The Real Estate School

APPRAISING
REAL ESTATE
UNIT 20

Page 391
 OVERVIEW
• Real estate licensees must be aware of the fundamental principles
of valuation in order to complete an accurate and effective
Competitive Market Analysis

Page 391
 APPRAISING
• Appraisal – An estimate or opinion of value based on
supportable evidence and approved methods
• Appraisal Report – An opinion of market value on a property
given to a lender or client with detailed and accurate information

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 APPRAISING
• Appraiser – An independent professional trained to provide an
unbiased estimate of value in an impartial and objective manner
according to the appraisal process
• Appraising is a
professional
service
performed for
a fee

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 APPRAISING
• Regulation of Appraisal Activities
• Appraisals used in connection with
federally related transactions must
be performed by a competent
individual who is subject to
supervision and regulation

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 APPRAISING
• Regulation of Appraisal Activities (cont’d)
• Appraisers follow the Uniform Standards
of Professional Appraisal Practice
(USPAP) which define the education,
examination, and experience required

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 APPRAISING
• Regulation of Appraisal Activities (cont’d)
• Three classes of certification:
1. Certified General Real Estate Appraiser – Appraise any
residential or nonresidential property
2. Certified Residential Real Estate Appraiser – Appraise
only residential property
3. Broker/Appraiser – Appraise properties valued under
$250,000 not involved in federally related transactions (no
longer available)

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 APPRAISING
• Comparative Market Analysis – A written analysis or opinion
relating to the probable sales price of a specific property

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 APPRAISING
• Licensees may prepare
a CMA to help determine
an asking price to secure
a listing or an offering
price for a buyer’s offer

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 APPRAISING
• Broker’s Price Opinion (BPO) – Less expensive alternative of
valuating property often used by lenders working with home equity
lines, refinancing, portfolio management, loss mitigation, and
collections

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 APPRAISING
• Broker’s Price Opinion (BPO) (cont’d)
• Pennsylvania allows licensees to perform
BPO’s in certain situations and only after
taking specific BPO education

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 APPRAISING
• Broker’s Price Opinion (BPO) (cont’d)
• BPO’s may be performed in situations that are not transaction
related:
1. Property own by lender after an unsuccessful sale at a foreclosure auction
2. Modification of a mortgage or line of credit
3. Short sale
4. Evaluation of a portfolio of properties

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 THE APPRAISAL PROCESS
• Data is divided into two basic classes:
1. General Data – Covers the nation, region, city, and
neighborhood
2. Specific Data – Covers details
of the subject property as well
as comparative data

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 THE APPRAISAL PROCESS
• Eight steps in the appraisal process:

1 2 3 4 5 6 7 8
Gather, Estimate Value
State the Highest & Estimate the
List the Data Record, Verify, Under Three Reconcile Report
Problem Best Use Land Value
Analyze Approaches

Figure 20.1

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 THE APPRAISAL PROCESS
• Appraisal reports should contain the following:
• Identify the property being appraised
• State purpose of intended use
• Define the value to be estimated
• Effective date of report
• State the extent of the process
• List all assumptions and limiting conditions

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 THE APPRAISAL PROCESS
• Appraisal reports should contain the following: (cont’d)
• Describe information considered, appraisal
procedures followed, and reasoning
to support conclusion
• Opinion of highest and best use
• Describe additional information used
• Signed certification

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 VALUE
• To have value in the real estate market, a property must have the
following characteristics:
• Demand – Need or desire for possession backed up by
DUST financial means
• Utility – Capacity to satisfy needs and desires
• Scarcity – Finite supply
• Transferability – The ease with which ownership can
be transferred
Page 397
 VALUE
• Market Value – The most probable price that a property should
bring in a fair sale
• The definition makes three assumptions:
1. Competitive and open market
2. Parties are acting prudently and
knowledgeably
3. Not affected by unusual circumstances

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 VALUE
• Market Value (cont’d)
• The most probable price is not the average or highest price in a
CMA or appraisal
• Parties are unrelated and acting
without undue pressure
• Parties are informed about the
property’s use and potential

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 VALUE
• Market Value (cont’d)
• Reasonable time for exposure on the market
• Payment made in cash or equivalent
• Unaffected by special financing,
services, fees, costs, or credits
in the transaction

Page 397-398
 VALUE
• Market Value (cont’d)
• Market Value vs. Market Price – Opinion of value based on
analysis of data vs. actual sales price

• Market Value vs. Cost – Cost (usually) does not equal market
value
Page 398
 VALUE
• Market Value (cont’d)
• Basic Principles of Value
• Anticipation – Value is created by the expectation that certain
benefits will be realized in the future
• Change – No physical or economic condition remains
constant
• Competition – Interaction of supply and demand

Page 398
 VALUE
• Market Value (cont’d)
• Basic Principles of Value (cont’d)
• Conformity – Maximum value is realized when a property is
in harmony with its surroundings
• Contribution – Value of any part of a property is measured
by its effect on the value of the whole parcel

Page 399
 VALUE
• Market Value (cont’d)
• Basic Principles of Value (cont’d)
• Highest and Best Use – The most profitable single use that is:
• Legally permitted
• Physically possible
• Financially feasible
• Maximally productive

Page 399
 VALUE
• Market Value (cont’d)
• Basic Principles of Value (cont’d)
• Increasing and Diminishing Returns – The addition of
improvements increases value only to the asset’s maximum
value
• Plottage – Merging adjacent lots into a single larger one
produces a greater land value than the sites would
separately

Page 399
 VALUE
• Market Value (cont’d)
• Basic Principles of Value (cont’d)
• Regression and Progression – The worth of a higher-quality
property is adversely affected by the presence of a lower-
quality property (regression) and the worth of a lower-quality
home is favorably affected by the presence of a higher-quality
property (progression)

Page 400
 VALUE
• Market Value (cont’d)
• Basic Principles of Value (cont’d)
• Substitution – Property’s maximum value tends to be set by
how much it would cost to purchase an equally desirable
property
• Supply and Demand – When supply increases, value
decreases; when demand increases, value increases

Page 400
THE THREE APPROACHES TO VALUE

1. Sales Comparison Approach

2. Cost Approach
3. Income Approach

Page 400
 THE THREE APPROACHES TO VALUE
1. Sales Comparison Approach – An estimate of value is obtained
by comparing the subject property with recently sold
comparable properties

Page 400
 THE THREE APPROACHES TO VALUE
1. Sales Comparison Approach (cont’d)
• Comparable properties are analyzed for differences between it
and the subject property

• Approach relies heavily on the principle of substitution

Page 400
 THE THREE APPROACHES TO VALUE
1. Sales Comparison Approach (cont’d)
• Elements of comparison:
• Property Rights • Market conditions since
the date of sale
• Financing Concessions
• Location
• Market Conditions
• Physical features and
• Conditions of Sale
amenities

Page 400-401
 THE THREE APPROACHES TO VALUE
1. Sales Comparison Approach (cont’d)
• Considered the most reliable approach when appraising single-
family homes

• Most appraisals include a minimum of three comparable sales

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 THE THREE APPROACHES TO VALUE
1. Sales Comparison Approach (cont’d)
• TIP - A dollar value is assigned to each difference between
the subject property and the comparable properties (comp)
• TIP - Adjustments are always made to comps NOT subject:
• If comp better than subject – decrease comp
• If comp worse than subject – increase comp
 THE THREE APPROACHES TO VALUE
#1 #2 #3

Sales Price ----- $ 150,000 $ 160,000 $ 157,000

1. Sales Square Footage 1,500

1,350 1,690
1,550
+ $2,500 - $2,500
Comparison
None 2 car
Approach Garage 1 car 1 car
+ $4,000 - $2,500
No
Fireplace Yes Yes Yes
+ $1,000
Figure 20.2 Acreage .25 acres .20 acres .32 acres .29 acres
(condensed)
Net
+ $7,500 - $5,000 -0-
Adjustments

Adjusted Value $ 157,500 $ 155,000 $ 157,000

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 THE THREE APPROACHES TO VALUE
2. Cost Approach
• Also based on the principle of substitution
• Most useful when appraising newer or special-purpose
buildings
• Usually not enough local sales
to use as comparables and
because the property does
not generate income

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 THE THREE APPROACHES TO VALUE
2. Cost Approach (cont’d)
• The cost approach contains five steps:
1. Estimate the value of the land
2. Estimate the current cost of constructing building
3. Estimate the accrued depreciation
4. Deduct accrued depreciation from current cost
5. Add land value to depreciated cost of building
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 THE THREE APPROACHES TO VALUE
2. Cost Approach (cont’d)
• Construction costs can be calculated in two ways:
1. Reproduction Cost – Cost to construct an exact duplicate
with both benefits and drawbacks
2. Replacement Cost – Cost to
construct a similar property
using current materials and
techniques

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 THE THREE APPROACHES TO VALUE
2. Cost Approach (cont’d)
• Determining Reproduction/Replacement Cost NEW
• Square Foot Method – The cost/square foot of recently
built structures multiplied by the number of square feet
• The most common and
easiest method of cost
estimation

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 THE THREE APPROACHES TO VALUE
2. Cost Approach (cont’d)
• Determining Reproduction/Replacement Cost NEW
• Unit-in-Place Method – The construction cost per unit of
measure of individual components

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 THE THREE APPROACHES TO VALUE
2. Cost Approach (cont’d)
• Determining Reproduction/Replacement Cost NEW
• Quantity Survey Method – The quantity and quality of all
materials and the labor are calculated on a unit-cost basis
then added to indirect costs to arrive at a total cost
• Most time consuming and most accurate

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 THE THREE APPROACHES TO VALUE
2. Cost Approach (cont’d)
• Determining Reproduction/Replacement Cost NEW
• Index Method – A factor representing the percentage
increase to the present time is applied to the original cost
of the property

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 THE THREE APPROACHES TO VALUE
2. Cost Approach (cont’d)
• Depreciation – Loss in value due to any cause
• Land does not depreciate
but retains its value
indefinitely

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 THE THREE APPROACHES TO VALUE
2. Cost Approach (cont’d)
• Depreciation is divided into three classes:
1. Physical Deterioration – Items in need of repair

Curable Incurable

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 THE THREE APPROACHES TO VALUE
2. Cost Approach (cont’d)
• Depreciation is divided into three classes:
2. Functional Deterioration – Outmoded or unacceptable
design features

Curable Incurable

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 THE THREE APPROACHES TO VALUE
2. Cost Approach (cont’d)
• Depreciation is divided into three classes:
3. External Depreciation – Negative factors external to the
property and beyond the owner’s control

Incurable Incurable

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 THE THREE APPROACHES TO VALUE
2. Cost Approach (cont’d)
• The easiest but least precise way to determine depreciation is
the Straight-Line Method
• Property’s cost is divided by the number of years of its expected
economic life

13 14 15 16 17 18 19 20 21 22 23 24

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 THE THREE APPROACHES TO VALUE
1. Land Valuation: 60’ x 135’ @ $450/front foot $ 27,000
Plus site improvements: driveway, landscaping, etc. 8,000
Total Land Value

2. Cost $ 35,000
Approach 2. Building Valuation: Replacement cost
1,500 sq. ft. @ $65/sq.ft.
Figure 20.3
$ 97,500
3. Less Depreciation:
Physical Depreciation
Curable: exterior painting $ 4,000
Incurable: structural deterioration 9,750
Functional Obsolescence 2.000
External Depreciation -0-
Total Depreciation
Page 403
 THE THREE APPROACHES TO VALUE
3. Income Approach – Based on the present value of the rights to
future income
• Assumes income derived from property will control the value
of the property
• Used for valuation of
income-producing
properties

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 THE THREE APPROACHES TO VALUE
3. Income Approach (cont’d)
• The income approach contains five steps:
1. Estimate annual potential gross income
2. Deduct allowance for vacancy and rent loss – Effective
Gross Income
3. Deduct annual operating expenses – Net Operation
Income (NOI)

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 THE THREE APPROACHES TO VALUE
3. Income Approach (cont’d)
• The income approach contains five steps: (cont’d)
4. Estimate the rate of return an investor will demand for
the investment for this type of building (Capitalization
Rate -or- Cap Rate)
5. Apply the Cap Rate to the property’s Net Operation
Income to estimate value

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 THE THREE APPROACHES TO VALUE
3. Income Approach (cont’d)
• Capitalization Rate Formulas:
• Income ÷ Cap Rate = Value
• Income ÷ Value = Cap Rate
• Value x Rate = Income
• If you know two variables you can always solve for the third

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 THE THREE APPROACHES TO VALUE
1. Potential Gross Annual Income
Market rent $ 60,000
Income from other sources 600
$ 60,600
3. Income 2. Allowance for Vacancy & Rent Loss (est. 4%)
Approach -2,424
Figure 20.4 Effective Gross Income

$ 58,176
3. Operating Expenses
Taxes $ 9,000
Insurance 1,000
Heat, utilities, electricity, water, gas 3,600
Repairs and decoration 2,600
Replacement of equipment 800
Legal, accounting, management 3,600
Page 406 $ 27,000
 THE THREE APPROACHES TO VALUE
3. Income Approach (cont’d)
• Gross Rent Multiplier (GRM) – Used if a one to four unit
rental property is being appraised
• Appraiser uses recent sales and rental data from at least four
properties that are similar to the subject
• Sales Price ÷ Monthly Gross Rent = GRM

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 THE THREE APPROACHES TO VALUE
3. Income Approach (cont’d)
• Gross Income Multiplier (GIM) – Used if a five or more unit
rental property is being appraised
• Sales Price ÷ Annual Gross Income = GIM

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THE THREE APPROACHES TO VALUE

Problem:
Determine the value of the old
Bishop McDevitt High School,
Harrisburg, PA

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THE THREE APPROACHES TO VALUE

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 THE THREE APPROACHES TO VALUE
• Reconciliation – The art of analyzing and effectively weighing the
findings from the three approaches to find an appropriate market
value
• Not simply the average of the three estimates of value

Page 407
 THE THREE APPROACHES TO VALUE
• Reconciliation (cont’d)
• Certain approaches are more valid and reliable with some kinds
of properties than others:
• Sales Comparison Approach – Single family homes
• Cost Approach – New or special-use properties
• Income Approach – Investment properties

Page 408