CHAPTER TEN

1. CHAPTER TEN VALUATION OF INCOME PROPERTIES: APPRAISAL AND THE MARKET FOR CAPITAL

2. Value Concepts • Market value: • Value for the “typical” market participant. • Most probable selling price, assuming “normal” sale conditions. • Investment value: • Value to a particular individual (investor). • Transaction price: • Price actually paid for a specific property.

3. Definition of market value The most probable price, which a property should bring in a competitive and open market under all conditions requisite to 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:

4. Definition of market value • buyer and seller are typically motivated; • both parties are well informed or well advised, and acting in what they consider their own best interests; • a reasonable time is allowed for exposure in the open market.

5. Definition of market value • payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and • 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.

6. Valuation approaches • Sales comparison approach • Income approach • Cost approach

7. Sales Comparison Approach • Basic Idea: • Value of a property can be determined by analyzing the sale prices of similar properties. • Why? • Because in a competitive market close substitutes will sell for similar prices.

8. 1- Identify Elements of Comparison & Value Adjustment 2 -Select Comparable Sales 3 -Adjust Comparable Sale Prices w.r.t. Subject 4 -Reconcile Adjusted Sale Prices; Obtain Indicated Value Sales Comparison Appraisal Approach

9. 1- Identify Elements of Comparability • Same subdivision? • Same price range? • Same size? • Same style? • Same vintage (age) ? • Other?

10. 2- Selecting Comparables • Must be properties that prospective buyers would consider substitutes • Must be true sales • Must be arms-length transactions • fairly negotiated transactions, best interest of each party dominates the deals • Select to minimize adjustments

11. 2- Selecting Comparables • Data sources: • Public records (county property tax assessor) • Multiple listing service (must have sale price) • Private vendors (title companies, others)

12. 3- Adjustment of Comparables • Goal: • To convert each comparable to an approximation of the subject. • Sequence of adjustments • Transactional Adjustments • Conditions of sale (arm’s length or not?) • Financing terms • Market conditions

13. 3- Adjustment of Comparables • Property Adjustments • Location • Physical characteristics • Legal characteristics • Use • Non-realty items (personal property)

14. Object of Adjustments Subject Comp 1 Comp 2

15. Example of Sales Comparison Approach • You are appraising a property located adjacent (close) to a high speed freeway. • Improvements consist of a one-story frame residence with 8 rooms and 2 baths in a total area of 2,000 sq. ft. • Of average quality construction, home was in good condition at time of inspection • Floor plan and items of equipment are typical for this class of property

16. Investigation disclosed the following: • Transactions involving comparable properties in the neighborhood of the subject • In a similar value range as the subject

17. Info on 4 Comparables (1) One year ago a 2,400 sq. ft. property not adjacent to freeway sold for $160,000. Improvements were nearly identical to subject residence in all but size. (2) This year a 2,400 sq. ft. property not adjacent to freeway sold for $150,500. This residence was highly similar to subject in all respects except for size.

18. Info on 4 Comparables (3) A 2,000 sq. ft. property not adjacent to the freeway sold 1 year ago for $150,000. These improvements are highly similar to subject. (4) A 2,400 sq. ft. property sold this year for $140,300. Located adjacent to the freeway, it was very similar to subject except for size.

19. Example, Cont. Problem: Based on the information given, develop an indication of the value of the subject, showing the source of each adjustment. Adjustment factors: The indicated adjustments are three: time, location relative to freeway, and size. They are derived as follows:

20. Adjustment Factors • Time: Sale 1 (1 year ago) $ 160,000 Sale 2 (current) 150,500 Difference $ -9,500 • Location: Sale 2 (not adjacent to freeway) $ 150,500 Sale 4 (adjacent to freeway) 140,300 Difference $ -10,200 • Size: Sale 1 (2,400 sq. ft.) $ 160,000 Sale 3 (2,000 sq. ft.) 150,000 Difference $ -10,000

21. Example, Cont. Note: Adjustment can be positive or negative. They are all negative here because the subject property is inferior to the comparables in all ways that matter to the market.

22. In the Real World... • Of course, in "real life" situations, indicated values never line up identically as in above example. • How many attributes of the homes should the appraiser attempt to price?

23. Income Approach • Focuses on the cash flows (income) generated by the property • Three techniques are used: • Gross Income Multiplier • Direct capitalization method • Discounted present value method • Note- the first two methods rely on current market transactions

24. Gross Income Multiplier • Potential Gross Income • - Less Vacancy • = Effective Gross Income • Less OE • = Net Operating Income • GIM= sales price/ gross income • Sale price = GIM × gross income

25. Gross Income Multiplier • To calculate GIM; • An estimate of Gross Income, based on market data • Sale price information is needed for comparable properties

26. Operating Expenses • Real estate taxes • Insurance • Utilities • Repair and maintenance • Admin. and general • Mgnt. and leasing • Salaries • Reserves • other

27. Capitalization Rate • When there are differences in OEs, use CR method. • Steps: • find the comparable properties. • find the NOI of comparable properties • find the value of comparable properties • Find the R for comparable properties. • Use this R to find the value of subject property

28. Net Operating Income • Potential Gross Income • Less Vacancy • = Effective Gross Income • Less OE • = Net Operating Income

29. Capitalization Rate Capitalization rate (“cap rate or R”) R = NOI/ value • Ratio of first year income to value • Rearranging equation, we get: • Value = NOI / R

30. Example R = NOI/ Value R = 35,380/ 3,75,000 R = 0.094 Value of our property= NOI /R 45000/0.094 = $4,78,723

31. Cost Approach • Procedure Estimated reproduction cost of improvements − Estimated depreciation = Depreciated cost of building improvements + Estimated value of site = Indicated value by the cost approach

32. Types of Depreciation • Physical deterioration: • Loss in value due to aging, decay and ordinary use • Functional obsolescence: • Loss in value due to changes in tastes, preferences, technological innovations, or market standards

33. Types of Depreciation • External obsolescence: • Loss in value due to changes beyond property boundaries (neighborhood change) • Increased traffic • Conversion to rental • Environmental degradation • Decline in demand