general appraisal concepts general... · appraisal concepts is meaningless without some knowledge...

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General Appraisal Concepts

LBA

2013 Appraisal Webinar Series

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BASIC APPRAISAL TERMINOLOGY

Many industries and professions have their own private code or

language. Appraising is no exception. Any discussion of

appraisal concepts is meaningless without some knowledge of

the language of appraising, starting with…

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Real Estate and Real Property

Real Estate

These two terms are often used interchangably, but they are not -

Real Property

Appraisers value real estate

Real estate is imovable and tangible

Real estate includes:

Land

All things that are a natural part

of land: trees and minerals

All things attached to the land by

people:

Site improvements

Buildings and their fixtures

Appraisers value real property

Real property includes all interests,

benefits, and rights inherent in the

ownership of real estate

Real property rights include:

Right to use the property

Right to sell the property

Right to lease the property

Right to enter the property

Right to give the property away

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Types of Real Property

Ownership and use rights can be identified as follows:

Fee Simple Estate – own the full bundle of rights

Leased Fee Interest – landlord’s interest in a leased property

Leasehold Interest – tenant’s interest in a leased property

Sub-Leasehold Interest – the tenant’s interest on a sub-lease

Sandwich Leasehold Interest – most typically from a ground lease

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Divided Partial Interest – individual ownership interests can be sold

Undivided Paritial Interest – ownership interests cannot be sold

Life Estate – right to use the property for life, often without payment

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Chart of Real Property Interests

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Leases and Risk

The property owner

retains the full bundle of

rights

When the owner no

longer wishes to use the

property, he can sell it or

lease it

Since it can be leased at

any time for market rent

and sold at any time for a

market sale price there

are no constraints other

than market conditions

Fee Simple Estate

The property owner has

transferred the right to

use the property to the

tenant via a lease

agreement

Use of the property is

exchanged for income

derived from the property

Leased fee interest lasts

for the duration of the

lease, after which the

property owner again has

the full bundle of rights –

the fee simple estate

Leased Fee Interest

Greatest risk because:

Tenant has no

ownership rights

Use term is limited

A leasehold interest can

be positive or negative:

Positive when

contract rent lower

than market rent

Negative when

contract rent is

higher than market

rent

Leasehold Interest

Leases transfer use rights from owner to tenant

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Easements

An easement is an interest in real property that transfers use, but not

ownership, of a portion of an owner’s property – may or may not run with

the land

• Access Easement – provides access to or through a property for

the benefit of the subject property or an adjacent property owner

• Utility Easement – issued to one or more utility companies

• Conservation Easement – restriction on future use to conserve the

land it its current condition

• Preservation Easement – prohibits or limits modifications to historic

properties

Types of Easements

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Other Use Rights

Transferable Development Rights (TDR)

Right to develop that a landowner cannot use is transferred to a landowner that can use it; most often used for preservation of agricultural land or historic properties or for protection of scenic features

Subsurface Rights

Typically related to oil & gas production, coal mining, gravel removal, or minerals production

The following rights can be owned, leased or sold:

Undistributed use and control of designated air space above a land area with stated elevations

Air Rights

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Non-Realty Items

1 Personal Property

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Trade Fixtures

Intangible Assets

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Personal Property

1 Personal property is movable and tangible

• Personal property is not permanently affixed to, or part of,

real estate – as opposed to fixtures, which are attached to

and become a part of real estate because of their

attachment

• Personal property is not endowed with the rights of real

property ownership

• Examples of personal property:

• Furniture, such as desks, tables, and chairs

• Free-standing shelves in retail stores

• Appliances: refrigerators, upright stoves, washers,

dryers

• Window treatments

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Trade Fixtures

2 Trade fixtures are movable and tangible

• Trade fixtures are items that are affixed to real estate but

are legally personal property by virtue of specific language

in a lease agreement

• Trade fixtures are affixed for the duration of the lease and

the tenant must remove them when the lease expires

• Trade fixtures are not endowed with the rights of real

property ownership

• Examples of trade fixtures:

• Restaurant booths

• Fitness equipment in a health club

• Affixed retail shelves

• Some affixed industrial equipment

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Intangible Assets

3 Intangible assets include the following:

• Reputation

• Trained work force

• Goodwill

• Copyrights

• Patents

• Trademarks

• Other assets

• Residual income

• Contracts

• Franchise agreement – for a restaurant or a hotel

• Management agreement – for hotel or parking garage

• Products agreement – such as a fuel agreement with a

jobber

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Valuation Terms

Value

The monetary worth of a property, good, or service to buyers and sellers at a given time

The present worth of the future benefits that accrue to real property ownership

Price

The amount a particular purchaser agrees to pay and a particular seller agrees to accept under the specific circumstances surrounding the transaction

The following may be used interchangibly, but are very different terms

The total dollar expenditure for an improvement, which applies to production (construction), and not exchange (sale)

Cost

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VALUE AND MARKETS

Real estate value cannot be calculated without an

understanding of real estate markets, in general, and the

specific market conditions that impact the property to be

appraised

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Types of Value

Value can have many meanings

Use Value – value of a property to a specific entity

Investment Value – value using specific investment parameters

Assessed Value – ascribed by the tax assessor

Fair Value – strictly an accounting term, is not used by appraisers

Insurable Value – replacement costs for insurance purposes

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Going Concern Value – includes realty and non-realty components

Market Value – property value in exchange under market conditions

Banks must only base their lending decisions on market value

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Market Value Definition

Buyers and Sellers

The regulatory definition requires the following:

Transaction

Typically motivated

Acting prudently

Acting knowledgably

Well informed or well advised

Acting in what they consider to be

their own best interest

The most probable price a property

would bring in a competitive and

open market under all conditions

requisite for a fair sale

Price is not affected by undue

stimulus

A reasonable time is allowed for

exposure on the open market

Payment is made in terms of cash or

comparable financing

Price is not impacted by special

financing or sale concessions

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Going Concern Value

Lending

A going concern value always includes both tangible and intangible assets

Property Types

The Interagency Appraisal and

Evaluation Guidelines prohibit loan-

to-value ratio calculations using a

going concern value

Real estate secured loans: Loan-to-

value ratio must be calculated using

the real estate market value

The value of the personal property

may be used for a chattel mortgage

The value of the intangibles may

support a business loan

It is difficult to value some properties

as real estate. Such property types

are first valued as going concerns

and then partitioned into the

component value portions

Properties valued as going concerns:

Hotels and motels

B&Bs

Nursing homes

Hospitals

Convenience stores

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Component Parts of a Going Concern

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Primary Value Influences

Agents of

Production

Anticipation &

Change

Forces of Value

Principals of

Value

Real estate market value is impacted by the following:

Land – finite amount and unchangable location

Labor – hard and soft cost of development

Capital – equipment, infrastructure to create other improvments

Entreprenerial Coordination – ability to combine the other three agents

Anticipation is derived from the expectation of future benefits from real estate and the opportunity costs of any investment

Change results from the interaction of the four forces of value

Social Forces – population statistics and trends

Economic Forces – employment, industry expansion, rental rates

Governmental Forces – public services, zoning and building codes

Environmental Forces – climate, topography, soil, transportation

Supply & Demand – prices vary as supply and demand vary

Substitution – property with the lowest price will be in greatest demand

Balance – value is created in equilibrium

Conformity – value created when a property conforms to demand

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Other Value Influences

• Externalities – factors outside a property can have positive or

negative influences on value

• Law of Increasing Returns – more of the agents of production will

enhance net income (up to a point)

• Law of Decreasing Returns – beyond a certain point, additional

expenditures will not create more value

• Contribution – a component’s value is measured by the amount its

absence would detract from value

• Surplus Productivity – the remaining net income after the four

agents of production have been met

• Progression – the value of an inferior property is enhanced by

association with better properties of the same type

• Regression – the value of a superior property is impaired by

association with inferior properties of the same type

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Different Sort of Market

Unlike the stock market, the commodities market, or on-line retail, real

estate is not an efficient market

• No two parcels of real estate are physically identical

• Usually only a few buyers and sellers will be interested in a

particular property type in a specific locale

• Supply and demand can often be out of balance

• Buyers and sellers of real estate may not be well informed

• Real estate is an illiquid, but durable product

• High transaction costs result from market inefficiencies

• Market participants cannot act quickly on new information or

changing trends, due to long development times

How real estate is different from other markets:

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Real Estate Market Terms

Specific real estate markets can be identified by:

• Market area

• Property type

• Property features

• Substitute properties

• Complementary properties

Submarket: a division of the

total market by the preferences

of a particular set of buyers and

sellers

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Real Estate Market Life Cycle

2) Characterized by

positive, but falling,

demand and increasing

vacancy levels

3) Characterized by

falling demand and

increasing vacancy

levels

1) Characterized by

sustained growth in demand

and increasing construction

activity

4) Characterized by

increasing demand and

decreasing vacancy

The duration of each stage and the progression timing can vary

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VALUATION PROCESS

Appraising is not all mathematical analysis – it is not as exact or

as provable as physics or engineering – appraising is part

research, part math, and part art

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The Art of Appraising

• With imperfect and inefficient real estate markets,

data from the market is not easily uncovered and

readily understood

• The art of appraising involves interpretation of the

market data when it is insufficient or unclear

• The art of appraising plays a part in comparable

selection

• The adjustment process is a mixture of the art and

the scientific elements of appraising

• The art of appraising can often involve subjectivity

and judgment

• The art of appraising is a combination of education,

common sense, and experience

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Appraisal Process

Every appraisal assignment involves eight steps:

Identification of the problem

Determination of the Scope of Work

Data collection and property description

Data analysis

Conclusion of the site value opinion

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Application of the approaches to value

Reconciliation of the value indications and final opinion of value

Report the defined value

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Foundation of Appraising

1 Every appraiser must be conversant with:

1) Real estate markets:

• How are they created

• How are they influenced

2) Appraisal tools and methods:

• What they are

• How they are applied

2 Uniform Standards of Professional Appraisal Practice (USPAP)

1) Sets the boundaries of appraising – the point beyond which

appraisers may not go

2) Appraisal concepts: how appraisers analyze markets within

the boundaries of USPAP

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Behavior of the Market

Knowledge of appraisal methodology is important, but…

The market trumps everything

The appraiser must research:

The property and its physical

aspects

Locational influences

Demographic and economic

influences

Real estate market trends for the

subject property type

There is no “right” or correct” or

“accurate” value, only the appraiser’s

opinion of value – supported by data

and analysis

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Land Valuation

• Sales Comparison Approach– the most commonly used method, as

it is usually the most reliable and straight-forward option

• Extraction – removes the contributory value of the building from an

improved sale, leaving land value as the remainder

• Allocation – partitions an improved sale between land and building

components using a ratio developed from sales

• Subdivision Development – deducts development costs and

holding/marketing costs over a construction and sales period

• Land Residual – calculates land value by application of different cap

rates to land and building income

• Ground rent capitalization – applies a cap rate to ground rental

income

Various techniques to estimate land value:

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Approches to Value

Income Approach

Assumes the subject property is leased at market terms with typical expenses

Capitalizes net income to value

If leased, examines contracted rent and expenses, capitalized into value

Cost Approach

Assumes the purchase of a similar site and development of a similar structure as the subject property, adjusted for depreciation

Includes a separate land valuation, which is added to the building analysis

Three valuation methods – can apply to both land and improved properties

Locates comparable properties (either improved or land)

Compares and adjusts the comparables to derive a range of reasonableness, from which the most likely value is chosen

Sales Comparison Approach

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Reversion

The process of analyzing the applied approaches to value

Reversion:

• Considers which approaches are

weakest in the current instance

• Considers which approaches are

most reliable

• May rely on one or a combination of

the approaches to value

• May average or use a weighted

average

• Concludes and lists:

• The market value

• The effective date

• The property interest appraised

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Contact Information: Heidi C. Lee, MAI, MRICS 504-512-6881 [email protected]

Do You Have

Any Questions?

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general appraisal concepts general... · appraisal concepts is meaningless without some knowledge...

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