbrance. Any claim or liability that affects or limits the title to property. An
encumbrance can affect the title such as a mortgage or other lien, or it can affect
the physical condition of the property such as an easement. An encumbrance
cannot prevent the transfer of possession, but it does remain after the transfer.
Encumbrances
Encumbr
Encumb
rances
A monetary claim
Use or physical
against a property
condition is affected
Liens
Lie
Li
ens
Encumbrances
E
ncum
umb
brances
Examples:
E
xam
amp
ples:
Examples:
E
xamp
amplles:
• Property
P
roper
ertty Tax
T
ax
Property
Tax
• Leases
LLeases
ease
asess
• First
First Mortgage
Morttgage
Mor
Mortgage
Easements
• Easements
E
asement
ntss
Equity
Loans
• Equity
E
quitty Loans
qui
Loa
Lo
ans
Encroachments
• Encroachments
Encroa
Encro
ach
chm
ment
ntss
Mechanics’
Liens
• Mechanics’
Mech
Mec
hani
nic
cs’ Liens
Lie
Li
en s
Deed
Restrictions
• Deed
Dee
De
ed Restrictions
Resstri
Re
ric
ction
tionss
• Judgments
JJudgments
udgments
Reservations
• Reservations
R
eser
servvations
Attachments
• Attachments
A
ttachments
All liens are encumbrances; not all encumbrances are liens.
Basic Appraisal Principles
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Part 3 – 41
Encumbrances
Our focus will be on encumbrances that are not liens. In Part 6, we’ll come back to this
topic and look at lien encumbrances. Leases are encumbrances, but we want to treat
them separately, and we will examine leases in Part 7.
A. Easements
Easement. The right to use another’s land for a stated purpose.
1. Easement appurtenant An easement that is attached to, benefits,
and passes with the transfer of the dominant estate; runs with the land for the
benefit of the dominant estate and continues to burden the servient estate.
S T R E E T
Easement
Servient Estate
Dominant
Estate
2. Easement in gross An easement that benefits a legal person or
entity (individual, corporation, partnership, LLC, government entity, etc.) and
not a particular tract of land; an easement having a servient estate but no
dominant estate.
Part 3 – 42
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Digging Deeper
Other
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
Types of Easements
affirmative easement
ancillary easement
avigation easement
clearance easement
conservation easement
cross easement
discontinuous easement
drainage easement
drip easement
easement by necessity
easement by prescription
facade easement
flowage easement
highway easement
line-of-sight easement
negative easement
non-apparent easement
overhead easement
party wall easement
permanent easement
perpetual easement
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
pipeline easement
pole line easement
preservation easement
private way of necessity
rail easement
reciprocal easement
right of drainage
right of entry
right of re-entry
right of way
scenic easement
servient easement
sewer line easement
slope easement
solar easement
subsurface easement
surface easement
temporary easement
utility easement
water line easement
End Digging Deeper
B. Encroachments
Encroachment. Trespassing on the domain of another.
1. An encroachment occurs when a portion of an improvement extends beyond
the site boundary of its owner’s land. Such unauthorized use can intrude into
a neighboring property, into a setback area, or public spaces.
a. Most encroachments are unintentional.
b. Encroachments may reduce the value, use, or enjoyment of the property
that has been intruded upon.
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Part 3 – 43
2. An encroachment is not an encumbrance in the truest sense of the term
because it is not a right or interest held by the encroaching party.
a. Longstanding encroachments can mature into an easement by
prescription or possibly a title issue via adverse possession. Easements
by prescription and adverse possession will be discussed in Part 7.
b. Encroachments don’t often appear on property title documents. Unless a
recent survey or a plot plan has been completed, an encroachment can
be missed. Careful observation by appraisers and real estate brokers can
point out potential encroachments. In such instances, a survey would be
required.
3. A court can order the removal of an encroachment. In some cases, when
the cost of removal is excessive or creates a hardship, the court can award
monetary damages to the party affected by the encroachment.
C. Deed restrictions
Deed restriction. A provision written into a deed that limits the use of land. Deed
restrictions usually remain in effect when title passes to subsequent owners.
1. Deed restrictions include restrictive covenants, subdivision restrictions, and
condominium bylaws. These are private agreements that affect the use of
land and therefore have the potential to affect value.
a. Created when a property owner includes the restriction in the deed upon
conveyance of the property and thus becomes binding on all grantees
b. What are some types of restrictive covenants a developer might include
for a new subdivision?
ƒ
Type of use (residential, multifamily, etc.)
ƒ
Type of construction (brick exterior, wood shake roofs, green
sustainability, etc.)
ƒ
Size of buildings (minimum or maximum)
ƒ
Prohibited practices (parking RVs, building fences, etc.)
c. Restrictions affect the owner’s right to use the property rather than the
owner’s right to sell. Deed restrictions that affect the latter are generally
unenforceable, and the courts consider them contrary to public policy.
Part 3 – 44
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2. Deed restrictions often have a specified time limit in which they are in effect.
The restrictions can be extended or removed with the majority consent of the
property owners whose properties are affected by the deed restrictions.
3. Conflicts in deed restrictions
a. Conflicts between a public restriction (such as a zoning ordinance) and
a private deed restriction are often resolved with the more protective
restriction prevailing, unless it is contrary to higher laws (for example,
federal laws).
b. A violation of the recorded restrictions might force a neighboring landowner
to file an injunction through the court to stop the prohibited practice.
ƒ
The property owners are the primary enforcers of restrictive
covenants.
ƒ
Failure to enforce restrictions over a long period of time might
void or diminish current or future attempts by owners seeking
compliance.
4. CC&Rs
a. CC&R is a term used to represent conditions, covenants, and restrictions.
b. CC&R is a list of expressed assurances and limitations on land use.
The term is often found in contracts between a land subdivider and a lot
purchaser. CC&R is specified in the conveyance.
3.1 Example
Green Sustainability Covenants and Restrictions. A growing
number of sustainable developments require that buildings meet
a green standard. Lakewood Ranch, Florida, is a green community
that features a variety of commercial, multifamily, and single-unit
detached housing. For more information, do an Internet search for
”Lakewood Ranch in Florida.”
D. Reservations
Reservation. A clause found in legal instruments and conveyances that
creates a new right or interest on behalf of the grantor. While title passes to
the grantee, some use or income is reserved for the grantor. Reservations may
include mineral rights, rental income, or easements.
Basic Appraisal Principles
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Part 3 – 45
E. Licenses
Licenses are NOT encumbrances, but we give them special mention here because
they are sometimes labeled incorrectly as encumbrances.
What are licenses?
1. Revocable oral or written agreement granting privilege to use property
2. Not an estate or an interest in land (and thus not an encumbrance)
3. Not assignable and can’t be sold
4. A personal agreement usually granted for a specified period of time
5. Example from the real world
3.2 Example—How a License Works
Edwards grants permission to his neighbor to park an RV on his property
while the neighbor builds a garage extension to house the vehicle. If
Edwards sells his property or dies, the license terminates.
Part 3 – 46
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Review
Part 3
Learning Objectives
Now that you’ve completed Part 3, you should be able to
; Identify distinctions between freehold and leasehold estates.
; Recognize distinctions between liens and other types of encumbrances.
; Distinguish types of non-lien encumbrances.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 1, pp. 3–5, and Chapter 7, pp. 59–66.
Terms and Concepts to Remember
Deed restriction
Estate in land
Leasehold estate
Easement
Fee simple absolute
License
Easement appurtenant
Fee simple defeasible
Life estate
Easement in gross
Personal property
Encroachment
Freehold estate
Remainder interest
(or remainderman)
Encumbrance
Leased fee
Reservation
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Part 3 – 47
Part 3 – 48
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Practice Test Section 1
This multiple-choice test is for your benefit and provides a review of
everything covered in Section 1. This is a closed-book test. Choose
the most correct answer.
1.
*
2.
*
3.
*
4.
*
Which of the following items are considered to be personal property?
A.
a tree orchard
B.
built-in cabinetry
C.
furniture
D.
interior light fixtures
Mayes owns a property but has leased it to Jacobs. Which term describes Jacobs’
right in the property?
A.
fee simple interest
B.
leased fee interest
C.
leasehold interest
D.
lessor interest
Real estate is best described as
A.
everything resting on the surface of the land.
B.
fixtures and building improvements.
C.
land and everything permanently attached to the land.
D.
the complete bundle of rights attached to land.
Mineral rights are an example of
A.
air rights.
B.
riparian rights.
C.
subsurface rights.
D.
suprasurface rights.
Basic Appraisal Principles
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Part 3 – 49
5.
An appraiser’s familiarity with a specific type of property applies to what concept?
*
A.
competency
B.
impartiality
C.
intended use
D.
sufficient diligence
6.
*
7.
Sanchez is appraising a property for a client with the intended use of filing a tax
appeal. In this type of assignment, Sanchez should
A.
find out what value the client’s lawyer recommends.
B.
not advocate the cause or interest of any party or issue.
C.
represent the client’s cause in the appeal.
D.
try to keep the value as low as possible.
Before an appraiser begins an assignment, the problem to be solved must be
identified. What is the next step the appraiser must take to ensure credible
assignment results?
A.
a preliminary opinion for the client
B.
a pro forma for the assignment
C.
a project timeline
*
D.
determination of the scope of work
8.
Chattel and personalty are terms used to describe
*
A.
emblements.
B.
fixtures.
C.
personal property.
D.
real property.
9.
Hooper gave permission to a nearby business neighbor to place a sign on his
corner property to advertise the neighbor’s liquidation sale. What has Hooper
given his neighbor?
*
A.
a license
B.
a partial interest in his property
C.
a personal easement in gross
D.
an estate
Part 3 – 50
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
10.
What is a tenancy (that is, estate) in which a lessee remains in possession of the
property without the lessor’s consent?
*
A.
tenancy at sufferance
B.
tenancy at will
C.
tenancy for years
D.
tenancy from period to period
Review quizzes and practice tests are intended to be taken during your personal study
time. Suggested answers are found in the solutions booklet.
Basic Appraisal Principles
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Part 3 – 51
Part 3 – 52
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Section 2
2
Part 4. Legal Description of Real Estate
Part 5. Forms of Property Ownership
Part 6. Controls on Ownership
Preview
Part 4
Legal Description of Real Estate
Figuring out legal descriptions is nearly an everyday occurrence for appraisers. It is
critical for an appraiser to know exactly what parcel of land is to be appraised. Legal
descriptions are very precise and assist appraisers in identifying the correct real estate.
In Part 4, we will look at the primary methods of legally describing land.
Learning Objectives
To prepare for Part 4, read the following learning objectives and refer to them as you
study this part of the handbook.
† Recognize and identify the three major land description systems.
† Identify measurements used in the rectangular survey system.
† Recognize definitions of principal meridian, baseline, township lines, range lines, and
townships.
† Calculate the area of a specific portion of a township.
† Write a legal description using the rectangular survey system.
Learning Tips
Part 4 will be a little more technical than the previous content, and you will need your
calculator to work basic math problems relating to land size.
A word about the HP 12C financial calculator: If you have a typical calculator that
performs basic math functions, you are welcome to use that calculator for solving the
math in Part 4. However, we assume that most participants will use the HP 12C as their
primary calculator for the entire course. Therefore, there is information on the following
page to help you get started with basic math functions for this calculator. Since you won’t
be doing financial calculations until later in the course, the preview to Part 4 focuses
on calculating basic math functions so you can solve the land size problems that are
included in Part 4.
Pay careful attention to the content on rectangular survey, because that content is more
challenging, and it will take a little more effort to grasp the terms and concepts. Once
you have the basics down, you’ll enjoy figuring out the various problems. You’ll need to
commit to memory the number of square feet in one acre of land. It’s just one of those
things you’ll have to know as an appraiser—for the rest of your life.
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Part 4 – 53
Getting Started with the HP 12C Calculator
If you want to perform basic math calculations on the HP 12C, and you’ve never used it
before, please read the following:
Basic Math Functions
We’re going to make this easy! Turn on the calculator using the ; key located on the
lower left side of the calculator.
Once the calculator is on, press the gold-colored f key, and then press 4. This will set
the calculator to display 4 decimal places to the right of zero. Next, clear the registers by
pressing f and then pressing H. The H function is located above the O key.
Pressing the f key activates the functions in the gold lettering found just above the
keys on the left side of the calculator. Pressing f H will clear any stored numbers
in the calculator’s memory. If you see the word begin in the display, it means you need to
reset the accrual period. Simply press the blue g key, and then press Â, which you
will find on the 8 key. The display should now be clear of any miscellaneous words or
letters, and you should see 0.0000 in the display. If you are using the HP 12C Platinum
version of the calculator, the display should have rpn below the numbers. If you see alg
in the display, you can switch it to rpn by pressing f ] and you’ll find the rpn toggle
is located on the Þ key. The classic version of the HP 12C always functions in rpn
mode.
There is no “equal” sign on the HP 12C, so we’ll use a different sequence. For example,
to calculate 25 + 10 = 35, enter the following keystrokes into the calculator:
2 5 \ 1 0 + (the display should now read 35.0000). This procedure,
referred to as RPN, can be used for all basic math functions when using the HP 12C.
Just remember that the last keystroke to enter is the math function you want to perform.
When you want to clear a previous entry or start a new calculation, press O to clear
the display. To fully clear the registers, it is a good practice to press f H because
that keystroke sequence will clear all the stored numbers in the registers and the display.
A comment from Hewlett-Packard about RPN. The HP 12C calculator uses a logic
process called RPN to save time and keystrokes. RPN is similar to the way you learned
math on paper, and it stands for Reverse Polish Notation. It was developed in 1920 by
Jan Lukasiewicz (a Polish mathematician) as a way to write a mathematical expression
without using parentheses and brackets. HP found Lukasiewicz’s method superior to
standard algebraic expressions when using calculators and computers and adapted RPN
for its first handheld scientific calculator in 1972 (note: this information is based on an
article published on Hewlett-Packard’s website—www.hp.com and search “Lukasiewicz”).
Helpful Measurements
ƒ
ƒ
ƒ
ƒ
ƒ
12 inches
3 feet
9 sq. ft.
43,560 sq. ft.
1 mile
Part 4 – 54
=
=
=
=
=
1 ft.
1 yd.
1 sq. yd.
1 acre
5,280 ft.
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Part 4.
Legal Description of Real Estate
When you ask someone how to find a particular location, you will typically get an address
and perhaps some directions using physical markers on how to find the address. Legal
descriptions are like that, but they are much more detailed and precise. In Part 4, we’re
going to look at three methods of legally describing real estate: metes and bounds,
rectangular survey, and lot and block. There are others, but these are the most common.
I.
Metes and Bounds
Metes and bounds system. A system for the legal description of land that refers
to the parcel’s boundaries, which are formed by the point of beginning (POB) and
all intermediate points (bounds) and the courses or angular direction of each
point (metes).
A. History and scope of the metes and bounds system
1. Metes and bounds is the oldest method of surveying land. It is still the
primary method used in the states that comprised the original 13 colonies.
2. Other states also use metes and bounds. Some limit its use to describing oddshaped parcels of land or in conjunction with the rectangular survey method.
3. Early descriptions were based on physical boundary markers. Measurements
were later added to provide greater precision in describing the land parcel.
B. How metes and bounds works
1. Begins and ends at a designated POB (point of beginning). The boundary
courses must produce a closed area.
2. Monuments (natural or manmade) may be used to establish boundaries.
3. Metes are measures that include direction and distance. Bounds are the
terminal points that in some cases are landmarks or monuments (see the
appendix for additional information).
Monument. A stone or other fixed object used to establish real estate
boundaries.
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Part 4 – 55
C. Precision of the method and limitations
1. Measurements are often qualified by the words more or less.
2. Actual physical distance between the monuments will typically take
precedence over the measurements provided in the description.
3. The destruction or natural deterioration of monuments can add to the difficulty
of identifying a parcel based on metes and bounds.
D. Example of metes and bounds
North Line of Section 22
140'
140
Northwest Corner of Section 22
260'
100'
100
TRACT CC
TRACT
'
00
2
0'
º3
45
S
West Line of Section 22
P.O.B.
400'
Description of Tract C: Commencing at the Northwest corner of Section 22,
thence South along the section line 140 feet; thence East 100 feet to a point
of beginning, thence continuing East 260 feet; thence South 45 degrees, 30
minutes East 200 feet; thence due West a distance of 400 feet; then North
to the point of beginning.
A full circle contains 360 degrees.
Each degree is divided into 60 parts,
and the parts are called minutes.
Each minute is divided into 60 parts,
and the parts are called seconds.

Symbol for degree: °

Symbol for minute: '

Symbol for second: "
The angle of 55 degrees, 30 minutes, 40 seconds can be written the following way:
55° 30' 40"
Part 4 – 56
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
II. Rectangular (Government) Survey System
Rectangular survey system. A land survey system used in Florida, Alabama,
Mississippi, and all states north of the Ohio River or west of the Mississippi
River except Texas; divides land into townships approximately six miles square,
each normally containing 36 one-square-mile sections of 640 acres, except
where adjusted for the curvature of the earth. Also called the government survey
system.
A. History and scope of rectangular survey
1. The government created the rectangular survey system in 1785 as the United
States expanded westward from the original 13 colonies in the Northeast.
2. It became the principal method of land description for most of the land west
of the Ohio and Mississippi Rivers.
3. The method divides land into a system of rectangles, which permits
description by identifying the particular rectangle in which the land
parcel is located.
B. Rectangular survey basics
1. System is based on two sets of
intersecting lines.
a. Principal meridians run north
and south.
A single
ƒ
6 miles × 6 miles, or
Township
ƒ
6 miles square, or
described
ƒ
36 square miles, or
as
ƒ
containing 36 sections
can be
b. Baselines run east and west.
2. There are 35 principal meridians in the United States. Principal meridians and
baselines are referenced to degrees of longitude and latitude.
3. Terminology.
a. Township lines. Survey lines that run east and west at six-mile intervals
north and south of a baseline and form the north and south boundaries of
townships.
b. Range line. One of a series of government survey lines that extend due
north and south at six-mile intervals and are numbered east or west from
the principal meridian. Range lines form the east and west boundaries of
townships.
c. Township. This is the area between two township lines and two range lines;
normally contains 36 sections of approximately 640 acres each.
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Part 4 – 57
Principal Meridian
Township
Lines
Township tier
Town
ship
T 2N R 3E
Base Line
Range Lines
d. Range. Vertical column of townships
e. Tier. Horizontal row of townships (also known as a township tier).
f.
Section. One of the 36 designated areas of land, each approximately one
mile square, into which each township is divided.
4. Township section numbering
6
5
4
3
2
1
7
8
9
10
11
12
18
17
16
15
14
13
West
West
East
East
19
20
21
22
23
24
30
29
28
27
26
25
31
32
33
34
35
36
6
Miles
6 Miles
6 Miles
Miles
North
North
South
South
Part 4 – 58
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Township Section by the Numbers
Section Description
Size
1 section
640 acres
½ section
320 acres
¼ Section
160 acres
¼ of ¼ section
40 acres
¼ of ¼ of ¼ section
10 acres
¼ of ¼ of ¼ of ¼ section
2.5 acres
1 Acre = 43,560 square feet
Example. Looking at Section 22 below, write a description for the parcel identified by the
shaded area.
E ½ of NW ¼ of SE ¼ of NE ¼ of Section 22, T 2N, R 3E
SECTION 22, TOWNSHIP 2N, RANGE 3E
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Part 4 – 59
Rectangular Survey Problems
The rectangular shaped illustrations for the three problems below represent one section of
640 acres. Use the illustrations to identify the parcel in the following legal descriptions.
1. Find the E ½ of SE ¼ of SE ¼.
2. Find the NE ¼ of SW ¼ of SW ¼.
How many acres are in the
above description?
3. Find the parcel for the following:
S ½ of SW ¼ of NW ¼,
Section 22, T 2N, R 3E,
Hennepin County, Minnesota
Part 4 – 60
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C. How to read a rectangular survey description
1. Start reading at the end of the description and work toward the beginning.
2. Generally, the longer the description, the smaller the land parcel it describes.
D. Correction lines in rectangular survey method
1. Range lines (those are the ones that run north and south) are only parallel
from a theoretical standpoint.
2. Range lines eventually meet at either the North or South Poles. Therefore, few
townships are exactly 6 miles square or contain exactly 36 sections.
3. To adjust for the curvature of the earth, the rectangular survey method uses
correction lines.
a. Every fourth township—north and south of a baseline—is designated as a
correction line (and this is a horizontal line).
b. On this correction line, the range lines are spaced to their full 6-mile width.
4. Surveyors follow specific rules to adjust for the fact that most townships do
not have precise dimensions or contain exactly 36 sections.
5. Undersized or oversized sections are known as fractional sections. Sections
that are exactly 1-mile square are called standard sections.
E. Government lots within the rectangular survey method
Government lots. Land areas that are not divided into quarters of a quarter
due to location or size; usually lie along the northern and western borders of
a township and along the edges of rivers or lakes, and extend from the border
or waterline to the first quarter of a quarter.
1. These areas, smaller than a full quarter section, were numbered by surveyors
and designated as government lots.
2. An example of a legal description of a Florida property with a government lot:
Government Lot 3 in Section 14, Township 40S, Range 23E
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Part 4 – 61
F. Rectangular survey descriptions that include metes and bounds
1. In states using rectangular survey, it is common to find metes and bounds
included within the government survey description for the following reasons:
a. The description involves an asymmetrical or irregular parcel of land.
b. The land parcel is simply too small to be described by quarter sections.
c. The described parcel does not follow recorded subdivision, section, or
quarter section lines.
2. Example of metes and bounds within a rectangular survey description
That part of the NW ¼ of Section 22, Township 2 North,
Range 3 East of the Third Guide Meridian West of the 5th
Principal Meridian, described as follows: Commencing at the
SE corner of the NW ¼ of Section 22, then west 200 feet
along the south line of the NW ¼ of said section; then north
300 feet parallel to the west line of said section; then east
200 feet parallel to the south line of said section; then south
along the east line of said section to the point of beginning.
III. Lot and Block System
Lot and block system. A system for the legal description of land that refers to
parcels’ lot and block numbers, which appear on recorded maps and plats of
subdivided land; may also be used for assessment maps.
A. How the lot and block system works
1. The lot and block system, also known as recorded plat, is basically a map
(albeit a very precise map) that is produced and then recorded in the county
where the land is located.
a. The map is based on the work of surveyors and engineers who subdivide
the land and assign lot numbers to identify individual sites within blocks.
b. To find the land parcel, you look up the recorded plat or subdivision at a
county office and then search for the referenced lot and block numbers.
c. Lots are contiguous, but the lot numbers don’t always coincide with the
tax parcel number.
2. Lot and block is used for identifying land within subdivisions, and it is the
most common form of legal description used in metropolitan areas.
Part 4 – 62
Basic Appraisal Principles
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B. To find the physical location of the recorded plat, other systems may be employed
such as metes and bounds or rectangular survey. After that, the plat is used with
its precise measurements to identify individual lots. Iron monuments are typically
placed on the corners of each lot.
PROPERTY ADDRESS: 1424 Emerald Court Carmel, Indiana 46030
PROPERTY DESCRIPTION: Lot 4 in PLEASANT ACRES, Block 1, an Addition to Hamilton County, Indiana, as per Plat thereof
Recorded as Instrument No. 9956337 Cabinet No. 2 Slide No. 549, in the Office of the Recorder of Hamilton County, Indiana
Block 1
Emerald
Court
40
.0
'
156.5'
136.0'
Lot 1
182.1'
150.0'
110.5'
40.0'
S00º 00' 01" W 406.5'
10' D.U.&S.E.
162.1'
R40.0'
175.0'
N00º 00' 01" E 471.5'
Lot 5
30' B.S.L.
240.0'
R60.0'
65.0'
216.0'
L
N89º 59' 59" E 388.3'
.1'
56
231.0'
R60.0'
75.2'
Lot 3
10' D.U.&S.E.
Lot 4
Lot 2
30' D.U.&S.E.
80.1'
308.2'
N00º 00' 01" E 752.0'
Point of Beginning
S89º 58' 58" E 388.3'
N
SE Corner of Section 4
T14N - R2E
D.U.&S.E. = Drainage Utility Sewer Easement
B.S.L. = Building Set-Back Line
TITLE COMPANY: Acme Title Insurance Corporation
Graphic was taken from Residential Property Appraisal, Exhibit 5.3, p. 159.
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Part 4 – 63
IV. Other Methods for Legal Description
A. If a recorded description is used that identifies a land parcel, even in a primitive
manner, it might be adequate. The description is not required to be one of the
three previously discussed methods of describing land.
1. Such descriptions must not be too vague or imprecise and thus cause
confusion about the location of the described land.
2. Simple descriptions can be adequate as long as they are verifiable through
physical or legal means.
B. Vertical description
1. This method is used to identify air space rights at precise elevations.
2. Condominium air lots are a typical use of vertical description.
3. Vertical descriptions use an established plane (bench mark) as a reference point.
Part 4 – 64
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Review
Part 4
Learning Objectives
Now that you’ve completed Part 4, you should be able to
; Recognize and identify the three major land description systems.
; Identify measurements used in the rectangular survey system.
; Recognize definitions of principal meridian, baseline, township lines, range lines, and
townships.
; Calculate the area of a specific portion of a township.
; Write a legal description using the rectangular survey system.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 12, pp. 166–168.
Residential Property Appraisal, Chapter 5, pp. 153–159.
Terms and Concepts to Remember
Baseline
Point of beginning (POB)
Section
Government lots
Principal meridian
Tier
Lot and block (recorded plat)
Range
Township
Metes and bounds
Range lines
Township lines
Monument
Rectangular (government) survey
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Part 4 – 65
Review Quiz
Fill in the missing data to the following questions:
1.
The method of legal description most frequently used west of the Mississippi River
is rectangular survey .
2.
Which section is directly north of Section 23? Section 14
3.
The SE ¼ of Section 10 contains how many acres? 160 acres
4.
A land parcel measuring 660 feet by 330 feet contains how many acres? 5 acres
5.
Malloy sold a land tract for $2,500 per acre described as S ½ of the NE ¼. What
was the total price of the land? $200,000 (80 acres × $2,500)
Use Township Section 12 illustrated below to answer questions 6 through 9.
B
D
C
A
240 acres
6.
Peterson purchased tracts A and B. How many acres did he buy?
7.
What are the dimensions of land tract “C”?
8.
Provide the legal description of tract “C”.
9.
What is the square foot size of land parcel “D”? 435,600 square feet 10 acres × 43,560 sq. ft.
1,320 ft. × 660 ft.
S ½ of SW ¼ of NE ¼ of Section 12
Review quizzes and practice tests are intended to be taken during your personal study
time. Suggested answers are found in the solutions booklet.
Part 4 – 66
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Preview
Part 5
Forms of Property Ownership
Understanding forms of property ownership is critical in the valuation of partial interests.
Appraisers need to know how ownership is held and what interest is to be appraised.
This can be something complex, such as a land trust, or relatively common, as in the
case of an undivided interest in the common area of a condominium project. Part 5
guides you through the basics of these different types of ownership.
Learning Objectives
To prepare for Part 5, read the following learning objectives and refer to them as you
study this part of the handbook.
† Recognize characteristics of ownership in severalty.
† Identify the four types of co-ownership.
† Identify the three parts of a trust.
† Distinguish between condominiums, cooperatives, and time-share forms of
ownership.
Learning Tips
Part 5 contains content that is fundamental to real estate, whether you are involved in
buying, selling, or providing a value opinion.
This material has a lot in common with Part 3 on rights and interests, so you should take
the same study approach. There are a lot of terms, and you need to assimilate as much
as you can. The terms in the review section are the ones to concentrate on, so don’t
spend extra time on terms that are not essential.
We purposely cover the content that is heavy on terminology early in the course so
that you have time to absorb the terms over several days. Your instructor will help by
reminding you from time to time of specific terms and how they relate to other areas of
real property valuation.
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Part 5 – 67
Part 5 – 68
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Part 5.
Forms of Property Ownership
Part 5 will take up where we left off in Part 3 when we discussed rights and interests in
real estate. At that time, we looked at the various interests in land such as fee simple,
life, and leasehold estates, but now we need to understand how a property is held and
how it can be conveyed to another individual or entity.
I.
Introduction
A. Understanding legal terminology
Conveyance
Document
Person Giving
the Document
Person Receiving
the Document
Deed
Lease
Mortgage
Offer
Option
Sublease
Trust
Contract for deed
Grantor
Lessor
Mortgagor
Offeror
Optionor
Sublessor
Trustor
Vendor
Grantee
Lessee
Mortgagee
Offeree
Optionee
Sublessee
Trustee
Vendee
Note. The terms mortgagor and mortgagee can be confusing. The mortgagee is the lender, and the
borrower is the mortgagor. This is because the borrower is giving the lender a mortgage deed (i.e.,
property interest) to be held in trust as security for the loan.
B. Ownership forms divide into three groups; ownership in severalty, co-ownership
(also known as concurrent ownership), and trusts.
II. Ownership in Severalty
A. What does it mean to hold ownership in severalty?
1. Ownership in severalty is really sole ownership by an individual or single entity.
ƒ
Severalty is derived from the word sever, meaning to separate or
set apart. The owner with an estate in severalty owns the property
separate from anyone else.
2. The owner of an estate in severalty has no restrictions on how the property is
transferred (sold) to another party.
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Part 5 – 69
B. Ownership in severalty and business organizations
1. Corporations
a. A corporation is a legal entity and composed of individuals conducting
business as if they were a single person.
b. A corporation’s identity is separate from its stockholders. Therefore,
corporate-owned real estate is unaffected by the death of any individual
stockholder.
c. Under a typical scenario, a corporate board of directors will empower
several of its key officers to acquire real estate for the corporation. The
lands purchased become corporate property.
2. Real estate investment trusts
Real estate investment trust (REIT). A corporation or trust that
combines the capital of many investors to acquire or provide financing for
all forms of real property. A REIT serves much like a mutual fund for real
property. Its shares are freely traded, often on a major stock exchange.
To qualify for the favorable tax treatment currently accorded such trusts,
90% of the taxable income of a REIT must be distributed among its
shareholders, who must number at least 100 investors; no fewer than five
investors can own more than 50% of the value of the REIT during the last
half of each taxable year. The US Securities and Exchange Commission
(SEC) stipulates that REITs with over 300 investors have to make their
financial statements public.
a. A REIT has sole ownership of the properties the entity possesses even
though it can have 100 or more investors.
b. A REIT is only taxed on its retained earnings.
c. The advantage of a REIT is that it provides small investors the opportunity
to pool their resources and channel them into large investments.
3. Syndicates are sometimes difficult to define as far as ownership. A syndicate
can operate as a partnership, limited partnership, corporation, or a REIT.
Syndication. A private or public partnership that pools funds for the
acquisition and development of real estate projects or other business
ventures.
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a. A syndicate is not a recognized legal entity.
b. Syndication is not a form of ownership in the normal sense, but it can
be organized in ways to make it fall under ownership in severalty. On the
other hand, it can just as easily fall under co-ownership.
c. Syndicates are groups of two or more people (or even firms) joined
together for the purpose of investing in real estate. A limited partnership
is the common ownership form of a syndicate.
III. Co-ownership
With co-ownership (or concurrent ownership), property is held by two or more
individuals and is categorized into four types.
ƒ
Tenancy in common
ƒ
Joint tenancy
ƒ
Tenancy by the entirety
ƒ
Community property
These four operate in comparatively the same way during the lifetime of the co-owners.
The differences become apparent when the property is conveyed or one owner dies.
A. Tenancy in common
1. Real estate may be owned by two or more people as tenants in common.
2. Each owner possesses an undivided fractional interest in the property held
under a tenancy in common.
a. The property is not physically divided.
b. The ownership interest is divided, and the co-owners are entitled to
possession of the whole property.
3. Unless the deed specifies the fractional interest each owner shares, it is
assumed to be equally divided among the owners.
4. Each co-owner holds a separate interest and can sell, mortgage, or transfer
this interest without consent of the other co-owners (as long as these actions
do not infringe on the rights and interests of the other co-owners).
a. No co-owner can transfer the ownership of the entire property.
b. Upon the death of a co-owner, the undivided interest passes in
accordance to the will of that owner.
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Tenancy in Common
Jim
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5. Business partnerships generally own real estate under tenancy in common.
Syndicates often operate in this manner using a limited partnership with the
syndicator as the general partner and the investors as limited partners.
6. When title to real estate is conveyed to two people and the deed does not
specify the form of tenancy, it is assumed as tenancy in common. However, if
those two people are husband and wife, some states might default to other
forms of co-ownership.
Joint Tenancy
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Part 5 – 72
Jim
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enan
ena
nts iin
n common
common
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B. Joint tenancy
1. Joint tenancy involves two or more people holding real estate but with right
of survivorship.
a. When a tenant dies under joint tenancy, the interests are passed to the
other surviving tenant and not to the heirs or according to a will.
b. The death of an owner in a joint tenancy form of ownership simply results
in one less owner.
2. Upon the death of each successive tenant, the surviving joint tenants
acquire the interest of the deceased. This continues until the last surviving
tenant has all the ownership interests, and the estate becomes an
ownership in severalty.
3. Joint tenancy is created by intentionally writing specific language into the
conveying deed that identifies all the parties to the joint tenancy. Other
requirements might be necessary, but the bottom line is that joint tenancy is
never assumed when a title is transferred; it must be specifically written in.
4. Termination of an estate in joint tenancy can be accomplished by agreement,
partition, or severance.
Jim
Jim
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Joe
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a. In the above case, Audrey cannot become a joint tenant because the
original joint tenancy is terminated by an agreement. She now has a
partial (or fractional) interest in the property as a tenant in common, with
Joe and Jerry remaining with an undivided interest as joint tenants.
b. In this case, Audrey has a one-third interest in the property—although a
judge might have to determine the actual interest—and she can transfer
that interest to another or leave it to her heirs when she dies.
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C. Tenancy by the entirety
1. This is a unique form of co-ownership for married couples in which each
spouse has an equal, undivided interest in the property.
2. Husband and wife as tenants by the entirety have rights of survivorship.
a. Upon the death of one spouse, the title automatically transfers to the
surviving spouse, creating an estate in severalty.
b. Tenancy by the entirety avoids probate for the surviving spouse.
3. To convey title, the signatures from both parties are required.
D. Community property rights
1. Nine states use this system for property owned by husband and wife. Each
spouse has an undivided one-half interest in property acquired during the
marriage. In contrast to joint tenancy, when one spouse dies, the survivor is
entitled to one-half of the community property. The other half is distributed
according to the will of the deceased. If there is no will, the interests will go to
the surviving spouse (or other heirs) depending upon applicable laws of the state.
2. Community property recognizes two classifications of property.
a. Separate property (real and personal)—Property that was solely owned by
either spouse before the marriage. The spouse can mortgage or convey
his or her separate property without the signature of the spouse who does
not own the property.
b. Community property (real and personal)—Property acquired by either
spouse during their marriage. Therefore, community property requires the
signature of both spouses before it can be encumbered or conveyed.
IV. Trusts
A. Understanding the basics of a trust
1. Real estate can be transferred to another person (called a fiduciary) to hold or
manage for the benefit of a third party.
2. The players are the trustor, the trustee, and the beneficiary. These players can
be people or legal entities such as corporations.
3. The beneficiary receives from the trustor any proceeds that come from the
property less the operating expenses of maintaining the trust. The income
can be for the lifetime of the beneficiary or for a specified period—or event.
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How a Basic Trust Works
Conveys
Conv
Con
veys Title
Titlle
Tit
Trustor
Trust
Trus
tor
Trustee
Fiduciary
Kelly
Beneficiary
Benefic
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cia
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Lawyyer
Law
Lawyer
Held in
TTrust
rust for:
for:
Kelly’s
Kelly’s
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Gra
Gr
andchi
hilldren
Grandchildren
B. Types of trusts
1. A living trust is created by an agreement while the property owner is alive.
2. A testamentary trust is established by the will of the property owner after his
or her death.
3. Land trust
a. Real estate is the only asset in a land trust.
b. The property title is conveyed to a trustee, but the trustor in this case is
also the beneficiary. The trustor has a beneficial interest in the property,
and that interest is actually treated as personal property.
c. Even though the beneficial interest is personal property, the beneficiary
still retains management and control of the property and has the right of
possession and the right to income or proceeds from a property sale.
d. A land trust is designed to provide tax and privacy advantages for the
beneficiary.
e. Duration of a land trust is typically for a specified period of time.
4. Another type of trust, previously discussed a few pages back, is one held by
investors under what is called a real estate investment trust, or REIT.
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V. Condominiums, Cooperatives, and Timeshares
These forms of ownership function most commonly within residential property types.
A. Condominium ownership
1. How condominiums function
a. Owner holds a fee simple title
to an individual condo unit.
ƒ
Each condominium
unit has its own legal
description. In states
that levy property taxes,
each condominium unit
receives its own tax
statement.
ƒ
An individual unit can be owned in a number of ownership forms such
as tenancy in common or joint tenancy as permitted by state laws.
b. Condominium owners also hold an undivided interest in the remaining
condominium real estate, known as common elements.
ƒ
Common elements outside the building can include
Land, community buildings, swimming pools, tennis courts,
boat slip for waterfront properties, and parking spaces.
ƒ
Common elements inside the building can include
Lobby, hallways, elevators, underground garage, exercise room, balconies, laundry, and storage areas.
2. A condominium can be a high-rise, a townhouse, or even a detached dwelling.
The determining factor in what constitutes a condominium is the legal
declaration that has been executed and recorded, not the style of the building.
3. The individual owners can sell to anyone unless the condominium association
has the right of first refusal. In that instance, the unit must be offered first to
the association (or owners within the association) at the same price before an
outside offer can be accepted.
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4. Condominium association dues
a. A condominium association is comprised of the individual unit owners.
It may have a board of directors, which supervises the operating costs
to maintain the building and grounds and performs other duties such as
negotiating insurance coverage. The board may also retain professional
management.
b. Association fees can be assessed equally or proportionately for each
unit. Developments implementing energy-efficient features, low-flow water
fixtures, and low-water landscaping should experience lower maintenance
costs, resulting in lower association fees compared to developments
without these features.
c. Association dues are typically assessed on a monthly basis.
d. Failure to pay association dues can result in the association obtaining a
court-ordered judgment to have the delinquent owner’s unit sold to pay
off the outstanding amount, or the association can place a lien on the
individual unit.
B. Cooperative ownership
1. Under cooperative ownership, a corporation owns the real estate.
a. The corporation offers shares of stock to prospective tenants.
ƒ
Apartment price equals stock price.
ƒ
Purchaser becomes shareholder in the corporation through
stock ownership.
b. Tenant obtains a proprietary lease to the apartment for the life of the
corporation.
2. Stock is personal property, and the tenants do not own real estate. They own
an interest in a corporation whose only asset is the property.
a. Property control is maintained by the shareholder’s management of
the corporation.
b. Shareholders in the cooperative are required to follow the bylaws of
the corporation.
c. The board of directors or a majority of the shareholders must
approve potential shareholders seeking to purchase an apartment
in the cooperative.
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d. Sales of cooperatives are sales of shares of stock and are not recorded
in the public record.
3. A cooperative has a budget to cover operating expenditures, mortgage
payments, insurance, and taxes. Funds are also set aside for replacement
and repairs of major building components.
a. Each shareholder is assessed the cost of maintaining the cooperative.
b. Shareholders in the cooperative must assume the cost of any nonpaying
shareholders who are failing to pay their periodic assessments.
c. If enough shareholders default on their assessment, the corporation
might not be able to pay its mortgage and/or tax payments. In that case,
the cooperative property could be sold by court order to satisfy the debt.
The shareholders who never defaulted on their payments would also lose
their property interests.
4. Lenders will typically accept the stock of the cooperative as collateral security
for obtaining a mortgage. In this case, the cooperative operates much the
same as any type of real estate secured by a mortgage.
C. Timeshare ownership
1. Timeshares typically involve
a resort property that allows
each owner the right to use
the facilities for a specific
period of time.
a. There are various types of timeshare properties based on leases, license
contracts, or club memberships. Timeshare ownership, however, is a fee
simple interest in condominium ownership with accompanying rights. The
ownership rights are limited to a specified time period, but the owner can
still mortgage, lease, sell, or bequeath the rights.
b. An ordinary 25-unit condominium might have 25 fee owners. A timeshare
ownership with the same number of units might have 300 or more fee
owners. Obviously, the number of owners sharing the acquisition costs is
what makes timesharing so attractive. For this shared price, the fee owners
have access to the property only during a specified period each year.
2. Some programs allow owners to swap timeshares among different facilities
that cooperate within a network. In other words, an owner can spend a week
in Aspen this year and then the Caribbean the following year.
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VI. Planned Unit Developments (PUDs)
A planned unit development is not a type of ownership. Nonetheless, this is a good
time to address the concept so you don’t confuse it with the ownership types we’ve
previously examined, particularly condominiums.
Planned unit development (PUD). A type of building development designed as a
grouping of complementary land uses, such as housing, schools, recreation, retail,
office, and industrial parks, contained within a single master development.
A. Planned unit developments were created to provide more efficient use of land.
This goal is achieved through a combination of higher dwelling density with a
greater amount of open spaces. That might sound contradictory, but it actually
works quite well. Going forward, PUDs may also implement sustainable building
development requirements, which complement the PUD concept.
Sustainable development. “Development that seeks to meet the needs
of the present without compromising the ability of future generations to
meet their needs.” Source: Brundtland Commission, “Report of the World
Commission on Environment and Development: Our Common Future.” For
more information, do an Internet search for the report.
1. PUDs cluster the buildings or residences into tighter spaces and then allow
larger open spaces that all owners in the PUD can share.
2. The above concept is not exclusive to PUDs, but it is the original source of the
concept, and it required special zoning to permit the higher densities.
B. PUDs are not an ownership type; but they don’t fit neatly into a zoning category,
although many cities have zoning designations for PUDs.
1. A PUD is created by covenants in the deed or long-term lease.
2. The property owners in the PUD own the land under their buildings.
3. Residential and commercial properties located in PUDs are typically appraised
in fee simple ownership with joint ownership of open areas. The appraiser,
however, must analyze the common amenities and benefits shared by all
property owners within the PUD.
4. The common open areas of the PUD are sometimes deeded to the
municipality, and local laws may require it in some areas.
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5. A planned unit development requires that there be an owner’s association
with non-severable membership and mandatory assessments.
C. A de minimis PUD is one in which the common elements owned by the
association have little or no effect on the individual property’s value. This term is
commonly used by the lending industry.
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Review
Part 5
Learning Objectives
Now that you’ve completed Part 5, you should be able to
; Recognize characteristics of ownership in severalty.
; Identify the four types of co-ownership.
; Identify the three parts of a trust.
; Distinguish between condominiums, cooperatives, and time-share forms
of ownership.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 1, pp. 4–5, Chapter 2, pp. 13–14, and
Chapter 7, pp. 67–74.
Terms and Concepts to Remember
Common elements
Ownership in severalty
Tenancy in common
Condominium ownership
Planned unit development (PUD)
Tenancy by the entirety
Cooperative ownership
Real estate investment trust (REIT)
Timeshare ownership
Co-ownership
Sustainable development
Trusts
Joint tenancy
Syndication
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Part 5 – 81
Review Quiz
Fill in the missing data to the following questions.
ownership in
1.
Ownership held by an individual or single entity is called
severalty .
2.
The party that gives a mortgage is called the mortgagor .
3.
Williams owns property with Campbell by tenancy in common. When Williams dies,
r heirs or according to her will
.
her interest in the property will go to
4.
In a basic trust, the fiduciary is known as the trustee .
5.
Elevators, tennis courts, and hallways in a condominium are
6.
Purchasing a cooperative unit means you are buying
7.
An ownership interest in real estate that allows the use of the property facilities
for a specified period of time is called timeshare ownership .
8.
Joint tenancy has a right of survivorship feature shared with what other form of
ownership? tenancy by the entirety
9.
Concurrent ownership is also known as co-ownership .
common elements .
shares of stock .
10. Trusts that allow 100 or more investors to pool their resources into large real
estate investments are called REITs .
Part 5 – 82
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Preview
Part 6
Controls on Ownership
Part 6 concludes some of the content that was presented in Part 3 earlier in the day.
There are four legal powers of government that can control property ownership. Near the
end of Part 6, we will examine lien encumbrances, which will balance out the other types
of encumbrances that were previously discussed.
Learning Objectives
To prepare for Part 6, read the following learning objectives and refer to them as you
study this part of the handbook.
† Identify four powers of government that can control property ownership.
† Recognize the purpose for which government levies special assessments.
† Recognize property features that can be regulated by zoning ordinances.
† Identify six types of lien encumbrances that can limit ownership in real property.
Learning Tips
Concentrate on the four powers that control property ownership. At the conclusion of this
part, you should be able to take an example of a government power and correctly place
it within its proper category of taxation, police power, eminent domain, or escheat. The
topic of lien encumbrances is less critical within the overall content of the course, and
we don’t want you to get bogged down in the details. The goal is to come away with an
overview on lien encumbrances. If you can cite several examples of lien encumbrances
and have a general understanding of how they function, you’re doing just fine. By the end
of the day, you might feel overwhelmed with terminology. That is a very normal response.
Concentrate on the terms found on each review page. Plan on taking some study time
after class to review your notes, but focus on the primary terms and concepts that were
covered today.
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Part 6 – 83
Part 6 – 84
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Part 6.
Controls on Ownership
Limitations on real estate ownership are divided into two categories—government
controls and encumbrances that affect title.
I.
Four Government Controls on Ownership
Estates in real property are subject to four powers of government.
ƒ
Taxation
ƒ
Eminent domain
ƒ
Police power
ƒ
Escheat
A. Taxation
Taxation. The right of government to raise revenue through assessments on
valuable goods, products, and rights.
1. Property taxation
The U.S. Constitution precludes the federal government from taxing real
property directly, reserving that right instead for state and local governments.
a. Taxes are levied against
real estate to support the
operation and services of
government at various levels.
These can include
ƒ
State government
ƒ
County government
ƒ
Public school districts
ƒ
Municipal government
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b. Ad valorem tax is used in property taxation because it is levied in
proportion to the value of the property to which the tax applies.
ƒ
Property taxes have their origin in the fiscal budget for each level of
government. Revenue (other than taxation) is estimated and paired
against anticipated expenses. The difference is assessed in a tax
levy against the properties within the taxing district.
ƒ
Taxable property in the district is valued by an assessor who
determines the assessed value of each real estate parcel.
c. Owners who disagree with the assessor’s value can file a tax assessment
appeal. Appraisers can be retained in these types of disputes over value.
ƒ
Tax assessment appeals can be made directly to the assessor,
to a board of equalization, or to the tax court. Some states have
specific procedural rules on filing tax assessment appeals.
ƒ
A successful appeal by an owner can result in a reduction of the
property assessment for a specific period of time.
d. Certain properties in a taxing district are tax-exempt. These can include
government-owned land and buildings, schools, and religious centers, as
well as public lands (including parks).
e. Many states provide various forms of exemption from property taxes
for renewable energy sources and/or green features for a given period.
Learn more about abatements at the Database of State Incentives for
Renewables & Efficiency, www.dsireusa.org.
f.
Part 6 – 86
Failure to pay property taxes brings a property into default, and it can be
sold by a designated authority unless redeemed by the property owner.
ƒ
Redemption is a right given to the property owner to reclaim the
property within a specified period (or number of years). The owner
must pay back taxes, plus any administrative costs, interest, and
penalties.
ƒ
If the owner does not redeem the property by the end of the
redemption period, the owner will be removed and the property will
be offered at public sale or auction to satisfy the amount owed.
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2. Special assessments
Special assessment. An assessment against real property levied by a
public authority to pay for public improvements, e.g., sidewalks, street
improvements, sewers; also called betterment tax.
a. Properties that benefit from specific public improvements share the cost
of those improvements (in whole or in part) through a special assessment
levied against them.
b. Some states limit special assessments so they don’t exceed the benefit
(in market value) to the assessed property.
c. The government entity making public improvements typically funds the
project through a bond sale. Once the bonds are issued, they become a
lien on the properties that benefit from the improvements.
ƒ
Special assessments for large projects are paid incrementally over
a number of years and are often included as part of the annual
property tax statement.
ƒ
If a property sells between the time a special assessment
becomes of record and the time it is actually levied, it is referred to
as a pending special assessment.
B. Eminent domain
Eminent domain. The right of government to take private property for public
use upon the payment of just compensation. The Fifth Amendment of the
US Constitution, also known as the takings clause, guarantees payment of
just compensation upon appropriation of private property.
1. Eminent domain is the government’s right to take or acquire privately held
land for public use.
2. The acquisition process is called condemnation.
a. Typically, the government entity will offer to purchase the property from the
owner. If the owner refuses the offer, the property is condemned.
b. Condemnation in eminent domain is distinctly different from the process
of a building official condemning a rundown building or dwelling due to
safety or health issues.
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Part 6 – 87
6.1 Dilemma
A large national company wanted to build its corporate campus in a location
accessible to public transportation and other favorable amenities. One municipality
eager to have the new campus located in its city offered a large tract of land it
considered blighted. The city then set out to purchase the properties in the blighted
area and condemn the remaining parcels held by owners unwilling to sell.
Can the city take the properties for this purpose?
Instructor guidance: The answer can depend on a number of factors. The
issue of condemning private property for use by another private party is
a hotly debated topic as a result of the 2005 Supreme Court ruling
(Kelo v. New London). Unless the courts find the taking arbitrary and
capricious, the city has the right to condemn. In either case, appraisers are
retained to address valuation issues.
C. Police power
Police power. The inherent power of government to regulate property in order
to protect public health, safety, and general welfare.
Police power is really the government’s power to control or regulate real property
in the public’s interest. Since no private rights are taken, police power is distinct
from eminent domain, although that very issue is sometimes debated in the
courts in cases involving zoning regulations.
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1. Four guiding principles of police power
a. Police power is intended to protect the health, safety, and general welfare
of the public.
b. Police power must be instituted and enforced in a nondiscriminatory
manner.
c. Police power should not negatively impact the value of a particular
property to such a degree that it constitutes confiscation.
d. Police power should provide a benefit to the public through its policies
and regulations.
2. Comprehensive plans are a form of police power used to control growth and
development. A comprehensive plan might include the following elements:
a. General guidance of land use
Examples. Residential, agricultural, business, industry, traffic and transit,
parks and recreation, watershed management, etc.
b. Housing needs
Examples. Single-family and multifamily at various density levels, rental
housing, senior housing, renewal projects
c. Transportation
Examples. Highways, public transit, pedestrian/bikeway, parking spaces
d. Community facilities
Examples. Schools, libraries, recreational facilities, police and fire
stations, hospitals, waste treatment plants, public utilities
e. Energy conservation
Examples. Designs favorable to reducing energy consumption and
including the use of renewable energy sources, high-performance and
green sustainability building practices
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Part 6 – 89
3. Zoning
Zoning. Public regulation of the use of private land through application of
police power; accomplished by establishing districts or areas with uniform
requirements relating to lot coverage, setbacks, type of improvement,
permitted activities, signage, structure height, minimum lot area, density,
landscaping, and other aspects of land use and development. (Bold added
for emphasis)
a. Zoning ordinances are local laws that implement the comprehensive
plan and provide regulation and control of land and structures within a
specified district.
b. Police power in action—The following items are some of the issues that
can be controlled through zoning ordinances.
ƒ
Building type
ƒ
Permitted uses
ƒ
Building height
ƒ
Setbacks
ƒ
Building style/appearance
ƒ
Lot size
ƒ
Natural resources protection
ƒ
Density
c. General zoning has broad classifications with divisions such as low,
medium, and high density; or in the case of industrial classifications, light
and heavy density. General zoning classifications may include
ƒ
Agricultural
ƒ
Residential
ƒ
Commercial
ƒ
Industrial
ƒ
Mixed use
ƒ
Public
d. Specialized zoning can include airports, waterfront properties, planned
developments, and historic districts to name a few.
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e. Zoning terminology
ƒ
Buffer strip Open spaces, landscaped areas, fences,
walls, berms, or any combination thereof used to physically separate
or screen one use or property from another so as to visually shield
or block noise, lights, or other nuisances; often associated with a
change of land use or density.
ƒ
Spot zoning An exception to the general zoning
regulations; permits specific, usually small, parcels of land to be
zoned for a use that is not permitted in the surrounding area.
ƒ
Zoning variance A legally authorized modification in the
use of property at a particular location that does not conform to the
regulated use set forth in the zoning ordinance for the surrounding
area; not an exception or change in the legally applicable zoning.
This zoning concept is sometimes classified by states in different
ways. Some states may call it a use variance, whereas others may
use a term such as development standard variance because it
deviates from the codified standard of the zoning ordinance (e.g.,
change in setback or a change in the number of parking spaces
allowed for that particular use).
ƒ
Legal nonconforming use A use that was lawfully
established and maintained, but no longer conforms to the use
regulations of its current zoning; sometimes known as a legally
nonconforming use.
4. Building codes
a. Building codes are another form of police
power intended to protect public health
and safety.
b. State and local governments adopt model
codes published by nationally recognized
organizations to establish minimum
requirements for building habitable
structures.
5. Other regulations affecting building
construction and renovation
a. State and local governments can have additional regulations that impact
an owner’s desire to improve his or her property.
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Part 6 – 91
b. Police power can include regulations from the following:
ƒ
Health department established at the state or local level
ƒ
Fire codes established by the state fire marshal
ƒ
State environmental protection agency
ƒ
Department of natural resources at the state level
c. Local governments may require a building permit before any improvements
are constructed on the property owner’s land. The permit serves as
evidence that the application has complied with the various regulations.
d. When the improvements have been completed and are in compliance with
all regulations, the local government will issue a certificate of occupancy
or compliance indicating the property can now be occupied.
D. Escheat
Escheat. The right of government that gives the state titular ownership of a
property when its owner dies without a will or any ascertainable heirs.
1. Escheat is not a restriction on ownership in the classic sense, but it is a way
for the state to acquire a privately-owned property.
a. Escheat affects both real and personal property.
b. When a property owner dies intestate, and there are no heirs to be found,
the property escheats to the state.
Testate. One who dies leaving a valid will; the condition of dying with
a valid will.
Intestate. The condition of dying without leaving a valid will.
2. The intent of escheat is to prevent real property from being abandoned with
no owner in title.
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II. Lien Encumbrances
Encumbrances affect ownership through public and private means. For example, a
property tax lien falls under the government’s power of taxation. A public right of way
is an easement that comes under the government’s power of eminent domain. On
the other hand, there are private easements that limit ownership rights, and in the
same way, a mortgage lien or mechanics’ lien is a private monetary claim against
the property.
Encumbrances
Enc
En
cumbran
ance
cess
Liens
Encumbrances
Examples::
Examples
Examples::
Examples
• Prop
Property
Prope
ert
rtyy T
Tax
ax
• LLeases
easess
ease
• Fir
First
Firs
st Mortgage
Mortga
Mortg
age
• Easem
Easements
Easeme
ent
ntss
• Equit
Equityy Loans
• Encroa
Encroachments
Encroac
chments
•M
Mechanics’
echani
nics
cs’’ Li
Lie
Liens
en s
•D
Deed
eed R
Restrictions
estrictions
• Judgm
Judgments
Judgme
ents
•R
Reservations
eservations
•A
Attachments
ttachments
Encumbrances were previously discussed in Part 3, which focused on encumbrances
that are not liens such as easements, encroachments, deed restrictions, and
reservations. Those encumbrances were largely private limitations on ownership with
a few exceptions crossing over into the public side. Now, we’re going to concentrate
on lien encumbrances—both public and private.
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Part 6 – 93
Liens
A. Liens are financial encumbrances.
Lien. A charge against property in which the property is the security for
payment of the debt.
1. A lien is a security interest in the property. The property owner is in the role
of a debtor, and a charge is attached to the owner’s property that gives a
creditor certain rights, such as the right to foreclose and use the proceeds to
pay the debt.
a. A lien does not create an ownership interest in the property.
b. A lien may impair or affect the marketability of the owner’s title to the
property, and since it is an encumbrance, it can also potentially affect
marketability—and market price.
ƒ
A lien is different from other encumbrances, because it is financial
in nature and attaches to the property due to a specified debt.
ƒ
When a lien is attached to real property, it does not necessarily
prevent the transfer of title. Indeed, a lien transfers with the property.
c. Once established, a lien runs with the land and binds subsequent owners
until the lien is paid and the owner’s title is cleared.
2. Liens fall into two general categories.
a. General lien is a type that binds all the assets of the individual
debtor (that is, the debtor’s property) to the lien.
b. Specific lien is a type that is levied against or attaches to a
specified piece of property.
c. Within the two general categories stated above, liens can also be
considered voluntary or involuntary.
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ƒ
Voluntary liens are created intentionally by the property owner’s
actions. A mortgage is considered a voluntary lien.
ƒ
Involuntary liens are created by law rather than by choice. For
example, a property tax lien is considered involuntary.
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3. Government liens include property tax liens and special assessment liens.
They also include liens from other forms of taxation.
a. A property tax lien attaches to the taxed property on the first day of the
year in which the tax is due. A special assessment lien attaches to each
of the properties identified by the government entity as benefiting from the
proposed public improvements.
b. If the property taxes are not paid, the state can foreclose and sell the
property to collect the unpaid property taxes. The same is true in the
case of a special assessment lien except that the local government entity,
rather than the state, would seek foreclosure on the property.
c. Government liens are considered specific liens.
4. Mechanics’ liens can arise when someone provides labor, skill, equipment, or
materials while improving, repairing, or maintaining the property.
a. The list of “mechanics” that potentially can file this type of lien include
contractors, subcontractors, and suppliers of building materials, as well
as skilled professionals such as engineers, architects, and surveyors to
name a few.
b. Most states require the contractor to provide a written notice to the
property owner that a lien could be enforced against the property if the
person providing the services or materials is not paid.
c. Mechanics’ liens are considered specific liens.
5. Mortgage liens are voluntary and one of the most common types of liens.
a. A mortgage lien is created by a contract between the property owner
and a lender. In this case, the owner (mortgagor) gives a lien against the
property to the lender (mortgagee) to secure repayment of the loan.
b. The lender can foreclose and force the sale of the property if the
mortgagor fails to pay the debt.
c. Mortgage liens are considered specific liens.
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Part 6 – 95
6. Judgment liens typically result from a lawsuit in which a monetary judgment
is awarded. The party that won the suit and was awarded the judgment is a
judgment creditor. The party who lost the lawsuit is a judgment debtor.
a. If the judgment debtor does not pay the awarded amount, the judgment
creditor can obtain a lien against the debtor’s property.
b. The lien attaches to all properties owned by the debtor in the county or
judicial district where the judgment was entered.
c. The lien also attaches to properties the debtor might have acquired during
the lien period.
d. The lien can also be extended to all the properties owned by the debtor
within the state.
e. Judgment liens are considered general liens.
7. Lien priority
a. Liens have a certain priority in how they are satisfied or paid off.
Generally, they follow the priority order based on when they were created
(that is, first come, first served).
b. In a forced sale or auction, liens are typically paid from the proceeds in
the order in which they attached to the property. However, there might be
more liens than available funds to pay them. Certain liens are considered
high priority and must be paid first.
Part 6 – 96
ƒ
Liens such as property taxes and special assessments fall into
this high priority category. Even so, property tax liens are paid
before special assessments liens.
ƒ
Mortgage liens are not high priority liens. That is why lenders insist
on a clear title before a mortgage is received from a borrower
so the loan becomes the first lien of record. The lien would still
come after any property tax and special assessment liens. A
second mortgage, such as an equity loan, would come after a first
mortgage on the priority list.
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8. Liens and legal issues
a. Lis pendens is a legal term signifying pending litigation that can affect
the ownership title to real estate. The lis pendens is not a lien; it’s simply
a notice of a potential lien in the near future. Filing a lis pendens puts
everyone with an interest in the property on notice that there is a possible
claim against the property. It also establishes the position in the line of
priority.
b. An attachment is a lien that allows a creditor with an interest in an
otherwise unsecured property to prevent the debtor from conveying title
while the dispute is being decided in court. In this case, the creditor files
a writ of attachment allowing the court to retain custody of the property
until the suit is concluded. The creditor will often have to post a surety
bond with the court sufficient to cover damages the debtor might suffer
while the court has custody of the property. The debtor can seek damages
from the bond if the creditor is not awarded a judgment by the court.
Attachment. Seizure of property by court order.
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Review
Part 6
Learning Objectives
Now that you’ve completed Part 6, you should be able to
; Identify four powers of government that can control property ownership.
; Recognize the purpose for which government levies special assessments.
; Recognize property features that can be regulated by zoning ordinances.
; Identify six types of lien encumbrances that can limit ownership in real property.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 1, pp. 4–5, and Chapter 2, pp. 13–14.
Terms and Concepts to Remember
Ad valorem tax
Lien priority
Spot zoning
Buffer strip (or buffer zone)
Mechanics’ lien
Taxation
Condemnation
Mortgage lien
Testate
Escheat
Police power
Zoning ordinance
Intestate
Special assessment
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Practice Test Section 2
This multiple-choice test is for your benefit and provides a review of
everything covered in Section 2. This is a closed-book test. Choose
the most correct answer.
1.
*
When a financial institution puts together a loan for a property owner, the lender is
referred to as the
A.
grantee.
B.
mortgagee.
C.
mortgagor.
D.
trustor.
2.
Which of the following limitations on ownership is not an exercise of government
power?
*
A.
covenants
B.
escheat
C.
special assessment lien
D.
zoning ordinance
3.
The Hawthorns bought a condominium unit in a resort area for $500,000. They
use the condo for one month out of every year, and during the remaining months,
they rent it out through an agreement with the property management. What type of
ownership do the Hawthorns have?
*
A.
condominium
B.
cooperative
C.
leasehold
D.
timeshare
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Part 6 – 101
4.
The form of legal description most often used west of the Mississippi River is
A.
bearing and azimuth.
B.
metes and bounds.
C.
recorded plat.
*
D.
rectangular survey.
5.
A claim against real property to secure repayment of a debt is
*
A.
a deed restriction.
B.
a lien.
C.
an easement.
D.
an encroachment.
6.
Sam Gates wants to buy a summer home with his sister Jean. Because they are
both retired and have no heirs, they want to be sure that if one of them dies, the
interest of the deceased will pass to the other sibling. Which form of ownership
should they use to acquire title?
*
A.
joint tenancy
B.
tenancy by the entirety
C.
tenancy in common
D.
tenancy in severalty
7.
When a corporation purchases real estate, it conducts this business as
A.
a limited partnership.
B.
a real estate investment trust.
C.
a syndicate.
*
D.
if it were a single person.
8.
Rick and Alice set up a living trust for their children involving a rental property they
own. In this type of agreement, the children are legally referred to as the
*
A.
beneficiaries.
B.
fiduciaries.
C.
trustees.
D.
trustors.
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9.
*
10.
*
11.
*
Common elements in condominium ownership include all of the following except the
A.
elevator.
B.
land.
C.
shareholder stock.
D.
swimming pool.
Justin owns a property with three other people. When Justin dies, his interest will
be passed according to his will and be part of his estate. In this property, Justin is a
A.
joint tenant.
B.
tenant by the entirety.
C.
tenant in common.
D.
tenant in severalty.
McKibbin has been approved to have a possessory interest in a property and is
given a proprietary lease. What kind of ownership does McKibbin have?
A.
condominium ownership
B.
cooperative ownership
C.
leasehold ownership
D.
timeshare ownership
12.
A buyer purchased a quarter acre of land for $5.00 per square foot. What was the
price of the parcel?
*
A.
$54,450
B.
$108,900
C.
$125,000
D.
$217,800
(43,560 sq. ft. / 4 = 10,890 × $5.00 = $54,450)
13.
The process used by the government to acquire land for public benefit is known as
*
A.
condemnation.
B.
eminent domain.
C.
escheat.
D.
foreclosure.
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Part 6 – 103
Digging Deeper
14.
*
How many acres are contained in the tract described as beginning at the NE
corner of the NW ¼, then south along the east line to the SE corner of said
quarter section, then west 2,640 feet, more or less, to the SW corner of the said
NW ¼, then in a straight line to the P.O.B.?
A.
40 acres
B.
80 acres
C.
120 acres
D.
160 acres
End Digging Deeper
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Section 3
3
Part 7. Contracts, Leases, and Deeds
Part 8. The Nature of Value
Part 9. Market Value
Preview
Part 7
Contracts, Leases, and Deeds
Appraisers see contracts such as purchase agreements and leases on a regular basis in
their business. Therefore, it is important to know the fundamentals of contracts. Another
important topic concerns how real property is transferred, so we’ll wrap up Part 7 with an
overview of deeds.
Learning Objectives
To prepare for Part 7, read the following learning objectives, and refer to them as you
study this part of the handbook.
† Identify the five elements of a valid contract.
† Differentiate between a gross lease and a net lease.
† Identify the four types of deeds by which real property can be legally conveyed.
Learning Tips
There are a number of areas in real estate that involve legal concepts, and this content
is one of those areas. It’s easy to master the content if you stick to the major terms and
concepts and don’t get bogged down trying to remember all the minute details.
Our understanding of real estate contracts has a lot of practical applicability to what
takes place in the market. For example, you might read in the newspaper next week an
article about a city’s option on land for a new sports stadium. Our hope is that after you
finish this course, you might guess (correctly) whether that option agreement involves a
unilateral or bilateral contract. Understanding how an option contract works can help you
see how real estate business is transacted and, ultimately, how it might impact value.
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Part 7.
Contracts, Leases, and Deeds
Appraisers view contracts, leases, and deeds as part of their research and analysis. The
nature of the appraiser’s work determines whether this task is carried out daily or on a
less frequent basis. In any event, the appraiser should be familiar with the basics of all
three.
I.
Contract Fundamentals
A. An overview of the basic elements of a contract
1. Voluntary
2. An agreement or promise
3. Legally competent parties
4. Legal consideration
5. Legal act
B. Express and implied contracts
1. An agreement put into words (written or spoken) is an express contract.
2. An agreement that is presumed to exist because of the parties’ actions is
an implied contract. A meal ordered at a restaurant is a common example as
there is an implied agreement to pay at the conclusion of the service.
C. Unilateral and bilateral contracts
1. Unilateral contract. Only one of the parties to the contract is legally obligated
to perform. An option agreement in real estate is a unilateral contract.
2. Bilateral contract. This type of contract exists when each party makes a
binding agreement to perform according to the contract. Most real estate
contracts are bilateral.
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Part 7 – 107
D. Forbearance
Contracts are agreements to perform in some specified way. Forbearance is when
the contract agreement is to not perform in a particular manner.
Forbearance. A lender’s agreement to postpone foreclosure proceedings,
allowing a debtor an opportunity to explore financing alternatives.
E. Five elements of a valid contract
This is a more detailed looked at the five elements listed in the overview on the
previous page.
Contract. A legally binding agreement between two or more persons that
represents their promise to do or not to do a particular thing. In many
jurisdictions statutes of frauds, or their equivalent, may render a real property
contract voidable if it does not consist of a signed, written agreement.
1. Consent. A contract must be entered into voluntarily as a freewill act by the
parties. A contract is voidable by the injured party if a party signing a contract
is under duress or menace (threat of injury). Misrepresentation or fraud can
also deprive a party from entering a contact in a free and voluntary manner.
2. Offer and acceptance. These are the two essential elements of a bilateral
contract, which constitutes the “meeting of the minds” or mutual assent.
The two parties are known as the offeror (the party who makes the offer and
looks for acceptance from the other party) and the offeree (the party to whom
the offer is made). In a unilateral contract, the acceptance is based on the
performance of the offeree. When an offer is presented in a bilateral contract,
there are several options for the party considering acceptance:
a. The offer can be rejected outright.
b. A change can be made to the offer, known as a counteroffer. This is
essentially a rejection unless accepted by the party making the offer.
c. The offer may expire if not accepted by the offeree within a specified time.
d. The offeror can revoke the offer any time before it is accepted by the
offeree. In that case, the offer no longer exists.
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3. Legally competent parties. The parties entering the contract must be of legal
age and have enough mental capacity to know the potential consequences of
their actions.
4. Consideration. This is something of legal value used as an inducement to
perform (or refrain as the case may be). Adequacy of the consideration is not
the issue.
5. Legal purpose. If the contract involves something unlawful, it is not a valid
contract. Such a contract could still be honored by the parties involved, but
it is unenforceable in the courts. To be valid, a contract must be for a legal
purpose.
F. Enforceability of contracts
The three categories of a contract’s legal status
1. Valid contract is an agreement in which all the elements of a contract are
present and, therefore, legally enforceable.
2. Void contract has no legal effect 6 and cannot be enforced in a court of law.
This may be due to the absence of one or more specific contract elements.
3. Voidable contract is technically valid but gives one or more parties the power
to legally void the agreement and thus cancel performance.
II. Types of Contracts
The primary focus in looking over the various types of contracts is to point out items
that would interest an appraiser and understand how these contracts function.
A. Real estate sale contract
Sale contract. A written document signed by a buyer and a seller who agree
to the transfer of ownership of real property; also called agreement of sale or
earnest money contract.
6.
Black’s Law Dictionary, Abridged 7th Edition, St. Paul: West Group Publishing Company, 2000.
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Part 7 – 109
1. The sale contract serves two functions:
a. It is a receipt for the buyer’s earnest money deposit that is made with the
offer to purchase.
Earnest money. A good faith deposit made by a purchaser as the
consideration component of a binding contract. In real property
transactions, this deposit is frequently applied to the buyer’s down
payment.
b. It becomes the contract of sale once it is executed with the signatures of
the seller (vendor) and buyer (vendee).
2. The essentials of a sale contract that are of interest to appraisers
a. Sale price and terms
ƒ
Financing details and any seller concessions
ƒ
List of personal property included in the sale
b. Contract date and potential closing date
c. Legal description of the land
d. Identification of title and form of deed to be conveyed
e. Contingencies, if any
f.
Seller’s disclosure statement (listing known defects)
g. Signature of all parties to ensure a valid contract
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B. Option contract
Option. A legal contract, typically purchased for a stated consideration, that
permits but does not require the holder of the option (known as the optionee)
to buy, sell, or lease real estate for a stipulated period of time in accordance
with specified terms; a unilateral right to exercise a privilege.
1. An option is in essence an agreement (or contract) to make a contract.
a. To be a valid contract, an option must have all the necessary elements.
b. The parties to an option are the optionor (typically the seller) and the
optionee (typically the buyer).
2. An option is a unilateral contract because it binds one party, and acceptance
of the option is based on performance.
7.1 Example—Option Contract
A municipality is interested in purchasing land for a new baseball
stadium. A developer has land the city believes might be a good
match for this project. An agreement on price is made, but the city
is uncertain if it can get all the other parties together to ratify the
purchase. The city takes an option on the property and pays the
developer an agreed amount to tie up the land for three months. The
purchase price of the land is set, but the municipality does not have
to buy the land. The developer must keep the option available for the
three-month period.
3. A common use of an option is in a lease that includes an option for the
tenant to purchase the property.
4. Options can be contingent upon specified events, such as a zoning change
being approved, the acceptance of a building permit to renovate the property,
or other similar conditions. Once the condition is met, the optionee may be
obligated to exercise the option, depending on how the option was written.
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Part 7 – 111
C. Contract for deed
1. Contracts for deed are also known as land contracts and installment (sale)
contracts.
Contract for deed. A contract in which a purchaser of real estate agrees
to pay a small portion of the purchase price when the contract is signed
and additional sums, at intervals and in amounts specified in the contract,
until the total purchase price is paid and the seller delivers the deed; used
primarily to protect the seller’s interest in the unpaid balance because
default can be exercised more quickly than it could be under a mortgage;
also called land contract or installment (sale) contract.
2. The parties to a contract for deed are the vendor (seller) and the vendee
(buyer).
a. The vendee purchases the property on an installment basis. A specified
amount is paid as the down payment, and then payments are established
to pay off the remaining balance.
b. The period of time for the payments is usually in years, say five or 10
years, but the contract can be shorter or longer in duration. In many
contracts for deed, there is a balloon at the end of the installment term.
This is a lump-sum payoff.
c. The vendor retains the title to the property, and the deed is not conveyed
to the vendee until the full purchase price is paid.
3. The vendee takes possession of the property and has nearly all the rights and
benefits that go with normal ownership. The vendee pays the insurance and
taxes and does all the maintenance on the property.
4. The rights of both parties are assignable, unless stipulated otherwise in the
contract. In other words, the vendee’s rights in the contract can be assumed
by a new purchaser if the property is sold while the contract is in effect. The
vendor may require approval of the new buyer to assure good credit history
and the ability to continue the payments.
5. Contracts for deed are more common in rural and agricultural areas. They
are also more common during times of tight financing. In fact, they may be
attractive to some sellers (essentially acting in the role of a lender) because
they can provide income at a specified interest rate over a specified period of
time. The buyers can also bide their time until lower interest rates arrive and
then refinance the property to pay off the contract for deed.
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6. There is no third-party lender involved, so the interest rate is not set by the
mortgage market (banks, mortgage companies, etc.) but by negotiation
between the buyer and seller. Many times, the negotiated interest rate will
be lower than the market interest rate, which gives the buyer an inducement
to buy the property with this favorable financing over another property
without this advantage. Often, this leads to buyers paying a higher sale price
for the property than others with bank financing would pay, which impacts
the sale price of a comparable sale with this favorable interest rate.
7. In many cases, the seller does not charge the buyer any of the standard
lender closing costs such as points, application fees, underwriting fees, etc.
This can induce a buyer to choose the seller’s property that has favorable
land contract terms.
8. In some instances, buyers for properties with a contract for deed are buying
that specific property because they do not qualify for conventional financing
offered through institutional lenders. This is a considerable inducement to
buy a property that offers a contract for deed and can cause the buyer to
overpay for a property because the buyer doesn’t have many choices.
9. While many people think that the risk associated with this type of financing
is all on the seller (contract holder), there can also be considerable risk for
the buyer if there is already an underlying mortgage on the property. The risk
for the buyer comes from the possibility of default if the buyer makes the
payments to the seller, but the seller does not make the payments to the
mortgage holder(s). Depending on the loan-to-value ratio, the buyer may lose
all that was invested in a case like this.
10. If the appraiser believes the sale price of the comparable sale was impacted
by seller financing included in a contract for deed, the appraiser should
adjust the comparable sale by the amount equal to the impact on the price.
Depending on the definition of value used in the appraisal if this type of
financing is associated with the subject property (rather than a comparable
sale), the appraiser will often ignore the financing since the value of the
subject property is not dependent on the sale price of the subject property,
but instead is dependent on the sale prices of the comparable sales.
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Digging Deeper
7.2 Example
Note: This example uses terms and concepts that will be presented in upcoming
sessions. Part 9 addresses market value and the concepts of cash equivalency
and nonmarket financing. Part 15 addresses math calculations in real estate,
including mortgage calculations. Therefore, use this example of contract for deed
financing as a preliminary introduction that you may wish to revisit after completing
Parts 9 and 15.
The subject property is selling for $400,000 with the seller accepting a fiveyear contract with an interest rate that is 2% under the current mortgage market
rates and a loan-to-value ratio of 90%. The loan is amortized over 30 years with
monthly payments, but there is a lump sum (balloon) payment in 60 months. The
appraiser found six comparable sales that sold with market rate financing. These
sales indicate that the cash equivalent market value of the subject property is
$370,000.
What is the market value of the subject property?
The market value under most definitions in use today would be $370,000, not the
selling price of $400,000. The $400,000 represents the sale price of the subject
property with the inducement given in the contract for deed. It does not represent
what the market would pay for the subject property, assuming a buyer obtains a
conventional mortgage, which is assumed in the defined value.
What is the value of the subject property if the seller gives the buyer a mortgage
that is 4% under market?
What is the market value of the subject property if the seller gives the buyer a
mortgage with 0% interest?
The value of the subject property is $370,000 in all cases, but the price of
the financing will be more or less, depending on the terms. This will be further
addressed in Part 8 when we discuss price versus value.
End Digging Deeper
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III. Leases
Leases are contracts, but we’ve placed them under their own special heading to
emphasize their importance to appraisers. The focus here will be broadly identifying
the different types of leases and their characteristics.
A. Quick review on leasehold and leased fee estates
1. Defining terms
a. Leased fee interest. The ownership interest held by the lessor, which
includes the right to receive the contract rent specified in the lease plus the
reversionary right when the lease expires.
b. Leasehold estate. The right held by the lessee to use and occupy real
estate for a stated term and under the conditions specified in the lease.
2. Leasehold estates may be considered personal property in some states.
There are four types of leasehold estates (from Part 3). Do you recall them?
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Estate for years
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Estate from period to period
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Estate at will
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Estate at sufferance
B. Lease bases
Lease. A contract in which the rights to use and occupy land, space, or
structures are transferred by the owner to another for a specified period of
time in return for a specified rent.
Note. Oral leases exist, but most states require a written lease when the term is greater than one year.
There are two bases used to set up leases.
1. Gross lease A lease in which the landlord receives stipulated rent
and is obligated to pay all of the property’s operating and fixed expenses. When
a landlord pays most, but not all, of the operating expenses, this may be
referred to as a modified gross lease.
2. Net lease A lease in which the landlord passes on all expenses to
the tenant.
Note. It is important for appraisers to be familiar with the local market terms
used to describe leases. In some markets, the term net lease may indicate that
the tenant pays only a portion of the operating expenses. The term absolute net
lease may be used to describe a lease in which the tenant pays all the operating
expenses.
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C. Types of leases
The examples below are a sampling of various types of leases. In the second course
in this series, Basic Appraisal Procedures, we will examine leases in more detail.
1. Flat rental lease A lease with a specified level of rent that
continues throughout the lease term.
2. Graduated rental lease A lease that provides for specified changes in
rent at one or more points during the lease term.
a. Step-up lease. The payments increase at specified intervals.
b. Step-down lease. The payments decrease at specified intervals.
A lease that provides for periodic rent adjustments
3. Revaluation lease
based on the market rental rate of the space. This is sometimes accomplished
through appraisal or arbitration.
4. Index lease A lease, usually for a long term, that provides for
periodic rent adjustments based on the change in an economic index.
5.
Percentage lease A lease in which the rent or some portion of the
rent represents a specified percentage of the volume of business, productivity,
or use achieved by the tenant. This type of lease is most frequently used for
retail properties. A straight percentage lease may have no minimum rent, but
most specify a guaranteed minimum rent and an overage rent.
a. Rents paid in shopping centers and malls are often percentage leases. A
percentage lease can be either a gross or net lease.
b. Overage rent. The percentage rent paid over and above the guaranteed
minimum rent or base rent; calculated as a percentage of sales in excess of
a specified breakpoint sales volume.
6.
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Sandwich lease
A lease in which an intermediate, or sandwich,
leaseholder is the tenant of one party and the landlord of another. (The words
tenant and landlord are substitutions for the words used in The Dictionary of
Real Estate Appraisal.)
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7.
Solar photovoltaic leases or power purchase agreements (PPAs) 7 vary
widely in terms but are generally for 20 years. The leases usually state that
the solar photovoltaic system is personal property and the property owner
is responsible for paying personal property tax (if any). The appraiser must
verify ownership and seek a copy of the lease. Some lease terms may have a
negative impact on the property’s market value.
IV. Deeds
A. The purpose of deeds
1. We’ve used the word title occasionally during the first day. Title has a two-fold
meaning. Let’s start with the basic definition.
Title. The combination of all elements that constitute proof of ownership.
a. If a person has title to real estate, it means he or she has the ownership
rights of the real estate. In other words, the person holds the bundle of
rights that belong with ownership.
b. Title also serves as the evidence of ownership. However, title is not a
printed document that a landowner can show to someone.
7.3 Example—Evidence of Ownership
When a retail store sells a product, it provides a receipt. That piece
of paper is evidence of the purchase that was made. When we
sell personal property, a bill of sale is provided to the buyer for the
same reason. We follow the same process in real estate, but we
use a document called a deed.
2. A deed is a written, legal instrument that conveys an estate or interest in real
property to someone else, assuming it is executed and delivered.
a. The parties in a deed are the grantor and the grantee, and we’ve heard
those terms before, so they should begin to sound like old friends.
7.
A solar power purchase agreement (SPPA) is a financial arrangement in which a third-party developer owns, operates,
and maintains the photovoltaic (PV) system and a host customer agrees to site the system and purchases the
system’s electric output from the solar services provider for a predetermined period. This financial arrangement allows
the host customer to receive stable, and sometimes cheaper, electricity, while the solar services provider or another
party acquires valuable financial benefits such as tax credits and income generated from the sale of electricity to the
host customer. Source: www.epa.gov/greenpower/buygp/solarpower.htm#one
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b. Elements of a deed
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Identification of the parties (i.e., grantor and grantee)
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Grantor who is legally competent
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Words of conveyance (i.e., a granting clause)
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Legal description of the real estate
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Consideration (usually in dollars) received by the grantor
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Executed by means of a written document signed by the grantor
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Delivery by the grantor and acceptance by the grantee
B. Types of deeds
General warranty deed. A covenant of warranty inserted in a deed that binds
the grantor and heirs to defend the title conveyed to the grantee and his or
her heirs against the lawful claims of all persons.
Special warranty deed. A deed of lands containing a covenant whereby
the grantor agrees to protect the grantee against legal claims arising during
the grantor’s period of ownership. If the warranty is against the claims of all
persons, it is a general warranty.
Bargain and sale deed. A deed that conveys real estate from a seller to a
buyer but does not guarantee clear title; used by court officials and fiduciaries
to convey property they hold by force of law, but to which they do not hold title.
It is also used in foreclosure and tax sales. Title insurance is recommended.
Quitclaim deed. A form of conveyance in which any interest the grantor
possesses in the property described in the deed is conveyed to the grantee
without warranty of title. A quitclaim deed offers the least protection to the
buyer. It is often used to clear a defect in the title when someone is thought
to have an interest or right in a particular property.
C. Voluntary and involuntary transfer of title
1. Deeds are used in the voluntary transfer of property title. The owner of the
land can do this through a gift or by selling the property.
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2. Title can also be transferred involuntarily (i.e., without the owner’s consent)
and is usually carried out by the operation of law. We have already looked at
some of these involuntary conveyances.
a. A person dies intestate. The property passes to the decedent’s heirs
according to the laws of the state. If there are no heirs, the property
escheats to the state.
b. Eminent domain. The owner’s land is taken for public use through the
process of condemnation.
c. Liens. The property owner fails to pay the mortgage or property taxes, and
the property is foreclosed to satisfy the debt.
3. There are two additional involuntary transfers of rights to consider.
a. Adverse possession This involuntary transfer of property takes
place when a party makes a property claim by taking possession over
a period of years, and the owner fails to contest the possession. This
type of transfer is allowed because the law recognizes that possession
and use of the land is an essential component of ownership. The time
required to obtain title legally by this process varies from state to state.
There are requirements for this type of land transfer.
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Open (i.e., the possession and use is obvious to everyone).
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Notorious (i.e., others know about it).
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Continuous possession and occupation.
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Hostile (i.e., without the consent of the true landowner).
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Adverse (i.e., to the true owner’s right of possession).
b. Easement by prescription The right to use another’s land, which
is established by exercising this right openly, hostilely, and continuously over
a statutory period of time. The use must be open, notorious, continuous,
exclusive, and without the owner’s permission. In this case, the claimant
gains a legal easement rather than legal title to the land.
A common example of an involuntary transfer is a roadway by prescription.
This type of easement can occur when a public road trespassed on an
individual’s property many years ago and the fee owner did not contest it.
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Review
Part 7
Learning Objectives
Now that you’ve completed Part 7, you should be able to
; Identify the five elements of a valid contract.
; Differentiate between a gross lease and a net lease.
; Identify the four types of deeds by which real property can be legally conveyed.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 23, pp. 418–420, 423–424.
Terms and Concepts to Remember
Adverse possession
Contract
Contract for deed
Deed
Earnest money
Option contract
General warranty deed
Quitclaim deed
Gross lease
Sales contract
Net lease
Title
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Review Quiz
Fill in the missing data to the following questions.
1.
An option agreement is a unilateral type of contract.
2.
The initial payment to bind a sales contract is called earnest money.
3.
Parties to a valid contract must enter the agreement voluntarily to satisfy the
element of consent .
4.
A contract where the seller acts in the role of a lender is called a
deed .
5.
In a gross lease, the tenant pays a fixed rent and the landlord pays
the property’s operating expenses.
6.
In a leased property, the landlord has a leased fee interest.
7.
When a party conveys whatever interest he or she has with no warranties, the type
of conveyance used is called a quitclaim deed .
8.
The involuntary transfer process by which a party takes possession and use of
another’s land over a period of years is known as adverse possession .
9.
The type of deed that provides all of the covenants to warrant title is known as
a general warranty deed .
contract for
10. A tenant has an ice cream shop in a shopping mall and pays $2,000 per month
plus 4% in overage rent based on gross sales after the first $100,000. This is an
example of a percentage lease.
Review quizzes and practice tests are intended to be taken during your personal study
time. Suggested answers are found in the solutions booklet.
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Preview
Part 8
The Nature of Value
Part 8 focuses on valuation aspects of real estate. The concept of value is the cornerstone
of real estate appraisal and thus a critical area to examine. There are several dilemmas
that will likely provoke discussion among participants in the class.
Learning Objectives
To prepare for Part 8, read the following learning objectives and refer to them as you
study this part of the handbook.
† Distinguish among cost, price, and value.
† Identify the four factors that create value.
† Distinguish among use value, investment value, market value of the going concern,
insurable value, assessed value, and fair value.
Learning Tips
Even though Part 8 is less intense than Part 7, there are new terms and concepts to
absorb. Be sure that you understand the differences between cost, price, and value.
In regard to the four factors that influence value, stick with basic concepts and don’t get
overly concerned with the details—concentrate on the big picture. As you study the types
of value, some terms can get confusing. Use key phrases or words to help you recall
certain terms. For example, particular investor is a key phrase linked to investment value.
The most critical type of value for appraisers will be addressed in Part 9.
Digging Deeper
For appraisers, the term value alone can be misleading. Appraisers typically refer to a
particular type of value rather than use the word value on its own.8
2
End Digging Deeper
8.
The Appraisal of Real Estate, 15th ed. (Chicago: Appraisal Institute, 2020), pp. 6, 21 – 22, 47 – 48.
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Part 8.
The Nature of Value
The average person uses the term value in a rather loosely defined way. Real estate
professionals, however, think of value in more precise terms.
I.
Overview of Cost, Price, and Value
A. Fundamentals of cost
8.1 Dilemma
A wealthy corporate executive spent nearly three years building a house at a cost
of $7 million. However, several months before the date of completion, the executive
received a promotion and was transferred out of the area. As part of a transfer
package, the executive’s company needed an appraisal of the property’s value to
measure against the construction cost that was guaranteed to the executive. Since
the residence is new and has never been lived in, the company thought cost and value
should be the same.
What are your thoughts on the company’s position?
Instructor guidance: In the case used as the basis for this dilemma, the
property sold for $2 million after 700 days on the market. The styling of the
house was highly individualistic, and the residence was overimproved in
comparison to surrounding homes. This is a good illustration that cost and
value may differ—perhaps significantly.
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Cost. 1. “The actual or estimated amount required to create, reproduce,
replace, or obtain a property.” (USPAP, Definitions)
2. The total expenditure to develop an improvement.
1. Cost is a fact.
a. It is the amount (in dollars) that is required to create, produce, or obtain
a property.
b. Cost is used by appraisers in relation to production, not exchange.
c. Cost can be an accomplished fact or a current estimate.
2. Cost is identified with the project such as actual construction costs or overall
development cost.
a. Construction cost is identified with structures and improvements.
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Direct (hard) costs are largely comprised of labor and materials, but
other costs such as equipment, site security, and fencing are included.
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Indirect (soft) costs are expenses such as the professional
services of architects and surveyors, costs for building permits,
and costs for insurance.
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Entrepreneurial incentive is a market-derived figure that represents the
amount an entrepreneur expects to receive as his or her contribution.
b. Development cost is identified with the overall project and includes the
construction costs mentioned above, plus acquisition costs and all the
other expenditures required to bring a property into an operating state.
3. Cost is independent of value. However, on some occasions, value might
coincide with cost, which offers important insight into the current economics
in the subject market.
B. Fundamentals of price
Price. “The amount asked, offered, or paid for a property.
“Comment: Once stated, price is a fact, whether it is publicly disclosed or
retained in private. Because of the financial capabilities, motivations, or special
interests of a given buyer or seller, the price paid for a property may or may not
have any relation to the value that might be ascribed to that property by others.”
(USPAP, Definitions)
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1. Price, in a more expanded definition, is the amount asked, or it can be the amount
offered—as well as the amount paid for a property.
2. Price may or may not have any relation to the value attributed to a particular property. Once
stated, price is a historical fact, whether it is publicly disclosed or retained in private.
8.2 Dilemma
Keaton recently purchased a property (land and building) for $150,000. Two independent
appraisers have provided opinions of $150,000 on the property, so in this case price and
value appear to be the same. However, Keaton now intends to sell the property and has
set a firm price of $200,000.
Assuming Keaton made no changes to the property and the market is stable, would anyone
pay the higher price?
Instructor guidance: Possibly, because price is influenced by many factors.
One factor is contract terms. If Keaton’s terms are $0 down at 3% interest
and 40 years to pay, that would be about $716 per month. To compare,
a 25-year mortgage at 7% with $0 down based on $150,000 is $1,060 per month.
A payment difference of $344 per month just might induce a buyer to pay a price
of $200,000, but the value of the property is still $150,000.
C. Fundamentals of value
Value. 1. “The monetary relationship between properties and those who buy, sell, or use
those properties, expressed as an opinion of the worth of a property at a given time.
Comment: In appraisal practice, value will always be qualified - for example, market
value, liquidation value, or investment value.” (USPAP, Definitions).
Also, see SVP, Definitions section.
2. The present worth of the future benefits that accrue to real property ownership
(The Dictionary of Real Estate Appraisal, 7th ed.)
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1. Value is based on the process of exchange. It is created in the dynamics that
take place between those who buy, sell, or use real and personal property.
2. Value is expressed as an economic concept. Therefore, it is not a fact, but
rather an opinion of the worth of a property as of a specified time.
II. Four Factors of Value
There are four interdependent factors that create value. The first two (utility and
scarcity) are supply factors, while desire and effective purchasing power are demand
factors. All of these factors must be present for a property to have value.
A. Utility
Utility. The ability of a product to satisfy a human want, need, or desire.
1. All properties must have utility that satisfies specific needs and desires.
a. Basic shelter for residential properties
b. Ability to generate income for commercial
c. Both of the above apply in farm properties
2. Utility is found in design features called amenities.
Amenity. A tangible or intangible benefit of real estate that enhances its
attractiveness or increases the satisfaction of the user. Natural amenities
may include a pleasant location near water or a scenic view of the
surrounding area; man-made amenities include swimming pools, tennis
courts, community buildings, and other recreational facilities.
3. The influence of utility depends on the characteristics of the property as seen
in the different forms of utility. Examples might include size utility, design
utility, energy efficiency, and location utility. Generally, the greater the utility a
property has, the greater its value.
4. Limitations on utility can impact value in a positive or negative manner. For
example, zoning regulations that might detract from a commercial property
might add value to a residential property. The same can be said about
environmental regulations or deed restrictions. The growing requirement to
report a building’s energy use (benchmarking) may enhance an energy-efficient
property’s value or negatively affect the building that is not energy efficient.
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Digging Deeper
Energy benchmarking. Tracking a building’s energy and water use and using a standard
metric to compare the building’s performance against past performance and to its peers.
These comparisons have been shown to drive energy-efficiency upgrades and increase
occupancy rates and property values. Source. District of Columbia, District Department of
the Environment, https://doee.dc.gov/service/energy-benchmarking
End Digging Deeper
B. Scarcity
Scarcity. The present or anticipated undersupply of an item relative to the
demand for it. Conditions of scarcity contribute to value.
1. If demand is constant, the scarcity of a commodity makes it more valuable.
2. Scarcity and utility are the essential ingredients in creating value, but they
work together. For example, the air we breathe has utility; but without scarcity,
it has no definable economic value.
C. Desire
Desire. A purchaser’s wish for an item to satisfy human needs (e.g., shelter,
clothing, food, companionship) or individual wants beyond essential lifesupport needs.
1. Desire can run the range from basic needs to lavish cravings.
2. An aspect of desire that appraisers need to be mindful of is perception.
How market players perceive the value of a commodity determines to a large
extent its demand.
D. Effective purchasing power
Effective purchasing power. The ability of an individual or group to participate
in a market, i.e., to acquire goods and services with cash or its equivalent.
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1. Unemployment and announced layoffs can affect consumer confidence in the
economy, but purchasing power is directly impacted on the people who lost
their jobs or will soon be unemployed.
2. A better example is to think about what happens to the value of a commodity
such as real estate when interest rates are high.
Supply and demand in perspective
The four factors that influence value operate within the economic principle of
supply and demand. In real estate, supply is the amount of a property type
available for sale or lease at various prices in a given market as of a given
time. We will look at this principle in Part 11.
III. Types of Value
There are various types of value an appraiser might work with for a given assignment.
The appraiser is responsible for identifying the exact definition of value applicable. In
the following discussion, we’re going to look at four in modest detail (market value will
be detailed in Part 9). There are more, but those are beyond the scope of this course.
A. Market value—This critically important value type will be covered extensively in Part 9.
B. Use value—The value a specific property has for a specific use.
1. Use value doesn’t always coincide with the best way to utilize and exploit the
property. For example, use value might be utilized where legislation has been
enacted to preserve farmland, timberland, or other open land spaces that are
located on the fringe of an urban area.
2. Use value may also come into play when appraising limited-market properties
and special-use properties that have relatively few potential purchasers.
Limited-market property examples
a. Large manufacturing plant
b. Research and development property
Special-use property examples
c. Religious facility
d. Museum, library, school e. Hospital, post office
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3. Use value may differ from market value.
4. Use value adds a specific person or firm to the description.
Use value. The value of a property based on a specific use, which may or
may not be the property’s highest and best use. If the specified use is the
property’s highest and best use, use value will be equivalent to market
value. If the specified use is not the property’s highest and best use,
use value will be equivalent to the property’s market value based on the
hypothetical condition that the only possible use is the specified use.
C. Investment value. The value of a property to a particular investor or class of
investors based on the investor’s specific requirements.
ƒ
Investment value is different than market value since it is not based on
what the typical purchaser pays in the marketplace. Investment value
is specific to the investor, whereas market value is impersonal and
detached.
D. Market value of the going concern. The market value of an established and
operating business including the real property, personal property, financial assets,
and the intangible assets of the business.
E. Insurable value. A type of value for insurance purposes.
1. Insurable value is based on the cost of physical items subject to loss.
2. Generally, insurable value is based on the building improvements, not the site
or land.
F. Assessed value. The value of a property according to the tax rolls in ad valorem
taxation.
1. Assessed values may differ from an assessor’s estimate of market value and
there are several reasons for this:
a. The assessed value might be based on an assessment ratio applied to
the assessor’s estimate of market value.
b. Assessed values can include partial exemptions such as homestead or
agricultural concessions.
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2. Assessed values are applied in ad valorem taxation and refer to the value of
the property according to the tax rolls.
8.3 Dilemma
Two residential properties in an assessor’s tax district are located on the same street
and are very similar. However, one property has been maintained impeccably by its
owner, and the other is unkempt with obvious signs of neglect by its owner.
Should the assessor set the values on these properties the same, or should they reflect
their respective conditions?
Instructor guidance: This is a tough question because the assessor does not
want to penalize an owner’s property with higher taxes simply because the
owner maintains the property. However, condition is part of a property’s
value, and the assessor is obligated to reflect any market difference,
including condition, in the valuation.
G. Fair value. In 2007, the Financial Accounting Standards Board (FASB) defined fair
value as “the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date.” For more information, see pages 51–52 of The Appraisal of Real Estate,
15th edition, published by the Appraisal Institute.
H. There are other specialized value types used in the real estate industry such as
liquidation value, agricultural use value (a value based solely on the property’s
agricultural productivity), and across the fence value (used in the valuation of
corridors)—and these are just a few examples.
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Review
Part 8
Learning Objectives
Now that you’ve completed Part 8, you should be able to
; Distinguish among cost, price, and value.
; Identify the four factors that create value.
; Distinguish among use value, investment value, market value of the going concern,
insurable value, assessed value, and fair value.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 3, pp. 15–22, and Chapter 6, pp. 48–55.
Terms and Concepts to Remember
Assessed value
Insurable value
Use value
Cost
Investment value
Utility
Desire
Market value of the going
concern
Value
Effective purchasing power
Fair value
Price
Scarcity
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Review Quiz
Fill in the missing data to the following questions.
1.
The value based on ad valorem tax rolls is called assessed value.
2.
Value is an opinion of the worth of a property as of a specified time.
3.
A tangible benefit of real estate that enhances its attractiveness or increases the
satisfaction of the user, but is not essential to use is called an amenity .
4.
Once stated, price is a historical fact.
5.
When interest rates rise and unemployment is high, it may affect a factor of value
called effective purchasing power.
6.
A hospital is classified as a special-use property for valuation purposes.
7.
Investment value is the value of an investment to a particular investor.
8.
An appraiser estimates the insurable value in the event there is a
catastrophic loss such as from a fire or flood.
9.
The market value of a business property including the real property and intangible
assets is called market value of the going-concern .
10. Development costs are identified with the overall project and include all
the expenditures required to bring a property into an operating state.
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Preview
Part 9
Market Value
With the fundamentals of value now established, we can focus on the most critical type
of value to appraisers. We have some basic math that you will have to work out when we
discuss cash equivalency and seller concessions, so have your calculator ready.
Learning Objectives
To prepare for Part 9, read the following learning objectives and refer to them as you
study this part of the handbook.
† Recognize the major components that appear in all definitions of market value.
† Recognize definitions and concepts of effective date, cash equivalency, seller-paid
points, arm’s length transaction, exposure time, and marketing time.
Learning Tips
Part 9 covers topics that go right to the heart of what an appraiser does. You will use
your calculator to solve a problem involving seller concessions, and your instructor will
walk you through the calculations step-by-step for that particular problem.
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Part 9.
Market Value
Now that we understand something about the nature of value, we want to look more closely
at the value type that carries the most significance to the appraiser—market value.
I.
Market Value Fundamentals
Various definitions of market value have been developed by professional organizations
and government agencies. Appraisers must ensure that the definition of market value
used in a specific assignment is appropriate for the intended use.
A. Market value is the dominant type of value sought in virtually every aspect of the
real estate industry.
Market value. “A type of value, stated as an opinion, that presumes the
transfer of a property (i.e., a right of ownership or a bundle of such rights), as
of a certain date, under specific conditions set forth in the value definition that
is identified by the appraiser as applicable in an appraisal.
“Comment: Appraisers are cautioned to identify the exact definition of market
value, and its authority, applicable in each appraisal completed for the
purpose of market value.” (USPAP, Definitions)
1. Market value is based upon the economic concept of exchange value.
a. This presumes the transfer of property rights (i.e., the rights of ownership
or the bundle of rights as discussed earlier).
b. The rights conveyed are not identified in the market value definition itself,
but the appraiser must identify the ownership rights in the appraisal. In
appraisal forms used by financial institutions, the identification of the
property rights appraised is accomplished by the appraiser indicating with
a checkmark on the form:  fee simple or  leasehold.
In complex properties that involve partial or fractional interests, the
appraiser must carefully identify and disclose the ownership rights.
2. Market value is a stated opinion.
a. The preferred phrase in use today is value opinion when referring to an
appraiser’s conclusion.
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b. Terms such as value estimate (or estimate of value) have waned in their
use, at least in connection to market value.
ƒ
The word estimate is still used in reference to cost, rents,
capitalization rates, and other components of the valuation
process. Today, the term value estimate is more frequently found
in ad valorem tax assessment and mass appraisal methodology,
particularly in reference to statistical analyses.
B. The components of market value are listed below. The various market value
definitions have similar wording.
1. Market value is expressed as the most probable price. These words
must be present in order to define market value. This phrase, however, is
actually quite recent. The previous wording was the highest price paid, which
was the standard used by lending institutions until the mid-1980s.
specified
date. The appraiser’s report will refer to this
2. As of a
component as the effective date of the appraisal.
a. The effective date is simply the date of the value opinion.
b. Effective date can be expressed in one of three ways: 1) Retrospective
(past), 2) Current (present), or 3) Prospective (future).
3. In cash, or terms equivalent to cash or in other precisely revealed
terms (to the seller).
Cash equivalency analysis. An analytical process in which the sale
price of a transaction with atypical financing or financing with unusual
conditions or incentives is converted into a price equivalent or consistent
with what a cash buyer would pay with all other factors the same.
The above definition is focused on comparable sale properties that include
financial arrangements assisted by the seller of the property (or a party that
is not the buyer). Such arranged financing terms have the potential to inflate
a contract selling price so that it no longer reflects market value as defined.
The following discussion looks at non-market financing terms and seller
concessions that can overstate contract prices of comparable properties.
First, let’s define what appraisers mean when they use the term comparables.
Comparables. A shortened term for similar property sales, rentals, or
operating expenses used for comparison in the valuation process.
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A Closer Look at Cash Equivalency
In the valuation process, appraisers investigate the sale prices of
comparable properties to learn if they sold with concessions and nonmarket financing terms to determine if they had any influence on the sale
price that would affect the analysis of the opinion of value for the subject
property. Appraisers often use the term “concessions” in a broad sense
to include non-market financing terms and a variety of seller incentives
and inducements that can give sellers a competitive edge.
Concessions. A concession is a financial payment, special benefit, or
non-realty item included in the sale contract or rental agreement as an
incentive to the sale or lease. Concessions occur when the seller or
lessor agrees to pay an inducement or to give some credit or property to
a buyer or lessee, who in turn agrees to pay a higher price than the seller
or lessor would normally receive for the property. Concessions usually
result in artificially inflated sale prices or lease rates.
Seller concessions may include:
ƒ Personal property (such as furniture, fixtures, and equipment)
ƒ Gift inducements and cash rebates (cruise tickets, a free month’s
rent, a landlord covering the moving costs of a new tenant)
ƒ Mortgage buydowns (i.e., when a seller pays discount points
on the buyer’s mortgage to lower the monthly payment. This is
sometimes referred to as a mortgage interest buydown even
though the buyer’s mortgage interest rate is not changed. The
“buydown” simply reduces the mortgage amount).
ƒ Seller paying closing costs that are normally paid by the buyer
ƒ Non-market transactions on the side between buyer and seller
(such as the seller paying an inflated price for a personal property
item of the buyer and the proceeds are then used in the buyer’s
equity down payment)
Financing terms. These are also categorized as concessions but are
specific to financing the sale. Non-market financing terms may include:
ƒ An existing mortgage at a favorable interest rate that is assumed
by the purchaser
ƒ Wraparound loans and loans with below-market or a blended
interest rate provided to the purchaser
The above examples offer a glimpse of the various concessions that
appraisers must watch for when analyzing market data.
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a. In developing an opinion of market value for the appraised property, an
appraiser must take into consideration the effect of any sale concessions
found in the selected comparable sales.
Remember that seller concessions and non-market financial terms
often induce the buyer to pay a higher price for a property. Adjusting
the comparable sales for cash equivalency brings them in line to reflect
market terms and conditions.
Adjusting sales for cash equivalency
ƒ
The sale price of a comparable sale is adjusted by the full amount
that a seller concession affected the price. The adjusted sale price
must reflect the price the property would have sold for without any
sale concessions, special inducements, creative financing, or other
incentives.
ƒ
The amount of the adjustment for concessions is not necessarily a
dollar-for-dollar calculation. Instead, it must reflect the adjustment
necessary to convert the price paid to a cash equivalent sale price
that reflects market value as defined.
—
In the case of a comparable sale with seller financing at a
discounted rate (such as in a contract for deed), the amount
of the adjustment can vary significantly, depending upon
how long the holding period is assumed to be or if the lower
closing costs are considered (see 7.2 Example in Part 7).
That is why these adjustments are not simple mathematical
calculations.
—
In the case of seller-paid closing costs or other monetary
rebates, it is often the case that the seller adds these costs
to the cash price that the seller is willing to accept.
b. Adjustments for cash equivalency are made to the comparable sales—not
to the subject property.
ƒ
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Concessions disclosed in the sale agreement of the subject property
are used for informational purposes. This can alert the appraiser
that the subject property’s sale may not reflect market conditions
or that the price is in some way inflated by the concessions. If the
subject sale is consummated and used as a comparable sale,
adjustments for the concessions need to be made to the sale price.
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ƒ
Seller-paid points are a common concession that appraisers adjust
for when analyzing comparable sales. These discount points are
intended to buy down the buyer’s mortgage amount and lower the
monthly payment. When paid by the seller, the expense is typically
added to the sale price in order to offset the dollar amount of the
concession. If an appraiser does not make adjustments to the
sale prices of the comparable sales for the price of the seller-paid
points, these extra expenses to the seller may readily inflate the
value indication of the appraised property.
ƒ
Buyer-paid points do not qualify as a concession requiring
adjustment by the appraiser because the sale price is unaffected.
Buyers may pay these points regardless of which property they buy,
and thus the seller does not have extra financing costs to recover.
Remember, a cash buyer does not have to pay any financing
expenses.
Discount points. A percentage of the loan amount that a
lender charges a borrower for making a loan; may represent a
payment for services rendered in issuing a loan or additional
interest to the lender payable in advance; also called points.
Each discount point is 1% of the original loan amount.
ƒ
One discount point equals 1% of the mortgage amount. If a seller
agrees to pay 3 points on a $350,000 property and the contract
terms specify the buyer’s mortgage to be $280,000, then the dollar
amount for the points is $8,400 ($280,000 × 0.03 = $8,400).
ƒ
If a seller agrees to pay $10,000 in points on a $200,000
property and the contract terms specify the buyer’s mortgage
to be $160,000, then the seller paid 6.25 points ($10,000 /
$160,000 = 0.0625, or 6.25%).
ƒ
In the above example with the $160,000 mortgage, the seller’s
contribution reduced the buyer’s mortgage by $10,000 (a mortgage
buydown). Therefore, if the lending interest rate is 5% and the loan
term is 25 years, the buyer’s monthly payment is lowered by nearly
$60. This amount may enable the buyer to qualify for the mortgage
that is needed to purchase the seller’s property.
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9.1 Dilemma
Halvorson is performing an appraisal assignment and has learned the following
information about a comparable property she wants to use in her appraisal:
The property sold during a tight credit market and high interest rates. At the time of
sale, the seller agreed to pay 6 points to buy down the buyer’s mortgage in order to
obtain the desired price. The buyer paid $250,000 and applied for an 80% mortgage.
How should Halvorson analyze the concessions?
Instructor guidance: Use this dilemma to teach the class how points are
analyzed. Show and explain each step of the process. Be aware that new
concepts (i.e., substitution and comparability of sales) are presented to the
class here, so take time to explain everything.
1) $250,000 sale price × 0.80 LTV = $200,000 mortgage
2) Seller-paid points: $200,000 × 0.06 = $12,000 mortgage buydown
3) $250,000 sale less $12,000 = $238,000 cash equivalent price
The appraiser should further analyze the market to ensure that the cash
equivalent price of $238,000 reflects what similar properties sell for
without seller concessions. Remember, seller concessions may impact the sale
price but not the value.
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Digging Deeper
Halverson is performing an appraisal assignment and has learned the following information
about a comparable property she wants to use in her appraisal. The property is new
construction with a LEED Silver Rating, which is a green rating awarded by USGBC. The
buyer received a $1,500 personal tax credit from the federal government for building
energy-efficiency construction and a $3,000 rebate from the utility company for energyefficient features and mechanicals installed. The rebate does not cover 100% of the cost of
the features. How should Halvorson analyze the rebates and tax credits the buyer received?
In this case, the appraiser should not consider the rebate or personal tax credit as a
concession in the sales comparison approach for the following reasons:
ƒ The rebate was not given by the seller and did not influence the sale price of
the property. The rebate offset only the gross cost. (When appraising this green
property, the appraiser would apply the rebate in the cost approach only with full
disclaimer of the rebate.)
ƒ Tax credits are individual to the buyer, not to the real estate, and should not be
considered in market value. Market value applies to the real estate, not to the
owner’s tax position.
ƒ Rebates are typically for short periods and for new construction or new replacement
features only. In this case, the seller did not offer a rebate to inflate the price of the
property. Instead, a third party, the utility company, offered the rebate.
Seller concessions that should be analyzed in the sales comparison approach when
using the sale as a comparable sale are those amounts paid by the seller that impact the
sale price. For example, a seller paid $5,000 toward the buyer’s closing costs, resulting
in a higher sale price. This sale required a concession adjustment because it inflated
the sale price and was given by the seller.9 Many times, concessions provide financing
options that are not otherwise available. Concessions may be revealed as part of the
contract, but often they are not.
This question distinguishes between a concession requiring a sales comparison
adjustment and a concession that is not a sales comparison adjustment. The growing
trend of green and high-performance properties has increased the availability of
concessions (incentives) and tax credits.
End Digging Deeper
9.
The word concession is defined in Part 9 under I.3.b A Closer Look at Cash Equivalency. For more information about
green building, see the courses listed under resources on the review page.
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4. The next component in defining market value is reasonable exposure in a competitive market under all conditions requisite to a fair sale.
5. Buyer and seller each acting
a. Prudently
b. Knowledgeably
c. For self-interest
d. Unaffected by undue stimulus
6. Self-test – combine all the components of market value—The following
definition is taken from The Appraisal of Real Estate, 15th ed., p. 48.
Market value is the most probable price, as of a
specified date, in cash, or in terms equivalent to
cash, or in other precisely revealed terms, for which the specified property
rights should sell after reasonable exposure in a competitive
market under all conditions requisite to a fair sale, with the buyer and seller
each acting prudently,
knowledgeably
and for self-interest, and
assuming that neither is under undue
duress.
C. An example of a market value definition used by agencies that regulate federally
insured financial institutions in the United States.
“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 is the consummation of a sale as of a specified
date and the passing of title from seller to buyer under conditions whereby:
ƒ Buyer and seller are typically motivated;
ƒ Both parties are well informed or well advised, and acting in what they
consider their best interests;
ƒ A reasonable time is allowed for exposure in the open market;
ƒ Payment is made in terms of cash in U.S. dollars or in terms of financial
arrangements comparable thereto; and
ƒ 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.”10
10. 12 C.F.R. Part 34.42(g); 55 Federal Register 34696, August 24, 1990, as amended at 57 Federal Register 12202,
April 9, 1992; 59 Federal Register 29499, June 7, 1994.
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II. Market Value in Appraisal Practice
Now that we have a basic understanding of market value, let’s turn our attention to
some issues related to market value and also practice our problem-solving skills.
A. Prior definitions of market value (that are no longer used) generally assumed a
sale was between unrelated parties under no duress. This was called an arm’slength transaction. Current definitions do not directly address the issue of
unrelated parties although it may be implicit in the definition. Nonetheless, some
government agencies and clients use the term arm’s-length transaction in their
policy guidelines, so you should be aware of the term.
B. When exposure time is a component of the definition for the value opinion being
developed in an assignment, the appraiser must also develop an opinion of
reasonable exposure time connected to that value opinion.
1. Exposure time is the time a property was available for sale in the market and
always presumes to occur prior to the effective date of the appraisal. The
concept of reasonable exposure includes not only sufficient and reasonable
time but also reasonable effort to sell the property.
2. Exposure time will differ depending on the real estate’s property type, value
range, and market conditions. The following are some examples that might
not meet the definition of market value:
a. Liquidation, forced sale (sheriff’s auction)
b. Excessive or limited time on the market
3. Marketing time is an opinion of the amount of time it might take to sell a real
or personal property interest at the concluded market value level during the
period immediately after the effective date of an appraisal.
Past
Exposure time
Marketing time
Future
Effective Date
of Appraisal
Note. USPAP provides guidance on these two topics in the form of Advisory
Opinions, specifically Advisory Opinion 7 (AO-7), Subject: Marketing Time
Opinions, and Advisory Opinion 35 (AO-35), Subject: Reasonable Exposure
Time in Real Property and Personal Property Opinions of Value. Appraisal
Institute Guide Note 14: Concept of Exposure Time also provides guidance.
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9.2 Discussion Question. In the Real World
1. Ackerson is working on an assignment of a newly built property and is
having difficulty finding comparable sales. After extensive research in the
property database at the county offices, Ackerson discovered four sales
of newly built homes. After further checking, it turned out that all four sales were
individually custom-built for the buyer and never offered on the open market.
Is it acceptable for Ackerson to use these sales in a market value appraisal?
Instructor guidance: Generally, no. The sales reflect the cost and price
between buyers and builders, but the properties were never offered on the
general market for a reasonable period of time. They should be considered
but not as primary market sales.
2. Whitney is working on an appraisal of a condominium unit located in an economically
distressed area. The research reveals that all comparable properties in the area are
foreclosure sales.
Is it appropriate for the appraiser to use these sales if market value is being sought?
Instructor guidance: Typically not appropriate. If the market is comprised
primarily of foreclosed properties, the appraisal should include non-forced
sales—even if those sales are located outside the immediate area.
3. Armstrong was asked to perform a retrospective appraisal using a date 3 years
prior to the date of the report. Armstrong used sales that sold and closed after the
effective date identified in her appraisal.
Can she use these sales in an appraisal assignment involving market value?
Instructor guidance: Yes, but she must also include sales that sold before
the effective date to ensure that the assignment results are not misleading.
“Misleading” is defined in USPAP as “intentionally or unintentionally
misrepresenting, misstating, or concealing relevant facts or conclusions.”
Note: This problem was based on a FAQ included with The Appraisal
Foundation’s USPAP document.
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Review
Part 9
Learning Objectives
Now that you’ve completed Part 9, you should be able to
; Recognize the major components that must be in all definitions of market value.
; Recognize definitions and concepts of effective date, cash equivalency, seller-paid
points, arm’s length transaction, exposure time, and marketing time.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 6, pp. 48–50, and Chapter 21,
pp. 380–385.
Terms and Concepts to Remember
Arm’s-length transaction
Exchange value
Most probable price
Cash equivalency
Exposure time
Concessions
Incentives
Seller-paid points
(or discount points)
Effective date
Marketing time
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Digging Deeper
Below is a comment on sales concessions connected to the definition of market value in
the appraisal form used by Fannie Mae, Freddie Mac, HUD, and VA.
*Adjustments to the comparables must be made for special or creative financing or
sales concessions. No adjustments are necessary for those costs that are normally
paid by sellers as a result of tradition or law in a market area; these costs are readily
identifiable since the seller pays these costs in virtually all sales transactions.
Special or creative financing adjustments can be made to the comparable property
by comparisons to financing terms offered by a third party institutional lender that
is not already involved in the property or transaction. Any adjustment should not be
calculated on a mechanical dollar for dollar cost of the financing or concession, but
the dollar amount of any adjustment should approximate the market’s reaction to the
financing or concessions based on the appraiser’s judgment.
End Digging Deeper
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Practice Test
Section 3
This multiple-choice test is for your benefit and provides a review of
everything covered in Section 3. This is a closed-book test. Choose
the most correct answer.
1.
A typical option contract to purchase real property binds which of the following?
A.
both buyer and seller
B.
neither buyer nor seller
C.
only the buyer
*
D.
only the seller
2.
The total dollar expenditure to develop an improvement is called
*
A.
cost.
B.
going-concern.
C.
price.
D.
use value.
3.
*
An increase in demand will typically affect a commodity in what way?
A.
a decrease in price
B.
an increase in market exposure time
C.
an increase in price
D.
an increase in supply
4.
An agreement that is presumed to exist because of the parties’ actions is called
an implied contract. In contrast, an agreement that is put into words (spoken or
written) is what type of contract?
*
A.
express contract
B.
forbearance contract
C.
legal purpose contract
D.
unilateral contract
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5.
Jensen has a sale contract on a property, but it does not state the legal
description, and it is not signed by the seller. The contract is
A.
implied
B.
unilateral
C.
valid
*
D.
void
6.
The value according to tax rolls in ad valorem taxation is called
*
A.
assessed value
B.
insurable value
C.
investment value
D.
liquidation value
7.
*
8.
*
9.
*
A portion of the purchase price given to bind the transaction is known as
A.
a guarantee certificate
B.
a purchase receipt
C.
earnest money
D.
trust funds
Warner is a tenant and pays a fixed rent, while his landlord pays all of the
operating expenses and real estate taxes. What type of lease is this?
A.
double net
B.
gross
C.
net
D.
sandwich
If demand is constant for a particular commodity, what factor of value would make
the commodity more valuable?
A.
desire
B.
effective demand
C.
scarcity
D.
utility
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10.
*
Jill sold her property interest to her sister Joanna, involving land they jointly
owned. Years later, Joanna decided to sell the land, but the buyer wanted
assurance that Jill had no rights to the property. What type of deed would Jill
provide in this situation?
A.
bargain and sale deed
B.
general warranty deed
C.
quitclaim deed
D.
special warrant deed
11.
The value of an investment property to one particular investor is called
*
A.
investment value
B.
market value
C.
market value of a going concern
D.
use value
12.
Rita purchased a timeshare property that included a one-week expense-paid trip
to the Cayman Islands as an inducement to buy the property. The trip was valued
at $3,000. If the property sold for $28,000, what is a reasonable cash equivalent
price for the property?
*
A.
$25,000
B.
$28,000
C.
$31,000
D.
none of the above
13.
*
The type of deed that provides the greatest warranty against lawful claims is a
A.
deed of trust
B.
general warranty deed
C.
special warranty deed
D.
title insurance certificate
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14.
A sale that takes place between unrelated parties is considered to be what kind of
transaction?
*
A.
arm’s-length
B.
cash equivalent
C.
reasonable exchange
D.
self-interest
Review quizzes and practice tests are intended to be taken during your personal study
time. Suggested answers are found in the solutions booklet.
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Section 4
4
Part 10.
Influences on Real Estate Values
Part 11.
Economic Principles
Part 12.
Applied Economics in Real Estate
Part 10
Preview
Influences on Real Estate Values
Part 10 provides ample opportunities for you to get involved in discussing influences that
you can observe in your market area. The class will start out by looking at the roots of
value in real estate. The remaining time is dedicated to the four forces that influence real
estate values.
Learning Objectives
To prepare for Part 10, read the following learning objectives, and refer to them as you
study this part of the handbook.
† Identify the four factors of production.
† Identify the four broad forces that influence value.
† Recognize particular examples of the operation of these four forces.
Learning Tips
Part 10 covers eight major components—the four factors of production and the four
forces that influence real estate values. There are a number of real estate principles that
come in sets of four, which can be confusing when you are seeking to remember various
terms and their associations. Knowing the concepts behind the surface terminology will
help lessen the confusion.
There are several group discussion projects, which provide a lot of time for you to interact
and share your observations of what you think influences value in the real estate market.
There is ample space in your handbook to write down notes, but these will come primarily
from class discussions rather than from information on the display screen.
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Part 10.
Influences on Real Estate Values
Market value is measured through an exchange process, but where does value in real
estate originate? Let’s answer that question first, and then we’ll look at the forces that
influence real estate values.
I.
Factors of Production
A. Overview of the economic concept
1. The production of goods, services, and income
depends on the combined effects of four essential
economic ingredients, commonly referred to as the
four factors of production.
a. Land
b. Labor
c. Capital
d. Entrepreneurial coordination
2. Definition
Factors of production. Land, labor, capital and entrepreneurial
coordination. (Also known as agents of production).
B. Appraisers need to see the relationship of cost to the four factors of production.
1. Market value is based on an exchange process, but before exchange can
be measured, real estate has already begun a process of assuming value
in connection to its development costs. These are the costs that bring real
estate into an operating state or condition, so let’s examine the factors that
give real estate its initial value.
a. The first factor is land. The cost of acquiring raw land begins the process
of adding value to the real estate. How the land is improved and utilized
can further add to its value—beyond the cost of acquisition or the cost of
the improvements made to the land.
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b. The second factor is labor. In our previous discussion of cost, we
found there were two categories: cost of construction and cost of
overall development. Labor is really the cost (both direct and indirect)
to construct market improvements on a site. Labor includes project
coordination and supervision.
c. The third factor is capital. Real estate development requires physical
capital such as equipment (machinery and tools), and buildings and
infrastructure (that is, capital goods) that can produce other goods.
d. The fourth factor is entrepreneurial coordination. The costs associated
with the entrepreneur’s ability to combine land, labor, and capital in a real
property development project. This is the investment of time, expertise,
and equity by the entrepreneur (or developer) in the project.
2. In a real estate project, the four factors of production combine to create
value in the property. The value is based on a developer’s interest to recoup
the cost of the investment plus make a profit on the project. Appraisers
recognize that market value has its basis in these four agents of production.
However, other forces can influence this value that is largely based on
development costs.
II. Four Forces that Influence Value
We want to take another look at the perspectives that characterize land rights—but
with a view toward the influence they have on real estate value.
A. Overview of the four forces
1. Governmental and legal—involves controls and regulations.
2. Economic—pertains to the circumstances and trends that affect supply
and demand.
3. Social—focuses on the changes in demographics, social trends, and
attitudes.
4. Environmental and geographic—involves the environmental surroundings,
both natural and man-made.
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10.1 Discussion Question. Value Influences – Governmental
Break into groups of four to eight people to discuss the various types of
governmental and legal influences that you see in the area where you live
that might have a measurable influence on real estate values. See how
many different types of laws, regulations, and policies that your group can
come up with. We will then regroup to discuss your findings with the whole class.
Instructor guidance (suggestions)

Rent controls
ƒ
Homestead exemption laws

Financing legislation
ƒ
Conservation initiatives (zoning)

Environmental legislation
ƒ
Agricultural policies (subsidies)

Police, fire, utilities
ƒ
Business taxes on sales and use

ƒ
Sign use control

Zoning and building codes
ƒ
Federal mandates to reduce energy use

Renaissance zone
ƒ
Tax credits for energy efficiency

Master (comprehensive) plans
Health codes
B. Governmental and legal forces
1. Political and legal activities at all levels of government can have a significant
impact on property values.
a. The legal climate (at a particular time or place) may overshadow the
natural market forces of supply and demand.
b. The government provides many of the necessary facilities and services
that affect land use patterns.
2. Appraisers identify and consider numerous governmental forces that can
influence property values.
a. Public services such as fire, police protection, utilities, refuse collection,
and transportation networks
b. Local zoning ordinances, building codes, and health codes—particularly
those that influence (positively or negatively) land use
c. National, state, and local fiscal policies
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C. Economic forces
1. What types of economic forces can you observe at the national and global
levels that influence real estate values?
ƒ
Price levels for crude oil (can affect demand for energy-efficient
and green sustainable construction)
ƒ
National debt and trade deficit/consumer confidence
ƒ
Terrorist activities (affecting travel industry)
ƒ
Tariffs and embargoes
ƒ
Competition with EU and Asian markets (that is, China)
ƒ
Foreign competition in agricultural products
2. What types of economic influences can you observe at the state and local
levels that impact real estate values?
ƒ
Cost and availability of credit
ƒ
Taxes
ƒ
Housing availability
ƒ
Employment and wage levels (housing affordability)
ƒ
Welfare
ƒ
Health care availability and health costs
3. To measure the influence of economic forces on real estate values, appraisers
examine the relationships between current (and anticipated) supply and demand.
a. A market area might experience heavy demand during a booming
economic period that drives up rents and prices on housing. The demand
can exert tremendous influence on how projects are carried out as far as
timing and breadth.
b. When the same market goes bust (for example, the dot-com industry),
the demand drops, and an oversupply of existing housing contributes to
lower values.
4. Economic forces are closely tied to employment and wages, but there are
many more forces that can exert pressure on real estate values.
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D. Social forces
10.2 Discussion Question. Value Influences – Social Trends
Break up into the same groups to consider and discuss the social trends
that you see taking place that are influencing values. Let’s divide the trends
into three categories—residential, commercial, and agricultural.
Residential
ƒ
Move toward more energy-efficient housing (tighter construction)
ƒ
Move toward green or high performance-rated homes
ƒ
Tight clustering of housing surrounded by large open natural areas
ƒ
Whirlpool tubs, microwaves, and home entertainment systems
ƒ
Disappearance of living room and dining room in new construction
ƒ
Home offices
Commercial
ƒ
Coffee shops (Starbucks replaces corner grocery store)
ƒ
Grocery and fast-food restaurants located in gas service stations
ƒ
Old buildings (warehouses) that transition to high-density residential
(lofts, etc.) and also convert into high-end entertainment centers
ƒ
Hyper stores such as Super Wal-Mart and Home Depot
Agricultural
ƒ
Trend toward more business ownership rather than family farms
ƒ
Leasebacks for recreational uses (hunting retreats, etc.)
ƒ
Organic farming, hobby farms, and farmer’s market
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1. Appraisers keep track of social forces largely as these forces relate to
population characteristics. This includes demographic data on age, gender,
and the rate of household formation and dissolution.
2. Social forces are seen in shifting attitudes and lifestyle options. Social trends
are interesting to observe, such as the coffee shop phenomena.
E. Environmental and geographic forces
1. Environmental and geographic issues that affect real estate
a. The Leadership in Energy and Environmental Design (LEED) Green
Building Rating System encourages global adoption of sustainable
green building and development practices through the creation and
implementation of universally understood and accepted tools and
performance criteria.
b. Hazardous substances within commercial and residential structures
ƒ
Lead (for example, in lead-based paint) and asbestos
ƒ
Radon
ƒ
Indoor air quality (IAQ) and mold issues
ƒ
Carbon monoxide (CO), backdrafting furnaces
ƒ
Electromagnetic fields (EMF) stray voltage (dairy farms)
ƒ
Polychlorinated biphenyls (PCBs)
ƒ
c. Hazardous substances in the surrounding environment
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ƒ
Leaking underground storage tanks
ƒ
Landfills and groundwater contamination ƒ
Old industrial sites
ƒ
Nuclear waste storage
ƒ
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2. Environmental laws and regulations that affect real estate
a. CERCLA—known as the Superfund law
ƒ
CERCLA stands for the Comprehensive Environmental Response,
Compensation, and Liability Act (enacted in 1980).
ƒ
The landowner of record had a potential liability when a release of
hazardous materials occurred on the property even if the owner did
not cause or was not responsible for the contamination.
ƒ
In 2002, the Small Business Liability Relief and Brownfields
Revitalization Act was signed into law and expanded the
Environmental Protection Agency’s (EPA) Brownfields Program. The
law also clarified Superfund liability for prospective purchasers,
innocent landowners, and contiguous property owners.
b. State and local laws place controls on businesses that produce, sell,
store, and transport hazardous materials.
3. Geographic issues that influence value
a. Climate conditions such as snowfall, rainfall, temperature, and humidity,
plus issues such as earthquakes and hurricanes
b. Topography (natural and man-made barriers) and soil conditions
c. Natural features of the surrounding area that create desirability
d. Natural barriers to future development such as rivers, mountains, lakes,
and oceans
e. Primary transportation systems, including federal and state highway
systems, railroads, rapid transit systems, and navigable waterways
f.
Linkages. Appraisers often consider the influence of various distance
factors. For example, the distance (in time and cost) to schools, public
transportation, employment and business centers, shopping, recreational
and cultural facilities, and religious centers have a significant influence on
real estate values. These relationships are called linkages. Many green
certifying organizations provide points for buildings with a high Walk Score
(proximity to services, amenities, and employment). For more information
on Walk Score, transit score, and bike score, visit www.walkscore.com.
F. The appraiser monitors and analyzes the four forces that influence value through a
number of economic principles that we will examine in Part 11.
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Review
Part 10
Learning Objectives
Now that you’ve completed Part 10, you should be able to
; Identify the four factors of production.
; Identify the four broad forces that influence value.
; Recognize particular examples of the operation of these four forces.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 3, pp. 18–19, Chapter 11, pp. 142–147,
Chapter 12, pp. 184–191, and Chapter 13, pp. 206–207, 212–213.
Terms and Concepts to Remember
Capital
Factors of production
Land
Economic forces
Governmental and
legal forces
Linkages
Entrepreneurial coordination
Environmental and geographic
forces
Labor
Social forces
Superfund law
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Review Quiz
Write a number on the line opposite each item below to indicate whether the item is
best described as
1. Governmental and legal
2. Economic
3. Social
4. Environmental and geographic
3
A sunbelt city has a growing population of senior citizens.
2
Stock market averages drop 40% of their value over a one-year period.
4
The lack of snow in the last five years hurt several industries in the upper
Midwest such as makers of snowmobiles, snow blowers, etc.
1 To conserve natural resources, a city makes it easier for developers to get
plans approved for clustered developments.
2 Higher gas prices cause housing prices and rents to increase near the
business centers of the city.
3
Two-bedroom homes are in greater demand due to smaller families.
2 The changing work environment causes home offices to increase in
popularity.
4
Couple decides against buying a property due to proximity to a landfill.
3 Couple weighs two locations and decides to purchase a particular property
because the area has high-speed Internet access.
4
Part 10 – 164
New interstate freeway creates a barrier dividing an existing neighborhood.
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Part 11
Preview
Economic Principles
Part 11 will take you through the economic appraisal principles that you will use every day
for the rest of your career as a valuation professional. There are seven primary principles
to walk through step-by-step. In addition, the class will discuss the topic of highest
and best use. This part doesn’t go into great detail, but you need to study the material
presented here carefully so you understand the basic concepts of highest and best use.
Learning Objectives
To prepare for Part 11, read the following learning objectives, and refer to them as you
study this part of the handbook.
† Recognize definitions of the economic principles of change, anticipation, supply
and demand, competition, substitution, balance, and externalities.
† Recognize the definition of highest and best use.
† Identify four tests used to analyze highest and best use.
Learning Tips
Focus on the seven basic economic principles, and be sure to spend some extra time on
highest and best use. You should plan to become familiar with the four tests of highest
and best use and terms such as interim use and consistent use. The concepts of highest
and best use as though vacant and as improved are also critical valuation concepts.
The basic terms and concepts regarding highest and best are fairly easy to understand,
but these terms are critical terms for an appraiser. Spend extra time now so your mastery
of these terms is complete.
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Part 11.
Economic Principles
Economic principles are like sculpting hands on a potter’s wheel that shape value into its
final form. Part 11 introduces seven primary principles, and Part 12 will show you how
these economic principles function in real-life situations.
I.
Economic Principles in Real Estate
A. Principle of change
Change. The result of the cause and effect relationship among the forces that
influence real property value.
1. Real estate markets are dynamic and subject to constant and immediate change.
a. Change is premised on the cause and effect relationship that takes place
in the market.
b. The dynamic nature of the governmental, economic, social, and
environmental forces that influence real property values accounts for
change.
2. Change is inevitable and continuous, but it can be gradual and not readily
perceived or observed by the appraiser.
3. Change is not always predictable.
a. Opinions of value are generally made as of a specified date.
b. The time period in which the value opinion is valid may be relatively brief
due to the dynamic nature of change in the marketplace.
B. Principle of anticipation
Anticipation. The perception that value is created by the expectation of
benefits to be derived in the future.
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1. Value is created by the anticipation of benefits to be derived in the future.
a. Present value is affected by expected future benefits or detriments.
ƒ
Anticipation can enhance or impair value, depending on what
buyers and sellers expect of the property in the future.
ƒ
Anticipation varies based on the property type (i.e., residential,
commercial, agricultural, and the subsets within these types).
b. Examples
ƒ
A negative example might be seen in a property with a known, but
not quantified, defect that causes buyers to be resistive because
of anticipated repairs or problems that might (or might not) develop
at some point in the future.
ƒ
A positive example can be seen when values are rising in a hot
real estate market. A buyer and seller might negotiate a price
based on the buyer’s anticipation that the property will be worth
more in the future and the seller is comfortable with the knowledge
that delaying the sale will likely result in a higher price offered by
another buyer.
2. Anticipation is always focused on the future, never on the past or present.
C. Principle of supply and demand
Supply and demand. This economic principle as applied within a real estate
appraisal context … states that the price of real property varies directly, but
not necessarily proportionately, with demand and inversely, but not necessarily
proportionately, with supply.
1. The nature of supply and demand
a. Real estate markets are created by the interaction of supply and demand.
b. The players are buyers and sellers, but they can also include landlords
and tenants in an investment property.
Part 11 – 168
ƒ
The interaction of buyers and sellers affects value directly.
ƒ
The interaction of landlords and tenants affects value indirectly
because there is no transfer in title; however, negotiated rents still
have a value impact on investment property.
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Operation of Supply and Demand
$350,000
Demand
Price
$300,000
$250,000
$200,000
$150,000
$100,000
Supply
1
2
3
4
5
6
7
8
9
Quantity of Properties (in hundreds)
Operation of Supply and Demand (Demand Shifts)
$350,000
Demand
As demand increases the
curve shifts to the right
Price
$300,000
$250,000
$200,000
$150,000
$100,000
Supply
1
2
3
4
5
6
7
8
9
Quantity of Properties (in hundreds)
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c. Market equilibrium. The balance point where supply and demand meet.
Market equilibrium. The theoretical balance where demand and
supply for a property, good, or service are equal…. Over the long
run, most markets move toward equilibrium, but a balance is seldom
achieved for any period of time.
ƒ
Theoretically, supply and demand move toward equilibrium, a point
that almost never occurs in the real market. The important factor
here is that supply and demand tend to move toward this point.
ƒ
An equilibrium point is one where price, cost, and market value are
equal. That doesn’t happen very often.
2. Supply
a. In real estate, supply refers to the number of properties, rental units,
or raw land parcels available or offered for sale. Appraisers should also
consider potential additions to supply in light of projects that are planned
or presently under construction.
b. The supply of real estate is dependent on the cost of the four factors
of production, which are brought together to produce a product that is
offered in the market.
c. Supply works in conjunction with scarcity, one of the four factors of value.
d. Changes in supply generally lag behind changes in demand.
e. Property values vary inversely with changes in supply.
Part 11 – 170
ƒ
If a particular property type becomes more plentiful than relative
demand, the equilibrium value declines.
ƒ
If properties become scarce and supply declines relative to
demand, the equilibrium price increases.
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3. Demand
a. Demand is not only the desire to purchase (or lease) goods and services,
but it also incorporates the ability to purchase.
Effective purchasing power. The ability of an individual or group to
participate in a market, i.e., to acquire goods and services with cash
or its equivalent.
Effective demand. The desire to buy coupled with the ability to pay.
When the term demand is used in economics or real estate analysis,
effective demand is usually presumed.
b. Demand is the amount of a property type that is desired for purchase or
rent at various prices in a given market for a given period of time.
4. Supply and demand examples
What are the following data telling you about supply and demand?
Period
Median Price
Properties
Offered
Properties
Sold
1st Quarter
$100,000
100
95
2nd Quarter
$110,000
75
75
3rd Quarter
$115,000
125
120
4th Quarter
$125,000
120
100
Instructor guidance: Evidence of balance as supply and demand
match. Properties are relatively in equilibrium.
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Again, what are the following data telling you about supply and demand?
Period
Median Price
Properties
Offered
Properties
Sold
1st Quarter
$350,000
110
100
2nd Quarter
$355,000
125
90
3rd Quarter
$345,000
135
75
4th Quarter
$360,000
125
120
Instructor guidance: Market slumps in 2nd and 3rd quarters;
then it recovers in the 4th quarter.
D. Principle of competition
Competition
1. Between purchasers or tenants, the interactive efforts of two or more
potential purchasers or tenants to secure a sale or lease.
2. Between sellers or landlords, the interactive efforts of two or more
potential sellers or landlords to secure a sale or lease.
3. Among competitive properties, the level of productivity and amenities or
benefits characteristic of each property considering the advantageous or
disadvantageous position of the property relative to the competitors.
1. Competition is the interaction of supply and demand.
a. When buyers can choose among multiple properties offering the same or
similar amenities and benefits, competition is created.
b. The same is true when multiple buyers bid or contend for a property in an
open and free market.
2. Moderate profits attract healthy competition.
a. Excess profits, however, can lead to ruinous competition.
b. Generally, competitive market forces keep excess profits in check.
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E. Principle of substitution
Substitution. The appraisal principle that states that when several similar or
commensurate commodities, goods, or services are available, the one with the
lowest price will attract the greatest demand and widest distribution.
1. This principle assumes rational, prudent market behavior with no undue cost
due to delay.
2. The premise is that a buyer will not pay more for a property than for another
that is equally desirable.
a. Property values tend to be set by the price of acquiring an equally
desirable alternate property.
b. The principle recognizes that buyers and sellers have options in the
pursuit of their real estate objectives.
ƒ
Buyers can look for existing properties that offer similar amenities
or can pursue a land site and build to suit.
ƒ
Sellers can use the same argument against pressure to accept an
offer that is lower than what it would cost to create a comparable
property.
3. The principle of substitution is foundational to traditional approaches to value.
$95,000
$102,000
$110,000
$112,000
$105,000
$110,000
$98,000
$104,000
4. Opportunity cost is a subprinciple of substitution. It is the cost of options
foregone or opportunities not chosen.
Example. A property owner chooses not to renovate or retrofit his
property, resulting in higher vacancy and a decrease in market value that
eventually exceeds the original cost of the renovation or energy retrofit.
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Part 11 – 173
Retrofit. To furnish (as a computer … or building) with new or modified
parts or equipment not available or considered necessary at the time of
manufacture. Source. Merriam-Webster Online, www.m-w.com
F. Principle of balance
Balance. The principle that real property value is created and sustained when
contrasting, opposing, or interacting elements are in a state of equilibrium.
1. This principle focuses on land and improvements.
a. When the combination of land and improvements is optimal, economic
balance is achieved based on the assumption that no marginal benefit or
utility is gained by adding another unit of capital.
b. This principle also incorporates a subgroup of principles that show how
value is affected through the integration of property components.
2. Subgroup principles based on the principle of balance
Increasing and decreasing returns. The concept that successive
increments of one or more agents of production added to fixed amounts
of the other agents will enhance income or value (in dollars, benefits,
or amenities) at an increasing rate until a maximum return is reached.
Beyond a certain point, each additional unit will add less income or value
than the unit before it. Also called law of increasing returns or law of
decreasing returns.
Contribution. The concept that the value of a particular component
is measured in terms of the amount it adds to the value of the whole
property or as the amount that its absence would detract from the value
of the whole.
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Surplus productivity. The net income that remains after the costs of
various agents of production have been paid.
Conformity. The appraisal principle that real estate value is created and
sustained when the characteristics of a property conform to the demands
of its market.
a. External conformity. The compatibility between a property and its
surroundings.
b. Internal conformity. The condition that exists when labor, capital,
coordination, and land are appropriately combined in a property.
c. Subprinciples of conformity
ƒ
Principle of progression
The concept that a lower-priced property will be worth more in a
higher-priced neighborhood than it would in a neighborhood of
comparable properties.
ƒ
Principle of regression
The concept that a higher-priced property will be worth less in
a lower-priced neighborhood than it would in a neighborhood of
comparable properties.
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G. Principle of externalities
Externalities. The principle that economies outside a property have a positive
effect on its value while diseconomies outside a property have a negative
effect on its value.
1. Real estate is physically immobile, thus it is affected more strongly by
external influences than other types of goods, services, or commodities.
2. Factors external to the property can either have a positive or negative effect
on its value.
a. Positive externalities. This is the infrastructure such as roads, highways,
bridges, utilities, water towers, police and fire protection.
b. Negative externalities. These are inconveniences imposed on property
owners by the action of others. For example an industrial company that
pollutes a waterway imposes a negative influence upon property owners
downstream from the plant.
3. Externalities can be broad based, such as international economic conditions
that affect availability of capital and freedom of trade.
II. Introduction to the Concept of Highest and Best Use
A. Defining highest and best use
Highest and best use. The reasonably probable use of property that results
in the highest value. The four criteria that the highest and best use must
meet are legal permissibility, physical possibility, financial feasibility, and
maximum productivity.
1. Four tests of highest and best use
a. Legal permissibility
Steps a and b come before c and d.
b. Physical possibility
c. Financial feasibility
d. Maximum productivity
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2. Highest and best use of the land as though vacant. The use of a property
based on the assumption that the parcel of land is vacant or can be made vacant
by demolishing any improvements.
3. Highest and best use of property as improved. The use that should be made of
a property as it exists. An existing improvement should be renovated or retained as
is so long as it continues to contribute to the total market value of the property.
4. Decision process in a highest and best use analysis:
Land as though vacant
Property as improved
Options
Options
Improve
Leave as is
Leave vacant
Alter
Demolish
B. Interim use
Interim use. The temporary use to which a site or improved property is put
until a different use becomes maximally productive.
C. Consistent use
Consistent use. The concept that land cannot be valued on the basis of one
use while the improvements are valued on the basis of another use.
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D. Excess land and surplus land
Surplus
AVENUE
Excess
STREET
1. Excess land. Land that is not needed to serve or support the existing use. The
highest and best use of the excess land may or may not be the same as the
highest and best use of the improved parcel. Excess land has the potential to
be sold separately and is valued separately.
2. Surplus land. Land that is not currently needed to support the existing use but
cannot be separated from the property and sold off for another use. Surplus
land does not have an independent highest and best use and may or may not
contribute value to the improved parcel.
3. All excess land could be surplus land, but surplus land is never excess land.
The market is the deciding factor on whether excess land could turn
out to be surplus land. However, a reverse application where surplus land
could become excess land is not possible, because surplus land cannot be
sold off separately.
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Review
Part 11
Learning Objectives
Now that you’ve completed Part 11, you should be able to
; Recognize definitions of the economic principles of change, anticipation, supply
and demand, competition, substitution, balance, and externalities.
; Recognize the definition of highest and best use.
; Identify four tests used to analyze highest and best use.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 3, pp. 22–28, Chapter 4, pp. 34–35, and
Chapter 17, pp. 289–315.
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Terms and Concepts to Remember
Anticipation
Externalities
Opportunity cost
Balance
Highest and best use
Progression
Change
Competition
Conformity
Consistent use
Contribution
ƒ Land as though vacant
Regression
ƒ Property as improved
Substitution
Interim use
Supply and demand
Increasing and decreasing returns
Surplus land
Market equilibrium
Surplus productivity
Excess land
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Review Quiz
Write a number on the line opposite each item below to indicate whether the item is
best described as
1. Anticipation
7.
Externalities
2. Balance
8.
Increasing and decreasing returns
3. Change
9.
Opportunity cost
4. Competition
10. Substitution
5. Conformity
11. Supply and demand
6. Contribution
12. Surplus productivity
1
Property
values tend to be set by the cost of acquiring an equally desirable
substitute.
9
The cost of options foregone or opportunities not chosen.
12
The
net income that remains after the costs of the various agents of
production have been paid.
7
Forces
outside a property that may have a positive or negative effect on
its value.
2
alue is created and sustained when supply and demand are moving toward
V
a state of equilibrium.
1
Value is the present worth of future benefits.
5
alue is created and sustained when the characteristics of a property
V
harmonize with the surrounding area and are typical in the marketplace.
6
The value a particular component adds to the value of the whole property.
3
The market is dynamic.
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Part 12
Preview
Applied Economics in Real Estate
Part 12 reviews the principles you just learned through practical applications. Your
instructor will guide you through the problems and may elect to have you work in small
groups on these applications.
Learning Objectives
To prepare for Part 12, read the following learning objective, and refer to it as you study
this part of the handbook.
† Apply economic principles to selected real-world situations.
Learning Tips
Applying economic principles to real-world applications will reinforce your understanding
of the terms and concepts presented previously. There is a section test at the conclusion
of Part 12 that covers the contents of Section 4.
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Part 12.
Applied Economics in Real Estate
In Part 12, you will apply the principles you learned in Part 11 to real life situations. You
won’t be able to incorporate all the principles in the various problems, but your instructor
will highlight as many principles as time allows.
Economic Principles
1. Anticipation
7. Externalities
2. Balance
8. Increasing and decreasing returns
3. Change
9. Opportunity cost
4. Competition
10. Substitution
5. Conformity
11. Supply and demand
6. Contribution
12. Surplus productivity
12.1 Problem
Pollution Plume
Several months ago, the property owners in a residential neighborhood
were surprised to read in their newspaper that several test wells had
been installed in their area to monitor a migrating pollution plume. Since that time,
no sales activity has taken place in the area.
1. What economic principles are at work in this problem? How are they working?
Anticipation, change, externalities, supply and demand. The market is
anticipating a negative impact. The external source of the problem
has significantly changed the dynamics of supply and demand.
2. What is your opinion about why there is no sales activity in the area?
No demand for the properties due to the uncertainty created by the
migrating plume. What value do these properties have, and to whom?
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12.2 Problem
Your instructor will lead the discussion on this problem and provide
additional details.
Two adjacent waterfront properties have been listed for sale at the
same price. Both have the same lot size but differ in their shoreline and street
frontage. Assuming these properties are alike in every way except for the shape of
the lots, which property will likely sell for more?
1. What economic principles are at work in this problem?
Balance, competition, increasing and decreasing returns, externalities,
substitution.
2. What features do you believe buyers are looking for in waterfront properties?
Access to the water and views of the water.
3. Which property will likely sell for more and why?
The property on the left with more linear feet on the waterfront will
likely have greater value than the adjacent property.
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12.3 Problem
Setback Requirements
A property owner buys a strip of land from his neighbor allowing him
to meet the setback requirements for adding a building improvement
that will increase the kitchen and informal dining area of his residence.
What economic principles are at work in this problem? How are they working?
Contribution, increasing and decreasing returns, and possibly conformity.
The principles reflect the owner’s belief that his property will be worth
more after the improvements are completed, but the reality of that
issue depends on the market’s reaction to the remodeling project.
12.4 Problem
Growing Population
A municipality is under pressure to bring in low-cost, energy-efficient
housing and rental units to meet its growing population needs.
Federal subsidies are available to cities over the next two years with projects that
meet specified guidelines. Regional studies show that growth will outstrip available
housing three to one in the next five years unless action is taken.
What economic principles are at work in this problem and why?
Anticipation, change, supply and demand, competition, externalities
due to social and economic pressures, and possibly opportunity cost.
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12.5 Problem
Resale of Property
A shopping strip of factory outlets was built within an upscale
suburban area. After five years of poor sales performance, the
stores closed, and the inventory was liquidated. The property sold after several
years on the market to a new owner who removed the buildings and built an
upscale car dealership with a LEED Silver certification.11
What economic principles are at work in this problem? How are they working?
Supply and demand, competition, opportunity cost, externalities.
Anticipation is also working in a negative manner for the outlet store and a
positive manner for the car dealership. It appears the outlet store was not
the highest and best use for this property given its upscale location.
The LEED certification is the investor’s contribution to the community.
Demand is growing for LEED-certified buildings because they have a lower
carbon footprint, are energy efficient, and should have higher net incomes
compared to traditional-built buildings of similar size.
11. The Leadership in Energy and Environmental Design (LEED) designation was introduced by the U.S. Green Building
Council (USGBC) in 2000 as a green rating system for commercial buildings.
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Digging Deeper
LEED Silver is one of several certifications that attests to a building meeting specific
green sustainability requirements. To get a LEED certification, a building project must fulfill
prerequisites and then receive points as it moves through different levels of certification.
Note. The final exam does not contain questions on LEED information or any information
in the Digging Deeper boxes.
End Digging Deeper
12.6 Problem
Market Resistance
In one-unit residences over $400,000, real estate brokers find
moderate market resistance to properties that lack a center island
in the kitchen and a whirlpool tub in the bath off the owner’s bedroom suite.
What economic principles are at work in this problem? How are they working?
Supply and demand, competition, contribution, conformity, and substitution.
Buyers in a particular market have expectations. Competing properties must
conform to these expectations; otherwise, buyers will find substitutes.
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12.7 Problem
Holdout to Land Acquisition
An elderly owner of a one-unit residential property is the last holdout
to a massive land acquisition undertaken for the development of
a large shopping complex. The exasperated developer is angered by the owner’s
refusal of his final offer to purchase the property at four times its market value.
The developer makes no further offers and builds the center without acquiring the
residence. As a result, the property is isolated by a parking lot on all sides.
1. What economic principles are at work in this problem?
Revenge (oops, that’s not a principle), anticipation, substitution,
conformity, externalities, change, supply and demand, and perhaps
opportunity cost could be the principles at work in this problem.
2. What alternatives could the developer have offered?
ƒ
Could have offered a life estate to the elderly owner
ƒ
Offered to move the existing dwelling to another location
ƒ
May have sought help from the municipality to condemn the
property if in the public interest (long-shot answer) especially in
light of the Supreme Court ruling in Kelo v. New London
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Review
Part 12
Learning Objectives
Now that you’ve completed Part 12, you should be able to
; Apply economic principles to selected real-world situations.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
None
Terms and Concepts to Remember
No special terms
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Practice Test Section 4
This multiple-choice test is for your benefit and provides a review of
everything covered in Section 4. This is a closed-book test. Choose
the most correct answer.
1.
Which principle states that the property with the lowest price attracts the greatest
demand and widest distribution when several competing properties are available?
A.
competition
B.
contribution
C.
increasing and decreasing returns
*
D.
substitution
2.
Four forces impact value. Employment levels, wage rates, and interest rates are
examples of which force?
*
A.
economic
B.
environmental and geographic
C.
governmental and legal
D.
social
3.
*
Which principle states that real estate value is created and sustained when the
characteristics of a property correspond to the demands of its market?
A.
balance
B.
conformity
C.
externalities
D.
highest and best use
4.
The elements that create wealth, income, or services when they are combined are
known as
*
A.
factors of production.
B.
forces that influence real estate value.
C.
land and improvements.
D.
surplus productivity.
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5.
*
6.
*
7.
*
8.
*
9.
*
A temporary use of a property until a different use becomes maximally productive is
A.
conditional use.
B.
excess use.
C.
interim use.
D.
nonconforming use.
Zoning, public transportation, and sales taxes are examples of which of the four
forces impacting value?
A.
economic
B.
environmental and geographic
C.
governmental and legal
D.
social
Avery is beginning a highest and best use analysis of a property with existing
improvements. What is the first analytical step Avery should perform?
A.
an analysis of consistent use
B.
an analysis of interim use
C.
an analysis of the land as though vacant
D.
an analysis of whether the property has excess land
A small average residence is located in an area of luxury homes. The effect of the
surrounding homes on the small residence is called
A.
conformity.
B.
excess profits.
C.
progression.
D.
regression.
In an office market that has more available space than tenants willing to rent,
what principle will affect pricing the most?
A.
anticipation
B.
competition
C.
conformity
D.
contribution
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10.
Which theory states that land cannot be valued on the basis of one use while the
improvements are valued on the basis of another use?
*
A.
consistent use
B.
interim use
C.
uniform use
D.
use value
11.
*
12.
An owner continues to make improvements to a property to the point where
the value is no longer enhanced. What subgroup principle of balance does this
illustrate?
A.
contribution
B.
increasing and decreasing returns
C.
opportunity cost
D.
surplus productivity
Moderate profits attract healthy competition, but excess profits can lead to what?
A.
decrease in demand
B.
equilibrium
C.
increase in supply
*
D.
ruinous competition
13.
Which of the following could not be considered an interim use?
*
14.
*
A.
building in a warehouse district currently used as a religious facility
B.
manufacturing business operating at 75% of its normal production
C.
rural tract of land farmed while awaiting subdivision approval
D.
vacant downtown commercial land used for surface parking
Ellis built his residence on two lots in a manner that makes it impossible to
subdivide the land. The land site situation that Ellis has is an example of what?
A.
excess land
B.
opportunity cost
C.
surplus land
D.
surplus productivity
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15.
Which of the following is not a test of highest and best use?
*
A.
environmental viability
B.
legal permissibility
C.
maximum productivity
D.
physical possibility
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Section 5
5
Part 13.
Market Fundamentals
Part 14.
Real Estate Math Basics
Part 15.
Math Applications in Real Estate
Part 13
Preview
Market Fundamentals
Part 13 looks at how money and capital markets influence real estate markets. These
markets are interrelated, and the economic principles discussed in Part 11 play out in
various ways so that the appraiser must be mindful of what is actually behind the changes
in the real estate market. The control of the money supply through the Federal Reserve and
the fiscal policies implemented by the U.S. Treasury certainly have a profound impact on
real estate. Related topics of inflation and the lending market will also be examined.
Learning Objectives
To prepare for Part 13, read the following learning objectives, and refer to them as you
study this part of the handbook.
† Distinguish among money markets, capital markets, and real estate markets.
† Identify short-term money instruments.
† Identify long-term money market instruments.
† Distinguish among guaranteed, insured, and conventional mortgages.
† Identify the two sources of capital for real estate.
† Recognize the definition of real estate market.
† Recognize four general categories of the Federal Reserve’s duties.
Learning Tips
Part 13 builds on the economic principles discussed in Parts 11 and 12. It’s easy to get
lost in the material because there are a lot of details when it comes to learning about the
forces that drive the real estate market. Keep your focus on the primary players:
ƒ There are three primary markets (money, capital, and real estate).
ƒ There are two primary agencies (the Federal Reserve and the Department of
the Treasury).
ƒ There are two primary sources of capital (equity and debt).
That sums up what you need to know—just define and understand each of the
primary players.
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Part 13.
Market Fundamentals
We’re going to examine how various markets work together to shape real estate value.
We’ll identify the primary market players and see the roles they play as they interrelate
and influence the real estate market.
13.1 Dilemma
Annuity or Lump Sum
You have just won the lottery with a grand prize of $160 million. You can collect the
money in equal payments over 25 years, or you can take a lump sum of $92 million,
which is really $65 million after taxes.
How would you spend or invest your newfound wealth?
Instructor guidance: Intended to get class participants thinking about
market competition for investment dollars. Would they have concerns about
risk and liquidity? Would they take the annuity or lump sum?
Life Insurance Investment
An acquaintance calls asking you for financial advice. Her husband recently died of
cancer, and she received $500,000 from his life insurance. She is 35 and has three
children under 7 years of age.
What advice would you give the widow on investing her funds?
This scenario is a contrast to the previous scenario, or is it? Should she pay
off the house or buy a house if currently renting? What about liquidity and
risk in her investment choices?
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I.
Market Competition
A. Start with the big picture
1. When appraisers value real property, they must take into consideration how
real estate competes with other investment options.
a. Investors have many choices about where to position their investment
dollars.
b. These alternative investments also influence and interact with each other.
2. What does a market investor consider today? For example, what issues were
important to you in the two scenarios (from 13.1 Dilemma) we just
discussed?
a. Return on investment
b. Return of investment
c. Risk
d. Liquidity
e. Economic outlook
3. History has shown that what
happens in one market can
greatly impact another market.
Think about these examples:
a. If the stock market were to
decline or increase 25% over
a nine-month period, what
effect would that have on real
estate values?
b. If the oil-producing nations (OPEC) corporately decided to increase or
decrease oil production in a significant manner, what impact could that
have on the real estate market in the United States and other freemarket economies?
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B. Economic principles at work in the market
1. Supply and demand
a. The demand for money is a function of economic forces.
b. The supply of money is largely a function of the Federal Reserve as it
regulates the money supply.
c. Supply and demand relationships set the price (or cost) of money.
ƒ
Money is the accepted medium of exchange in the marketplace.
ƒ
Since most goods and services are priced in monetary terms,
the value of money greatly influences market pricing domestically
and abroad.
2. Competition
a. Competition works with the supply and demand of money.
b. This interaction (of supply and demand) takes place within a market.
Market. 1. A set of arrangements in which buyers and sellers are
brought together through the price mechanism; the aggregate of
possible buyers and sellers and the transactions between them.
2. A gathering of people for the buying and selling of things; by
extension, the people gathered for this purpose.
c. Markets compete against one another for investment dollars.
ƒ
For example, the bond market competes against the stock market.
ƒ
There is also competition within real estate markets on whether to
buy or to lease (that is, tenant market versus ownership market).
ƒ
In a larger sense, the real estate markets compete against the
money markets and the capital markets (terms we will define shortly).
3. Substitution
a. Investors substitute one investment for another as the dynamics of the
market change.
b. If an investment offers similar benefits at a lower price, the investment
dollars will flow toward the lower-priced investment.
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C. The role of risk
1. Risk plays a significant role in how investments compete against each other.
2. Various types of risk might include
Digging Deeper
ƒ
Market risk
ƒ
Liquidity risk
ƒ
Financial risk
ƒ
Environmental risk
ƒ
Capital market risk
ƒ
Legislative risk
ƒ
Inflation risk
ƒ
Management risk
End Digging Deeper
II. Money Markets, Capital Markets, and Real Estate Markets
A. Money market
Money market. The interaction of buyers and sellers who trade short-term
money instruments.
1. When money is plentiful, the price of money declines. When money is scarce,
the price rises (a function of the supply and demand of money).
a. We express the price of money as an interest
rate—that is, the cost to borrow funds.
b. Interest rates are critically important in all markets,
because as the demand for money increases, the
supply will decrease and thus drive up the interest
rate (that is, price of money).
c. A change in the interest rates affects discount and
capitalization rates, which have a direct influence
on real estate values.
d. Interest rate risk (yet another type of risk) is the chance that the value of
a security will change due to an adjustment in interest rates. For example,
a drop in bond prices often takes place as a result of rising interest rates.
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2. Short-term money instruments that comprise the money market can include
a. Federal funds
b. Treasury notes
c. Certificates of deposit (CDs)
d. Commercial paper
e. Municipal notes
f.
Eurodollars
US funds available at a Federal Reserve
Bank for member banks
In the US, intermediate securities with
maturities of 1 to 10 years
Time deposit financial instrument with a
banking organization
Corporation’s promissory notes used to
borrow short-term funds
Short-term, federally tax-exempt
obligations of local governments
US dollars that are held in banks outside of
the US
3. The anticipated cost and availability of these short-term funds is a key
consideration for real estate developers (for example, in construction
development projects).
B. Capital market
Capital market. The interaction of buyers and sellers trading long- or
intermediate-term money instruments.
1. Traditional real estate investments involve the use of two types of capital—
debt and equity. (See content under the heading Sources of Capital for Real
Estate, which is under Roman numeral IV.)
a. Equity is the cash an individual or entity places into an investment. In real
estate, it is the dollar difference between what the property could be sold
for and the debts against it. In a brokerage account, equity is the value of
the account’s securities less any debit balance in a margin account.
b. Debt is the money that an individual or entity has borrowed.
2. Equity investors (that is, equity market) are compensated by dividends (cash
flows) and the potential appreciation in the value of their investment. Equity
investors assume greater risk because their earnings are subordinate to
operating expenses and debt service.
3. Debt investors participate in bonds and mortgages and receive fixed or
variable interest on their investment through repayment of the principal upon
maturity. Thus, debt investors look for security in the form of a lien on the
assets (of the investment) as their claim on investment earnings.
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4. Capital instruments are divided into long-term and intermediate-term and
may include
a. Bonds or debentures
b. Stocks
c. REITs
d. Mortgages
e. Deeds of trust/contracts for deed
5. Mortgages have a special relationship to real estate, so let’s take a closer
look at the mortgage market.
a. What is the difference between a mortgage and a loan? A mortgage is
really a special type of loan.
Mortgage. A pledge of a described property interest as collateral
or security for the repayment of a loan under certain terms and
conditions.
Another way to define the word—A mortgage is a loan secured by the
collateral of some specified real property, which obliges the borrower to
make a predetermined series of payments.
b. Mortgages can be divided into different tiers.
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ƒ
First mortgage
ƒ
Second and third mortgages—referred to as junior liens or
mortgages. These mortgages come behind the first mortgage in
lien priority. Because of the greater risk of their lien priority, they
often carry a higher interest rate.
ƒ
Home equity loans (can also be in the form of consumer loans,
lines of credit, etc.) are another type of junior lien but may carry a
shorter term, say five or 10 years.
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c. Amortization is the repayment of a loan by installments. It is the process
of retiring debt through a systematic repayment of the principal together
with interest on the outstanding principal balance.
How does amortization work?
Principal and interest for a 30-year mortgage at 7%
Payment
Principal
Payment
Interest
Principal
Number
Balance
Amount
Paid
Applied
New Balance
1
$150,000.00
$997.95
$875.00
$122.95
$149,877.05
2
$149,877.05
$997.95
$874.28
$123.67
$149,753.38
12
$148,607.36
$997.95
$866.88
$131.08
$148,476.29
60
$141,370.68
$997.95
$824.66
$173.29
$141,197.38
120
$128,964.24
$997.95
$752.29
$245.66
$128,718.58
240
$86,443.82
$997.95
$504.26
$493.70
$85,950.12
360
$992.17
$997.95
$5.79
$992.17
$0.00
The above figures are based on amortization schedules published by lenders. The printed
figures are rounded to the nearest cent, whereas the actual calculations are more precise.
Total interest paid in 30 years assuming no prepayment: $209,263.35
d. Types of mortgages
ƒ
Guaranteed mortgage
Department of Veterans Affairs (VA) loan
ƒ
Insured mortgage
HUD’s Federal Housing Administration (FHA) program
and also private mortgage insurance (PMI) for
conventional mortgages
ƒ
Conventional mortgage
ƒ
Energy-efficient mortgage (EEM)—may be conventional, FHA, or VA
ƒ
Balloon mortgage
Mortgage that is not fully amortized at maturity
and requires a lump-sum payment
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C. Real estate market
Real estate market. Buyers and sellers of particular real estate and the
transactions that occur among them.
1. Real estate markets are divided into categories based on property types and
their appeal to different market participants.
2. These categories are further divided into submarkets that correspond to the
preferences of the buyers and sellers.
3. The preferences of market participants are influenced by governmental and
legal, economic, social, and environmental and geographic forces.
4. Real estate cycles can follow patterns of expansion, decline, recession, and
recovery based on various economic factors. The position of the real estate
market is relative to its cycle and can be evidenced by activities and events
such as increased foreclosures, vacancies, escalating prices, or rare practices
such as multiple bids offered on a property.
III. Monetary and Fiscal Policy
A. The Federal Reserve
1. The Federal Reserve, the central bank of the United States, was founded
by Congress in 1913 to provide the nation with a safe, flexible, and stable
monetary and financial system.
2. The Federal Reserve’s duties fall into four general areas:
a. Carry out the nation’s monetary policy.
b. Supervise and regulate banking
institutions and protect the credit
rights of consumers.
c. Maintain the stability of the financial system.
d. Provide certain financial services to the U.S. government, the public,
financial institutions, and foreign official institutions.
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3. The Federal Reserve (often referred to as the Fed) is comprised of 12
regional banks and a number of member banks. It is independent of the U.S.
president and Congress.
a. The seven-member Board of Governors directs the Fed.
b. The U.S. president appoints the board members to 14-year terms, and the
members cannot be dismissed during the appointed term.
4. What the Federal Reserve regulates
a. Reserve requirements
If the Fed wants to restrict the money supply, it increases the percent of
reserves that member banks must maintain, and vice versa.
b. Federal discount rate
The interest rate charged by the Federal Reserve for funds borrowed by
member banks. The federal discount rate directly impacts the prime rate
or the rate that commercial banks charge their best customers for shortterm loans.
c. Federal Open Market Committee (FOMC)
The FOMC’s members are responsible for setting the interest rates and
credit policies of the Federal Reserve System.
B. U.S. Department of the Treasury
1. The Federal Reserve determines monetary policy, but the Department of
the Treasury implements fiscal policy through decisions guided by the U.S.
Congress regarding the federal budget, expenditures, and revenues.
2. The Treasury raises funds and pays bills. It generates currency, collects taxes,
and borrows money.
3. The policies of the Treasury affect markets and the value of securities. For
example, when deficit budgets in the Treasury necessitated the borrowing of
foreign funds, the United States became a net importer of funds. These shifts
in policy have short- and long-term effects on the markets.
4. The value of the dollar against other currencies and the effect on the rate of
inflation all have an impact on real estate values in our global economy.
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Part 13 – 207
C. Pattern of rates
1. Inflation
Inflation. An erosion of the purchasing power of currency characterized by
price escalation and an increase in the volume of money.
2. The inflation rate is the rate of change in the price level, which is reflected in
consumer price indices (CPIs).
3. Effects of inflation
a. Money and capital market conditions are cyclical. As the economy
expands, competition for capital increases, costs for goods and services
increase, and inflation escalates. The Fed subsequently tightens money
and credit until the economy slows down.
b. Inflation can also result when the supply of currency increases with no
growth in underlying wealth, so the value of each unit declines.
4. Inflation in contrast to appreciation
a. Appreciation is an increase in the price or value of a property or
commodity resulting from an excess of demand over supply or other factors.
b. Investors watch the rate of appreciation and inflation because the latter
erodes the yield rate, and nominal rates will increase to offset the loss.
5. Nominal interest rates versus real interest rates
a. A nominal interest rate is a stated or contract rate.
ƒ
An investor buys a one-year bond at $1,000 face value that pays a
“nominal” rate of 6% and pays the investor $1,060 at maturity.
b. A real interest rate is a nominal interest rate that has been adjusted for
expected inflation.
ƒ
An investor’s bond matures and pays $1,060, but consumer goods
that cost $1.00 a year ago now cost $1.02 due to inflation.
ƒ
6% (nominal rate) − 4% (real interest rate) = 2% (inflation premium).
c. Nominal interest rates, which are reported daily in the financial press, are
said to be composites of the “real” cost of funds, or the real interest rate,
and the premiums that investors demand to protect their currency value
from being eroded by inflation.
Part 13 – 208
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d. Understanding the difference between nominal interest rates and real
interest rates is important to appraisers when capitalizing income,
particularly in yield capitalization, which will be covered in other courses.
6. Business and real estate cycles
a. Business cycles are discernible, recurring phases of business activity, and
the real estate cycle generally follows the business cycle.
b. Because of the ripple effect of a healthy real estate industry on other
sectors like construction, furniture, appliances, and building materials, the
government has chosen to promote economic recovery by stimulating real
estate sales through the availability of moderately-priced mortgage money.
IV. Sources of Capital for Real Estate
A. The two sources of capital for real estate are the money market and the capital
market. Another way to break it down is to say the two sources of capital are debt
and equity investors.
1. The debt investor usually participates in bonds and mortgages, seeking
certain income and repayment of principal. This investor is conservative in
outlook and relatively passive.
2. The equity investor is usually more aggressive and willing to take risks, so the
funds used for equity investments are called venture capital.
B. Equity and debt sources of capital
Equity Sources
Debt Sources
1. Individual investor
1. Savings and loan association
2.
Trust (including REITs)
2. Commercial banks
3.
Partnerships
3. Life insurance companies
4.
General partnership
5.
Limited partnership
4. Mutual savings banks and
stockholder-owned banks
6.
Syndication
5. Junior mortgage originators
7.
Joint venture
6. Secondary mortgage market
8.
Pension fund
a. Fannie Mae
9.
Life insurance companies
b. Freddie Mac
10. International equity capital
c. Ginnie Mae
d. Farmer Mac
7. Farm Credit Bank
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Part 13 – 209
C. How the primary and secondary mortgage markets function
1. The primary market is where borrowers and mortgage originators come
together, and the mortgage lenders include banks, thrifts (such as savings
and loan associations and savings banks), mortgage companies, and credit
unions.
2. After a borrower closes on a loan, the primary market lender can decide to
hold the mortgage in its portfolio or sell it in the secondary mortgage market.
3. The secondary market is where lender mortgages are assembled and
packaged into pools of mortgage-backed securities to be traded to investors.
4. Institutions such as Fannie Mae and Freddie Mac package the loans from
lenders into securities (e.g., collateralized mortgage obligations) and then sell
them to investors on Wall Street. The eventual buyers of these securities may
include pension funds, insurance companies, and hedge funds to name a few.
This process returns money to the primary market so that lenders can make
new loans to other home buyers.
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Review
Part 13
Learning Objectives
Now that you’ve completed Part 13, you should be able to
; Distinguish among money markets, capital markets, and real estate markets.
; Identify short-term money instruments.
; Identify long-term money market instruments.
; Distinguish among guaranteed, insured, and conventional mortgages.
; Identify the two sources of capital for real estate.
; Recognize the definition of real estate market.
; Recognize four general categories of the Federal Reserve’s duties.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Green Mortgages – Energy Efficient Mortgage Guide. For more information, go to:
www.mortgageloan.com/environment.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 10, pp. 111–136.
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Part 13 – 211
Terms and Concepts to Remember
Debt
Junior lien
Money market
Equity
Liquidity
Mortgage
Federal Reserve
Market
Real estate market
Inflation
Capital market
Risk
Digging Deeper
Deflation. 1. A decrease in the general price level.
2. A period in which the purchasing power of money rises.
End Digging Deeper
Part 13 – 212
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Review Quiz
Fill in the missing data to the following questions.
1.
The interaction of buyers and sellers who trade short-term money instruments is
referred to as a money market.
2.
Bonds, stocks, and mortgages are capital instruments.
3.
A pledge of a described property interest as security for repayment of a loan is
called a mortgage.
4.
An FHA loan is an example of an insured mortgage.
5.
The U.S. Treasury implements the fiscal policy of the United States.
Check the appropriate box for each question.
6.
Inflation and appreciation are terms that describe the
same thing.
7.
The Federal Reserve carries out the nation’s
monetary policy.
8.
Treasury bills are considered to be short-term
money instruments.
9.
The two sources of capital for real estate are
federal funds and the secondary mortgage market.
TRUE
FALSE
10. Risk plays a significant role in how investments
compete against each other.
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Part 13 – 213
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Part 14
Preview
Real Estate Math Basics
Appraisers use math to solve real estate valuation problems. The math problems in this
course do not go beyond the level of beginning algebra. Even so, your math skills might
be a little rusty, so Part 14 includes a review of some math basics to bring you up to
speed. Feel free to ask questions about any problem that doesn’t make sense to you.
Learning Objectives
To prepare for Part 14, read the following learning objective, and refer to it as you study
this part of the handbook.
† Solve basic math and percentage problems.
Learning Tips
Some people become stressed if they know that there are math problems in a course.
Math is used every day by appraisers to solve problems for clients, and math is a
constant part of an appraiser’s professional life.
Usually, participants enjoy math if they approach it with the right attitude. Your instructor
will walk you through the appraisal math problems step-by-step.
If you are good at math and the content seems too simplistic, take time to help
classmates who might be a bit rusty in their math skills.
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Part 14 – 215
Part 14 – 216
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Part 14.
Real Estate Math Basics
Did you know that math is the only science that was invented just for you? Appraisers
use math to solve real estate problems, and today you’re going to see how to use math
as an appraisal tool.
I.
Math as an Appraisal Tool
A. Problem solving and attitude
1. The attitude you have toward solving problems that involve arithmetic,
mathematics, or algebra is often the same attitude you will have in solving
complex appraisal problems.
2. What is your attitude toward problem solving?
B. Math is what appraisers do every day.
1. Examples
a. Calculating the area size of land and buildings
b. Deriving a median price for a group of sales
c. Converting cash flows into value for an income-producing property
d. Deriving the percentage change in price based on changing market
conditions
e. Calculating an effective property tax rate
2. A typical appraisal problem. Mosley is appraising a vacant land site that is
two thirds of an acre in size and has 112.3 feet of frontage on the street. The
appraiser’s market data indicates a price of $2.90 per square foot. What is
the price per foot for the 112.3 feet of road frontage?
1 acre = 43,560 / 3 = 14,520 × 2 = 29,040 sq. ft. for the land
29,040 × $2.90 = $84,216 value of the land
$84,216 / 112.3 frontage = $749.92 per front foot (or $750)
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Part 14 – 217
II. Solving Basic Appraisal Problems
A. The T-Bar can be used to solve various mathematical problems involving percents.
1. The T-Bar works for three formulas:
ƒ
Total
=
Part / Rate
ƒ
Part
=
Rate × Total
ƒ
Rate
=
Part / Total
2. If you are solving a percentage problem, the T-Bar can be set up as follows:
PART
Divide
Divide
Divide
RATE
TOTAL
Multiply
3. Simple rules for using the T-Bar
a. When solving for a component below the bar, you will divide. In that case,
remember to first enter the top number into your calculator because that
number is divided by the known component found below the bar.
b. When solving for a component above the bar, you will multiply the two
components below the bar.
B. Using the T-Bar to solve problems
14.1 Problem
Introductory T-Bar Problems
1. A property owner discounted his asking price by 12% in order to
attract market interest in the property.
If the original asking price was $250,000, how much was the price reduction?
$30,000 Answer
Divide
Divide
0.12
$250,000
Multiply
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14.1 Problem, cont.
2. Culver discounted his asking price by $45,000.
If the original asking price was $300,000, what was the percentage price
reduction?
$45,000
Divide
( Answer is 15%)
Divide
0.15
$300,000
Multiply
3. McDaniel lowered his asking price by 10%.
If the original asking price was $450,000, what was the revised asking price of
the property?
Note: In this case, the solution can be shortened by restating the problem to
say that the revised asking price is 90% of the original price. This will save
you one step in the solution.
$405,000 Answer
Divide
Divide
0.90
$450,000
Multiply
4. A tenant gave the landlord a damage deposit that was 150% of the monthly
rent.
If the monthly rent is $2,100, what is the amount of the damage deposit?
Note: In this problem, the rate is greater than 100% and can be written as 1.50.
Therefore, the “part” will be greater than the “total” in the solution.
$3,150 Answer
Divide
Divide
1.50
$2,100
Multiply
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Part 14 – 219
14.2 Problem
Practice Problems
1. A seller was charged a $43,500 commission fee by her real
estate broker.
If the sale price was $725,000, what was the broker’s commission percentage?
$43,500
(Answer is 6%)
0.06
$725,000
2. A client included $5,000 rush service in the overall assignment fee of $25,000.
What is the percent attributable to the rush service fee?
$5,000
(Answer is 20%)
0.20
$25,000
3. How much money does Torres need to deposit to earn $3,000 in annual interest
if the annual interest rate is 5%?
$3,000
0.05
$60,000 Answer
4. Conventional financing requires 20% as a down payment, and a pre-qualified
buyer has $70,000 cash available.
What is the maximum price the buyer can afford?
$70,000
0.20
Part 14 – 220
$350,000 Answer
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14.2 Problem, cont.
5. Jeter paid $10,800 in debt service last year (principal and interest) based on
an original mortgage amount of $150,000.
What percent is the annual debt service to the mortgage amount?
$10,800
(Answer is 7.2%)
0.072
$150,000
C. Solving percentage change using an HP 12C
1. If the current sale price of a property is $241,500 and the prior sale was
$210,000, how much did the property increase—expressed as a percent
increase from the prior sale?
In this problem, the base price is $210,000, and we need to solve the
percent increase (to $241,500). On the HP 12C, you can use the à (delta
percent) key to derive the percentage change.
Calculations
Step
Explanation
HP 12C
Display
0.00
1
Clear memory
fH
2
Key in the prior value
210000 \
210,000.00
3
Key in the current value
241500
241,500.00
4
Calculate the % change
à
15.00
The price increased 15% (do a math check; $210,000 × 1.15 = $241,500).
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Part 14 – 221
2. The listed asking price of a property was $250,000, but the property
eventually sold for $220,000. How much was the discount—expressed as a
percent?
Calculations
Step
Explanation
HP 12C
Display
0.00
1
Clear memory
fH
2
Key in the asking price
250000 \
250,000.00
3
Key in the selling price
220000
220,000.00
4
Calculate the % change
à
–12.00
The price of the property decreased 12% from the original asking price.
Check: $250,000 × 0.12 = $30,000; $250,000 – $30,000 = $220,000.
14.3 Problem
Finding Percentage Change Using an HP 12C
1. The median sale price for one-unit properties in the city of
Lynwood is currently $182,000. The median price two years
earlier was $227,500.
What is the change in median price from two years ago expressed as a percent?
$227,500 \ $182,000 à equals −20.00 (or −20%)
2. An investor experienced a loss of 20% in her REIT mutual fund during the
previous two quarters.
If the investor’s REIT portfolio was valued at $50,000 prior to the loss, how much of
a percentage gain in the fund does she need to fully recover?
$50,000 \ 0.80 µ $50,000 à equals 25.00 (or 25%)
Note: $40,000 is the portfolio value after the 20% loss
Or try f H $40,000 \ $50,000 à equals 25.00 (or 25%)
Part 14 – 222
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Review
Part 14
Learning Objectives
Now that you’ve completed Part 14, you should be able to
; Solve basic math and percentage problems.
Terms and Concepts to Remember
No special terms
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Part 14 – 223
Review Quiz
Solve the problem to the following questions. Answers are found in the solutions
booklet.
1.
A property owner sold her 3/4-acre site for $3.50 per square foot. What was the
final selling price of the land?
43,560 sq. ft. × 0.75 = 32,670 sq. ft. × $3.50 per sq. ft. = $114,345
2.
The property taxes on a land parcel increased by $984 in the last year. If the taxes
were $12,300, what is the percentage of increase?
$984
(Answer is 8%)
0.08
$12,300
HP 12C calculation: $12,300 \ $13,284 à equals 8.00
$13,284 used above was derived by adding $12,300 and $984
3.
An existing building cost $450,000 when it was new. Over the years, the building
has depreciated 15% due to wear and tear. What is the depreciated cost of
the building?
$382,500 is the answer
0.85
$450,000
In the above solution, think of the building as 85% depreciated or
alternatively: $450,000 × 0.15 = $67,500 amount of depreciation
$450,000 − $67,500 = $382,500 depreciated cost of the building
Part 14 – 224
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4.
The Fairchilds’ property was listed for $525,000, but it was reduced in price to
$493,500 due to a lack of market interest. What is the price discount expressed
as a percentage?
$31,500
(Answer is 6%)
0.06
$525,000
$525,000 − $493,500 = $31,500 / $525,000 = 0.06, or 6% discount
HP 12C calculation: $525,000 \ $493,500 à equals −6.00
5.
A property listed on an Internet auction website had a minimum reserve of
$160,000, which is the price not revealed to online bidders. After the bidding
opened, the offers exceeded the reserve, and the property eventually sold for
$174,400. What percent over their reserve price did the sellers receive?
$14,400
(Answer is 9%)
0.09
$160,000
$174,400 − $160,000 = 14,400 / $160,000 = 0.09, or 9% increase
HP 12C calculations: $160,000 \ $174,400 à equals 9.00
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Part 15
Preview
Math Applications in Real Estate
Part 15 focuses on percentage problems that involve real estate issues. The content has
a practical emphasis that looks at tax rate and mortgage calculations. You’ll conclude by
studying calculations covering floor area ratio and land-to-building ratio.
Learning Objectives
To prepare for Part 15, read the following learning objectives, and refer to them as you
study this part of the handbook.
† Solve percentage problems that occur in appraisal practice.
† Apply tax assessment rate calculations.
† Solve floor area ratio problems.
Learning Tips
The first step in solving a percent problem is to figure out the base to which the percent
applies. This issue was introduced in Part 14, and now we want to build on it. Your
instructor will walk you through the process on some of the early problems so that you
are comfortable with the calculations.
Part 15 is largely applications based on math procedures you previously learned. This
part is designed to allow ample time to work through the problems.
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Part 15 – 227
Part 15 – 228
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Part 15.
Math Applications in Real Estate
Now that we’ve reviewed some math basics, let’s look at applications that are found in
real estate appraising.
I.
Percentage Problems
A. Percentage problems that involve an increase or decrease in value or price.
1. When considering these kinds of percentage problems, try to identify the base
number to which the percent applies. That will provide clues on whether the
problem requires multiplication or division.
a. If the base number is disclosed within the problem, the percent is typically
applied to that number. Use multiplication to solve this type of problem.
b. If the base number is the solution being sought (an unknown number), the
percent is applied to another number in the problem to obtain the base.
Typically, you will use division to solve a problem like this.
Comment on 15.1 and 15.2 Problems
ƒ The four questions for 15.1 and 15.2 Problems appear on
facing pages so you can see how these complementary
problems are solved.
ƒ 15.1 Problem addresses a common type of percentage issue
by using multiplication applied to a known base number.
ƒ 15.2 Problem uses the same players and percentages, but
it presents a different perspective. In this case, the base
number (to which the percent applies) is not given. To solve
this particular type of percentage problem requires division.
ƒ Understanding these problems is the key to unlocking the
other percentage problems presented in Part 15.
B. Real estate applications using percentages.
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Part 15 – 229
15.1 Problems
Using Multiplication to Solve Percentage Problems
1. Sue purchased a property for $100,000. After making
improvements, she sold the property for 10% more than she
paid for it.
What is the new sale price?
$110,000
1.10
$100,000 (Base)
Or $100,000 (base) × 1.10 (percent applied) = $110,000
2. Jim purchased a property for $100,000. He later sold the property during a
down market period for 10% less.
What is the new price?
$90,000
0.90
$100,000 (Base)
Or $100,000 (base) × 0.90 (percent applied) = $90,000
Think of the new price as 90% of the original purchase price.
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15.2 Problems
Using Division to Solve Percentage Problems
1. Sue sold her property for $110,000. This price is 10% more
than what she paid for it.
What was the original purchase price?
$110,000
1.10
$100,000 (Base)
Or $110,000 / 1.10 (percent applied) = $100,000 (Base)
2. Jim sold his property for $90,000 during a down market period. This price was
10% less than what he paid for it.
What was the original purchase price?
$90,000
0.90
$100,000 (Base)
Or $90,000 / 0.90 (percent applied) = $100,000 (Base)
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15.3 Problems
Practice in Percentage Problems
1. Jacquelyn sold her condominium for $126,000. This price was 5%
more than she paid for it.
What was the original purchase price?
Clue. First, decide whether the problem has supplied the base number to which a
percent is applied, or if you have to apply the percent to another number to obtain the
base. Next consider whether the base is inferior or superior.
$126,000
1.05
$120,000 (Base = original price)
Or $126,000 / 1.05 (percent applied) = $120,000 (Base)
2. An appraiser selected a property that sold for $253,000 as a comparable sale in
an assignment.
If the sale is 15% superior to the subject property, what is the value of the subject property?
Clue. The wording used in this question is a bit tricky and makes it confusing whether
the comparable sale or the subject property is the base. Moreover, appraisers adjust
the comparable sale, not the subject property. However, when you run into a question
like this, treat the subject property as the base and solve it.
$253,000
1.15
$253,000 / 1.15 = $220,000;
Part 15 – 232
$220,000 (Base)
Check: $220,000 × 1.15 = $253,000
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15.3 Problems, cont.
3. A farm property sold for $1.35 million. The sale was 10% below market due to
a forced sale situation.
What is the market price for the property?
$1,350,000
0.90
$1,500,000 (Base)
$1,350,000 / 0.90 = $1,500,000
Check: $1,500,000 × 0.90 = $1,350,000
4. A commercial property sold for $850,000, but the sale fell through and the
property eventually sold for $816,000.
What is the discount as a percent?
$816,000
4% (1.00 − 0.96)
0.96
$850,000 (Base)
$816,000 represents 96% of the original sale price, so the discount is 4%.
HP 12C calculation: $850,000 \ $816,000 à equals –4.00 (or 4%)
II. Tax Rate Calculations
A. Property taxes are often expressed as a mill rate.
1. A mill is equal to one-thousandth of a dollar (1 mill = $1.00 / 1,000 = $0.001)
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2. Another way to express a mill is $1.00 of tax for every $1,000 of assessed value.
Note. Some taxing districts may calculate their tax rate differently, such as
rates per $100 rather than rates per $1,000.
15.4 Example—Using the Mill Rate to Find the Tax Amount
If the mill rate in the area is 25, and the assessed value is $125,000,
then multiply the assessed value by the mill rate.
ƒ
$125,000 assessed value × 0.025 mill rate = $3,125 in taxes
Assessed value
We previously defined assessed value in Part 8, but for purposes of
calculation, remember that assessed value is a ratio based on the
assessor’s estimate of market value.
Market value × Assessment ratio = Assessed value
Example of a 60% assessment ratio:
$246,000 (MV) × 0.60 = $147,600 assessed value
So if the mill rate is 25.0, the tax is ($147,600 × 0.025) $3,690.
B. Effective tax rate
1. Appraisers can also calculate the effective tax rate by dividing the property tax
amount by its market value (or multiply the mill rate by the assessment ratio).
2. For an effective tax rate, the property’s market value or sale price is used
rather than an assessed value (which is based on a ratio to market value).
15.5 Example—Finding the Effective Tax Rate
A property with taxes of $3,690 and a market value of $246,000 has an
effective tax rate of 1.5% (a T-Bar can be used to solve this problem).
ƒ
3,690 / $246,000 = 0.015 (or 1.5% effective tax rate)
ƒ
Let’s say an assessor has a market value of $3,800,000
assigned to a commercial property with current taxes of
$68,400. If a new renovation increases the value to $5 million,
an effective tax rate can be used to estimate the tax for next
year (such as $5 million × 0.018 = $90,000 in taxes). To derive
the effective rate of 1.8%, divide $68,400 by $3,800,000.
C. Tax rate problems
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15.6 Problems
Using the T-Bar to Solve Tax Rate Problems
1. Petrie’s property has a market value of $140,000 and is assessed at 60% of its value
for tax purposes. If the mill rate is 18 mills, what is the annual tax on the Petrie property?
$140,000 (MV) × 0.60 (assessment ratio) = $84,000 assessed value
$1,512 (Annual tax)
0.018
$84,000
2. The McIntosh Orchard Farm has a semiannual tax of $12,000. The mill rate in the area is
30 mills, and properties are assessed at 80% of market value. What market value did the
assessor assign for the McIntosh property?
Clue. There are three mathematical steps to solving this problem.
$12,000 × 2 = $24,000 annual property taxes
$24,000
0.030
$800,000 Assessed value
$800,000
0.80
$1,000,000 Market value
Or, $24,000 / 0.03 = $800,000 / 0.80 = $1,000,000 market value
What is the effective tax rate for the McIntosh Orchard Farm property?
$24,000 / $1,000,000 = 0.024 (or 2.4%) effective tax rate, or
the 0.030 mil rate × 0.80 assessment ratio = 0.024 (or 2.4%)
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III. Mortgage Calculations
15.7 Problems
Percent of Down Payment and Mortgage Amount
1. If Express Bank has a loan limit of 75% on qualified properties,
what is the maximum mortgage available on a $215,000 sale?
$161,250 (Answer)
0.75
$215,000
2. If a buyer places 20% down on a $175,000 sale, what is the mortgage amount?
$140,000 (Answer)
(100% − 20%)
0.80
$175,000
3. The Steiner property sold for $350,000, and the lender stated the buyer could
mortgage $315,000 using private mortgage insurance. What is the loan to
value (LTV) percentage?
$315,000
(LTV is 90%)
0.90
$350,000
4. A property sold for $635,000, and the credit union provided a commitment to the
buyer for $508,000. What down payment percentage did the credit union require?
$127,000 ($635,000 − $508,000)
(Answer is 20%)
Part 15 – 236
0.20
$635,000
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Mortgage points
Points. A percentage of the loan amount that a lender charges a borrower for
making a loan; may represent a payment for services rendered in issuing a loan or
additional interest to the lender payable in advance; also called loan fee.
Note. Each point is equal to 1% of the mortgage amount.
15.8 Problems
Calculating Mortgage Points
1. A borrower obtained a loan from a lender who charged an
origination fee of 1 point.
How much did the borrower have to pay on a $150,000 mortgage?
$1,500 for 1 point
0.01
$150,000
2. In order to sell her property in a tight market, Collins paid 4½ points on the
sale of her $180,000 residence.
If the buyer is applying for an 80% loan, what was the dollar amount of the
points that Collins paid?
First step: $180,000 × 0.80 = $144,000 mortgage amount
$6,480 in points
0.045
$144,000 Mortgage
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Part 15 – 237
15.8 Problems, cont.
3. The financing on the Collins’ property (in the previous question) was changed
so that she paid $5,670 to buy down the interest rate on the buyer’s
mortgage.
If it is a 90% mortgage, how many points did Collins pay?
First step: $180,000 × 0.90 = $162,000 mortgage amount
$5,670 (in points)
Answer is 3.5 points
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0.035
$162,000
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IV. Floor Area Ratio (FAR) and Land-to-Building Ratio
A. Floor area ratio (FAR)
1. FAR represents the relationship of the gross size of a building to its land area.
Zoning ordinances in some municipalities govern the density (or intensity) of
development using the floor area ratio method.
Floor area ratio (FAR). The relationship between the above-ground
floor area of a building, as described by the zoning or building code, and
the area of the plot on which it stands; in planning and zoning, often
expressed as a decimal, e.g., a ratio of 2.0 indicates that the permissible
floor area of a building is twice the total land area.
2. FAR (also known as building-to-land ratio) can be defined as
Gross square footage of all structures on a site
Gross square footage of the land site
Note. The definition of gross square footage varies by municipality.
3. FAR is the reciprocal of the land-to-building ratio (and note that land-to-building
ratio is defined at the end of Part 15).
4.
Commercial FAR examples based on a 60,000 sq. ft. building
15.9 Example—FAR of a Commercial Building
a. Two-story structure situated on a 60,000-sq.-ft. site has a
FAR of 1.0 (60,000-sq.-ft. building / 60,000-sq.-ft. site).
b. Three-story building situated on a 30,000-sq.-ft. site has a
FAR of 2.0 (60,000-sq.-ft. building / 30,000-sq.-ft. site).
c. Six-story structure situated on a 15,000-sq.-ft. site has a
FAR of 4.0 (60,000-sq.-ft. building / 15,000-sq.-ft. site).
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Part 15 – 239
5. Residential FAR example
15.10 Example—FAR of a Residential Building
a. FAR is more commonly used in commercial applications, but some
cities are using FAR in residential neighborhoods to limit the
building area that can be placed on the site.
b. For example, a 25,000-sq.-ft. site might be limited to 5,000 sq. ft.
of improvements on the land. In this case, the FAR is 0.2
5,000 sq. ft. / 25,000 sq. ft. = 0.2, or 20%).
c. The building area counted in the FAR can include roofed parking
areas, patios, and decks, depending on the zoning ordinance.
6. FAR allows flexibility in development
Given the same size land site, a developer has flexibility in designing a
building for a particular site governed by FAR.
15.11 Example—Flexibility in Design
A zoning ordinance might have a FAR of 2 for a specific district.
Therefore, a 100,000-sq.-ft. site would permit a building size up to
200,000 sq. ft. As long as the project conformed to setbacks, the
developer could have various options such as erecting an 8-story
building or a 4-story building with a FAR no greater than 2.
Both buildings are the same size (200,000 sq. ft.) and situated on the
same size site (100,000 sq. ft.). Each has the same FAR, because
they have the same ratio of building area to land area.
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15.12 Problem
Floor Area Ratio
1. If a land site has 12,500 square feet with a FAR of 7, how many
square feet of building area can be developed on the land?
12,500 sq. ft. × 7 (FAR) = 87,500 sq. ft.
2. A site has 30,000 square feet, and the building will occupy 40% of the land.
If the FAR is 6, how many square feet of building area can be developed, assuming
there is no restriction on the number of stories?
30,000 sq. ft. × 6 (FAR) = 180,000 sq. ft.
3. In the previous problem, how many stories must the building be to achieve the
maximum building size with the assumption that it will occupy 40% of the land?
6 (FAR) / 0.40 = 15 stories (or 180,000 sq. ft. / 12,000 sq. ft.)
Note: 30,000 sq. ft. site × 0.40 = 12,000 sq. ft. (for the first floor)
4. A developer wants to erect a building on a land site using 1/4 of the land area.
If the municipality has a FAR of 6, how many stories can the building have?
6 / 0.25 = 24 stories
5. What if the same developer wanted to build on 3/4 of the land site?
6 / 0.75 = 8 stories
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B. Land-to-building ratio
1. Definition
Land-to-building ratio. The proportion of land area to gross building area;
one of the factors determining comparability of properties.
2. Land-to-building ratio is the reciprocal of FAR.
Gross square footage of the land Gross building area
15.13 Example—Land-to-Building Ratio
If the land area is 80,000 sq. ft., and the gross building area is
40,000 sq. ft., the land-to-building ratio is 2 to 1 (and the FAR in this
example is 0.50).
3. Land-to-building ratios affect the utility of a property and therefore the market
appeal and property value.
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Review
Part 15
Learning Objectives
Now that you’ve completed Part 15, you should be able to
; Solve percentage problems that occur in appraisal practice.
; Apply tax assessment rate calculations.
; Solve floor area ratio problems.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 13, P. 240.
Symbols and Formulas, Capitalization Selection Tree, & Sample Problems” P. 9 at
www.appraisalinstitute.org/education (click on Basic Appraisal Principles)
Terms and Concepts to Remember
Effective tax rate
Mill rate
Floor area ratio
Points
Land-to-building-ratio
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Part 15 – 243
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Practice Test Section 5
This multiple-choice test is for your benefit and provides a review of
everything covered in Section 5. This is a closed-book test. Choose
the most correct answer.
1.
*
2.
*
3.
Thompson paid an annual property tax this year of $2,940. If the mill rate is
28 and the assessed ratio is 60% of market value, what market value did the
assessor assign to the Thompson property?
A.
$157,500
B.
$175,000
C.
$262,500
D.
none of the above
$2,940 / 0.028 = $105,000 / 0.60 = $175,000
Which of the following is NOT a money market instrument?
A.
certificates of deposit
B.
Eurodollars
C.
stocks
D.
treasury bills
Fannie Mae, Freddie Mac, and Ginnie Mae participate in a market known as the
A.
equity market.
B.
money market.
C.
primary market.
*
D.
secondary market.
4.
Walton purchased a property six months ago for $200,000. Properties have been
appreciating at a rate of 10% per year. What is Walton’s property likely to be worth
today based on this rate of appreciation?
*
A.
$180,000
B.
$210,000
C.
$220,000
D.
$222,222
$200,000
× 1.05 (5% is used for six months) = $210,000
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Part 15 – 245
5.
*
6.
*
7.
*
8.
The entity that carries out the nation’s monetary policy is called the
A.
FDIC.
B.
Federal Reserve.
C.
Office of the Comptroller of the Currency.
D.
U.S. Treasury.
The Bremer property was initially overpriced and sat on the market for an extended
period before it sold 15% below the market at $153,000. What should the Bremer
property have sold for if it had not been overpriced?
A.
$130,000
B.
$175,950
C.
$180,000
D.
$191,250
$153,000 / 0.85 = $180,000
A purchaser applied for a 70% mortgage, and the seller agreed to pay 4 points on
the mortgage. If the seller paid $5,600 in points, what was the selling price?
A.
$114,286
B.
$140,000
C.
$200,000
D.
$238,000
$5,600 / 0.04 = $140,000 / 0.70 = 200,000
What entity guarantees mortgages?
A.
Department of Housing and Urban Development (HUD)
B.
Fannie Mae
C.
Federal Housing Administration (FHA)
*
D.
Department of Veterans Affairs (VA)
9.
The median price of $5,000 per tillable acre declined 15% in the last year due to
an economic downturn. What is the current median price?
*
A.
$4,250
B.
$4,347
C.
$5,750
D.
$5,882
Part 15 – 246
$5,000
× 0.85 = $4,250 current median price
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10.
A property has taxes of $3,200 and a market value of $200,000. What is the
effective tax rate?
*
A.
1.6%
B.
2.0%
C.
10.5%
D.
62.5%
$3,200 / $200,000 = 0.016 (or 1.6% effective tax rate)
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Section 6
6
Part 16.
Measurement and Statistics
Part 17.
Introduction to Financial Calculations
Part 18.
Time Value of Money Concepts
Part 16
Preview
Measurement and Statistics
Part 16 provides a nice change of pace from Part 15, yet it also reinforces the math
concepts you have been reviewing. Appraisers have a practical need to figure out areas
of land and building, and that’s what the first half focuses on. The section on statistics is
introductory and examines statistical terms and how they interrelate with each other.
Learning Objectives
To prepare for Part 16, read the following learning objectives, and refer to them as you
study this part of the handbook.
† Calculate geometric areas.
† Solve for mean, median, and mode.
Learning Tips
You should find the material on measurement to be straightforward and practical. The
topic of statistics may sound intimidating, but it is introductory in scope and focuses on
terminology and calculations that you performed in basic algebra—calculations of the
mean, mode, and median.
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Part 16.
Measurement and Statistics
Don’t let the title scare you. Appraisers
physically measure land and building
structures. Thus, there are certain formulas
for measurement purposes that you will
need to know. In addition, appraisers also
measure and interpret data, and that’s
where a general understanding of statistical
concepts becomes important. Part 16 gives
you an introductory peek into statistics.
I.
Measurement Basics
A. Formulas for calculating perimeter and area
Area Measured
Perimeter
Formula or Method
This is the linear distance around an area or structure
and is the sum of all the sides.
In the case of a circle, the perimeter is referred to as
the circumference, and the formula is C = πd, where
π = 3.141593 and d = the diameter of the circle.
Rectangle
Area = Length × Width
Triangle
Area = ½ (Base × Height) or
Trapezoid
Area = ½ (Sum of the bases) × Height
Acre
There is no formula for an acre other than to
remember that it takes 43,560 sq. ft. to equal 1 acre.
Base × Height = Area
2
B. Application problems
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16.1 Problem
Measurement Problems
1. What kind of polygon is the irregular-shaped lot pictured below,
and what is the site’s total area and perimeter footage?
50'
97'
93'
93'
97'
100'
This is a trapezoid with the formula ½ (base1 + base2) × height
½ (100’ + 50’) × 93’ = 6,975 sq. ft. in area
Perimeter is 100’ + 97’ + 50’ + 97’ = 344 linear feet of perimeter
2. Calculate the acreage of Tract A.
2,500
feet
TRACT A
5,000
feet
6,000 feet
Trapezoid area = ½ (2,500 ft. + 5,000 ft.) × 6,000 ft. = 22,500,000 sq. ft.
22,500,000 sq. ft. / 43,560 sq. ft. = 516.5 acres
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16.1 Problem, cont.
3. A residential lot has a fenced rear yard. The fence is set back from the
property line 2 feet on all sides except for the front property line, which is 70
feet.
What is the total linear feet of fencing?
80’ − 4’ = 76’ in width
150’ − 70’ − 2’ = 78’ in length;
30'
150'
(76’ − 30’) + 78’ + 76’ + 78’ = 278 feet
Note: Lot is 12,000 sq. ft.
70'
80'
If the fencing costs $12.50 per linear foot, what is the total cost of the fence?
278 feet × $12.50 = $3,475 total cost of the fence
Digging Deeper
Area Measured
Formula or Method
Circle
Area = πr² (π = 3.141593 and r = radius)
Cubic foot
When calculating the volume of an object, add the height to the
area formula.
A cubic foot is 1 ft. length × 1 ft. width × 1 ft. height
Cubic yard
Same approach as cubic feet. 1 cubic yard = 27 cu. ft.
End Digging Deeper
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16.1 Problem, cont.
4. The Reynoldses plan to finish their basement area into habitable space. The
foundation exterior measures 36 ft. by 26 ft. and has 12-inch thick concrete
block perimeter walls. They have ordered carpet and pad to fill the entire
interior space of the basement plus another 10% in excess to match the
carpet pattern.
If the carpet, pad, and installation cost $20 per square yard, what is the
total cost?
36'
34'
26'
24'
Basement Area
Interior dimensions are 34 ft. × 24 ft. = 816 sq. ft.
Add 10% for excess 816 sq. ft. × 1.10 = 897.6 sq. ft.
897.6 / 9 = 99.73 yards (round to 100 yards) × $20 = $2,000
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16.1 Problem, cont.
5. Calculate the size of this residence.
36'
12'
1-Story
17'
14 '
12'
8'
32'
32'
40'
Garage
20'
24'
Porch
28'
2-Story
22'
14'
8'
4'
12'
What is the gross living area (GLA) of the residence?
Note: The gross living area does not include the porch and garage. The first
step is to find the missing dimensions based on the measurements that have
been provided in the sketch. Remember to include the area of the second floor
in the GLA to account for the 2-story portion of the residence.
40 × 28 × 2 stories = 2,240 sq. ft.
12 × 4 × 2 stories = 96 sq. ft.
14 × 12 × 1 story = 168 sq. ft.
22 × 17 × 1 story = 374 sq. ft.
2,240 + 96 + 168 + 374 = 2,878 sq. ft. for GLA is the answer
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II. Statistical Concepts for Appraisers
Statistics are used by appraisers to interpret data and support assignment results.
Statistics are tools that we use to manipulate numbers (in a positive sense) to gain a
broader perspective on what we analyze.
A. What are statistics?
1. Statistics is a branch of mathematics that deals with numerical data,
beginning with its collection and analysis and continuing through to its
interpretation and presentation.
2. A statistic is a single number that describes a characteristic of a set of
numbers. We can refer to a statistic as a number that represents a group.
3. Econometrics is the application of mathematics and statistics to the
interpretation of economic data, testing of economic theories, and solution of
economic problems.
B. Introductory terms
1. Data types
a. Quantitative data are numbers that can be measured and compared with
a certain degree of objectivity and precision.
Examples: Building size, acreage, parking spaces, rentable
area, building age, proximity to a local attraction, etc.
b. Qualitative data are more subjective and are often represented by words
rather than numbers. Qualitative data is still valuable as a source of
information, and when correctly ranked or systematically treated, it can
significantly improve the appraisal modeling process. Qualitative data can
also be quantified in an econometric context.
Examples: Building style, condition, quality, view amenity, etc.
2. Population. The complete set of all the items in a specific category. A
population is also referred to as a universe.
3. Sample. In statistics, a subset of a population selected for analysis.
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4. Variable. In statistics, a characteristic or attribute of an item, service, or
individual that can change from observation to observation.
The specific value of a variable is sometimes referred to as a variate.
C. Measures of central tendency
Appraisers commonly use statistics to measure a central tendency in a group of
numbers to determine if there is a pattern. For example, a residential appraisal
report form used by lenders asks for the predominant price and age of singlefamily housing that is located within the market area of the appraised property.
In this case, the lenders want to know the mode (i.e., most frequently occurring)
price and age found in the subject property’s market area—and how the subject
property relates to that mode. Measures of central tendency are a normal part of
an appraiser’s analytical tools in everyday practice.
1. Mean
a. Commonly referred to as an average
b. If you were asked for the average of the numbers 2, 3, 4, you could
easily figure it in your head and say 3. It’s not so easy with the following
set of numbers.
What is the average of 17, 83, and 245?
17 + 83 + 245 = 345 / 3 = 115 is the arithmetic mean
c. The above calculation can be represented by the formula below.
Digging Deeper
Where……
-
X= ΣX
n
= Mean
Σ = The total of
X = The variates (i.e., numbers)
n
= The number of variates
The equation is an efficient and easy way to express a mathematical thought, certainly
much quicker than to say that the arithmetic mean is equal to the sum of the variates
divided by the number of numbers in the data set.
End Digging Deeper
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2. Median
a. The median is a positional average; it’s the number in the middle.
b. To find the median, it is first necessary to arrange the data in ascending
or descending order; this is called an array. Then, count in an equal
number from each end. The formula is provided below.
Md = n+1
2
In this formula, Md = median and n = number of variates in the data set.
This formula will only give you the position of the median. For example, if
there are five numbers in the data set, then 5 + 1 = 6 / 2 = 3. The median
will be the third number in from either end, once the data are arrayed.
c. Here’s a data set.
7, 3, 8, 4, 2
First array the data.
2, 3, 4, 7, 8
Count in 3 variates from either end of the array, and you’ll find the median.
If there is an odd number of numbers in a data set, the median will always
be one of the actual numbers. If there is an even number of numbers, the
median may or may not be an actual number in the distribution.
ƒ
Look at this data set.
2, 3, 3, 4
Let’s work the formula (four numbers + 1) / 2 = 2.5. The median
occupies the position midway between the second and third
number in from either end of the array. The number that is halfway
between 3 and 3 is 3, and that is the median.
ƒ
Let’s make a slight change to the data set.
2, 3, 4, 5
The median is still the number that lies midway between the
second and third numbers in this four-number distribution, but it is
now the number that is halfway between 3 and 4, or 3.5.
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d. The median is relatively easy to understand and compute. It is affected by
the number (but not the value) of extremes. It is useful when the mean is
affected by extreme values.
3. Mode
a. Mode is the most frequently occurring number in a distribution. What’s the
mode in the following data set?
2, 3, 4, 5, 5, 6
The mode in this data set is 5, because there are more fives than any
other number.
b. Example of a bimodal distribution
2, 3, 3, 4, 5, 5
Now there are two modes—3 and 5.
D. Measures of dispersion
1. The mean, median, and mode are measures of central tendency and tell us
where numbers tend to cluster. We can also examine measures of dispersion,
which quantify the extent to which data vary from the average.
2. The simplest measure of dispersion is the range. This is the difference
between the highest and the lowest value in the data set. In the last set of
numbers, the range is 3, which is the difference between 5 and 2.
3. A more meaningful measure of dispersion is the standard deviation. It is a
measure of the variance in the data away from the mean. The smaller the
standard deviation, the better.
E. Forward thinking on statistics
1. Our focus for this course is to introduce basic statistical concepts and terms.
Upcoming courses in your career path will examine the process of mathematically
modeling real estate data and using tools such as regression analysis.
2. Appraisers are using statistics and mathematical modeling more frequently in
their analysis, and this will continue to increase.
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Review
Part 16
Learning Objectives
Now that you’ve completed Part 16, you should be able to
; Calculate geometric areas.
; Solve for mean, median, and mode.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 14, P. 254–259.
Terms and Concepts to Remember
Array
Population (also universe)
Mean
Range
Median
Variable
Mode
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Review Quiz
Answer the questions below.
Questions 1 – 3 are based on the following information:
An appraiser is researching sales of hotels located along a stretch of a busy
interstate freeway. The appraiser uncovered the following data:
Property
1.
*
2.
*
3.
*
Sale Price
Rooms
Building Area
Gross Room Revenue
Sale 1
$5,400,000
120
45,000 sq. ft.
$15,000
Sale 2
$4,800,000
100
37,500 sq. ft.
$16,000
Sale 3
$5,460,000
130
50,000 sq. ft.
$14,000
Sale 4
$4,290,000
110
42,000 sq. ft.
$13,000
What is the mean sale price?
A.
$3,950,000
B.
$4,800,000
C.
$4,987,500
D.
$5,000,000
$19,950,000 / 4 = $4,987,500
What is the range of the gross room revenue?
A.
$1,000
B.
$2,000
C.
$3,000
D.
$6,000
$16,000
− $13,000 = $3,000
What is the median size of the hotels’ building area?
A.
42,000 sq. ft.
B.
43,500 sq. ft. Halfway between 42,000 sq. ft. and 45,000 sq. ft.
C.
45,000 sq. ft.
D.
50,000 sq. ft.
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4.
*
Calculate the shaded area of the bay window.
A.
20 sq. ft.
B.
24 sq. ft.
C.
44 sq. ft.
D.
48 sq. ft.
8'
2'
2'
2'
Bay Area
12'
(12 × 2) + ½ (8 + 12) 2 = 44 sq. ft.
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Part 17
Preview
Introduction to Financial Calculations
In Part 17, you’ll use the financial functions of your HP 12C calculator for the first time.
You may have used the HP 12C in Part 4 for basic math, but now you’ll use it for financial
calculations. The first few pages provide an introduction to the calculator, and then you
get right into various types of calculations. For the most part, you have all the keystrokes
printed in your handbook for the HP 12C. By the time you’ve completed Parts 17 and 18,
you’ll understand how to derive basic financial calculations.
Learning Objective
To prepare for Part 17, read the following learning objective, and refer to it as you study
this part of the handbook.
† Use a financial calculator to perform mortgage calculations.
Learning Tips
If you’ve never used a financial calculator before, you’ll find this material to be exciting.
The goal is to teach you how to perform basic financial calculations. You don’t need to
know all the nuances of the calculator—just the basics.
Almost all of the calculator keystrokes are printed, and your instructor will provide
guidance as you work on the problems.
There is a little more space between paragraphs on some pages to allow you to take
extra notes.
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Part 17 – 266
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Part 17.
Introduction to Financial Calculations
It’s time to take the financial calculator out of the box. The one we will be using in class
is the Hewlett Packard 12C. You’re welcome to use other calculators, but the operation
and keystrokes of those calculators won’t be covered in class or the course handbook.
This material was designed for beginners, so if you’ve never worked with a financial
calculator—this introduction is for you!
I.
Getting Started
A. Calculator basics
1. Understanding the RPN mode of operation for the HP 12C
Please see the preview to Part 4 for an overview of what RPN is and how it
processes math calculations.
a. There is no “equal (=) sign.” To input the first number you want to work
with, press the \ key immediately after you input the number.
b. Use operation keys such as z for division and µ for multiply, etc., in
place of the “equal sign” key. The HP 12C works very nicely in calculating
a series of numbers with multiple functions. Try the operations below.
3 × 21 – 15 / 3 = 16.00 Keystrokes: 3 \ 2 1 µ 1 5 - 3 z
c. The HP 12C can display the answer to 9 decimal places.
ƒ
Answers are rounded to the number of decimals places we specify.
ƒ
To set the number of decimal places you want to show in the
display, use the f key, and then press a number key 1 through
9 to specify the decimal places you want. For example, to set 4
decimal places press f and then 4.
ƒ
We recommend that you set the decimal places to at least 4 when
working with problems that will include answers with decimals. For
problems resulting in an answer with dollars and cents, set the
decimal display for 2 decimals.
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Part 17 – 267
d. The display may show a decimal rounded to two places; however, the HP
12C stores and works with the number to 9 decimal places. Let’s divide 2
by 3, and you’ll get a nonterminating decimal.
2 / 3 = 0.67 (for 2 decimals) or 0.666666667 (for 9 decimals)
2. Clearing the financial registers
a. It is important to clear all the registers in your calculator when you begin a
new financial calculation.
b. In the HP 12C, there are a number of storage registers. You’ve likely
worked with this function in a basic calculator where you have memory
keys, such as M+ or M–. In the HP 12C, the “memory” keys are more
sophisticated.
ƒ
The HP 12C has financial registers, stack registers, and the
register, which can be used to store numerical data.
ƒ
To clear all the registers at once in the HP 12C, press the f key and
then H. This procedure will place a zero in the registers and display.
last x
3. Financial payment settings
a. Most of the financial calculations you will be working with have payments
that come at the end of a period rather than the beginning. The calculator
is defaulted to make payments at the end of a period.
b. If you see the word begin in the display, then you will need to reset the
calculator. The word end will not appear in the display when the calculator
is set to its default settings.
c. Check your calculator display to verify that the word begin does not
appear. Look in the instruction booklet that came with your calculator
for further information.
ƒ
For the HP 12C, press the blue g key and then 8. You’ll notice
that under the “8” is the blue word Â.
d. The g key is used to enable the functions that appear in the blue
lettering at the base of individual keys. In this course, we use it to
enable the functions associated with the w and ¼ keys to carry out
a conversion from annual compounding to monthly compounding. For
example, pressing the g key and then the w key multiplies the number
(that has been entered) by 12 and then stores it in the register.
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II. Financial Calculations
A. Understanding the financial operation keys
1. There are five keys located at the top of the HP 12C calculator, which are used
to perform financial functions.
Function
HP 12C Key
Number of payments
n
Periodic rate as a percent
¼
Present value
$
Periodic payment
P
Future value
M
2. Key entry reminders
a. The financial information can be entered in any order.
b. If you know four of the five items, you can solve for the fifth item. In certain
financial calculations, one of the items might be represented by zero.
c. The key you press will carry out the operation depicted in white letters
shown on the face of the key. The g (blue key) on the HP 12C accesses
the action displayed in blue letters on the base of the key. The f key
accesses the action displayed in gold (or orange) letters located just
above the key.
ƒ
The f key on the HP 12C calculator shifts the function of the key
similar to the keys on a computer keyboard; however, you do not
have to hold the key down while pressing the next key.
ƒ
Press the f key, and then press 7; the display changes to 7
decimal places.
ƒ
The f key shifts the white-lettered key function to the function
above the key, while the g key shifts the function to that stated
below the white-lettered key.
d. When performing mortgage calculations, keep the time frames consistent.
Interest must be monthly for monthly payments and quarterly for quarterly
payments. Your instructor will help you with this function (and the
keystrokes are in the course handbook).
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Part 17 – 269
e. If you are working with cash flows on mortgage payments, either the PV
or the PMT must be a negative number. Which component is negative
depends on the perspective taken by the appraiser. From the investor’s
position, mortgage payments are a negative cash flow, whereas they are
positive from the lender’s position.
On the HP 12C, enter a number, and then press the Þ key to make it
negative. “CHS” means change sign. This is the equivalent of using the
plus/minus key +/– on a standard calculator.
f.
Clear the financial registers before beginning calculations, even if you
have just turned on the calculator. For the HP 12C, press f H.
17.1 Problem
Calculation of Mortgage Problems
1. Calculation of an annual mortgage payment
The Mansfield consulting firm has a mortgage with a beginning balance of
$850,000 and an annual interest rate of 9% on its building. The term is 25
years, but the firm makes only one payment each year.
Calculate the payment.
Instructions: Identify the financial variables of the problem and what is to
be solved. As you work the calculations, use the sleeve of your HP 12C
(or a piece of paper) to cover the calculator keystrokes so that only the
“explanation” is visible until the problem has been solved.
25
n
i
9 pv
$850,000
Calculations
Step
Explanation
1
Clear memory
2
Number of periods
3
4
5
Interest rate
Present value of mortgage
Calculates payment
pmt ? fv
HP 12C
fH
25 n
9¼
850000 Þ $
P
-0Display
0.00
25.00
9.00
−850,000.00
86,535.31
Note: Set your calculator to display 2 decimal points. The payment amount in
this problem is a positive number, because we’re looking at it from the lender’s
perspective. If we took it from Mansfield’s perspective, the payment would be
negative (because the cash flow would be going out).
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17.1 Problem, cont.
2. Calculation of a monthly mortgage payment
Note: In this mortgage calculation, we will be using the g key to convert
the number of periods and annual interest to monthly compounding. For the
present time, our use of the g key will be limited to that function.
Brookes is obtaining a 30-year mortgage on her newly constructed residence.
The interest rate of 6.5% and the loan will be set up with monthly payments.
If the mortgage amount is $225,000, what is the monthly payment?
30
n
i
Calculations
Step
6.50
pv
$225,000
pmt ? fv -
Explanation
HP 12C
0-
Display
Number of periods
fH
30 g n
360.00
3
Interest rate
6.5 g ¼
0.54
4
Present value of mortgage
225000 Þ $
5
Calculates payment
P
1
Clear memory
2
0.00
−225,000.00
1,422.15
Work the next problem by calculating the monthly mortgage payment
Cohen has a 20-year mortgage set up with monthly payments and an interest
rate of 9.75%.
If the mortgage face amount is $136,500, what is the monthly payment?
20
n
i
Calculations
Step
9.75
pv
$136,500
pmt ? fv -
Explanation
HP 12C
1
Clear memory
fH
2
Number of periods
20 g n
3
Interest rate
9.75 g ¼
4
Present value of mortgage 136500 Þ $
5
Calculates payment
P
0-
Display
0.00
240.00
0.81
−136,500.00
1,294.73
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Part 17 – 271
17.1 Problem, cont.
3. Calculation of a mortgage term
Let’s use Cohen’s $136,500 mortgage from the previous example, but change
the interest rate to 6.25%.
If the monthly payment is $1,170.38, calculate the term of the mortgage (in years).
?
n
i
6.25
pv
$136,500
pmt
$1,170.38
fv -
0-
Calculations
Step
Explanation
HP 12C
Display
1
Clear memory
fH
0.00
2
Interest rate
6.25 g ¼
0.52
3
Present value of mortgage
136500 Þ $
4
Monthly payment
1170.38 P
5
Calculates # of payments
n
6
Divides payments by 12 months
12 z
−136,500.00
1,170.38
180.00
15.00
Note: If you do not enter the change sign for Step 3, there will be an error.
How long would it take Cohen to pay off the mortgage if $100 were added to
each monthly payment?
?
n
i
6.25
pv
$136,500
pmt
$1,270.38
fv -
0-
Calculations
Step
Part 17 – 272
Explanation
HP 12C
Display
1
Clear memory
fH
0.00
2
Interest rate
6.25 g ¼
0.52
3
Present value of mortgage
136500 Þ
4
Monthly payment
1270.38
5
Calculates # of payments
n
6
Divides payments by 12 months 12 z
$
−136,500.00
1,270.38
158.00
13.17
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17.1 Problem, cont.
4. Calculation of remaining mortgage balance
You can find the remaining balance due on a loan at any time during the
amortization schedule using the financial keys. The individual might need
to know the remaining balance for early payoff of a fully amortized loan or a
scheduled balloon.
Let’s say we have a loan of $278,000, paid monthly for 23 years at 10.25%
interest. Find the remaining balance after 7 years.
23
n
i
10.25
pv
$278,000
pmt ? fv ?
Calculations
Step
Explanation
HP 12C
1
Clear memory
fH
2
# of periods
23 g n
3
Interest rate
10.25 g ¼
4
Present value of mortgage
278000 Þ $
5
Monthly payment
P
6
Number of periods expired
7gn
7
Remaining balance
M
Display
0.00
276.00
0.85
−278,000.00
2,625.62
84.00
247,345.08
Note: Once you have the answer for Step 7, do not clear the register.
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Part 17 – 273
17.1 Problem, cont.
5. Calculating the percentage paid off
Keep the remaining balance (Step 7) from the last calculation in the display of
your calculator. Let’s subtract the remaining balance from the original loan of
$278,000, and then take the result and divide it by the base of $278,000 to
see the percentage amount that has been paid off.
Calculations
Step
Explanation
HP 12C
1
Subtract original loan amount
Þ 278000 +
2
Divide by loan
278000
3
Calculate percent paid off
z
Display
30,654.92
278,000
0.11
Note: The above calculation is simply taking the amount paid off ($30,654.92)
and dividing that by the original loan amount ($30,654.92 / $278,000).
Now change the display to show the answer with decimals to 9 places. If you
calculated this as a stand-alone problem (rather than retaining the numbers
from no. 4), the answer would have a slight difference (0.000000014).
Note: For additional calculations using the HP 12C, see the appendix.
Part 17 – 274
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Review
Part 17
Learning Objective
Now that you’ve completed Part 17, you should be able to
; Use a financial calculator to perform mortgage calculations.
Recommended Reading
Symbols and Formulas, Capitalization Selection Tree, & Sample Problems, P. 3–8, 12–13;
and Financial Calculator Practice Exercises at www.appraisalinstitute.org/education
(click on Basic Appraisal Principles for the booklet and exercises)
Manual for HP 12C
Terms and Concepts to Remember
No special terms for Part 17
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Part 17 – 275
Review Quiz
Read the information about Romero’s mortgage, and answer the questions that follow.
Romero has been approved for a $350,000 adjustable rate mortgage with interest set at
6.5% and monthly payments set up over the 30-year term of the loan.
n
1.
30 i
6.5 pv
$350,000
pmt ? fv -?
What is Romero’s monthly payment?
HP 12C: 30 g w  6.5 g ¼  350,000 Þ $  P 
$2,212.24 payment
2.
Using the payment calculated from Question 1, what will be the balance at the end
of the 6th year?
HP 12C: 6 g w M $322,228.79 remaining balance
or 30 g w 6.5 g ¼ 350,000 Þ $ P  6 g w M
3.
What is the percentage paid off after six years?
HP 12C: With the remaining balance of $322,228.79 in the display, enter
350,000 - Þ  350,000 z  0.079346 (or about 8%)
Note: The à key can also be used (350,000 \ $322,228.62 à)
4.
Romero originally wanted a shorter loan term, but the payments would be
$2,609.51, and that was too high for Romero. What was the loan term based on
that payment?
HP 12C: 6.5 g ¼  350,000 $  2,609.51 Þ P w
(240 will be in the display after entering “n”) 12 z  20 years
Part 17 – 276
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Part 18
Preview
Time Value of Money Concepts
In Part 18, you’ll continue to use your financial calculator. Part 18 begins with cash
flows and how they operate and then examines the differences in simple and compound
interest. The last half of Part 18 examines time value of money concepts and what is
commonly referred to as “the six functions of a dollar.”
Learning Objective
To prepare for Part 18, read the following learning objective, and refer to it as you study
this part of the handbook.
† Use a financial function calculator to solve problems in simple and compound interest.
Learning Tips
Part 18 provides additional practice with your financial calculator. As in Part 17, many of
the financial calculations are printed. When you review this material, it is a good idea to
read the problem and do the calculations without looking at the printed keystrokes. The
more you do this, the more comfortable you will be in carrying out financial calculations.
If you continue to simply read the keystrokes, the concepts from Part 18 won’t sink in.
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Part 18 – 277
Part 18 – 278
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Part 18.
Time Value of Money Concepts
Time value of money (TVM) is fundamental to financial calculations. In Part 18, you’ll look
at compound interest and what is commonly referred to as the six functions of a dollar.
I.
Understanding Cash Flow
A. The first step in solving a real estate investment problem is to know where the
money is going.
1. Cash flow (CF) diagrams tell us where the money flows over time.
If you were to diagram your savings account over the last year, there might be
a series of financial events.
$1,200
Withdrawals
$800
Months 
1
2
3
4
5
6
7
8
9
10
11
12
–$1,000
Deposits
–$2,000
a. The horizontal line represents time and is divided into regular periods.
b. The down arrows represent negative cash flows. If you put in $2,000
to open the account on January 1 and then deposit $1,000 on May 1,
these arrows will show as money you’ve deposited to keep the savings
account operational.
c. The up arrows represent a positive cash flow. That’s the money you
receive from the account.
d. In a cash flow diagram, the money deposited (that is, invested) is
negative, and the money withdrawn (that is, received from the investment)
is positive.
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Part 18 – 279
2. The cash flow perspective can change, but the principle remains the same.
a. The cash flows will be either positive or negative depending on the
perspective you take on the problem.
b. In the prior example, the bank will look at your deposits and withdrawals
in your savings account using a complete reversal of the cash flow signs.
c. From the bank’s perspective—if it lends you money, the cash flow is
negative; the cash flow is positive when you make a payment on the loan.
d. Think of it this way—when you’re giving cash to a person (that is, cash
flowing out), that’s negative, and when the person gives money to you,
(that is, cash flowing in), that’s positive. You can change the perspective
to a bank, your client, or anyone you choose—the rule, however, stays
the same.
B. Simple and compound interest
The bedrock precept upon which financial calculations are grounded is
that money earns interest over time. The particular interest we speak of is
compound interest, but to understand compound interest, we first have to
know simple interest.
1. Simple interest
Simple interest. Interest in each period calculated based on the original
deposit or investment. The interest does not compound.
a. Jeff and Tina loaned $4,000 to their daughter so she could buy a used
car to go to and from the college campus. The parents arranged for their
daughter to repay the $4,000 after four years plus simple annual interest
of 6% to be paid each year. How much will they receive in total when the
loan is repaid?
$4,000 × 0.06 × 4 = $960 interest + $4,000 = $4,960
Remember, the $4,000 is not returned until the 4th year.
Amortization is not used in this example.
b. Except for situations involving family and friends, simple interest rarely
happens in the real world. However, you should know the concept and how
it contrasts to compound interest.
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2. Compound interest
Compound interest. Interest earned on the original investment amount
and on previously earned interest.
a. Banks rarely use the simple interest formula to calculate funds in their
business operations with bank customers.
b. The phrase, “A bird in the hand is worth two in the bush,” is axiomatic of
the relationship between time and money. An investor would rather have a
dollar in hand now than wait five years for it.
ƒ
A dollar “in hand” now can be invested to earn more money or
interest. For example, let’s say you invest $1,000 in a money
fund at 8% interest. What would it be worth after five years? A
quick mental calculation might come up with a 40% increase (or
$1,400) based on simple interest (i.e., 8% × 5 years). But when
compounding is considered, the investment grows more quickly.
ƒ
The money in the example above would be compounding, or
earning interest on the interest. See the compound interest table
below.
Year
ƒ
Beginning Balance
Interest
Ending Balance
1
$1,000.00
$80.00
$1,080.00
2
$1,080.00
$86.40
$1,166.40
3
$1,166.40
$93.31
$1,259.71
4
$1,259.71
$100.78
$1,360.49
5
$1,360.49
$108.84
$1,469.33
The above table shows that the $1,000 investment increased
nearly 47% in the five-year period based on annual compounding.
c. Many investments have the interest compounded semiannually, quarterly,
monthly, or even daily. The more frequently it is compounded, the faster
the money will grow.
d. The reverse is also true. Money to be received at some point in the
future is worth less than money available now. This is called discounting.
Using the example above and an 8% discount rate, the right to receive
$1,469.33 five years from now is worth $1,000 today.
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Part 18 – 281
3. Compound interest effects. If you placed $1,000 into an investment earning
6% annual interest for one year, it would earn $60 of simple interest. Let’s
contrast that with the effects of compounding.
Note: Clear your financial registers before performing financial calculations.
Interest—compounding annually
$1,060.00
HP 12 C  $1,000 Þ $  6 ¼ 1 n  M 
Note: Compounding annually over one period is the same as simple interest.
Interest—compounding quarterly
HP 12 C  $1,000 Þ $  6 \ 4 z ¼ 
1\4µnM
$1,061.36
Interest—compounding monthly
HP 12 C  $1,000 Þ $  6 g ¼ 1 g n  M 
$1,061.68
4. There are three different types of interest rates that we refer to in
financial problems.
a. Periodic rate. The rate applied to the investment from period to period.
b. Annual nominal rate. The periodic rate multiplied by the number of
periods in a year.
c. Annual effective rate. The rate that includes the effect of compounding.
d. What are the effective rates for the scenarios we just examined?
ƒ
Nominal interest rate
6.00% ƒ
Interest compound annually
6.00% $60.00 / $1,000
ƒ
Interest compound quarterly
6.14% $61.36 / $1,000
ƒ
Interest compound monthly
6.17% $61.68 / $1,000
A monthly periodic rate of 0.5% = a nominal rate of 6%
Part 18 – 282
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
5. Rates of return
a. A prudent investor ultimately seeks a total return greater than or equal to
the amount invested. Therefore, the investor’s expected return consists of
two components:
ƒ
Return of capital—recovery of the amount invested.
ƒ
Return on capital—a reward of the assumption of risk.
b. Returns from real estate can take a variety of forms, and we will get
a look at them in the next course, Basic Appraisal Procedures, but the
broader discussion on rates and measures of return will be examined in
the courses General Appraiser Income Approach, Parts 1 and 2.
6. Another rate that appraisers work with is called the mortgage constant, which
is more properly defined as mortgage capitalization rate.
Mortgage capitalization rate (RM). The capitalization rate for debt; the
ratio of the annual debt service to the remaining principal balance of the
mortgage loan. The mortgage capitalization rate (RM) is equivalent to the
periodic (monthly, quarterly, annual) mortgage constant multiplied by
the number of payments per year on a given loan on the day the loan is
initiated.
a. We will save this concept for more discussion in a later course, but
the term sounds more intimidating than it really is. Appraisers use
the mortgage constant (or mortgage capitalization rate) in valuation
techniques involving income-producing properties. To calculate the
mortgage constant, the annual debt service (that is, the principal and
interest for one year) is divided by the mortgage amount.
Annual Debt
Service
Mortgage
Constant
Mortgage
Amount
b. Example. In Part 14, no. 5 in 14.2 Problem, Jeter had annual debt service
of $10,800 based on a mortgage of $150,000. In that problem, the
mortgage constant is 7.2%. This rate is different from the stated interest
rate for the mortgage (which is about 6% for Jeter’s loan) because it
includes the interest and a portion of the principal.
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Part 18 – 283
II. Time Value of Money
A. Definition
Time value of money. The concept underlying compound interest that holds
that $1 (or another unit of currency) received today is worth more than $1
(or another unit of currency) received in the future due to opportunity cost,
inflation, and the certainty of payment.
B. Appraisers examine real estate problems to address the financial questions that
investor-clients have—questions such as
1. Future value of $1
What will this investment be worth at a future specified time?
2. Future value of $1 per period
What will this income stream be worth at a specified future time?
3. Payment of $1 period to a sinking fund
How much money should I regularly set aside to cover repairs and
improvements to my property?
4. Present value of $1
This investment will be worth a specified amount at a future date, but what is
the value right now?
5. Present value of $1 per period
What is the present value of this income stream?
6. Payment to amortize $1
What will be my annual debt service on a loan for a specified amount, interest
rate, and duration?
Part 18 – 284
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
C. Time value components
1. Future of $1
Amount of one (Sn). The compound interest factor that indicates the
amount to which $1 (or other unit of currency) will grow with compound
interest at a specified rate for a specified number of periods. The amount
of one is one of the six functions of one found in standard financial tables;
also called future value of one.
a. What will an investment of $12,000 grow to if it earns 6% annually over
15 years?
15
n
i
6 pv
$12,000
pmt -
0 - fv ?
Calculations
Step
Explanation
HP 12C
Display
1
Clear memory
fH
2
# of periods
15 n
3
Interest rate
6¼
4
Present value of deposit
12000 Þ $
5
Asks for future value
M
0.00
15.00
6.00
–12,000.00
28,758.70
b. Practice problem. What will $5,000 grow to if it earns 5.25% annually
over seven years?
7
n
i
5.25 pv
$5,000
pmt -
0 - fv ?
Calculations
Step
Explanation
HP 12C
Display
1
Clear memory
fH
0.00
2
# of periods
7n
7.00
3
Interest rate
5.25 ¼
5.25
4
Present value of deposit
5000 Þ $
5
Asks for future value
M
–5,000.00
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
7,153.60
Part 18 – 285
2. Future of $1 per period
Amount of one per period (Sn ). The compound interest factor that
indicates the amount to which $1 (or other unit of currency) per period will
grow with compound interest at a specified rate for a specified number of
periods; … also called sinking fund accumulation factor or future value of
one per period.
Annuity. A contract providing for regular payments of predictable amounts.
Regular payments are those that occur at a constant interval, such as
monthly, quarterly, or annually. Predictable amounts include those that are
level, that escalate based on the Consumer Price Index, that step up, or
that can be predicted in any other way.
a. What will an investment of $5,000 per year grow to in six years at 6%
annual interest?
6
n
i
6 pv - 0 - pmt
Calculations
Step
Explanation
Clear memory
1
$5,000
fv ?
HP 12C
Display
fH
0.00
2
# of periods
6n
6.00
3
Interest rate
6¼
6.00
4
Payment
5000 Þ P
–5,000.00
5
Asks for future value
M
34,876.59
b. Practice problem. If Sullivan places $3,000 each year in her Roth IRA,
what will it grow to in 15 years at 8% annual interest?
15
n
i
8 pv - 0 - pmt
Calculations
Step
Part 18 – 286
Explanation
$3,000
fv ?
HP 12C
Display
1
Clear memory
fH
2
# of periods
15 n
3
Interest rate
8¼
4
Payment
3000 Þ P
–3,000.00
5
Asks for future value
M
81,456.34
0.00
15.00
8.00
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
3. Sinking fund factor
Sinking fund factor (1/Sn). The compound interest factor that indicates
the amount per period that will grow, with compound interest, to $1 (or
other unit of currency).
a. What amount must be deposited annually in an investment earning 6% so
that you will have $25,000 in 10 years?
10
n
i
6 pv - 0 - pmt ? fv
$25,000
Calculations
Step
Explanation
HP 12C
1
Clear memory
fH
2
# of periods
10 n
3
Interest rate
6¼
4
Enter future value
25000 Þ M
Safety step to assure 0 in PV
0$
Required annual deposit
P
5
Display
0.00
10.00
6.00
–25,000.00
0.00
1,896.70
b. Practice problem. Acme Hardware plans to resurface the parking lot in
seven years. What amount must be set aside annually to accumulate the
$60,000 cost of resurfacing if 5% annual interest is used?
7
n
i
5 pv - 0 - pmt ? fv $60,000
Calculations
Step
Explanation
HP 12C
Display
1
Clear memory
fH
0.00
2
# of periods
7n
7.00
3
Interest rate
5¼
5.00
4
Enter future value
60000 Þ M
–60,000.00
Safety step to assure 0 in PV 0 $
5
Required annual deposit
P
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
0.00
7,369.19
Part 18 – 287
4. Present value of $1
Present value of one (1/Sn). A compound interest factor that indicates
how much $1 (or other unit of currency) due in the future is worth today.
Discounting. Conversion of benefits received in the future (e.g., periodic
incomes, cash flows, reversion) to present value.
a. What should an investor pay for the right to receive $10,000 in 11 years
at 6%?
11
n
i
6 pv ? pmt - 0 - fv
$10,000
Calculations
Step
Explanation
HP 12C
Display
1
Clear memory
fH
2
# of periods
11 n
3
Discount rate
6¼
4
Enter future value
10000 Þ M
Safety step to assure 0 in PMT
0P
Calculates present value
$
5
0.00
11.00
6.00
–10,000.00
0.00
5,267.88
b. Practice problem. The reversion value of a commercial property three
years from now is estimated to be $900,000. What is the present value
of the property if the discount rate is 9%?
3
n
i
9 pv ? pmt - 0 - fv
$900,000
Calculations
Step
HP 12C
Display
1
Clear memory
fH
0.00
2
# of periods
3n
3.00
3
Discount rate
9¼
9.00
4
Enter future value
900000 Þ M –900,000.00
Safety step to assure 0 in PMT
0P
Calculates present value
$
5
Part 18 – 288
Explanation
0.00
694,965.13
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
5. Present value of $1 per period
Present value of one per period (an). A compound interest factor that
indicates how much $1 (or other unit of currency) paid periodically is
worth today; … also called present worth of one per period or ordinary
level annuity factor.
a. What might an investor pay to receive an income stream of $120,000 per
year for 18 years if the investor wanted a 6% yield?
18
n
i
6 pv ? pmt
$120,000
fv -0-
Calculations
Step
Explanation
HP 12C
Display
1
Clear memory
fH
2
# of periods
18 n
3
Desired yield
6¼
4
Enter income PMT
120000 Þ P
Safety step
0M
Calculates present value
$
5
0.00
18.00
6.00
–120,000.00
0.00
1,299,312.42
b. Practice problem. Willis is analyzing an investment that will pay $20,000
per year over a period of eight years. If Willis wants to yield 8%, what
might he pay for this investment?
8
n
i
8 pv ? pmt
$20,000
fv -0-
Calculations
Step
Explanation
HP 12C
Display
1
Clear memory
fH
0.00
2
# of periods
8n
8.00
3
Desired yield
8¼
8.00
4
Enter income PMT
20000 Þ P
Safety step
0M
Calculates present value
$
5
–20,000.00
0.00
114,932,78
Basic Appraisal Principles
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Part 18 – 289
Digging Deeper
c. Practice problem. Energy modeling software typically uses a present
value calculation to estimate the value of energy-efficient features. For
example, the energy retrofits on a house cost the owner $18,000, but
the resulting savings is estimated to be $1,200 per year. The retrofits
have an expected 20-year lifespan. The owner expects an annual yield
of 6% on this same money in an alternative investment. What is the
present value indication of the energy savings?
20
n
i
6 pv
? pmt –$1,200 fv -0-
Calculations
Step
Explanation
HP 12C
Display
1
Clear memory
fH
2
# of periods
20 n
3
Desired yield
6¼
4
Enter estimated annual savings
1,200 Þ P
Safety step
0M
Calculates present value
$
5
0.00
20.00
6.00
–1,200.00
0.00
13,763.91
End Digging Deeper
Part 18 – 290
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
6. Installment to amortize $1
Installment to amortize one. The compound interest factor that
represents the installment needed to repay one unit of currency with
interest at a specified rate for a specific number of periods; the reciprocal
of the level annuity factor. Sometimes abbreviated ITAO; also called the
partial payment factor or amortization factor. When expressed annually,
it may be referred to as the mortgage constant, loan constant, annual
constant, or mortgage capitalization rate.
a. Smith loaned $65,000 to his business partner for a five-year term at 6%
annual interest and with annual payments. What is the payment amount?
5
n
i
6 pv $65,000 pmt ? fv - 0 -
Calculations
Step
Explanation
HP 12C
Display
1
Clear memory
fH
0.00
2
# of periods
5n
5.00
3
Interest rate
6¼
6.00
4
Enter PV
65000 Þ $
Safety step to assure 0 in FV
0M
Required annual payment
P
5
–65,000.00
0.00
15,430.77
b. Practice problem. Matthews negotiated a refinance with her bank for a
$285,000 mortgage based on a 5.75% rate and a 25-year term. What is
the monthly payment for this mortgage?
25
n
i
5.75 pv
$285,000
pmt ? fv -0-
Calculations
Step
Explanation
HP 12C
1
Clear memory
fH
2
# of periods
25 g n
3
Interest rate
5.75 g ¼
4
Enter PV
285000 Þ $
Safety step to assure 0 in FV
0M
Monthly payment
P
5
Display
0.00
300.00
0.48
–285,000.00
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
0.00
1,792.95
Part 18 – 291
D. Financial tables
1. Financial tables were designed before financial calculators came on the scene.
a. All six TVM financial functions are provided as factors.
b. Once the appraiser has determined the factor, it’s a matter of multiplying
the factor by the appropriate number in the real estate problem.
2. Financial tables generally display interest rates from 3% to 30% with various
levels of compounding at the more popular rates (that is, monthly, quarterly,
semiannual and annual). For rates above 12%, most financial tables limit the
information to annual compounding.
3. Selecting the proper column is determined by the function to be solved in
a particular problem. Columns 1 and 2 address FV. Column 3 addresses a
payment amount based on FV. Columns 4 and 5 address PV, and Column 6
addresses a payment amount based on PV.
4. A sample portion of the financial table for 7% interest compounded annually is
displayed below.
7.00% ANNUAL INTEREST RATE
1
Future Value
of $1
2
Future Value
Annuity of
$1 per Year
3
Sinking
Fund
Factor
4
Present
Value
of $1
(Reversion)
5
Present
Value
Annuity of
$1 per Year
6
Installment
to
Amortize $1
Years
Years
1
1.070000
1.000000
1.000000
0.934579
0.934579
1.070000
1
2
1.144900
2.070000
0.483092
0.873439
1.808018
0.553092
2
3
1.225043
3.214900
0.311052
0.816298
2.624316
0.381052
3
4
1.310796
4.439943
0.225228
0.762895
3.387211
0.295228
4
5
1.402552
5.750739
0.173891
0.712986
4.100197
0.243891
5
5. To solve a financial problem, apply the appropriate factor. For example, if a
company has to replace a boiler in five years, how much must be saved each
year to accumulate the boiler’s cost of $15,000 if the annual interest rate is
7%? To solve this problem, use a financial table for 7% annual interest, and
identify the sinking fund factor assigned to five years (0.173891). Multiply
the factor by the total cost of $15,000 to derive $2,608.36. This is the
amount that must be deposited in an account each year (compounding at 7%
annually) during the five-year period.
Part 18 – 292
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
6.00% ANNUAL INTEREST RATE
1
Future Value
of $1
2
Future Value
Annuity of
$1 per Year
3
Sinking
Fund
Factor
4
Present Value
of $1
(Reversion)
5
Present Value
Annuity of
$1 per Year
6
Installment
to
Amortize $1
Years
Years
1
1.060000
1.000000
1.000000
0.943396
0.943396
1.060000
1
2
1.123600
2.080000
0.485437
0.889996
1.833393
0.545437
2
3
1.191016
3.183600
0.314110
0.839619
2.673012
0.374110
3
4
1.262477
4.374616
0.228591
0.792094
3.465108
0.288591
4
5
1.338226
5.637093
0.177396
0.747258
4.212364
0.237396
5
6
1.418519
6.975319
0.143363
0.704961
4.917324
0.203363
6
7
1.503630
8.393838
0.119135
0.665057
5.582381
0.179135
7
8
1.593848
9.897468
0.101036
0.627412
6.209794
0.161036
8
9
1.689479
11.491316
0.087022
0.591898
6.801692
0.147022
9
10
1.790848
13.180795
0.075868
0.558395
7.360087
0.135868
10
11
1.898299
14.971643
0.066793
0.526788
7.886875
0.126793
11
12
2.012196
16.869941
0.059277
0.496969
8.383844
0.119277
12
13
2.132928
18.882138
0.052960
0.468839
8.852683
0.112960
13
14
2.260904
21.015066
0.047585
0.442301
9.294984
0.107585
14
15
2.396558
23.275970
0.042963
0.417265
9.712249
0.102963
15
16
2.540352
25.672528
0.038952
0.393646
10.105895
0.098952
16
17
2.692773
28.212880
0.035445
0.371364
10.477260
0.095445
17
18
2.854339
30.905653
0.032357
0.350344
l0.827603
0.092357
18
19
3.025600
33.759992
0.029621
0.330513
11.158116
0.089621
19
20
3.207135
36.785591
0.027185
0.311805
11.469921
0.087185
20
21
3.399564
39.992727
0.025005
0.294155
11.764077
0.085005
21
22
3.603537
43.392290
0.023046
0.277505
12.041582
0.083046
22
23
3.819750
46.995828
0.021278
0.261797
12.303379
0.081278
23
24
4.048935
50.815577
0.019679
0.246979
12.550358
0.079679
24
25
4.291871
54.864512
0.018227
0.232999
12.783356
0.078227
25
26
4.549383
59.156383
0.016904
0.219810
13.003166
0.076904
26
27
4.822346
63.705766
0.015697
0.207368
13.210534
0.075697
27
28
5.111687
68.528112
0.014593
0.195630
13.406164
0.074593
28
29
5.418388
73.639798
0.013580
0.184557
13.590721
0.073580
29
30
5.743491
79.058186
0.012649
0.174110
13.764831
0.072649
30
Basic Appraisal Principles
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Part 18 – 293
18.1 Problem
Using Financial Tables to Solve Problems
Instructions. Use the financial table on the prior page to solve the
same six questions that you previously worked with your financial
calculator. The questions are reprinted below, and all are based on 6% (compound)
annual interest.
1. What will an investment of $12,000 grow to if it earns 6% annually over
15 years?
$12,000 × 2.396558 (Column 1) = $28,758.70
2. What will an investment of $5,000 per year grow to in six years at 6%
annual interest?
$5,000 × 6.975319 (Column 2) = $34,876.59
3. What amount must be deposited annually in an investment earning 6% so that
you will have $25,000 in 10 years?
$25,000 × 0.075868 (Column 3) = $1,896.70
4. What should an investor pay for the right to receive $10,000 in 11 years
at 6%?
$10,000 × 0.526788 (Column 4) = $5,267.88
5. What might an investor pay to receive an income stream of $120,000 per year
for 18 years at 6% annual interest?
$120,000 x 10.827603 (Column 5) = $1,299,312.36
6. Smith loaned $65,000 to his business partner for a five-year term at 6%
annual interest and with annual payments. What is the payment amount?
$65,000 × 0.237396 (Column 6) = $15,430.74
Note: For Questions 5 and 6 above, the answers will be different by a few cents
from answers derived from a financial calculator. This is because the financial
table is limited to six decimal places to the right of zero.
Part 18 – 294
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Review
Part 18
Learning Objective
Now that you’ve completed Part 18, you should be able to
; Use a financial function calculator to solve problems in simple and compound
interest.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
Symbols and Formulas, Capitalization Selection Tree, & Sample Problems, P. 3 – 8,
12 – 15; and Financial Calculator Practice Exercises at www.appraisalinstitute.org/
education (click on Basic Appraisal Principles for the booklet and exercises)
Terms and Concepts to Remember
Annuity
Discounting
Simple interest
Cash flow
Present value of $1
Sinking fund factor
Compound interest
Rate of return
Time value of money (TVM)
Basic Appraisal Principles
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Part 18 – 295
To help you know which financial component to solve for, the following chart might prove
helpful in your studies. The question mark (?) represents the unknown to be solved.
PV
PMT
1
Future value of $1
$1
2
Future value of $1 per period
3
Sinking fund factor
4
Present value of $1
?
5
Present value of $1 per period
?
$1
6
Amortization factor
$1
?
FV
?
$1
?
?
$1
$1
Source: David M. Bradley, MAI, SRA
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Digging Deeper
In our discussion of the present value of $1, we defined discounting. The term discount
rate was noted in the calculations for the HP 12C, so we’ve included the definition.
However, discounting and discount rate are topics that will have greater coverage in
upcoming courses such as Basic Appraisal Procedures and the General Appraiser Income
Approach courses. For now, you only need to be generally familiar with the terms.
Discount rate. A rate of return on capital used to convert future payments or
receipts into present value.
Mortgage Capitalization Rate Revisited
If you would like some additional practice to help you grasp the mortgage constant, here
is a problem you can tackle.
Problem. In Part 17, under 17.1 Problem, Question 1, Mansfield Consulting had a 25year mortgage of $850,000 with an annual debt service of $86,535.31. We provided
the T-Bar formula as reference and a blank T-Bar for your use. Calculate the mortgage
constant on loan for Mansfield Consulting.
Annual Debt
Service
Mortgage
Constant
Mortgage
Amount
$86,535.31
10.18%
$850,000
Answer. If you went back to Part 17 to review the original problem, you should have
discovered that the original mortgage was at 9%. The mortgage capitalization rate
(or mortgage constant) is different than that rate because it includes a portion of the
principal that is paid off with each payment. The mortgage constant is 10.18%.
End Digging Deeper
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Practice Test Section 6
This multiple-choice test is for your benefit and provides a review of
everything covered in Section 6. This is a closed-book test. Choose
the most correct answer.
1.
*
2.
Kramer put $12,000 into an investment on August 10th and took out $3,000 on
September 31st. How should the cash flows be recorded (that is, money direction)?
A.
+$12,000 and –$3,000
B.
+$12,000 and –$9,000
C.
–$12,000 and +$3,000
D.
–$12,000 and –$3,000
What does RPN represent?
A.
rational positive numbers
B.
really powerful numbers
C.
return on net principal
*
D.
Reverse Polish notation
3.
Which of the following terms is commonly referred to as an average?
*
4.
*
A.
array
B.
mean
C.
median
D.
mode
Wheatley is considering a mortgage with a face amount of $195,000 and is
debating whether to get the 30-year mortgage at 6% or the 20-year mortgage at
5.5%. What is the difference between the two monthly payments?
A.
$61.93
B.
$172.26
C.
$227.92
D.
$2,150.93
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5.
Peterson began saving $10 per week and deposited it every month in her money
market account, earning 4.25% and compounding monthly. If she continues this
practice, how much will she have after 10 years?
A.
$5,968.29
B.
$6,289.15
C.
$6,316.04
*
D.
$6,465.65
6.
What amount must be deposited annually in an account earning 7.5% interest that
compounds annually to accumulate $100,000 in 15 years?
*
7.
*
8.
*
9.
*
A.
$302.01
B.
$3,828.72
C.
$3,979.46
D.
$7,068.59
What should Greenberg pay for the right to receive $60,000 in seven years at 10%
interest compounded quarterly?
A.
$29,976.06
B.
$29,991.67
C.
$30,052.67
D.
$30,789.49
A simple measure of dispersion of the difference between the highest and lowest
value in a data set is known as the
A.
mean.
B.
range.
C.
standard deviation.
D.
variate.
An annuity functions in a similar manner to what time value component?
A.
future of $1
B.
future of $1 per period
C.
present value of $1 per period
D.
sinking fund factor
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Section 7
7
Part 19.
Analyzing Market Areas
Part 20.
The Nature of Appraisals
Part 21
Appraisal Principles in Practice
Part 19
Preview
Analyzing Market Areas
One of the things appraisers do in an appraisal is to identify the market area. This is
important because from this area, the appraiser will select comparable sales, rental
data, and other information critical to the appraisal analysis. The handbook will cover
the characteristics of market areas and the value influences that are exerted upon them
through various forces. You’ll also identify types of districts that can be classified within a
given market area.
Learning Objectives
To prepare for Part 19, read the following learning objectives, and refer to them as you
study this part of the handbook.
† Recognize the definitions of market area, neighborhood, and district.
† Identify the four stages of a neighborhood life cycle.
† Recognize the definitions of transition and gentrification.
† Identify the four major value forces on market areas.
† Recognize the definition of linkages.
Learning Tips
Concentrate your efforts on terminology and how the various concepts of market area
interrelate. Sometimes market area is confused with neighborhood and/or districts,
which is easy to understand since they often overlap each other. Neighborhoods and
districts generally have an emphasis on land use characteristics, whereas market area is
more focused on the behavior of buyers and sellers of properties that compete with the
subject of the appraisal assignment. Part 19 concludes with a review quiz that will help
you to distinguish among the different type of districts found in a market area.
Part 19 begins the last day of the course, and you should be aware that the morning
session contains important concepts for you to learn. You’ll need to be attentive to terms
today, as it is likely that some of them will show up on the final exam.
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Part 19.
Analyzing Market Areas
I.
Understanding Market Areas
A. What is a market area?
Market area. The geographic region from which a majority of demand comes
and in which the majority of that competition is located...
1. To understand how an appraiser analyzes a market area in a valuation
assignment, it’s necessary to understand neighborhoods and districts.
Neighborhood. A group of complementary land uses; a congruous
grouping of inhabitants, buildings, or business enterprises.
District. A neighborhood characterized by homogeneous land use, e.g.,
apartment, commercial, industrial, agricultural.
2. Market areas, neighborhoods, and districts often overlap in the appraiser’s
analysis of a property, and these terms can be easily confused because each
has an influence on the subject property from differing perspectives.
a. Market area is focused on the behavior of buyers and sellers of properties
that directly compete with the subject of the appraisal assignment,
whereas neighborhoods and districts have an emphasis on land use
characteristics. Of course, land use plays a key role in the behavior of
buyers and sellers—so the three terms are not isolated but instead tend
to blend and overlap.
b. A market area can encompass one or more neighborhoods and/or
districts and, in some instances, a market area can be wholly identified
within a specific portion of a neighborhood or district.
3. The subject property of an appraisal assignment is influenced by the
governmental/legal, economic, social, and environmental/geographic forces
that permeate the market area in which it is located. These are the very
forces the appraiser is analyzing when identifying a market area.
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B. How is a market area identified?
1. The appraiser may start by defining the physical boundaries of the subject
property’s neighborhood, but more importantly, the appraiser must go beyond
that and identify the factors influencing the prices of competing properties in
the market area—which may extend beyond the identified neighborhood and
into competing neighborhoods.
2. The analysis of the market area begins by looking at all the relevant
influences being exerted on the property’s value.
a. The process starts at the subject property and extends out from that
point to encompass the factors influencing its property value.
b. When no more qualifying factors are found that would impact the value
of the subject property and its surrounding properties, the boundaries for
analysis of the market area are set.
C. Purpose of analyzing the market area in an appraisal assignment
1. Provides a framework, or context, in which the value conclusion is developed
2. Identifies the area that has the greatest influence on the subject property’s
use and value
3. Establishes potential limits for data searches used in the approaches to value
4. Helps the appraiser determine the stability of an area and may also indicate
future land use and value trends
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II. Characteristics of Market Areas
On the previous page, the identification of a market area was briefly discussed. The
content presented here looks at that process in more detail by breaking it down
into four areas; geographical boundaries, change and transition, the life cycle of a
neighborhood, and gentrification.
A. Geographical boundaries
1. The appraiser starts the process of identifying the market area by first roughly
defining the physical boundaries. This is a starting point, and the analysis will
be tempered by the other characteristics (that will be discussed).
a. Begin with the subject property, and then look around at the physical
characteristics of the area, types of structures, land use, topography,
access, etc., and see how they identify with the subject property.
b. Draw a preliminary boundary on a map, and start testing the boundary
against the other characteristics you will uncover as the process continues.
2. Boundaries of a market area reflect the forces that influence values on all
surrounding properties in the same way as they do on the appraised property.
3. Boundaries may be established by physical attributes or changes in use.
a. Physical attributes and landmarks
ƒ
Natural features
Rivers, wetlands, lakes, canyons, elevated areas, forests
ƒ
Man-made features
Freeways, railroads (and light rail transit), power lines, subdivisions
b. Changes in use
ƒ
From agricultural to residential, or a change to industrial uses
ƒ
From one-unit residential to higher-density residential or to
commercial uses
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B. Change and transition
1. Market areas are dynamic and subject to constant change.
2. The appraiser must recognize changes taking place in a market area.
Pertinent questions to determine change include the following:
a. Are there new uses evident in the market area?
b. Are there changes in density or an increase in commercial influence in a
residential neighborhood?
c. Is property maintenance changing?
d. Are many properties listed for sale in the area?
3. The appraiser must analyze the effect, if any, these changes have on value.
a. Changes in competing areas must be analyzed for impact on the subject
market area.
b. Rapid growth or decline in one market area may impact another. For
example, growth in suburban business centers may negatively influence
the central business district of a city.
4. Transition
Transition. Changes in neighborhood use from one use to another, e.g.,
agricultural to residential, residential to commercial.
a. Transition is related to the principle of change, but it is a separate concept.
b. Transition is identified with land use, whereas change is broader
and encompasses more characteristics. The two can take place at
different rates and have different effects on the same property within a
neighborhood.
c. Change can be short-term or long term, but transition usually has a
long duration.
d. Analyzing trends in the neighborhood and in the market area is part of the
appraiser’s overall market analysis.
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C. The life cycle of the subject neighborhood helps to define the characteristics of
the market area.
1. Growth A life cycle stage in which the neighborhood gains
public favor and acceptance.
2. Stability A life cycle stage in which the neighborhood
experiences equilibrium without marked gains or losses.
3. Decline A life cycle stage of diminishing demand in a
neighborhood.
A life cycle stage characterized by renewal,
4. Revitalization
modernization, and increasing demand.
D. Gentrification
Gentrification. A process of community change in which middle- and upperincome persons purchase properties in a neighborhood and renovate or
rehabilitate them, causing property values to rise and often displacing earlier,
usually poorer (low-income) residents.
1. Gentrification is not easily defined nor described.
2. Gentrification typically occurs in older urban market areas where the current
residents moved in during a declining period in the life cycle of the market
area. Through a natural resurgence of demand, the current occupants
are displaced one by one, and the dwellings are renovated leading to a
transformation in the economic and social characteristics of the area.
3. Gentrification and revitalization are related, but the terms have different
meanings. Revitalization usually comes about by an organized (often public)
renovation, restoration, or building program. Gentrification doesn’t have
this organized or public effort; it is private and more random in how it takes
place. Nonetheless, it results in revitalization of the market area. The current
occupants are displaced but not through public takings such as eminent
domain as might be the case in an urban renewal (publicly-sponsored) project.
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III. Value Influences on Market Areas
The four forces that influence value were previously discussed in Part 10.
A. Governmental and legal
These considerations relate to laws, regulations, and taxes, and the enforcement
of these constraints on market area inhabitants. Relevant governmental
considerations include the following factors:
1. Taxation and special assessments
2. Public and private restrictions
3. Schools
4. Police and fire protection
5. Planning and development activities
B. Economic
Economic considerations relate to the financial capacity of a market area’s
occupants and their ability to maintain properties. Relevant economic
considerations include the following factors:
1. Economic profile of residents
2. Types of financing available
3. Price and rent levels
4. Construction, conversion, and vacant land
5. Extent of owner occupancy
6. Vacancy rates
7. Changes in use or economic base
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C. Social
Social considerations relate to the status, physical environment, services,
affordability, and conveniences of a location. Relevant considerations include the
following factors:
1. Population density
2. Age and income levels of occupants
3. Quality of services
4. Crime rate
D. Environmental and geographic
Environmental considerations consist of any natural or manufactured features
that are contained in or affect the market area. Relevant environmental
considerations include the following factors:
1. Location within the community
Linkage. 1. Time and distance relationship between a particular use and
supporting facilities, e.g., between residences and schools, professional
services, shopping, and employment.
2. The movement of people, goods, services, or communications to and
from the subject site, measured by the time and cost involved.
The time-distance relationships (that is, linkages) between a property or
market area and other destinations or origins include
a. Transportation systems (public and private)
b. Linkages to employment, shopping, schools, recreation, and places of
worship
2. Topography, soil, climate, and view
3. Land use patterns, density of buildings, and open space
4. Age, type, size, condition, and appearance of structures
5. Adequacy, cost, and quality of services
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6. Environmental liabilities
a. Environmental laws and regulations have an influence on property values.
The appraiser is not expected to be an expert in these areas but must be
on the alert for potential liabilities and report evidence of past or present
environmental hazards in the area.
b. Environmental liabilities might include the presence of radon, asbestos,
PCBs, chemicals, pesticides, and water contamination.
E. Valuation bias, fair housing, and equal opportunity
1. The Fair Housing Act (FHA) and Equal Credit Opportunity Act (ECOA) provide
protection to consumers by prohibiting unfair and discriminatory practices
related to groups such as those in the partial list identified below.
ƒ
Race
ƒ
Color
ƒ
Religion
ƒ
National origin
ƒ
Gender
ƒ
Marital status
ƒ
Familial status
ƒ
Age
ƒ
Receipt of public assistance
income
ƒ
Disability
Source: Fair Housing Act (FHA) and Equal Credit Opportunity Act (ECOA)
2. Fair housing and lending laws effect how appraisers present verified data
and assignment results in their appraisal reports pertaining to discriminatory
practices identified in federal and state laws.
a. Valuation bias, whether explicit or implicit, is antithetical to what defines
an appraiser and is detrimental to public trust. Appraisers must render
valuation services in an impartial and objective manner that does not
favor, or withhold legal rights, or distinguish among people, or in any
manner lead to unlawful discrimination toward groups identified in fair
housing and fair lending laws.
b. Appraisers must not rely on unsupported conclusions relating to personal
characteristics of the groups identified in the table above. Moreover,
appraisers must comply with applicable laws that may prohibit the use
of even supported conclusions in assignments if the appraiser’s findings
lead to discriminatory practices against individuals and groups protected
by fair housing and fair lending laws.
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3. Appraisers should use factual descriptions rather than subjective phrases,
and avoid stereotyping and other forms of bias in communicating assignment
results.
19.1 Discussion Question. Market Area Description
An abandoned and boarded-up property is located next to the subject
property you are appraising in a predominantly Black neighborhood of 100
residences. You find that another vacant property is located several blocks
away.
How should you report this?
Instructor guidance: Encourage the class to discuss how unsupported, and
sometimes even supported conclusions, related to personal characteristics can
lead to discriminatory practices.
Suggestion: “There are 100 residential properties in the defined market
area of which 2% are vacant. The appraiser’s research indicates this is typical of
competing areas and is accepted in the marketplace.”
IV. District Types
A. One-unit residential districts
A one-unit residential district is an area dominated by owner-occupied, residential
homes where residents often take an active role in maintaining or enhancing the
value of their properties.
B. Multifamily residential districts
Multiunit residential districts are generally subject to the same influences as oneunit residences with an increased emphasis on certain aspects such as parking
and vacancy rates.
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C. Commercial districts
Commercial districts are groups of offices or stores. There are several types of
districts included in this category.
1. Highway commercial districts
2. Retail districts
3. Central business districts (CBD)
Central business district (CBD). The core, or downtown area, of a city
where the major retail, financial, governmental, professional, recreational,
and service activities of the community are concentrated.
D. Retail districts
Retail districts, more than any other type of property, rely on the local trade area
for their economic base. Types of retail property include
1. Regional shopping center. A shopping center that offers a variety of general
merchandise, apparel, furniture, home furnishings, services, and recreational
facilities and is built around one or more full department stores. This type of
shopping center is usually enclosed, with an inward orientation of the stores
connected by a common walkway, and parking surrounds the outside perimeter.
a. The appraiser analyzes the makeup of the trade area, competition, and
proposed competition for regional shopping centers.
b. Regional centers increase the value of the surrounding land as the
demand increases for satellite stores, offices, and other commercial uses.
2. Community shopping center. Typically a shopping center that offers a wider
range of apparel and other soft goods than neighborhood centers. Among the
more common anchors are supermarkets, super drugstores, and discount
department stores. The primary trade area extends out from the center about
three to six miles.
3. Neighborhood shopping center. A local shopping center with a gross leasable
area generally ranging from 30,000 to 150,000 square feet. A neighborhood
shopping center offers consumable goods and personal services, and it usually
serves a trade area within three miles of its location.
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E. Office districts
Office districts include planned office parks and strip developments on major
arteries or in older multistory buildings in the CBD. These districts are sensitive
to access and support services like nearby restaurants.
F. Agricultural districts
The appraiser should consider soil type, land use, crops grown, crop markets, and
water supplies when delineating agricultural districts.
G. Industrial districts
Industrial districts can take many forms from large, old complexes with heavy
industry use to modern industrial parks with light industry use. These districts are
dependent on the political climate and the availability of utilities and energy. The
following considerations are important for industrial districts:
1. Availability of labor (quantity and quality of skill levels)
2. Availability of materials
3. Distribution facilities
Examples include ingress and egress, on-site parking, and linkages by air, rail,
water, or highway systems.
H. Specialty districts
1. Medical districts
Medical districts may consist of hospitals, health care facilities, doctors’
offices, and medical parks.
2. Research and development parks
Research and development parks may consist of universities, independent
firms that specialize in research, or departments of large companies.
3. High technology parks
Examples of high technology park tenants include electronics and computer
firms. These parks are often located near universities or research and
development parks.
4. Education districts
Colleges, universities, and community colleges, and the attendant housing
and services may constitute a district.
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5. Historic districts
Government agencies may designate historic districts, or individuals
may informally perceive them. Tax credits and restrictions on changes or
innovations might apply to historic districts designated by the government.
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Review
Part 19
Learning Objectives
Now that you’ve completed Part 19, you should be able to
; Recognize the definitions of market area, neighborhood, and district.
; Identify the four stages of a neighborhood life cycle.
; Recognize the definitions of transition and gentrification.
; Identify the four major value forces on market areas.
; Recognize the definition of linkages.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 10, pp. 111–117, and Chapter 11,
pp. 137–164.
Guide Note 18: Personal Characteristics and Valuation Practice, Guide Notes to
the Standards of Professional Practice of the Appraisal Institute, https://www.
appraisalinstitute.org/professional-practice/ethics-and-standards/guide-notes-to-thestandards-of-professional-practice-of-the-appraisal-institute/
Terms and Concepts to Remember
District
Linkages
Neighborhood
Gentrification
Market area
Transition
Life cycle of a neighborhood
(four stages)
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Review Quiz
Write a number on the line opposite each item below to indicate whether the item is
best described as
1. One-unit residential districts
8.
Specialty districts
2. Multifamily districts
9.
Historic districts
3. Central business districts
10. Growth
4. Retail districts
11. Stability
5. Office districts
12. Decline
6. Industrial districts
13. Revitalization
7. Agricultural districts
14. Gentrification
4
Regional shopping center
3
Downtown business area
1
A cluster of condominium projects
4
A mix of big-box stores, fast-food restaurants, and a car dealership
1
Vintage, one-unit residential homes
7
Grain elevator, corn fields, low density, distant linkage
6
Acme Fluid Power, Advanced Metal Etching, Jimson Anodizing
13 City-organized effort to invigorate a declining retail district
2
Duplexes and apartments
10 Open land transitioning to new residential developments
12 A stage where vacant and abandoned industrial buildings are observed
8
Part 19 – 316
Medical research center, hospital, physician’s office center
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Part 20
Preview
The Nature of Appraisals
Part 20 builds on the material introduced at the beginning of the course. Terms such
as appraisal practice and intended use should be sounding more familiar by now. The
handbook goes into greater detail on how to distinguish appraisal practice from other
valuation services. Part 20 concludes with an overview of the components that lead up
to the appraiser’s scope of work.
Learning Objectives
To prepare for Part 20, read the following learning objectives, and refer to them as you
study this part of the handbook.
† Recognize the definitions of appraisal practice, valuation services, appraisal, and
appraisal review.
† Identify the basic assignment elements used in the appraiser’s scope of
work decision.
Learning Tips
Your goal is to obtain a general understanding of the differences between appraisal
practice and valuation services. Appraisal practice is a subset of valuation services, and
there are distinguishing characteristics that set these two apart.
You will also need to distinguish between the two primary types of appraisal practice—
appraisal and appraisal review. The more challenging content is the process of problem
identification used to determine the appraiser’s scope of work. Don’t try to memorize the
scope of work flowchart. From Part 1 you might recall the problem identification process
and the six assignment elements that are typical for an appraisal. We’re going to broaden
that process and add two more elements when considering assignments that fall
under appraisal practice. If you can remember the dominant elements of intended user,
intended use, and purpose, you’re doing just fine.
Your instructor will highlight the terms and concepts from the chart that you might need
to know for the exam, and these will be terms that are familiar to you.
Scope of work is addressed again in Part 21 through practical applications. If it is
confusing to you, you’ll have another opportunity to address it in more detail in the
national course covering professional standards and ethics.
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Part 20.
The Nature of Appraisals
It’s time to re-examine some of the ethical concepts introduced at the beginning of
this course. In the introduction to Part 1, you thought about the question, “What is an
appraiser?” You also looked at the various types of services within appraisal practice.
Part 20 presents appraisal practice within the broader aspect of valuation services and
then digs a little deeper into scope of work.
I.
Valuation Services and Appraisal Practice
A. Valuation services
Valuation service. “A service pertaining to an aspect of property value,
regardless of the type of service and whether it is performed by appraisers
or by others.” (USPAP, Definitions)
1. Valuation services pertain to all aspects of property value and include
services such as
a. Appraisal practice
b. Brokerage
c. Auctioning
d. Property management
e. Real property consulting
f.
Advocate consulting
g. Collecting market data
2. Valuation services are performed by appraisers and by others.
3. An appraiser has an obligation to not misrepresent his or her role when
performing valuation services outside of appraisal practice.
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B. Appraisal practice
1. Appraisal practice is a property service “performed by an individual acting as
an appraiser” (USPAP, Definitions), including the following:
a. Appraisal
b. Appraisal review (USPAP, Definitions)
c. Other services while acting an appraiser, which may include
ƒ
Providing sales data
ƒ
Trend analysis
ƒ
Zoning study
ƒ
Assessment study
ƒ
Teaching an appraisal course
Instructor guidance:
These services cannot have
a valuation component;
otherwise, they would fall
under appraisal or appraisal
review.
20.1 Discussion Question. In the Real World
Brokerage Services
Janssen, a real estate broker who is also an appraiser, has been retained to
list and sell a property. As part of her brokerage services, Janssen provides
a competitive market analysis (CMA) to determine the asking price of a property listing.
Is the CMA service she provides her client considered appraisal practice?
Instructor guidance: If Janssen is acting as an appraiser, her service is
appraisal practice. If she is acting as a broker, it isn’t appraisal practice.
Janssen needs to be clear about her role and state it clearly to her client,
“I’m not acting as an appraiser in providing this service. Instead, I’m acting as
a broker.”
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2. Client expectation plays an important role when an appraiser is retained to
perform valuation services.
a. Client expectation is inherent in the definition of appraiser.
Appraiser. “One who is expected to perform valuation services
competently and in a manner that is independent, impartial, and
objective.” (USPAP, Definitions)
b. Appraisal practice is a subset of valuation services, and client
expectations can be a deciding factor in what type of service the
appraiser provides. The following Venn Diagram, which can be found in
USPAP, Advisory Opinion 21, depicts the relationship.
3. The two primary services of appraisal practice are defined as follows:
Appraisal. “The act or process of developing an opinion of value; an
opinion of value.” (USPAP, Definitions)
Appraisal review. “The act or process of developing an opinion
about the quality of another appraiser’s work (i.e., a report, part
of a report, a workfile, or some combination of these), that was
performed as part of an appraisal or appraisal review assignment.”
(USPAP, Definitions)
Note. Also, see SVP for the definition of appraisal.
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II. Scope of Work
A. Solving a client’s problem involves a master plan called the valuation process,
which will be the focus of our next course. A critical component of the valuation
process is scope of work.
1. Definition for scope of work
Scope of work. “The type and extent of research and analyses in an
appraisal or appraisal review assignment.” (USPAP, Definitions)
2. Definitions of three key elements within the problem identification process.
These elements are essential to the appraiser’s scope of work determination.
Intended user. “The client and any other party as identified, by name
or type, as users of the appraisal or appraisal review report by the
appraiser, based on communication with the client at the time of the
assignment.” (USPAP, Definitions)
Intended use. “The use(s) of an appraiser’s reported appraisal or
appraisal review assignment results, as identified by the appraiser
based on communication with the client at the time of the assignment.”
(USPAP, Definitions)
Purpose of an assignment. The objective of an assignment—e.g., in an
appraisal assignment, to develop an opinion of the defined value of a
specified interest in real estate.
ƒ
The term purpose used in the process of defining a client’s problem was
edited in prior versions of USPAP to mean type and definition of value
and requires citing the source of the definition.
Note. Also, see SVP for the definitions of scope of work, intended user,
and intended use.
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The Scope of Work Decision Process in Appraisal Practice
Source: Flowchart adapted from content published by The Appraisal Foundation
Who does the appraiser intend
Client
Client
and
Other
Clientand
andOther
Other
Intended
Users
Intended
IntendedUsers
Users
will use the conclusions?
How does the appraiser
Intended
Intended
Use
IntendedUse
Use
intend the conclusions to
Scope
Scope
Scope
of
Work
of Work
Work
be used?
Purpose
Purpose
Type
and
Purpose–––Type
Typeand
and
Definition
Value
Definition
Definitionofof
ofValue
Value
Type of
Assignment
Effective
Effective Date
Date
Effective
Date
Appraisal
Past
Appraisal review
Current
Other services
Future
Type of
Property
Subject’s
Subject’s Relevant
Relevant
Characteristics
Characteristics
Characteristics
Real property
Legal
Personal property
Physical
Intangible property
Economic
Assignment
Assignment
Conditions
AssignmentConditions
Conditions
Extraordinary assumptions
Hypothetical conditions
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B. Once the problem is identified, the appraiser can determine the scope of work to
solve the problem. Here are some of the decisions the appraiser must determine:
1. How will the subject property be identified and to what extent? This often
includes the property’s legal description, identifying maps, and photographs,
but it can go deeper depending on the intended use.
2. Definition
Personal inspection. “A physical observation performed to assist in
identifying relevant property characteristics in a valuation service.”
(USPAP, Definitions)
How extensive should the inspection of the property be (that is, in the case
of tangible property)? In some cases, an exterior-only inspection is sufficient;
in other assignments, a more thorough observation process is required. If the
property has multiple units, the appraiser must decide whether a sampling of
the units will be inspected or if each unit must be inspected.
3. The appraiser must decide the type of data to research and the types of
analyses that are appropriate for the assignment.
4. The appraiser also decides the amount of research and analysis that is
sufficient to produce credible assignment results.
C. Scope of work contains the ingredients to solve the client’s problem. If the scope
of work is flawed, there is a strong chance that the assignment results will be in
error or even misleading.
D. The appraiser must be ready to confirm that the scope of work is acceptable and
adequate to provide credible assignment results.
E. A closer look at assignment conditions
1. Assignment conditions serve identified purposes in appraisals, appraisal
reviews, and other services, and must be used with sufficient care.
Assignment conditions. “Assumptions, extraordinary assumptions,
hypothetical conditions, laws and regulations, jurisdictional exceptions,
and other conditions that affect the scope of work.” (USPAP, Definitions)
2. Extraordinary assumptions and hypothetical conditions are two common types
of assignment conditions employed for specific uses by appraisers.
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3. Definitions
Extraordinary assumption. “An assignment-specific assumption as of
the effective date regarding uncertain information used in an analysis
which, if found to be false, could alter the appraiser’s opinions or
conclusions.” (USPAP, Definitions)
Note. Also, see SVP for the definition of hypothetical condition.
Hypothetical condition. “A condition, directly related to a specific
assignment, which is contrary to what is known by the appraiser to exist
on the effective date of the assignment results, but is used for the
purpose of analysis.” (USPAP, Definitions)
a. An extraordinary assumption presumes as fact otherwise uncertain
information about the property.
20.2 Example—When an Extraordinary Assumption Might Be Used
Proposed construction with a prospective date. A value opinion
that presumes the construction will be complete is based on an
extraordinary assumption because the appraiser cannot be certain
the construction will be completed as proposed.
b. A hypothetical condition generally presents a “what if” scenario for
valuation purposes.
20.3 Example—When a Hypothetical Condition Might Be Used
ƒ
Proposed construction based on a current value—The physical
improvements are not presently there, so the appraiser views
the property as if the improvements were there and conditions
the value upon completion.
ƒ
Eminent domain involving a partial acquisition—This appraisal
typically requires two values—one before the acquisition and one
after the acquisition but both as of the same effective date.
4. An appraiser must follow prescribed rules in deciding whether it is appropriate
to use an extraordinary assumption or a hypothetical condition, and the
appraisal report must properly disclose its use.
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5. The additional assignment conditions stated in the definition are addressed
and discussed in a separate course on standards and ethics.
F. Final thoughts—appraisal practice and advocacy
1. Whenever an individual is acting in the role of an appraiser, the work falls
under appraisal practice.
2. Assignments under appraisal practice must be performed with impartiality,
objectivity, independence, and without accommodation of personal interest.
3. An individual acting in the role of an appraiser must not accept an assignment
or perform services in a manner that advocates the cause or interest of any
party or issue.
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Review
Part 20
Learning Objectives
Now that you’ve completed Part 20, you should be able to
; Recognize the definitions of appraisal practice, valuation services, appraisal, and
appraisal review.
; Identify the basic assignment elements used in the appraiser’s scope of
work decision.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 1, pp. 1–3, 6–7.
Terms and Concepts to Remember
Appraisal
Hypothetical condition
Purpose of an appraisal
Appraisal practice
Intended use
Scope of work
Appraisal review
Intended user
Valuation services
Extraordinary assumption
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Review Quiz
Fill in the answers to the following questions.
1.
Appraisal practice is a subset of valuation services .
2.
An individual performing a valuation service while acting in the role of an appraiser
falls under the category of appraisal practice .
3.
The act or process of developing an opinion about the quality of another’s work is
called appraisal review .
4.
When a value type is defined in the scope of work, such as an opinion of market
value in a real property assignment, this is also referred to as the purpose of the assignment.
5.
If the scope of work decision is flawed, there is a strong chance
the assignment results will be misleading.
Check the appropriate box for each question.
6.
An appraisal is the process of developing an opinion
of value.
7.
A prospective value has an effective date in the past.
8.
The party the appraiser identifies by name or type as a
user of the appraisal report is an intended user.
9.
An appraiser teaching an appraisal course is performing
appraisal practice.
TRUE
FALSE
10. A broker’s competitive market analysis if performed by an
appraiser is always exempt from being classified as
appraisal practice.
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Part 21
Preview
Appraisal Principles in Practice
No new content is presented in Part 21. Instead, there are three scope of work problems
that review the content you’ve been learning all along. There is ample space to write
notes, but that’s up to you. These are real-world problems, and if you get involved and
dig into them, you will come away with some practical information about how appraisers
solve client problems.
Learning Objective
To prepare for Part 21, read the following learning objective, and refer to it as you study
this part of the handbook.
† Apply scope of work decisions to real estate appraisal problems.
Learning Tips
The three problems involving scope of work determinations, which were designed to help
you retain the scope of work content.
The three problems are for discussion, but if you decide to take notes, you will have a
wealth of information on how the problem identification process is used to determine an
assignment’s scope of work in real-world appraising.
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Part 21.
Appraisal Principles in Practice
Part 21 contains three problems that will help you implement the concepts that you’ve
learned in this course and apply them to real world appraisal situations. The emphasis
will be on the process of solving the problem rather than the final answer. In most
cases, the actual solutions would take additional research beyond what we can do in the
classroom with the time allotted. Your instructor will provide ample guidance.
I.
Problem Solving
A. Your scope of work decision requires an organized thought process, which begins
with identifying the problem to be solved. Here are some of the questions to
address as you go through the process of identifying the problem.
1. Who is my client?
a. Are there other intended users other than the client?
b. What level of knowledge and sophistication does the client and intended
users possess in regard to this particular assignment?
2. What is the intended use of my opinions and conclusions?
3. What is the value type (or purpose) of this assignment? Is it market value,
investment value, or some other type of value, and what is its definition and
the source of the definition?
4. What type of assignment (that is, appraisal, appraisal review, or other services)?
5. What type of property is the subject property (that is, real property, tangible or
intangible personal property, or intangible business asset)?
6. What is the effective date (that is, past, current, or future), and is more
than one effective date required (for example, current and prospective value
opinions)?
Effective date. “The date to which an appraiser’s analyses, opinions,
and conclusions apply; also referred to as date of value.” (USPAP,
Definitions)
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7. What are the relevant property characteristics of the subject property?
Relevant characteristics. “Features that may affect a property’s value
or marketability such as legal, economic, or physical characteristics.”
(USPAP, Definitions)
Physical characteristics. “Attributes of a property that are observable
or measurable as a matter of fact, as distinguished from opinions and
conclusions, which are the result of some level of analysis or judgment.”
(USPAP, Definitions)
8. Are there any assignment conditions to consider such as hypothetical
conditions, extraordinary assumptions, laws, and regulations?
B. Once the problem is identified, the next step is to determine the scope of work.
Remember that scope of work is defined as “the type and extent of research and
analyses in an appraisal or appraisal review assignment” (USPAP, Definitions).
Expanding on this definition, the appraiser’s scope of work includes (but is not
limited to) the following considerations, which are based on standards and the
valuation process:
ƒ
The degree the appraiser needs to identify the subject property;
ƒ
The degree the appraiser observes the physical property;
ƒ
The type and extent of data investigated; and
ƒ
The type and extent of analytical processes applied to form opinions or
conclusions
C. Appraisers have freedom in determining their scope of work but are also
accountable to ensure their scope of work decision is suitable for the specific
appraisal or appraisal review assignment.
D. The appraisal report must contain sufficient information to allow the client and
other intended users identified to understand the scope of work performed (see
B.). This disclosure
ƒ
Must be appropriate for the intended use of the assignment results.
ƒ
Can consolidate the disclosure in a specific section, sections, or
throughout the report and use any label for identification.
E. For the scope of work problems on the following pages, focus on the process that
will lead to a credible solution rather than the solution itself.
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II. Problems for Scope of Work Decisions
For the first problem, there are step-by-step questions to lead the class through the
problem identification process and show how it logically leads to the scope of work
determination.
21.1 Problem
Determining Scope of Work
A financial institution has asked you to appraise a one-unit
residence so the borrower can finance the purchase of the property.
The lender wants the appraisal completed on a form report typically used by
Fannie Mae and Freddie Mac.
1. Who is the client, and who are the intended users?
The lender is the client and intended user.
2. What is the intended use?
To assist the financial institution in making a lending decision
3. What is the type and definition of value and its source (that is, what is the
purpose)?
An opinion of market value as defined in lending regulations
4. What is the assignment type?
Appraisal
5. What type of property is the subject property?
Real property
6. What is the effective date?
Current date
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21.1 Problem, cont.
7. What is the subject of the assignment and what method (approach) to value is
most relevant?
One-unit residence in fee simple interest. The sales comparison
approach is the most relevant method of analysis.
8. What are the assignment conditions?
None. The value is current and based on market trends within a
reasonable market exposure time.
9. What does the problem identification process tell you about determining your
scope of work for this assignment?
The appraiser’s scope of work would address
ƒ
The degree the appraiser needs to identify the subject property;
ƒ
The degree the appraiser observes the physical property;
ƒ
The type and extent of data investigated; and
ƒ
The type and extent of analytical processes applied to form
opinions or conclusions
The class can discuss each of the four issues.
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21.2 Problem
Scope of Work for Multitenant Office Building
A bank has contacted you to appraise a proposed LEED Silver
multitenant office building that will be completed in 12 months. The
bank wants three values—one current in the property’s current condition, one at
the future completion date, and the other at stabilized occupancy. The bank is a
regulated institution, and the loan is a federally-related transaction.
C u r r e n t v a lu e
is the vacant land site
E x t r a o r d in a r y
Assumption
E x t r a o r d in a r y
Assumption
1. Who is the client, and who are the intended users?
The client is the bank, and intended users are other parties identified
by the appraiser based on communication with the client.
2. What is the intended use?
To assist the lender in making a lending decision in a federally
related transaction.
3. What is the type and definition of value and its source (that is, what is the purpose)?
An opinion of market value as defined in lending regulations
4. What is the assignment type?
Appraisal
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21.2 Problem, cont.
5. What type of property is the subject property?
Real property (versus personal property or intangible property)
6. What is the effective date?
A federally related transaction requires a current value based on the
current condition of the property. In this case, that would be the
value of the vacant site. The bank also wants prospective values when
completed and at stabilized occupancy. Thus, more than one effective
date is required.
7. What is the subject of the assignment and what method (approach) to value is
most relevant?
Income-producing characteristics of this multitenant office building
would make the income capitalization approach the primary approach
for valuing this building, but the sales comparison and cost
approaches might also be applicable methods of analyzing value,
depending on data availability. The LEED Silver certification indicates
the buildings will have energy-efficient and green features that may
command higher-quality tenants, higher rents, and possibly lower
vacancy rates.
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21.2 Problem, cont.
8. What are the assignment conditions?
The prospective values would be based on an extraordinary assumption.
The current value would have no special conditions. If the bank wanted a
current value “as if complete, with a minimum LEED Silver certification,”
that would be a hypothetical condition. It is important to make the LEED
rating part of the “as complete.” Developers often raise or lower
the green rating based on the circumstances that arise during
construction. The appraiser should require a copy of the rating
worksheet showing the categories rated and points achieved in each
category. This will assist the appraiser in understanding the green
and energy-efficient features that may materially affect the income
and expenses of the property.
9. What does the problem identification process tell you about determining your
scope of work for this assignment?
Discuss the four issues addressed in the first problem.
ƒ
The degree the appraiser needs to identify the subject property;
ƒ
The degree the appraiser observes the physical property;
ƒ
The type and extent of data investigated; and
ƒ
The type and extent of analytical processes applied to form opinions
or conclusions
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21.3 Problem
Scope of Work for a Land Acquisition
A county attorney has contacted you regarding 100 acres of
farmland used for growing corn that will be bisected with a proposed
county road. The attorney wants to know the amount that should be offered to the
property owner for the land the county is taking. The land is designated for future
residential development, and its proximity to new developments suggests the
current use will change in five years if not sooner.
Work through the problem identification process and lay out your scope of work.
1. Client and intended user is the county.
2. Intended use is to assist the county in establishing a reasonable offering
price.
3. The purpose is an opinion of market value (as defined in the appraisal
report, the source is from the jurisdiction taking the property) of
the property before and after the acquisition of the land for the roadway.
4. Appraisal is the assignment type.
5. The subject property is real property.
6. Effective date is the date of taking as established by the county.
7. Relevant characteristics—agricultural farmland with likely change in
use suggests development of the sales comparison approach.
8. Assignment conditions include a current value of the property before the
county road is constructed and an “after” value based on a
hypothetical condition that assumes the new county road is in place
on the same date.
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21.3 Problem, cont.
The appraiser should also consider the following in the scope of
work decision:
ƒ
The degree the appraiser needs to identify the subject property;
ƒ
The degree the appraiser observes the physical property;
ƒ
The type and extent of data investigated; and
ƒ
The type and extent of analytical processes applied to form opinions
or conclusions
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Review
Part 21
Learning Objective
Now that you’ve completed Part 21, you should be able to
; Apply scope of work decisions to real estate appraisal problems.
Resources
The Appraisal Institute offers the Valuation of Sustainable Buildings Professional
Development Program, which consists of the following courses: Introduction to Green
Buildings: Principles & Concepts; Case Studies in Appraising Green Residential Buildings;
Practical Applications in Appraising Green Commercial Properties; and Residential and
Commercial Valuation of Solar. For more information, go to www.appraisalinstitute.org/
education/your-career/professional-development-programs.
Recommended Reading
The Appraisal of Real Estate, 15th ed., Chapter 4, pp. 29−32, Chapter 5, pp. 39−45.
Terms and Concepts to Remember
No particular terms
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Practice Test Section 7
This multiple-choice test is for your benefit and provides a review of
everything covered in Section 7. This is a closed-book test. Choose
the most correct answer.
1.
A group of complementary land uses defines a
A.
community.
B.
district.
C.
market area.
*
D.
neighborhood.
2.
A fully developed neighborhood continues to experience good demand and a modest
rise in property values. How would you classify the life cycle period of this area?
A.
decline
B.
growth
C.
revitalization
*
D.
stability
3.
Appraiser Mills described the market area as a blue-collar area with good pride of
ownership in the area residences. This is an example of
A.
conformity.
B.
homogeneity.
C.
lessor interest.
*
D.
stereotyping.
4.
A district has a research center, high-tech companies, and a university. This
describes what kind of district?
*
A.
commercial
B.
industrial
C.
office
D.
specialty
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5.
In a scope of work decision, an opinion of market value and its definition are the
elements that are also known as
A.
intended use.
B.
objective.
C.
opinion type.
*
D.
purpose.
6.
Partners Bank had questions about an appraisal, so it decided to get a second
opinion from another independent appraiser. What is this second assignment
called?
*
A.
appraisal
B.
appraisal review
C.
broker’s price opinion
D.
real property consulting
7.
*
8.
*
9.
*
Rivers, forested areas, and marshlands are examples of natural features that
define what type of boundaries within a market area?
A.
economic
B.
geographic
C.
legal
D.
social
The area surrounding Independence Hall in Philadelphia, where the Constitution of
the United States was signed, is an example of this kind of district?
A.
educational
B.
historic
C.
single-family
D.
specialty
What is the process called when a market area goes from agricultural to
residential?
A.
change
B.
conversion
C.
transformation
D.
transition
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10.
An appraiser provided advice on various commercial building sites to a client,
including a value opinion on the optimum recommended site. What type of
appraisal practice did the appraiser perform?
*
A.
appraisal
B.
appraisal review
C.
property management
D.
real property consulting
11.
Trotter performed an appraisal with an “exterior-only” inspection. The degree to
which a property is inspected is which part of the appraisal development process?
A.
appraiser’s certification
B.
appraiser’s statement of disclosure
C.
limiting conditions statement
*
D.
scope of work
12.
Moyer completed an appraisal for a bank on a property that was being refinanced.
The owners of the property paid for the appraisal when they completed the
application at the bank and were promised a copy of the appraisal report. In this
case, what is the property owner?
*
A.
an intended user only
B.
a party who is neither the client nor an intended user
C.
both the client and an intended user
D.
the client only
13.
A declining market area experiences resurgence in demand due to buyers wanting
to move closer to the center of the city. As a result, the current tenants are
gradually displaced from the area. What is this process called?
*
A.
gentrification
B.
growth
C.
market cycle
D.
renaissance
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14.
*
A real estate agent who is not an appraiser provides a client with an asking price
that will be used to list a property on the market. The agent
A.
cannot provide this service.
B.
has performed appraisal practice.
C.
has performed a valuation service.
D.
is practicing appraisal without a license.
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Section 8
8
Part 22.
Exam Content Review
Part 22.
Exam Content Review
Part 22 is designed to help you prepare for the Basic Appraisal Principles exam. Your
instructor will provide a brief 30- to 40-minute overview and highlight key areas for you
to study. After that, you have a self-study period of about 45 to 55 minutes. Then your
instructor will provide guidance on how the exams will be distributed.
I.
Preparing for the Exam
A. Basic information
1. The exam is comprised of 60 multiple-choice questions.
2. Participants are allowed two hours to complete the exam.
3. The exam is closed book, and all materials must be removed from the table.
4. A financial calculator is required for some exam questions. We recommend
the HP 12C calculator.
5. Participants may leave the classroom to use restroom facilities, but they must
leave their exam facedown at the table while out of the room.
B. Guidance on studying for the final exam
1. The objectives contain the content that will be tested.
2. Focus on the terms and concepts listed on the review page of each part.
C. Guidance on taking the final exam
1. Read each question completely.
2. Choose the most correct answer. Some answers may be correct to a limit, but
there is an answer that is correct and specific to the question.
3. Do not read information into questions beyond the information stated in the
questions.
4. Review your questions and double-check your math.
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Part 22 – 347
II. Content Covered in the Course
The following outline provides the approximate percentage for content covered in the
exam. It will help you know where to concentrate your studies.
Part 1. The Appraiser and Public Trust (7%)
Part 2. The Nature of Real Estate (6%)
Part 3. Rights and Interests in Real Estate (6%)
Part 4. Legal Descriptions of Real Estate (7%)
Part 5. Forms of Property Ownership (6%)
Part 6. Controls on Ownership (6%)
Part 7. Contracts, Leases, and Deeds (6%)
Part 8. The Nature of Value (6%)
Part 9. Market Value (4%)
Part 10. Influences on Real Estate Values (3%)
Part 11. Economic Principles (9%)
Part 12. Applied Economics in Real Estate (See Part 11)
Part 13. Market Fundamentals (9%)
Part 14. Real Estate Math Basics (3%)
Part 15. Math Applications in Real Estate (6%)
Part 16. Measurement and Statistics (4%)
Part 17. Introduction to Financial Calculators (3%)
Part 18. Time Value of Money (3%)
Part 19. Analyzing Market Areas (7%)
Part 20. The Nature of Appraisals (3%)
Part 21. Appraisal Principles in Practice (See Part 20)
Part 22 – 348
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix
Appendix
Self-Study Material
The appendix provides additional information on concepts you have studied and
additional practice with some of the math problems in the course. The new material in
the appendix is not tested on the exam.
Part 1.
The Appraiser and Public Trust
Effective date. The date on which the appraisal or review opinion applies
(SVP, Definitions section).
Valuation process. A systematic set of procedures an appraiser follows to
provide answers to a client’s questions about real property value.
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix – 349
Appendix
Appendix – 350
Self-Study Material
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix
Self-Study Material
Part 2.
The Nature of Real Estate
Additional Terms—Surface Rights
Accretion. A gradual process by which additional dry land is created when deposits
are left by a river or stream, which increases the size of the owner’s land.
Reliction. A process by which dry land is created by the receding water line.
Avulsion. The sudden removal of land from the property of one owner to that of
another, e.g., by inundation or a change in the course of a river.
Erosion. The wearing away of surface land by natural causes, e.g., running water, winds.
Meander line. A line that points out the curves and lines of a bank or shore; a survey
line that establishes the bank or shoreline of a stream or lake.
Additional Terms—Partial Interests
Undivided partial interest. An interest in a specific property that is shared by the
co-owners; no co-owner may unilaterally convey or encumber any specific part thereof.
Divided interest. An interest in part of a whole property, e.g., a lessee’s interest.
Undivided interest. Fractional ownership without physical division. Co-owners share the
property rights owned (e.g., tenants in common).
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix – 351
Appendix
Self-Study Material
Water Rights
Non-navigable waters. These are waters unaffected by the tide. The adjoining property
owners typically own the submerged land to the center of the lake, river, or stream.
Navigable waters. These waterways and bodies of water are owned and controlled
by the federal or state government. Adjoining property owners own the land above
the mean high water mark. The government owns the property below the mean high
water mark and the property beneath the water. The public has the right to use the
waterways for transportation and recreational purposes.
Non-navigable
NonNon
-navigabl
gable
e Water
Water
Propertyextends
Property
Property
Proper
e
extends
xtendstoto
ccenter
ente
nterrofo
s
tream
center
offstream
stream
Navigable
N
avigabl
ble
e Water
Wate
terr
Public
Public
Publi
c
Appendix – 352
Property
Property
P
rope
operrty extends
extends
extend
stoto
ge
river’s
edge
rriver’s
ive
verr’s edge
edg
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix
Self-Study Material
Part 3.
Rights and Interests in Real Estate
Further Insight on Fee Simple Defeasible
Fee Simple
Fee
Simple
Estate
Estate
Fee Simple
Fee
Simple
Absolute
Absolute
Fee Simple
Fee
Simple
Defeasible
Defeasible
LeasedFee
Leased
Fee
Interest
Interest
Fee simple defeasible estates can be divided into two types:
Fee simple determinable. A fee simple estate can be qualified by a special
limitation. The ownership interest ends automatically if the current owner
fails to comply with the limitation. The prior owner retains the possibility of
reverter. That means if the limitation is violated, the prior owner (or heirs)
reacquires ownership. To create this kind of estate, language such as so
long as, while, or during is used to distinguish the special limitation.
Example. An owner grants land to a non-profit group so long as it is used as
a summer camp for disabled children.
Fee simple subject to a condition subsequent. The current owner must not
engage in an activity or perform certain actions stipulated by the prior owner.
The prior owner has a right of re-entry to observe whether the condition has
been violated. If so, the prior owner can retake possession of the property
through legal action (i.e., not automatic). To create this estate, language
such as on the condition that is used to stipulate the condition subsequent.
Example. An owner grants land on the condition that the new owner will not
permit alcohol consumption on the property.
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix – 353
Appendix
Appendix – 354
Self-Study Material
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix
Self-Study Material
Part 4.
Legal Description of Real Estate
Further Insight
Metes and bounds—In our research, we found that there isn’t common agreement on the
precise meaning of metes or the meaning of bounds. Some respected sources indicate
that metes are distances and bounds are directions. We respect both sides and have
decided for this course that:
ƒ
Metes are measures that include direction and distance
ƒ
Bounds are the terminal points which in some cases are landmarks and monuments
ƒ
Rectangular survey—You might find it helpful to remember that:
ƒ
Meridian lines are longitude lines and run north and south to the poles
ƒ
Baselines are latitude lines that run parallel to the equator
Practice problem. Write a legal description for the parcel identified by the shaded area.
Section 5, T 2N, R 3E
The solution to the practice problem is provided on the next page.
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix – 355
Appendix
Self-Study Material
Solution to the practice problem from the previous page
S ½ of SW ¼ of NE ¼, Section 5, T 2N, R 3E
Appendix – 356
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix
Self-Study Material
Part 14.
Real Estate Math Basics
Refresher on Fractions, Decimals, and Percents
A. Fractions
Appraisers typically don’t work with fractions from a raw mathematical standpoint,
but we certainly deal with fractions everyday as expressions (e.g., the parcel has a
½ acre of land, or there are 1¾ baths in the house). Appraisers also see fractions
in formulas, particularly in capitalization—so we need to know how fractions
operate.
1. Appraisers typically convert fractions into something more useful mathematically,
such as decimals. To convert a fraction into a decimal, divide the numerator by
the denominator.
Numerator 
Denominator 
1
4
=
0.25
3
4
=
0.75
3
8
=
0.375
2. Land is sometimes referred to in fractional components, such as a 3/4 acre
site or a 1/2 acre lot. Practice on the following problems.
a. A property listed for sale is stated to have 7/8’s of an acre. What is the
size of the property in square feet?
Check your answer. 7 divided by 8 is 0.875. That’s what 7/8’s is when
written as a decimal number. Now multiply the decimal by the square feet in
an acre and you’ll have the correct answer.
0.875 × 43,560 sq. ft. = 38,115 sq. ft.
b. If a property owner sold his 3/4 acre site for $3.50 per square foot, what
was the selling price?
Check your answer. 3 divided by 4 is 0.75. Multiply the decimal by the square
feet in an acre and then multiply that result by $3.50.
3,560 sq. ft. × 0.75 = 32,670 sq. ft. × $3.50 = $114,345
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix – 357
Appendix
Self-Study Material
B. Decimals
1. Appraisers must exercise caution when reading decimals.
Which of the following decimals is larger?
0.345 or 0.368
Which of the following numbers is the smallest?
0.085, 0.1, or 0.17
Answers: 0.368 and 0.085
2. To convert decimals to percents, multiply by 100, or move the decimal point
2 places to the right and insert a % sign. Cover the answers on the right, and
convert the following decimals to percents.
a. 0.80 80%
b. 0.05 5%
c. 0.625 62.5%
d. 0.0045 0.45%
C. Percent
1. The term percent means “per hundred.” Therefore, 20 percent (20%) is 20 per
100. Think of the word per as meaning “to divide.”
2. To convert percents to decimals, divide by 100, or move the decimal point 2
places to the left and eliminate the percent (%) sign. Cover the answers on
the right and convert the following percents to decimals.
a. 7.25% 0.0725
b. 55.5% 0.555
c. 200% 2.0
d. 0.01% 0.0001
Appendix – 358
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Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix
Self-Study Material
Part 15.
Math Applications in Real Estate
Indexing
Appraisers solve indexing problems, but knowing how to solve indexing problems is not
required for this course (or the exam). Nevertheless, indexing is a percent problem, and
you might enjoy working through a few indexing problems to broaden your math skills.
A. A lease might provide for adjustments to the rent based on an index, such as
the Consumer Price Index (CPI). Generally, a base point is identified, and index
numbers are assigned to specific time periods to reflect changes from the base.
1. An index problem can be solved as a percentage problem, but it can also be
set up and solved as a ratio or proportion.
a. A ratio is a comparison of two numbers and in this case, two fractions.
b. The ratio of 3 out of 4 can be expressed as ¾ or 3:4. Two equivalent
fractions can be expressed as a proportion.
3
6
=
4
x
3
4

=
6
3 / 4 = 0.75 and 6 / 0.75 = 8
8
c. In most proportion problems, three of the numbers are provided and the
fourth is missing (x).
d. The problem is solved by converting the first fraction into a decimal and
then dividing the numerator of the second fraction as shown above.
2. In an indexing problem, it doesn’t matter if the numbers are inverted as long
as the proportion is properly matched.
4
x
=
3
6

4
3
=
8
6
4 / 3 = 1.3334 and 6 × 1.3333 = 8
a. In the above problem, solving for x will produce a non-terminating number
“1.3333…”and that will result in a final answer of 7.9999, which can be
rounded to 8.0.
b. The key to this approach is to use multiplication rather than division in the
final step.
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix – 359
Appendix
Self-Study Material
B. Indexing problems
1. A lease has a rent of $4.00 per sq. ft. and is tied to an index of 1.75. If the
index rises to 1.90 at the time of the adjustment period, what is the new rent
per square foot?
1.75 is to $4.00 as 1.90 is to x (which is the new rent per sq. ft.)
1.75 / $4.00 = $0.4375 and 1.90 / $0.4375 = $4.34 new rent
The other way to solve this problem is to invert the numbers and use
multiplication in the final step.
$4.00 is to 1.75 as x is to 1.90
$4.00 / 1.75 = $2.2857 × 1.90 = $4.34 new rent
2. A lease has a rent of $6.25 per sq. ft. and is tied to an index of 1.44. If the
index rises to 1.60 at the time of the adjustment period, what is the new rent
per square foot?
1.44 is to $6.25 as 1.60 is to x (which is the new rent per sq. ft.)
1.44 / $6.25 = $0.2304 and 1.60 / $0.2304 = $6.94 (rounded)
If you use an HP 12C on the above problem, use the exchange key (located
one key to the left of the O key and looks like o). This key exchanges
the order of operation when used in the last step. The keystrokes are:
1.44 \ 6.25 z 1.60 o (the exchange key) and then press z
The other way to solve this problem is to invert the numbers.
$6.25 is to 1.44 as x is to 1.60
$6.25 / 1.44 = $4.3403 × 1.60 = $6.94 new rent
3. An appraiser finds that the actual cost of a structure was $200,000 three
years ago with an index of 125. If the current index is 150, what is the new
cost estimate to build a comparable structure?
125 is to $200,000 as 150 is to x (which is the new cost estimate)
125 / $200,000 = 0.000625 and 150 / 0.000625 = $240,000
Alternative method: $200,000 / 125 = $1,600 × 150 = $240,000
Appendix – 360
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Appendix
Self-Study Material
Part 17.
Introduction to Financial Calculations
Other Calculations with Financial Calculators
The following calculations are not covered in class and are intended for self-study.
A. Determining the statistical mean of a number set
1. There is a routine for HP calculators to quickly determine the mean for a set
of numbers. Let’s try it on the following array:
13, 25, 278, 6, 774, 213, 149
2. Enter the numbers in the HP 12C by using the _ key after each entry. The
_ key is to the left of the + key on the HP 12C. Here’s the next step:
a. Press the g key and then Ö (which is on the “0” key), and you should
get the result.
b. This process allows you to access the “mean” key to find the central
tendency in the array of seven numbers.
c. The mean for this example is 208.29.
B. Percent calculation
1. You can use the b key to solve percentage problems.
To find 35% of $500
Calculations
Step
Explanation
HP 12C
Display
1
Clear memory
fH
2
Base number
500 \
3
Percentage
35
35.00
4
Calculates the amount
b
175.00
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
0.00
500.00
Appendix – 361
Appendix
Self-Study Material
2. Solving percentage change with the HP 12C was introduced in Part 14, but it’s
good practice to review and test yourself on another problem.
If the current sale price of a property is $524,700 and the prior sale was
$495,000, what is the percentage change?
Generally, in a problem such as this, we think of the prior sale as the base.
In other words, how much has the property increased since the prior sale?
The formula looks something like this where the ∆ delta symbol represents
the change.
∆=
Current value – Prior value
Prior value
∆=
$524,700 – $495,000
$495,000
When you key the prices into the calculator, remember to start with the base,
which, in this case, is the prior value (i.e., don’t key in the numbers based on
the sequence used in the formula).
Calculations
Step
Explanation
HP 12C
Display
1
Clear memory
fH
2
Key in the prior value
495000 \
495,000.00
3
Key in the current value
524700
524,700.00
4
Calculates the % change
à
0.00
6.00
The property increased 6.00% (math check; $495,000 × 1.06 = $524,700).
Appendix – 362
Basic Appraisal Principles
Appraisal Institute / American Society of Farm Managers and Rural Appraisers / American Society of Appraisers
Client File #:
Appraisal File #:
Residential Green and Energy Efficient Addendum
Client:
Subject Property:
Form 820.06*
R
City:
State:
Zip:
Additional resources to aid in the valuation of green properties and the completion of this form can be found at
http://www.appraisalinstitute.org/education/green_energy_addendum.aspx
The appraiser hereby certifies that the information provided within this addendum:
• has been considered in the appraiser’s development of the appraisal of the subject property only for the client and
intended user(s) identified in the appraisal report and only for the intended use stated in the report.
• is not provided by the appraiser for any other purpose and should not be relied upon by parties other than those identified
by the appraiser as the client or intended user(s) in the report.
• is the result of the appraiser’s routine inspection of and inquiries about the subject property’s green and energy efficient
features. Extraordinary assumption: Data provided herein is assumed to be accurate and if found to be in error could alter
the appraiser’s opinions or conclusions.
• is not made as a representation or as a warranty as to the efficiency, quality, function, operability, reliability or cost savings
of the reported items or of the subject property in general, and this addendum should not be relied upon for such
assessments.
Green Building: The practice of creating structures and using processes that are environmentally responsible and resource-efficient
throughout a building’s lifecycle from siting to design, construction, operation, maintenance, renovation, and deconstruction. This
practice expands and complements the classic building design concerns of economy, utility, durability, and comfort (US EPA). High
Performance building and green building are often used interchangeably.
Six Elements of Green Building: A green building has attributes that fall into the six elements of green building known as (1) site, (2)
water, (3) energy, (4) materials, (5) indoor environmental quality, and (6) maintenance and operation. The energy and water
elements are the most measurable elements of green or high performance housing. Appraisers need savings amounts to develop an
income approach to support energy efficient contributory value.
THIRD-PARTY VERIFICATIONS (See types defined in glossary).
The following verified items are considered within the appraisal analysis of the subject property:
Green Certification
Certifications attest
that the home meets
certain minimum
thresholds.
Energy Label
Labels disclose the
state the home’s
energy assets.
Verified Energy
Improvements
Only include
improvements with
verified
documentation.
Completed by:
Environmental Protection Agency (EPA):
 Indoor airPLUS  WaterSense  ENERGY STAR
Energy Department (DOE):
 Zero Energy Ready Home (ZERH)
Home Innovation Research Labs NGBS Home Remodel:
Home Innovation Research Labs NGBS New Home:
 Bronze
 Silver
 Gold
 Emerald
Living Building Challenge (LBC):
 Living Building Certified
 Petal Certification
Passivhaus Standard:
 PHI Low Energy  EnerPhit  Passive House
Passive House Institute US:
 PHIUS+ 2015
USGBC LEED:
 Certified
 Silver
 Gold
 Platinum
Other:
Date
Green Certification Version: ____
ABOVE VALID ONLY IF CHECKED:
Verified:
Organization URL:
 Verification reviewed on site
__/__/____ ____________________________________________  Verification attached to this report
RESNET’s HERS
Estimated energy savings for this home: $____/year ____¢kWh rate dated__/__/__
Rating (0 to 150): _____ Energy Savings includes electricity, heating & Cooling.
 Sampling Rating
Score below 100 indicates energy costs are expected to be lower than average local
 Projected Rating
code home per square foot. HERS Index Report estimates energy cost based on
 Confirmed Rating
number of bedrooms plus one. Only a “confirmed rating” is a diagnostic test.
DOE’s Home Energy
Estimated energy savings for this home: $____/year ___¢kWh rate dated __/__/__
Score
Energy Savings includes electricity, heating & Cooling.
Score (1 to 10): ______ Score above five indicates energy costs are expected to be lower than average local
 Official Score
home. Home Energy Score estimates energy cost based on state average energy
 Unofficial Score
rates and the home’s energy features.
Other Energy Score:
Estimated energy savings: $____/year __¢ kWh rate dated __/__/__
Range ( ____ to ____ ): Describe energy label system:
_____
Date
Score or Rating Version: ____
Verified:
Organization URL:  www.resnet.us/
ABOVE VALID ONLY IF CHECKED:
__/__/____  www.homeenergyscore.gov
 Verification reviewed on site
 Other:____________________
 Verification attached to this report
Explain energy-related improvements:
Cost of improvements: $_______
Date
Verified:
__/__/____
Certificate of Efficiency Improvements Version: _____ ABOVE VALID ONLY IF CHECKED:
Organization URL:  Other: _____________________  Verification reviewed on site
 energystar.gov/homeperformance
 Verification attached to this report
Title:
Date:
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the
appraiser may need to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or
guarantees as to, and assumes no responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI
Reports®. AI Reports® AI-820.06 Residential Green and Energy Efficient Addendum© Appraisal Institute 2017, All Rights Reserved
November 2019
Client:
Client File #:
Subject Property:
Appraisal File #:
EFFICIENCY FEATURES (Water, Energy, and Environmental. See types defined in glossary).
The following items are considered within the appraisal analysis of the subject property:
Insulation
Building Envelope
Windows
Day Lighting
ENERGY STAR®
Appliances
Water Heater
HVAC & Related
Equipment
Describe in
comments area.
Indoor
Environmental
Quality
Water Efficiency
 Fiberglass Blown-In  Foam Insulation  Cellulose  Fiberglass Batt Insulation
 R-Value ____Wall ____Ceiling  Other (Describe): ____________________________________________
Envelope Tightness: __________________ Unit:  __CFM25 __ CFM50 __ ACH50 __ ACH natural
Instructions: Insert the rating as a number that could be 0.5 to 7ACH50 or higher. The lower the number, the
more air tight the envelope. Building Codes for area show maximum Envelope Tightness allowed based on the
climate zone. Not all areas have adopted a building code. http://bcap-energy.org/
 Double Pane
 Solar
 ENERGY STAR®  Low E
 High Impact  Storm
 Tinted
 Triple Pane
Shades
 Other (Describe): _______________________________
 # Of Skylights: ____  # Of Solar Tubes: ____
(% Of lighting LEDs): _______________________________
ENERGY STAR®:  Dishwasher  Refrigerator  Washer/Dryer  Other: _________________________
Energy Source:  Propane
 Electric
 Natural Gas
 Other: _________________________
Note: ENERGY STAR® appliances do not result in an ENERGY STAR® Home.
Size: _____ gallons
 ENERGY STAR®
 Solar (next page)
 Heat Pump
 Coil
 Tankless
 High Efficiency HVAC
 Heat Pump
Thermostat/Controllers?
 Yes
 No
SEER:
_______
Efficiency
Programmable Thermostat?
 Yes
 No
Efficiency Rating:
_____%
Rating:
Auxiliary heat source?
 Yes
 No
AFUE*
_____%
COP: _____
Radiant Floor Heat?
 Yes
 No
*Annual Fuel-Utilization
HSPF: _____
Geothermal?
 Yes
 No
Efficiency
SEER: _____
Electric Vehicle Ready? (car charger)  Yes
 No
EER: _____
 Energy (ERV) or Heat Recovery Ventilator (HRV)
 Non Toxic Pest Control
 Radon System:
 Other Measured Whole-House Ventilation Device (See glossary)
 Active
 Passive
 Humidity Monitoring Device installed
 Reclaimed Water System (Describe): ______________  Rain Barrels Used in Irrigation
 Greywater reuse system
Cistern size: _______ gallons
 Water Saving Fixtures
Location of cistern: _________________________
Utility Costs
Annual Utility Cost: $ _____/year, based on: __/__/____ to __/__/____ (full year).
# Of Occupants: _____
Includes (check all that apply):  Electric  Heating  Water  Other: ______
Comments
Include source for
information
provided in this
section.
If a property is built green but not formally certified, it still deserves proper description and analysis to value
the features. The market analysis is of the structure’s physical, economic, and locational attributes and not an
analysis of its label alone. Provide additional information that illustrates how this property exceeds local
building code. This document is intended for new construction or existing homes that have been retrofit to
include higher energy or green features.
The objective of this Addendum is to standardize the communication of the high performing features of residential properties.
Identifying the features not found on the appraisal form provides a basis for comparable selection and analysis of the features.
Builders, contractors, homeowners, and third party verifiers are encouraged to complete this Addendum and present to
appraisers, agents, lenders, and homeowners. Complete the pages that apply to the property appraised and provide to
appraiser prior to the completion of an appraisal. Provide the Addendum to the lender at the time of loan application to assist
them in understanding the property type so an appraiser with sufficient knowledge of this property type will be engaged to
provide an appraisal to meet secondary mortgage market guidelines.
Completed by:
Title:
Date:
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the
appraiser may need to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or
guarantees as to, and assumes no responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the
AI Reports®. AI Reports® 820.06 Residential Green and Energy Efficient Addendum © Appraisal Institute 2017, All Rights Reserved
November 2019
Client:
Client File #:
Subject Property:
Appraisal File #:
Solar Panels
The following items are considered within the appraisal analysis of the subject property:
Solar Photovoltaic (Electric) System
Type of
Ownership
Panel
Specifications
Array
Placement
Array #___
Array #__ (if applicable)
 Leased  Owned
* Solar Loan with UCC Filing
 Power Purchase Agreement (PPA)
 Leased
 Owned
 Solar Loan  UCC Filing
If solar loan has UCC Filing, it is considered personal
 Power Purchase Agreement (PPA)
property and should not be included in market value.
System Size: ________________ kW (1kW = 1000 Watts)
Year Installed: _____ ll: _________ Energy Production:
________________________ kWh Source of Energy
Source of Energy Production Estimate:
______________________________________________
Manufacturer: _________________________________
Warranty on Panels: _______________________ years
System Size: ________________ kW (1kW = 1000 Watts)
Year Installed: ____________________________
Energy Production: ________________________ kWh
Source of Energy Production Estimate:
______________________________________________
Manufacturer: _________________________________
Warranty on Panels: _______________________ years
 Fixed Mount  Tracking Mount
Tilt / Slope: ____________________________________
Azimuth: ______________________________________
Affects energy
production.
*Orientation
Tilt / Slope: ____________________________________
*Azimuth: ____________________________________
Inverter
Specifications
Number of Inverters per Array: ____________________
Year Installed:________________________
Wattage: _________________________________watts
Manufacturer: _________________________________
Warranty Term: ____________________________years
Energy Storing
Batteries
Number of Inverters per Array: ____________________
Year Installed: _________________________
Wattage: _________________________________watts
Manufacturer: _________________________________
Warranty Term: ____________________________years
Battery Type: □ Lithium-ion □ Lithium-ion Polymer □ Lead Acid □ Lead Calcium □ AGM □ GEL
Manufacturer: __________________ Storage Capacity: _____kWh
Warranty Term: ______ years
Year Installed: _____
Name of Utility
Company:
Charge / kWh
from Utility
$ __________ / kWh
Solar Thermal Water Heating System
Direct
 Integral collector
Type of System
Active:
Passive:
Collector Type
 Flat-Plat  Integral
Back-Up
System
 Conventional Water Heater
 Tankless Heat Pump
Solar Energy
Factor (SEF)
 Indirect
 Thermo-syphon
 Evacuated-Tube Solar
Storage Tank
Size
Gallons: ___________
System Age
Year Installed: _____________
 Tankless On Demand Warranty
Term
Manufacturer
*Rating ranges 1 to 11. Higher number is more efficient.
Proposed Solar Installation
A free online tool
and manual for
valuing the energy
production of the
Solar PV System is
available at
www.pvvalue.com.
Download the
PV Value™ Manual
for explanation of
the solar terms on
this form and
inputs used in the
PV Value Tool.
Roof Shape:  Pitched  Flat  Rounded  Multiple
Rafters:  Typical  Engineered Wood Trim  Rough Sawn  Structured Insulated Panel Roof  Metal  TJI Rafters
Decking:  No decking  Plywood  Tongue & Groove  OSB  Skip sheathing/Purlin  Structured Insulated Panel
Slope/Roof Pitch: _______ ______ ______ (example: S1_6/12_)
Roof Material:  Comp Shingle  Rolled Asphalt  Concrete Tile  Clay Tile  Slate  Corrugated Metal  Standing
Seam Metal  Polycarbonate/fiberglass  Foam  Tar and Gravel  Wood Shake
Number of layers of roof material: ___________ (Attach photograph of roof material and attic space)
Electrical Service:  Overhead  Underground
Main Electrical Panel:  Main Breaker Panel  MB & Sub Panel  Fuse Box Amperage: _______
Remaining spaces in main service panel (MSP), subpanel (if in garage), and utility meter (if located separate from MSP):
___ (Attach photograph of inside of electrical panel and door closed and a picture of three feet back to show space
around the main service panel (and subpanel)).
Red flag –  Gas line within 3’ of electrical panel  More than 3 layers of roof covering  Wood Shake Shingles
 Composition Shingle over Wood Shake  Tile Roof Without Decking  Composition Shingle less than 2:12 pitch
 Roof section over 12:12 pitch  Unpermitted structure/addition  Metal Trusses  No permanent foundation
 Carport may not be structurally sound  SIP Roofing may not be structurally sound  Open/No walls (Patio)
Completed by:
D
e
c
k
i
n
g
:
Title:
Date:
*NOTICE: The AppraisalInstitute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the
N
appraiser may need to provide
additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or
o
guarantees as to, and assumes
no responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the
AI Reports®. AI Reports®
November 2019
d 820.06 Residential Green and Energy Efficient Addendum © Appraisal Institute 2017, All Rights Reserved
e
Client:
Client File #:
Subject Property:
Appraisal File #:
Location - Site
The following items are considered within the appraisal analysis of the subject property:
Source:  http://www.walkscore.com
Walk Score
Score:
Public Transportation
 Bus Distance: _______ Blocks
Site
Orientation (front faces):
Landscaping:
 East / West  North / South  Water Efficient
 Other: ___________________________
 Train: Distance: ______ Blocks  Subway Distance: ______ Blocks
 Natural  Pond/Lake on site  Rain Garden
Comments
Incentives – Amount of Incentive and Terms
The following items are considered within the appraised value of the subject property and based on effective date of value.
Federal
State
Local
Comments
Incentives offset cost and should be reported and described in the cost approach section of the report.
Clearly identify the incentives that offset the gross cost of construction to meet appraisal standards.
Incentives are typically not a sales concession in sales comparison approach since they do not transfer with
the property and are not paid by the seller. Incentives are typically for a specified period and only those
available as of the date of value should be addressed in the appraisal process. Incentives may be available
to offset repairs or deferred maintenance items as well. Incentives, rebates, and tax credits for most U.S.
properties can be found at www.dsireusa.org
The objective of this Addendum is to standardize the communication of the high performing features of residential
properties. Identifying the features not found on the appraisal form provides a basis for comparable selection and
analysis of the features.
•
Builders, contractors, homeowners, and third party verifiers are encouraged to complete this Addendum and
present to appraisers, agents, lenders, and homeowners. Appraisers typically do not have sufficient information
to complete this addendum without builder, contractor, or third party verifier documentation.
•
Attach this completed document to the MLS listing to provide sufficient detail on sales and listings to assist
buyers, appraisers, and real estate agents in understanding the high performance features of the property.
•
Complete the pages that apply to the property appraised and provide to appraiser prior to the completion of an
appraisal.
•
Provide the Addendum to the lender at the time of loan application to assist them in understanding the property
type so an appraiser with sufficient knowledge of this property type will be engaged to provide an appraisal to
meet secondary mortgage market guidelines.
Completed by:
Title:
Date:
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the
appraiser may need to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or
guarantees as to, and assumes no responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the
AI Reports®. AI Reports® 820.06 Residential Green and Energy Efficient Addendum © Appraisal Institute 2017, All Rights Reserved
November 2019
Client:
Client File #:
Subject Property:
Appraisal File #:
Residential Green and Energy Efficient Addendum
Additional Resources
Appraised Value and Energy Efficiency: Getting it Right. This document provides links to resources in understanding the secondary
mortgage market guidelines on appraisals of energy efficient and green features. It addresses the following:
• What can builders do?
• For Buyers: Assuring a competent appraiser for your home
• For Lenders: A sample letter that should be completed and provided to the lender at the time of mortgage application
alerts the lender to the special features that requires an appraiser with knowledge of the property type.
https://www.appraisalinstitute.org/assets/1/29/AI-BCAP_Flyer.pdf
Residential Green Valuation Tools. A textbook resource for completing the AI Residential Green and Energy Efficient Addendum is
available. It can be purchased at the following website: http://www.appraisalinstitute.org/residential-green-valuation-tools/
Glossary
ASHRAE 700 / ICC National Green Building Standard (NGBS): An ANSI-approved residential green building standard
developed by the National Association of Home Builders (NAHB) and the International Code Council (ICC). It is applicable
to single and multifamily projects, renovations and additions and residential land development. To comply, all buildings
must incorporate sustainable lot development techniques and address energy, water & material resource efficiency and
indoor environmental quality. Also, all owners must be educated about building operation and maintenance.
https://www.nahb.org/en/research/nahb-priorities/green-building-remodeling-and-development/icc-700-national-green-buildingstandard.aspx
Building Envelope: The building envelope is everything that separates the building’s interior from the exterior. This includes the
foundation, exterior walls, roof, doors and windows. The envelope rating should be compared to the local building code
requirements for this rating to identify a structure that exceeds the building code.
Energy Recovery Ventilation System (ERV) or Heat Recovery Ventilators (HRV): These systems provide fresh air without wasting all
the energy already used to heat the indoor air. By recovering sensible (heat) or latent (moisture) energy from the stale indoor air,
they offer fresh air ventilation with reduced energy loss.
ENERGY STAR Certified New Homes: EPA’s ENERGY STAR certified homes are independently verified to be at least 15 percent more
efficient that code-built homes, and include additional energy efficiency measures that can deliver savings of up to 30 percent
compared to standard new homes. More than just a collection of ENERGY STAR products, an ENERGY STAR certified home includes a
comprehensive package of energy efficiency systems and features that work together to deliver better performance, including a
High-Efficiency Heating & Cooling System, a Complete Thermal Enclosure System; a Water Protection System; and Efficient Lighting
& Appliances. www.energystar.gov/newhomes
ENERGY STAR Products: Behind each blue label is a product, building, or home that is independently certified to use less energy and
cause fewer of the emissions that contribute to climate change. Today, ENERGY STAR is the most widely recognized symbol for
energy efficiency in the world. In order to earn the label, ENERGY STAR products must be third-party certified based on testing in
EPA-recognized laboratories. In addition to up-front testing, a percentage of all ENERGY STAR products are subject to "off–the–shelf"
verification testing each year. The goal of this testing is to ensure that changes or variations in the manufacturing process do not
undermine a product's qualification with ENERGY STAR requirements. https://www.energystar.gov/about/origins_mission
Geothermal: A geothermal heat pump uses the constant below ground temperature of soil or water to heat and cool your home.
http://energy.gov/energysaver/articles/geothermal-heat-pumps
HERS Index: The Home Energy Rating System (HERS) Index is an industry standard by which a home’s energy efficiency is measured.
It’s also the nationally recognized system for inspecting and calculating a home’s energy performance. A qualified third party
certifier assesses the house based on its physical characteristics. The energy estimates from this assessment may vary depending on
the lifestyle of the occupants, increasing utility expenses, and changes in the maintenance or characteristics of the energy features.
There are three rating types: sampling rating, projected rating, and confirmed rating. A Sampling Rating is an application of the
Home Energy Rating process whereby fewer than 100% of a builder’s new homes are randomly inspected and tested to evaluate
compliance with a set of threshold specifications. A Projected Rating: A Rating Type that encompasses one individual dwelling or
dwelling unit and is conducted in accordance with Section 5.1.4.3.1 through 5.1.4.3.5 of the ANSI/RESNET/ICC Standard 301. A
Confirmed Rating is a rating type that encompasses one individual dwelling or dwelling unit and is conducted in accordance with
Sections 5.1.4.1.1 through 5.1.4.1.3. More information: http://www.resnet.us/hers-index. The ANSI standard utilized in the HERS
Index is posted at http://codes.iccsafe.org/app/book/content/PDF/ICC%20Standards/ICC_301-2014/ICC_RESNET_301.pdf.
Home Energy Score (HES): The Home Energy Score, developed and managed by the U.S. Department of Energy (DOE), is a national
system that allows homes to receive an energy rating, like the MPG rating available for cars. The Home Energy Score uses a 10-point
scale to reflect how much energy a home is expected to use under standard operating conditions. The Home Energy Score uses a
standard calculation method and considers the home’s structure and envelope (walls, windows, foundation) and its heating, cooling,
and hot water systems. Only Assessors who pass DOE’s Simulation Training can provide the Home Energy Score.
www.HomeEnergyScore.gov
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the
appraiser may need to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or
guarantees as to, and assumes no responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI
Reports®. AI Reports® AI-820.06 Residential Green and Energy Efficient Addendum© Appraisal Institute 2017, All Rights Reserved
November 2019
Indoor airPLUS: EPA’s Indoor airPLUS is a voluntary EPA label for new homes that integrate a set of construction practices and
technologies to reduce indoor air pollutants and improve the indoor air quality in a new home beyond minimum code requirements.
It is only available to homes that first meet ENERGY STAR® Certified Home requirements. Http://www.epa.gov/indoorairplus
LEED: Leadership in Energy and Environmental Design is a green certification program created by the U.S. Green Building Council
(USGBC). As an internationally recognized mark of excellence, LEED provides building owners and operators with a framework for
identifying and implementing practical and measurable green building design, construction, operations and maintenance solutions.
http://www.usgbc.org/DisplayPage.aspx?CMSPageID=1988
Living Building Challenge: Created by the Living Future Institute, the Living Building Challenge is the world’s most rigorous proven
performance standard for buildings. People can use the regenerative design framework to create spaces that, like a flower, give
more than they take. Living Building Challenge certification requires actual rather than modeled performance. Therefore, projects
must be operational for at least twelve consecutive months prior to evaluation. https://living-future.org/lbc/basics/
Low E: “Low emissivity” indicates a coating is added to the glass surface. The coating allows visible light to pass through the glass
while stopping radiant heat energy from entering the building by passing through the glass. Approximately 40% of the sun’s harmful
ultra violet rays are blocked and insulation enhanced. https://energy.gov/energysaver/energy-efficient-windows
NGBS Small Project Remodel: Run by the Home Innovation Research Labs, this program certifies whole house and small project
remodels as energy efficient. Unlike the Whole–House Remodel, the Small Project certification is prescriptive. Chapter 12 of the
National Green Building Standard includes a list of mandatory practices, related to materials use, sustainable products, energy
efficiency, and indoor environmental quality. A Home Innovation Accredited NGBS Green Verifier gives a final inspection to verify
Small Project certification. During inspection, the Verifier will ensure the applicable practices have been met.
http://www.homeinnovation.com/services/certification/green_homes/remodeling_certification/remodel_home_certification_process
NGBS Whole Home Remodel: Run by the Home Innovation Research Labs, this program certifies whole house and small project
remodels as energy efficient. Certification of a whole-building remodel requires demonstrating that there has been a minimum of a
15% reduction in energy consumption and at least a 20% reduction in water consumption over the pre-remodel condition. There are
some mandatory practices that must be met. A minimum number of points must be obtained from practices related to Lot Design,
Resource Efficiency, Indoor Environmental Quality, and Homeowner Education.
http://www.homeinnovation.com/services/certification/green_homes/remodeling_certification/remodel_home_certification_process
Passivhaus Standard: German standard for low energy homes that began in the 1980s. Passivhaus is a rigorous, voluntary standard
for energy efficiency in a building, reducing its ecological footprint. It results in ultra-low energy buildings that require little energy
for space heating or cooling. The Passive House Institute (PHI) is an independent research institute that has played an especially
crucial role in the development of the Passive House concept - the only internationally recognized, performance-based energy
standard in construction. http://passiv.de/en/
Passive House Institute US (PHIUS): Buildings designed and built to the PHIUS+ 2015 Passive Building Standard consume 86% less
energy for heating and 46% less energy for cooling (depending on climate zone and building type) when compared to a codecompliant building. PHIUS+ 2015 is the first and only passive building standard based upon climate-specific comfort and
performance criteria aimed at presenting a cost-optimized solution to achieving the most durable, resilient, and energy-efficient
building possible for a specific location. http://www.phius.org/home-page
Passive Solar: Passive solar is technology for using sunlight to light and heat buildings with no circulating fluid or energy conversion
system. http://rredc.nrel.gov/solar/glossary. A complete passive solar building design has the following five elements: (1) aperture
(collector) (2) absorber (3) thermal mass (4) distribution (5) control. http://www.nrel.gov/docs/fy01osti/27954.pdf
Rain Garden: A rain garden is a depressed area in the landscape that collects rain water from a roof, driveway or street and allows it
to soak into the ground. Planted with grasses and flowering perennials, rain gardens can be a cost effective and beautiful way to
reduce runoff from your property. Rain gardens can also help filter out pollutants in runoff and provide food and shelter for
butterflies, songbirds and other wildlife. More complex rain gardens with drainage systems and amended soils are referred to as
bio-retention. https://www.epa.gov/soakuptherain/rain-gardens
SEER: Seasonal energy efficiency ratio - The higher the SEER rating, the more energy efficient the equipment is. A higher SEER can
result in lower energy costs. https://energystar.zendesk.com/hc/en-us/articles/212111387-What-is-SEER-EER-HSPFSmart House: A smart house is a home that has highly advanced, automated systems to control and monitor any function of a
house – lighting, temperature control, multi-media, security, window and door operations, air quality, or any other task of necessity
or comfort performed by a home’s resident. http://architecture.about.com/od/buildyourhous1/g/smarthouse.htm
Water Heaters: Types are described here: http://energy.gov/energysaver/articles/solar-water-heaters.
WaterSense: EPA released its Final Version 1.1 WaterSense New Home Specification. This specification will be effective January 1,
2013 and establishes the criteria for new homes labeled under the WaterSense program and is applicable to newly constructed
single-family and multi-family homes. http://www.epa.gov/watersense/new_homes/homes_final.html
Whole Building Ventilation System: A whole building ventilation system assists in a controlled movement of air in tight envelope
construction. Whole building ventilation equipment is often a part of the forced air heating or cooling systems. There are various
methods of providing whole home ventilation including a heat recovery ventilator (HRV) or an energy recovery ventilator (ERV). Four
primary types of systems here: https://energy.gov/energysaver/whole-house-ventilation
Zero Energy Ready Home (ZERH): To qualify as a DOE Zero Energy Ready Home, a home shall meet certain minimum requirements,
be verified and field-tested in accordance with HERS Standards by an approved verifier, and meet all applicable codes. Builders may
meet the requirements of either the Performance Path or the Prescriptive path to qualify a home.
http://energy.gov/eere/buildings/zero-energy-ready-home
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the
appraiser may need to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or
guarantees as to, and assumes no responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the
AI Reports®. AI Reports® 820.06 Residential Green and Energy Efficient Addendum © Appraisal Institute 2017, All Rights Reserved
November 2019
Client File #:
Appraisal File #:
Commercial Green and Energy Efficient
Addendum
Client:
Subject Property:
City:
State:
Zip:
Form 821*
Additional resources to aid in the valuation of green properties and the completion of this form can be found at
http://www.appraisalinstitute.org/education/green_energy_addendum.aspx
The appraiser hereby acknowledges that the information provided within this addendum:
 has been considered in the appraiser’s development of the appraisal of the subject property only for the client and intended user(s)
identified in the appraisal report and only for the intended use stated in the report.
 is not provided by the appraiser for any other purpose and should not be relied upon by parties other than those identified by the
appraiser as the client or intended user(s) in the report.
 is the result of the appraiser’s routine inspection of and inquiries about the subject property’s green and energy efficient features.
Extraordinary assumption: Data provided herein is assumed to be accurate and if found to be in error could alter the appraiser’s
opinions or conclusions.
 is not made as a representation or as a warranty as to the efficiency, quality, function, operability, reliability or cost savings of the
reported items or of the subject property in general, and this addendum should not be relied upon for such assessments.
 is not to be construed as a replacement for an appraisal report but is an Addendum to an appraisal report. This Addendum is not
designed to assign value to each of the components identified. The Addendum is provided as a part of the description of the properties’
special characteristics that have been included in the analysis and value conclusions in the appraisal report. It also serves the client in
securing adequate information on the property type to assist in hiring the appraiser with knowledge and experience in this special
property type.
Green Building: The practice of creating structures and using processes that are environmentally responsible and resource-efficient throughout a
building’s lifecycle from siting to design, construction, operation, maintenance, renovation, and deconstruction. This practice expands and
complements the classic building design concerns of economy, utility, durability, and comfort. 1 High Performance building and green building are
often used interchangeably; however, they do have different definitions.
High Performance Building: A building that integrates and optimizes all major high-performance building attributes, including energy efficiency,
durability, life-cycle performance, and occupant productivity. 2
Six Elements of Green Building: A green building has attributes that fall into the six elements of green building known as (1) site, (2) water, (3)
energy, (4) materials, (5) indoor air quality, and (6) maintenance and operation. A Green Building will be energy efficient but an energy efficient
building is not synonymous with Green Building.
Property Type
Category of Property: (explain) _______________________________
This Addendum is for property types that include multifamily, all types of commercial, and industrial use properties. The Addendum can be used
for proposed or existing structures including retrofits.
Who may complete this Addendum?
The Addendum may be completed by any of the following:





LEED AP serving on project’s charrette
Green Rater that rated the project
Developer/builder involved in developing the project
Investor with sufficient information and documents to support the data
Appraiser
The appraiser must have sufficient knowledge and experience of the property type to review an Addendum completed by others and comment on
any inconsistencies or omissions noted. The person completing the Addendum should complete the “Completed by” Section of this Addendum.
The objective of this Addendum is to standardize the communication of the green and/or high performing features of commercial properties.
Identifying the features provides a basis for comparable selection and analysis of the features.
The Addendum will assist the client in extracting the documents necessary to expedite the appraisal process by having a better understanding of
the special property features. This will assist the client in securing the appraiser with knowledge and experience in the property type.
The Addendum can be attached to the listing of the property, which will allow the appraiser more detail on sales and listings of similar properties.
The Addendum may be used in its entirety or only the pages that apply.
Intended Users of this Addendum: Lender as part of their scope of work, appraisers as a supplement to the appraisal report, investors as a
summary of special green/energy features, and/or real estate agents as a supplement to a listing.
1
U.S. Environmental Protection Agency at www.epa.gov/greenbuildings/pubs/about.htm
2
Energy Policy Act of 2005 (Public Law 109-058) at http://www.nibs.org/?page=hpbc
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the appraiser may
need to provide additional data, analysis and work product not called for in this form. The Appraisal Institute plays no role in completing the form and disclaims any responsibility for
the data, analysis or any other work product provided by the individual appraiser(s). AI Reports® AI-821 Commercial Green and Energy Efficient Addendum © Appraisal Institute 2014,
All Rights Reserved.
October 2014
Client:
Client File #:
Subject Property:
Appraisal File #:
Documentation to Appraiser
The client should supply the qualified real estate appraiser with the following documents and information for analysis. This information should be
supplied in advance of the appraisal bidding process to allow the appraiser full disclosure of the potential scope of work. Check the items that will be
made available to the appraiser.
1.
LEED checklist (if appropriate). Alternatively, if certified by another organization the checklist used by the certifier should be provided to the
appraiser. (The checklist is the worksheet used by the green certified to award points for the green rating. The green score may be
presented as a preliminary score on proposed construction and subject to a final inspection upon completion of construction. The
appraiser should be presented with the final rating prior to the final inspection.) The checklist will address the six elements of green
building identified earlier in this Addendum.
Comment: This document assists the appraiser in understanding the shade of green and areas that received most points. For instance, a
commissioned building will have a checklist used by the rater. The checklist is extremely useful in documenting the details on the subject
property. The checklist will address in detail the materials element that appraisers may not be qualified to identify.
A property may be green but not have a green third party certification. The green features must be documented and presented to the
appraiser. The valuation is of the construction and not the certification; therefore, if the property possesses green features it should be
appraised for the features it possesses.
2.
Contact information for details of green, (LEED consultant, architect(s), builder, charrette member, and engineer)
Comment: This will help inform the appraiser about the components and makeup of the building. An appraiser should expect to receive all
pertinent information from all parties of a transaction.
3.
Energy modeling results (or Third Party Energy Ratings for Residential)
Comment: The energy modeling results can be critical in analyzing cost implications due to various green energy strategies or components.
The appraiser should verify that the projections used are realistic and that they fit the manner in which the facility will be used. The greatest
risk with energy modeling is that the projections employed do not fit actual building use and will result in an under- or overestimate of
utility costs. The energy modeling should provide an estimated energy savings. (A cost benefit analysis and/or engineering modeling
report may explain the choice and benefit of the systems used.)
4.
Plans and specifications
Comment: Even in an existing building, these documents should be made available if possible. Specifications should include product
descriptions from manufacturers. This helps inform the appraiser what is actually found at the property. If the property is proposed or new
construction, the builder should provide the cost breakdown of the property.
5.
Intended goals of construction or retrofit
Comment: If the subject is an existing building that has been upgraded or retrofitted, it is necessary to have basically the same discussions
regarding intended goals, projections, etc. Once the validity of the energy modeling projections is established, the appraiser can make
projections about projected energy savings.
6.
Commissioning Report (for high performance building systems and/or solar photovoltaic systems)
Comment: Commissioning is a third-party verification process used to evaluate whether the systems are designed, installed, functionally
tested, and capable of being operated and maintained to perform in conformity with the owner’s project requirements. This process is
viewed by a number of institutional investors as a prime mechanism of risk mitigation. This factor should be considered when comparing
the subject with its competitive set. The nature and extent of the commissioning process should be considered in the risk analysis.
7.
Tenant leases
Comment: Among other things, this is important to analyze who benefits from energy efficient improvements – the owner or tenant. It is
also helpful to determining whether the leases within the building are similar to and competitive with those signed at the comparable
properties. In the area of green strategies, innovations in tenant improvements (TIs) and space design may impact longer-term costs and
result in potential savings. There could be reduced downtime between leases and construction and material costs, as well as reduced risk
levels associated with space delivery and construction—depending upon the strategies, design, and components used.
8.
Incentives (such as property tax rebates, utility rebates or incentives: public sector, private sector or utility)
Comment: Where incentives are substantially monetary in nature or result in monetary, direct, and exclusive benefits to the project or
owner, there is a good chance that the market value of the real property may be affected. The appraiser should be prepared to understand
and address the contributory value of incentives. The impact of rebates and incentives should be considered in all three approaches to
value, as appropriate. The availability and duration of the incentive should be examined and appropriately incorporated into the relevant
approaches. Rebates and incentives should not be confused with income tax effects, such as accelerated depreciation, federal
Investment Tax Credits (ITC), or Renewable Energy Credits (RECs) which are generally not considered part of the real property for a market
value appraisal. Tax effects may have a material influence on the financial feasibility of a project but care should be exercised to separate
income tax effects that accrue to the ownership entity from rebates and incentives that accrue to the real property.
9.
Financing Benefits/Burdens
Comment: This is important to determining the extent that a discrete loan that stays with the upgrade package may be below or above
market and attractive or unattractive to assume. The appraiser should also balance the non-financial attributes of the green project to
determine how many, if any, property rights are burdened. Financing products such as PACE (Property Assessed Clean Energy) may reflect
a priority lien to the first mortgage, similar to a bond assessment, and typically survive ownership transfers of the property. Appraisers and
their clients should consider how to address and report the impact of such financing when developing the Scope of Work.
10. Operating Expenses.
Comment: Operating expenses – both historical and pro-forma – are important to understanding the ongoing operating expense impacts of
a green or high performance property. In addition to the typical two or three years of operating expenses, appraisers and their clients may
require more detailed reporting of individual expenses.
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the appraiser may need
to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or guarantees as to, and assumes no
responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI Reports®. AI Reports® AI-821 Commercial Green and Energy
Efficient Addendum © Appraisal Institute 2014, All Rights Reserved
October 2014
Client:
Client File #:
Subject Property:
Appraisal File #:
Certification or Verification of Green or Energy Efficient Features
Certifying Organization:
Certification Program USGBC
 USGBC (LEED®) _________________*Define rating system
LEED®
and Ratings
Attach the rating
worksheet that
provides the ratings
for each element to
provide a better
understanding of the
features. The
worksheet will assist
in comparing the
subject to sales rated
by different
organizations.
http://www.usgbc.org/leed/certification
 Core & Shell Only  Interior Design ___________________
 LEED for Existing Buildings: Operations & Maintenance
 Other:_______________________
Year Certified: _______  Report Attached or  Certification viewed on site
Green
Globes®
Rating:  LEED Certified:  LEED Silver  LEED Gold
 Describe Score If not listed:_________________
Certifying Organization:
 Green Globes® __________________*
*Define rating system
http://www.greenglobes.com
Year Certified: _______
Energy Star®
 LEED Platinum
 Report Attached or  Certification viewed on site
Rating: ___________________
□ Energy Star®
http://www.energystar.gov/buildings/about-us
Year Certified: _______
 Report Attached or  Certification viewed on site
Rating: ______________________
Home
Innovation
Research
Labs (NGBS)
□ Home Innovation Research Labs (NGBS)*
http://www.homeinnovation.com/green *Define rating system
NGBS New Construction:____________________________________
NGBS Rennovation of Existing Buildings:_________________________
Year Certified: _______
 Report Attached or  Certification viewed on site
Version:  NGBS 2008  NGBS 2012  NGBS 2015  NGBS ________(year)
Rating:  NGBS Bronze  NGBS Silver  NGBS Gold  NGBS Emerald
Other Green □ Name Certifying Organization:__________________________________________
Green Certifying Organization URL (website) __________________________________
Certifying
Organization
Year Certified: _______
 Report Attached or  Certification viewed on site
Rating: ______________________
Additions
Explain any additions or changes made to the structure since it was certified:
Do changes require recertification to verify rating is still applicable?  Yes  No
Recycle Programs
 Tenant Recycle Program
 Composting Program on Site
 Green Operations & Management
 Other ______________
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the appraiser may need
to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or guarantees as to, and assumes no
responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI Reports®. AI Reports® AI-821 Commercial Green and Energy
Efficient Addendum © Appraisal Institute 2014, All Rights Reserved
October 2014
Client:
Client File #:
Subject Property:
Appraisal File #:
Comments
The worksheets will
provide a review of all
categories and
address the six
elements of green
building identified on
the previous page of
this Addendum.
If a property is built green but not formally certified, it still deserves proper description and analysis to value the features.
The market analysis is of the structure’s physical, economic, and locational attributes and not an analysis of its label
alone. If no formal certification was obtained but the structure has green attributes, please describe in this area.
The worksheet will
more specifically
identify the green
materials included in
the property.
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the appraiser may need
to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or guarantees as to, and assumes no
responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI Reports®. AI Reports® AI-821 Commercial Green and Energy
Efficient Addendum © Appraisal Institute 2014, All Rights Reserved
October 2014
Client:
Client File #:
Subject Property:
Appraisal File #:
Site Element
The following items are considered within the appraised value of the subject property:
Walk Score
Public Transportation
Site
On Site Water
Retention
Parking
Score:_______
http://www.walkscore.com
 Bus – Distance:______ Blocks
Transit Score _____
http://www.walkscore.com
Orientation - front faces:
 East/West
 North/South
 Train – Distance: _______ Blocks
 Subway – Distance: _____ Blocks
Landscaping:  Water Efficient
 Native 
 Built on brownfield
 Wetlands – acres:______
 Drip Irrigation  Smart Irrigation Controllers
 Irrigation supplied by wet pond or onsite water source
 Dry Pond (size) _______ Acres
 Wet Pond (size) _______ Acres
 Rain Garden  Vegetated Roof
 On site ____spaces ___ /1,000 SF  Parking spaces reduced based on public transportation proximity
 Surface material _____________  Public parking garage or lot _______ blocks from property
(pervious concrete, grass, gravel, shell)
 Permeable pavement
Comments
Water Element
 Reclaimed Water System (Explain):_____________
 Greywater reuse system
 WaterSense® fixtures





Waterless urinals
Low flow or sensor water fixtures
Cistern - Size: ______ Gallons for irrigation
Rain Barrels Provide Irrigation
Other: ___________________________
Comments: Identify other features that may be included in the element of water that have not been identified under the Site or Water Efficiency
Sections.
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the appraiser may need
to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or guarantees as to, and assumes no
responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI Reports®. AI Reports® AI-821 Commercial Green and Energy
Efficient Addendum © Appraisal Institute 2014, All Rights Reserved
October 2014
Client:
Client File #:
Subject Property:
Appraisal File #:
Energy Element
The following items are considered within the appraised value of the subject property:
Insulation
 Fiberglass Blown-In  Foam Insulation  Cellulose  Fiberglass Batt Insulation
 Other (Describe):_____________________________________________________
R-Value:  Walls _____  Ceiling _____  Floor______
Roof
Windows
Day Lighting
Mechanicals
HVAC (Describe
in Comments Area)
Construction type: __________________
 Vegetated Roof
 Reflective Roof  Other:__________
 ENERGY
 Low E
 Double Pane
 High Impact  Storm
 Glazed
 Solar Shades
 U-Value ___
STAR®
 Triple Pane
 Other (Explain) ___________________
 ENERGY STAR
 Skylights
 Daylighting ______________________
Light Fixtures
#:_____
 Daylighting –optimized fenestration design
 LED Lighting
 Solar Tubes  Daylight-responsive electric lighting controls
 T-8 Florescent
#:______
 Daylight-optimized interior design (such as furniture design, space planning and
Lighting
room surface finishes)
ENERGY STAR®
Water Heater:
Other features: chillers, boilers, industrial type mechanicals
Appliances:
 Solar
__________________________________________
 Dishwasher
 Heat Pump
 Refrigerator
 Tankless  Coil
__________________________________________
 Office Equipment
Size: ______ Gal.
 Other__________
 Heat Pump
 High Efficiency HVAC
Efficiency Rating:
SEER:______
_____________
 Thermostat/Controllers
 Passive Solar Design
Efficiency Rating:____%
COP:_________
 Other:______________
(Defined in Glossary)
AFUE* ____%
HSPF:________
_____________________
*Annual Fuel-Utilization
SEER:________
Efficiency
EER: ________
 Programmable Thermostat
Utility Costs
 Radiant Floor Heat
Average Annual Energy Cost: $ _______ per kWh $
 Geothermal
based on:_______________(Utility Bills/I&E Statements)
Hours of Operation: ___________________  # Employees: _____
After Hours or weekend hours of use: ___________
 Daytime cleaning (reduces energy costs)
Energy Audit
 Energy Audit attached
Has an energy audit/rating been performed on the subject property?
If yes, comment on work completed as result of audit.
Comments
(Include source for
information provided
in this section)
 Dashboards # _____
 Yes
 No
 Unknown
Information was provided by:
Attach documents or
reference source
Indoor Air Quality Element
 Energy Recovery Ventilator Unit or Whole Building Ventilation System
 Non Toxic Pest Control
 Other:_________________________________
 Co2 sensors
Comments: Describe additional features implemented that would affect the indoor air quality. Indoor air quality can be affected by building material
choices as well as items listed herein. (See Rating Worksheet for items identified in this category)
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the appraiser may need
to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or guarantees as to, and assumes no
responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI Reports®. AI Reports® AI-821 Commercial Green and Energy
Efficient Addendum © Appraisal Institute 2014, All Rights Reserved
October 2014
Client:
Client File #:
Subject Property:
Appraisal File #:
Maintenance & Operations Element
 Operations & Maintenance Manual  Demountable Walls
 Other __________________
 Staff Training Program
 Management has Green Training
Commissioning
 Daytime cleaning (reduces energy costs)
 Post Occupancy Commissioning
 Date of PO Commissioning ____________
Note: Certifications for certain standards, such as USGBC’s LEED EB O&M, are valid for a limited time. In order to maintain that particular
certification, the building must be reassessed every five years to determine whether it meets the then-current certification standards. It is
essential to verify that a building’s certification is valid.
Comments:
Note: The information provided on the operations and maintenance reflects details provided by others. Appraisers typically do not have sufficient
detail to judge the operations and maintenance of the whole building as a system. Buildings that have been commissioned on a regular basis
should have commissioning reports that provide operations and maintenance details by a qualified professional.
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the appraiser may need
to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or guarantees as to, and assumes no
responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI Reports®. AI Reports® AI-821 Commercial Green and Energy
Efficient Addendum © Appraisal Institute 2014, All Rights Reserved
October 2014
Client:
Client File #:
Subject Property:
Appraisal File #:
Incentives – Amount of Incentive and Terms
The following items are considered within the appraised value of the subject property:
Federal
State
Local
Note: Tax abatements are available in some areas and make a significant contribution to lower expenses.
Source
(For example
www.dsireusa.org)
Comments
Incentives offset cost
and should be
reported in the cost
approach section of
the report.
Incentives
Completed by:
Title:
Date:
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the appraiser may need
to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or guarantees as to, and assumes no
responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI Reports®. AI Reports® AI-821 Commercial Green and Energy
Efficient Addendum © Appraisal Institute 2014, All Rights Reserved
October 2014
Client:
Client File #:
Subject Property:
Appraisal File #:
Ea
Commercial Addendum Glossary
Building Envelope: The building envelope is everything that separates the building’s interior from the exterior. This includes the
foundation, exterior walls, roof, doors and windows.
Energy Recovery Ventilation System: Often called Heat Recovery Ventilators (HRV). These systems replenish the indoor air
without wasting all the energy already used to heat the indoor air. In some climates, these systems are also used to handle
water vapor in the incoming air.
Earth Advantage Commercial: Earth Advantage Commercial is a green building certification program for small commercial
buildings. http://www.earthadvantage.org/commercial/ Note: This program does not require energy modeling.
ENERGY STAR®: Energy Star, sponsored by the EPA, rates buildings based on their energy use relative to buildings of similar
vintage, design, construction, use and occupancy. Through ENERGY STAR, the nation's most energy efficient buildings can earn
ENERGY STAR certification http://www.energystar.gov/buildings/about-us Note: The program claims of 35% lower energy
costs is not a basis for adjustment in an appraisal. The appraiser must evaluate the efficiency and develop appropriate
adjustments using acceptable appraisal methodology.



Portfolio Manager: EPA’s online energy management and tracking tool calculates 1 – 100 ENERGY STAR scores for
eligible commercial and institutional buildings, such as K-12 schools, office buildings, and many others. Portfolio
Manager also allows you to track improvements over time, compare similar buildings within a portfolio, generate
reports, and quantify greenhouse gas emissions.
Target Finder: This tool is similar to Portfolio Manager, except it’s used to estimate performance. By entering the
estimated energy use of a commercial building design or renovation project, you can project its future 1 – 100 ENERGY
STAR score.
Energy Performance Indicators (EPIs): Available for 11 different types of industrial or manufacturing plants, EPIs enable
energy managers and corporate executives to evaluate the energy efficiency of their plants relative to others in their
industry.
National Green Building Standard (NGBS): NGBS is an ANSI-approved green building rating system and part of the International
Code Council’s (ICC) International Codes (I-Codes). The NGBS provides practices for the design, construction, operation, and
certification of new and existing residential buildings, including single family homes and multifamily buildings. Home Innovation
Research Labs is the national Adopting Entity and certification agency for the NGBS. www.homeinnovation.com/green
Green Globes®: Green Globes is an online green building rating and certification tool that is primarily used in Canada and the
USA. http://www.greenglobes.com
 New Construction/Significant Renovations
 Commercial Interiors (i.e. Office Fit-ups)
 Existing Buildings (offices, multi-residential, retail, health care, light industrial)
Geothermal: A geothermal heat pump uses the constant below ground temperature of soil or water to heat and cool the
building. http://energy.gov/energysaver/articles/geothermal-heat-pumps
LEED®: Leadership in Energy and Environmental Design is a green building rating system sponsored by the United States
Green Building Council (USGBC). LEED provides building owners and operators with a framework measurable green building
design, construction, operations and maintenance solutions. http://www.usgbc.org/DisplayPage.aspx?CMSPageID=1988
 LEED for Building Design and Construction (LEED BD+C) rating systems
 LEED for Interior Design and Construction (LEED ID+C) rating systems
 LEED For Existing Buildings: Operations and Maintenance (LEED EB: O+M) rating systems
Life Cycle Assessment (LCA): LCA is a technique to assess the environmental aspects and potential impacts associated with a
product, process, or service, by:
 Compiling an inventory of relevant energy and material inputs and environmental releases
 Evaluating the potential environmental impacts associated with identified inputs and releases
 Interpreting the results to help you make a more informed decision
Source: http://www.epa.gov/nrmrl/std/lca/lca.html
Passive Solar: Passive solar is technology for using sunlight to light and heat buildings with no circulating fluid or energy
conversion system. http://rredc.nrel.gov/solar/glossary A complete passive solar building design has the following five
elements: (1) aperture (collector) (2) absorber (3) thermal mass (4) distribution (5) control.
http://www.nrel.gov/docs/fy01osti/27954.pdf
SEER: Seasonal energy efficiency ratio - The higher the SEER rating, the more energy efficient the equipment is. A higher SEER
can result in lower energy costs. http://www.energystar.gov/index.cfm?c=tax_credits.tx_definitions&dts=ssps,mcs,seer,eer .
Water Sense: EPA released its Final Version 1.1 WaterSense New Home Specification. This specification will be effective
January 1, 2013 and establishes the criteria for new homes labeled under the WaterSense program and is applicable to newly
constructed single-family and multi-family homes. http://www.epa.gov/watersense/new_homes/homes_final.html
Water Heaters: Solar, Heat Pump, Tankless On Demand or Tankless Coil water heaters are described at the following location:
http://energy.gov/energysaver/articles/solar-water-heaters.
WaterSense has developed WaterSense at Work, a compilation of water-efficiency best management practices, to help
commercial and institutional facilities understand and better manage their water use, help facilities establish an effective water
management program and identify projects and practices that can reduce facility water use.
http://www.epa.gov/watersense/commercial/bmps.html
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the appraiser may need
to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or guarantees as to, and assumes no
responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI Reports®. AI Reports® AI-821 Commercial Green and Energy
Efficient Addendum © Appraisal Institute 2014, All Rights Reserved
October 2014
Client:
Client File #:
Subject Property:
Appraisal File #:
Whole Building Ventilation System: A whole building ventilation system assists in a controlled movement of air in tight envelope
construction and may include air-purifying systems. Whole building ventilation equipment is often a part of the forced air
heating or cooling systems.
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the appraiser may need
to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or guarantees as to, and assumes no
responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI Reports®. AI Reports® AI-821 Commercial Green and Energy
Efficient Addendum © Appraisal Institute 2014, All Rights Reserved
October 2014
Client:
Client File #:
Subject Property:
Appraisal File #:
GREEN PROPERTY VALUATION RESOURCES
Appraisal Institute Introduction to Valuing Commercial Green Buildings
http://www.appraisalinstitute.org/library/bok/IntroGreen.pdf
Appraisal Institute Green Building Education
http://www.appraisalinstitute.org/education/green/default.aspx
Case Studies in Appraising Green Commercial Buildings including functional obsolescence
http://www.appraisalinstitute.org/education/course_descrb/PDFs_for_Web/Course_828/toc-case-studies-green-comm-bldgs.pdf
Capital Markets Briefing Paper green building business case released at the NYSE
http://webstore.ansi.org/FindStandards.aspx?Action=displaydept&DeptID=3144#.UGjO2Y7XfQc
Green Building and Property Value – provides a review of the commercial green building property value identifying the
components of green that may materially affect value. This document was developed by the Appraisal Institute and
Institute For Market Transformation (IMT)
http://www.imt.org/resources/detail/green-building-and-property-value
Retail Green Lease Primer – This two-page document helps guide retailers and retail owners to improving the efficiency of
their facilities. It can be helpful to appraisers in understanding green leases. http://www.imt.org/resources/detail/retail-greenlease-primer
Building Energy Performance Assessment News - This website offers many resources on green mortgage underwriting for
commercial and residential properties. Http://www.bepanews.com
*NOTICE: The Appraisal Institute publishes this form for use by appraisers where the appraiser deems use of the form appropriate. Depending on the assignment, the appraiser may need
to provide additional data, analysis and work product not called for in this form. The Appraisal Institute makes no representations, warranties or guarantees as to, and assumes no
responsibility for, the data, analysis or work product provided by the individual appraiser(s) in the specific contents of the AI Reports®. AI Reports® AI-821 Commercial Green and Energy
Efficient Addendum © Appraisal Institute 2014, All Rights Reserved
October 2014