Class Discussion Balemi et al (2021). “Covid-19.s impact on real estate markets: review and outlook” What commercial real estate sector was most hit by the pandemic? How does this impact property values and why? How did covid impact the housing markets? How did covid impact the Mortgage Markets? Real Estate Valuation BUQS3022 Lecture 3 The Valuation Process Course Instructor: Prof Kola Akinsomi The Valuation Process What is the Valuation Process? • The valuation process is a systematic procedure an appraiser follows to provide answers to a clients questions about real property value. The objective of most appraisal assignments is to develop an opinion of market value. The Valuation process contains all the steps appropriate to appraisal assignment. The Valuation Process The Appraisal Process Step 1: Problem Definition Real estate identification Use of appraisal Value definition Effective Date Identification of property characteristics The Appraisal Process Step 2: Scope of Work Determination Scope of work is the most critical decision an appraiser will make in performing an assignment. Solving an appraisal problem involves: 1. Identifying the problem 2. Determining the solution 3. Applying the solution The Appraisal Process • Step 3: Preliminary Analysis & Data Collection. – Information • General – trends Social, Economic, Governmental and Environmental data • Specific – property and comparable Legal, Physical, locational, cost, income and expense information • Supply & Demand – future changes Supply includes vacancy rates, absorption rates, competitive properties Demand incudes population income, employment. The Appraisal Process • Step 4: Highest and Best Use Analysis “the reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value”. – – Vacant vs. improved Vacant may be highest and best use. 1. Identify use with highest overall return 2. Helps identify comparable properties The Appraisal Process • Step 5: Land Value Estimate – Sales comparison – Allocation (ratio) – Extraction (less improvements) – Subdivision & development – Land residual technique (NOIland) The Appraisal Process • Step 5: Application of Three Approaches: Sales Comparison (VSC) Cost (VC) Income (VI) The Appraisal Process • Step 6: Reconciliation Using various estimates of value under a number of methods determine one estimate of value. How? The Income Approach • Should look familiar! • GI=GO (DCF model) N V0 t 1 NOI t NSPN 1 y 1 y V0 NOI R t N The Income Approach • Gross income multipliers SP IM GI * • Potential or effective gross income The Sales Comparison Approach • Underlying economic theory: Similar goods sell for similar prices. • Applicable to all property types but works best for property types with frequent transactions. • Data, data, data.. Sales Comparison • Procedure: – Research market/gather data – Verify information – Select units of comparison (ft^2, apt. unit, etc) – Develop comparable analysis – Compare comps to subject with respect to elements of comparison & make adjustments – Reconcile Sales Comparison • Sequence of adjustments: – Financing terms – Conditions of sale – Market conditions – Location – Physical characteristics Sales Comparison • A(n) adjustment will be made to the comparable price when the comparable property is superior to the subject property. • Net adjustments lead to the adjusted sales price. Sales Comparison Uses and limitations: – Good data = good results – An easy “amateur” appraisal – Financing advantage – No data = no use The Cost Approach • Underlying economic theory: No prudent buyer would pay more than it would cost to purchase the land and develop. • Applicable to all property types but does not have the ease of sales comparison. • Data, data, data.. Cost Approach • Procedure: – Estimate site value – Estimate hard and soft costs of improvements including reasonable profit – Estimate accrued depreciation in the structure – Add site value to improvement depreciated cost Cost Approach Direct (hard) costs – Building permits – Labor – Materials – Equipment – Security – Contractors profit Cost Approach Indirect (soft) costs: – Consulting – Engineering and architecture – Cost of carry (fees, points, interest, lease-up) – Selling expenses – Leasing commissions Cost Approach Comparative Unit Method: – Determine (find) estimate of cost per unit of area – Aggregate cost per unit – Size matters – Use of benchmark building • Adjust for size, finish quality, time, etc. Cost Approach Unit in Place Method: – Each category (section) of the building’s cost is estimated. – Foundation, sprinkler, roof, framing, on a square foot cost basis Cost Approach Quantity Survey Method – Most complex and time consuming – No aggregation of data according to size – Number of labor hours, direct cost supplies are estimated and the cost of each is applied. – Rarely used. Cost Approach Depreciation: – Non-accounting sense – Three major types: • Physical deterioration • Functional obsolescence • External obsolescence – Economic life, effective (actual) age, remaining economic life Cost Approach Market Extraction Method (depreciation): – Transaction prices of similar properties with respect to age/depreciation – Sale price minus land = depreciable cost (1) – Estimate the replacement cost (2) – (2)-(1) = total depreciation Cost Approach • Age-Life Method (depreciation) – Estimate total economic life of similar properties – Estimate effective age – Compute ratio of effective age (subject) to total economic life – Apply ratio to development cost Cost Approach • In summary: V0 Vland Development Cost Accrued Depreciation • Useful when there is not an active market for the subject property type Appraisal Method Summary • Comparable sales – Like goods sell for like prices – Requires transaction data on “similar” properties • Income approach – Value is PV(future benefits) – Most relevant for income producing real estate • Cost approach – Buyers will not pay more than the cost – Utilizes industry cost estimators Thanks for Listening!
