Chapter 7
Valuation Using the Sales
Comparison and Cost Approaches
Real Estate
FIN 331
Fall 2015
Valuation
A.Valuation calculations are required when a:
1. property acquisition is contemplated or
2. a structure is
a.
b.
c.
d.
modernized
renovated
abandoned
demolished
3. site is developed
4. property is used as collateral for a loan
Value Concepts
A. Market value:
1. Most probable selling price, assuming
“normal” sale conditions.
2. Value for the “typical” market participant
may not be fundamental value.
B. Investment value:
1. Value to a particular individual (investor).
C. Transaction price:
1. Price actually paid for a specific property
Value Concepts
A. True Value
1. In perfectly competitive markets, transaction
prices should be identical to true or intrinsic
value
2. Prices are continuously revealed by prices of
perfect substitutes (similar dynamics to stock
markets)
3. Result: we are all price takers.
Users of Appraisals
A.
B.
C.
D.
E.
Buyers
Sellers
Mortgage Lenders
Corporate acquisitions, mergers or
dissolutions
Courts
1.
2.
3.
4.
Divorces
Eminent domain cases
Settlement of estates
Bankruptcy
APPRAISALS
A. Appraisals
1. An unbiased written estimate of the fair
market value of a property
a. Appraiser’s final estimate of property value
b. Data upon which the estimate is based
c. Assumptions and calculations used to arrive at
the particular estimate
APPRAISALS
2.
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?
Uniform Standards of Professional
Appraisal Practice (USPAP)
A.
Required & followed by all states &
federal regulatory agencies
1. Appraisers are state certified
2. MAI designation?
B.
C.
Imposes ethical obligations & minimum
appraisal standards
Maintained by the Appraisal Foundation
Non-profit industry group that Congress (in 1989)
charged with setting minimum requirements for all
(state) certified appraisers
APPRAISALS: USPAP
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
3.
Collect Data and Describe Property
a.
b.
c.
4.
Market Data: general characteristics or
region/city/neighborhood
Property Data: Site, building and location characteristics
Comparable Property data: market information on
comparables
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
APPRAISALS: USPAP
5. Determine value of land:
a. Important to value separately from
improvements
6. Apply 3 Approaches to Valuation
a. Sales comparison approach
b. Cost approach
c. Income approach
APPRAISALS: USPAP
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
APPRAISALS: USPAP
B. Three Types of Appraisal Reports
1. Self-contained report
a.
b.
Contains full detail & information used to estimate
market value
Usually takes a full narrative (long & formal) approach
2. Summary appraisal report
a.
b.
c.
Summarizes conclusions of the appraisal
Majority of data & techniques are kept in appraiser’s
work file
For homes, usually use “form” instead of narrative
reporting option
1)
Ex., Uniform Residential Appraisal Report (Exhibit 7-12)
APPRAISALS: USPAP
1. Restricted appraisal report
a. Provides minimal discussion of the appraisal
1)
refers to internal file documentation
b. Tells client what the property is worth
c. Client cannot give appraisal to anyone else
d. Usually least expensive of the three options
Sales Comparison Approach to
Estimating Market Value
A. Sales Comparison Approach
1. Basic Idea: Value of RE can be determined by
analyzing the sale prices of similar properties
2. Why? In a competitive market, close
substitutes should sell for similar prices
3. Major difficulty? How many truly close
substitutes exist & how many of these have
sold recently?
Sales Comparison Approach to
Estimating Market Value
A. Steps in Sales Comparison Report
APPRAISALS: USPAP
B. Selecting Comparable Sales
1. Must be properties that prospective buyers
would consider substitutes
2. Should be arms-length transactions
a. Fairly negotiated prices that occurred under
“normal” conditions
b. For example, not a distressed sale
3. Select to minimize required physical and
locational adjustments
APPRAISALS: USPAP
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
4. Zillow
Sales Comparison Approach to
Estimating Market Value
D. Adjustments to Comparable Sale Prices
1. Convert characteristics of each comparable
to an approximation of subject
2. Sequence of adjustments
a. Transactional adjustments: nature of the deal (see
list top of page 171)
b. 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. The Major Assumption?: Cost of creating a
property is related to its market value
Cost Approach to Estimating
Market Value
B. Two concepts of cost:
1. Replacement cost: Cost to create something of equal
utility (functionality)
2. Reproduction cost:
a.
b.
Cost of an exact physical replica
Complication in application?
C. Methods to estimate replacement cost
1. Quantity survey method
2. Cost per square foot or cubic foot
3. Unit in place
Cost Approach to Estimating
Market Value
D. Sources replacement cost estimates
1.
2.
3.
4.
R.S. Means www.rsmeans.com
Marshall and Swift www.marshallswift.com
Consulting firms
Builders/contractors
Cost Approach to Estimating
Market Value
E. Special Issue of Accrued Depreciation –
Commercial Property
1. Difference between replacement cost & market
value of improvements
2. Types of accrued depreciation that must be
considered:
a. Physical deterioration: Loss in market value due to
aging, decay & ordinary use
b. Functional obsolescence: Loss in value due to changes
in tastes, preferences, technological innovations, or
market standards
c. 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