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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
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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
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1 Personal Property
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Trade Fixtures
Intangible Assets
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Personal Property
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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
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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
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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
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• 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
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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
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• 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
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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
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• 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]
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