Chapter 7
Valuation Using the Sales
Comparison and Cost Approaches
Real Estate
FIN 331
Fall 2013
MARKET VALUE, INVESTMENT
VALUE, AND TRANSACTION PRICES
A. Appraisals
1.
An unbiased written estimate of the fair market value of
a property
a.
b.
c.
2.
Appraiser’s final estimate of property value
Data upon which the estimate is based
Assumptions and calculations used to arrive at the particular
estimate
Why Do We Have To Estimate Market Value?
a.
b.
c.
d.
To get an estimate of the probable selling price under current
market conditions
Lenders require an estimate of market value to make a
reasonable mortgage decision
Real estate markets are assumed to reflect near perfect
competition; the implication is that transaction occur at or
very near true (or intrinsic) values
Question: Are we all price takers?
MARKET VALUE, INVESTMENT
VALUE, AND TRANSACTION PRICES
A. The Appraisal Process: Uniform Standards of
Professional Appraisal Practice (USPAP)
1. Identify the appraisal problem
a.
b.
c.
d.
e.
Client & intended uses of appraisal
Date of valuation
Rights to be valued (fee simple, etc.)
Type of value to be estimated: market, insurance, or taxable
value?
Important assumptions or conditions
a.
b.
c.
Time & personal requirements
Outline of proposed appraisal report
Data & procedures used to complete required tasks
2. Determine the required scope of work
MARKET VALUE, INVESTMENT
VALUE, AND TRANSACTION PRICES
4. Perform data analysis
a.
b.
c.
d.
Market analysis: Effects of demand & supply
Highest & best use; use which is
legally/physically/financially permissible
Highest & best use as though vacant: considers any possible
use
Highest & best use as improved: must consider any cost of
demolition
5. Determine value of land: Important to value
separately from improvements
6. Apply 3 Approaches to Valuation
a.
b.
c.
Sales comparison approach
Cost approach
Income approach
MARKET VALUE, INVESTMENT
VALUE, AND TRANSACTION PRICES
7. Reconcile indicated values from 3 approaches
a. Weight based on relative reliability of the three
approaches
8. Report final value estimate
a. Report writing is an extremely important function
b. Must meet requirements of 1 of 3 reporting options
1)
2)
3)
Self-contained report: full narrative description of process
Summary report: summary of conclusions, principal
points of process
Restricted report: minimal discussion, limited to use by
client
Sales Comparison Approach to
Estimating Market Value
A. Sales Comparison Approach
1.
2.
3.
B.
Basic Idea: Value of RE can be determined by analyzing the
sale prices of similar properties
Why? In a competitive market, close substitutes should sell for
similar prices
Major difficulty? How many truly close substitutes exist & how
many of these have sold recently?
Selecting Comparable Sales
1.
2.
3.
Must be properties that prospective buyers would consider
substitutes
Should be arms-length transactions
a.
b.
Fairly negotiated prices that occurred under “normal” conditions
For example, not a distressed sale
Select to minimize required physical and locational
adjustments
Sales Comparison Approach to
Estimating Market Value
C. Data Sources
1. Public records (e.g., county property tax assessor)
2. Multiple listing service
3. Private vendors (title companies, others): CoStar for
commercial properties
D. Adjustments to Comparable Sale Prices
1. Convert characteristics of each comparable to an
approximation of subject
2. Sequence of adjustments
a.
b.
Transactional adjustments: nature of the deal (see list top of
page 171)
Property adjustments: unique feature of property (ditto)
3. Recent price trends
Cost Approach to Estimating
Market Value
A.
Procedure
1.
Estimated reproduction cost of improvements
− Estimated accrued depreciation
= Depreciated cost of building improvements
+ Estimated value of site
= Indicated value by the cost approach
2.
B.
The Major Assumption?: Cost of creating a property is related to its market value
Two concepts of cost:
1.
2.
Replacement cost: Cost to create something of equal utility (functionality)
Reproduction cost:
a.
b.
C.
Cost of an exact physical replica
Complication in application?
Methods to estimate replacement cost
1.
2.
3.
Quantity survey method
Cost per square foot or cubic foot
Unit in place
Cost Approach to Estimating
Market Value
D. Sources replacement cost estimates
E.
1.
2.
3.
4.
R.S. Means www.rsmeans.com
Marshall and Swift www.marshallswift.com
Consulting firms
Builders/contractors
1.
Difference between replacement cost & market value of
improvements
Types of accrued depreciation that must be considered:
Special Issue of Accrued Depreciation – Commercial
Property
2.
a.
b.
c.
Physical deterioration: Loss in market value due to aging, decay &
ordinary use
Functional obsolescence: Loss in value due to changes in tastes,
preferences, technological innovations, or market standards
External (economic) obsolescence: loss of value due to neighborhood
changes
Homework Assignment
A. Key terms: Accrued depreciation,
Appraisal, Comparable properties, Market
value, Property adjustments, Replacement
cost, Reproduction cost, Restricted
appraisal report, Transactional
adjustments
B. Study questions: 2, 3, 4, 7, 8, 12