Chapter 9

REAL ESTATE APPRAISAL

What is the property worth?

Sellers want to know

Buyers want to know

Lenders want to know

Insurers want to know

Tax assessors want to know

Appraisers are professionals trained to form

credible opinions of the value of properties.

Appraisal Regulation

Financial Institutions Reform, Recovery,

and Enforcement Act (FIRREA) of 1989

Federal oversight

Appraisals in federally related transactions

must be performed by state-licensed or
state-certified appraisers

Involve certain federal govt agencies

Intuitions regulated or insured by federal

agencies

E.g. banks

Appraisal Foundation

Nonprofit educational organization

AQB Appraisal Qualification Board

Established minimum education and experience

guidelines for state licenses/certification

ASB Appraisal Standards Board

Established Uniform Standards of Professional

Appraisal Practice (USPAP) that must be
followed in federally related transactions

These standards are often required in all

appraisals

State determined

5
AQB License & Certification Guidelines

Four appraiser categories

Trainee appraisers

Licensed appraisers

Certified residential appraisers

Certified general appraisers

Trainee Appraisers

Works under supervision of a licensed or certified

appraiser

Minimum of 75 hours of classroom instruction in

appraisal topics to qualify

No experience requirement

No exam

Typically will hold this position for no more than 2

years

Licensed Appraisers

Authorized to perform appraisals on 1-4 unit

residential properties

Complex transactions of less than $250,000

Noncomplex transactions of less than $1,000,000

Minimum of an associates degree, or at least 30

semester hours of college-level education

Minimum of 150 classroom hours of instruction

Pass a written exam on appraisal topics

Completed at least 2,000 hours of appraisal

experience

Certified Residential
Appraisers

Appraise 1-4 unit residential properties regardless

of transaction value or complexity

Minimum of a Bachelors degree

Minimum of 200 hours appraisal education

Includes 150 from the licensed appraisal requirement

Examination

Minimum of 2,500 hours of appraisal experience

Certified General Appraiser

Can appraise any type of property

Minimum Bachelors degree

Minimum of 300 hours classroom instruction

Includes prior certification instruction

Exam

3,000 hours appraisal experience

Including at least 1,500 hours of non-residential

appraisal work

10
Uniform Standards of Professional Appraisal
Practice from the ASB

USPAP

10 Standards

www.apprasalfoundation.org

For example Standard 1 requires appraisers to carefully

examine the appraisal problem to be solved and to
perform the necessary tasks to form a credible opinion
of value.

Required to use recognized appraisal methods and

techniques

Apply techniques appropriately

Identify the real estate involved and the definition of value

that will be investigated

11

What Is Value?

Market value

Investment value worth to a particular investor

based on that investors personal standards of
investment acceptability

Price versus market value

Market value versus cost of production

Other types of value

Assessed value

Insurable value

12

Market Value

What is usually trying to be determined

From FIRREA:

The most probable price which a property should

bring in a competitive and open market under all
conditions requisite for a 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 the title from seller to buyer under
5 conditions whereby:

5 Conditions of a Market
Value Sale
1.

Buyer and seller are typically motivated

2.

Both parties are well informed or well advised, and

acting in what they consider their best interests

3.

A reasonable time is allowed for exposure in the open

market

4.

Payment is made in terms of cash in U.S. dollars or in

terms of financial arrangements comparable thereto

5.

The price represents the normal consideration for the

property sold unaffected by special or creative
financing or sales concessions by anyone associated
with the sale

Investment Value

Value in use

The value of a property to a particular investor,

based on that investors personal standards of
investment acceptability

Differs from market value in that:

Investment value is the value of a property to a

specific investor

Market value refers to the value of a property to a

typical, but unspecified, buyer in the market

GM Building, NYC

Price v. Market Value

Price is the amount paid in a given

transaction

Different factors might influence the actual

price paid

Thus, the price might not be the same as the

appraised market value

Price should reflect the market value if the 5

conditions of market value are met

Market Value v Cost of

Production

Developers wouldnt build if the cost

of production was consistently higher
than market value

Everyone wants to make a profit, right?

But mistakes can happen

So although costs are an indication of

value, market value may be higher or
lower than cost of production

Other Types of Value

Assessed value

Value placed in the property for the purpose of

property tax assessments

Insurable value

How much insurance needed to compensate

the other in case of loss

Actual cash value

Replacement cost

19

Key Appraisal Principles

Anticipation
Change
Substitution
Contribution

Anticipation

Current value of a property depends on the

anticipated utility or income that will accrue to the
property owner in the future

Present value should represent future benefits

Appraiser should be skilled in national, regional,

local, and neighborhood trends

Silicon valley

Changing roads

Future planned construction

Change

Closely related to the principle of anticipation

Due to the dynamic nature of the markets,

appraisers should be aware of the macro forces
that affect real estate, such as:

Economic

Political

Social

Environmental

Every estimate of value must be made as of a

specific date

Substitution

A prudent buyer wont pay more for a property than the

cost of acquiring an equally desirable substitute on the
open market

A lot and home can be purchased and constructed for

$300,000

Most houses in that area wont sell for more than around
$300,000

This principle is fundamental to the 3 traditional

approaches to RE valuation

Sales comparison

Income

Cost

Contribution

Diminishing marginal utility and diminishing

returns

The value of the improvements to land depends

on the amount that it contributes to the value of
the whole

Landscaping may add more value than an

improvement to the building

At some point though, if you spend too much on that, you

wont recoup your costs

Not all improvements add value to the property

Buyers may not want the improvement, regardless of the

cost

24

The Appraisal Process

Step 1 Definition of the problem

Type of value

Description of property

Specific property rights

Use of the appraisal

Effective date

Step 2 Data selection and collection

General market analysis

Specific property analysis

Step 3 Highest and best use analysis

As though vacant

As improved

25

The Appraisal Process, cont.

Step 4 Application of the three approaches

to valuation

Sales comparison approach

Cost approach

Income approach

Step 5 Reconciliation of value indications

Step 6 Report of defined value

Step 1: Define the Problem

Type of value to be estimated will determine the type of

data to collect and how to analyze it

Market?

Rental?

Insurable?

Assessed?

Investment?

Identification of the property

Location and description

Easements, etc.

Physical characteristics of the property

Step 1: Contd

Define the specific property rights to be

appraised

All

Partial

Air rights

An easement

Reversionary right in a leased fee

Must include any limitations on these property rights

Restrictive covenants

Land-use controls

Step 1: Contd

How is the appraisal going to be used?

Current value

Past value

Insurance claims

Inheritance taxes

Future value

Project assessment

Again, a specific date for the valuation is a must!

Step 2: Data Selection and

Collection

The appraiser must identify and collect the data

what allows for an accurate estimation of the
property value

General

Macro

Specific

Comparables

Construction costs

Income/expense

30

Step 3: Highest and Best Use

Analysis

To form an opinion of market value, appraisers

must first decide how the market will use the
property. Competition between potential buyers
will result in the property being used in its highest
and best use.

Highest and Best Use must be:

Legally permissible

Physically possible

Financially feasible

Maximally productive

Highest and Best Use

Estimates of value are based upon the concept that

the highest and best use of a property has already
been identified

Assumed that market competition will result in the

most efficient use of the property

Even if it means changing the propertys use

Any estimate of market value MUST include a

determination of the propertys highest and best use

Highest and best use is affected by many factors

Past/present use, land-use controls, access to utilities,

etc.

Woolworth Building, NYC

Cost: $68M

($150M w/Renovation

Costs)

Prices:

1 bedroom

2 bedrooms

Start at $9.575M

2 Pavilion residences (have private terraces)

Start at $7.25M

3 bedrooms

1,200 sf start at $3.875M

$20M+ each

Penthouse

$110M

Comes with a 2-story living room, fireplace, elevator, and

outdoor observatoryBARGAIN!

Step 4: Application of the 3

Approaches to Value
Sales

comparison
approach
Cost approach
Income approach

35

Sales Comparison Approach

Comparable sales data selection

3-6 properties

Arms length transactions

Adjustment of sales data

Make the comps reflect the subject

property as much as possible

Look at differences between the two sets

Identify individual differences that may

affect value

36

Sales Comparison Approach

Elements of comparison

Property rights conveyed

Conditions of sale

If there are significant differences, then the comp property may not be able to
be used

Financing terms

If unique, then the value of the comp property should be adjusted to reflect this

Market conditions

Locational characteristics

Physical characteristics

i.e. fee simple v life estate

Everything from number of BRs to size, interior design, architecture

These steps mirror the steps a potential purchaser would

go through when determining which property to buy

37

Cost Approach

Estimating site value

Estimating production cost

Reproduction cost (exact replica)

Replacement cost (equally functioning improvement)

Estimating accrued depreciation

Physical deterioration (wear and tear)

Functional obsolescence (less utility or ability to generate income)

Economic obsolescence (factors outside of the property)

Cost to produce the building depreciation + site

value and site improvements

38

Income Approach

Estimate the market value by estimating the expected future

income

Gross income multiplier (or gross rent multiplier)

GIM = Value/Gross Income

Net income capitalization (cap rate)

Ignores expenses, so comps need to have the same structure

Capitalization Rate = Net Income/Value

Discounted cash flow

Estimate all future cash flows and discount them to get their
present value

The sum of all future cash flows is the net present value (NPV), or
expected cost

Reconcile Value Indications

into a Final Value Estimate

You would think that the three valuation techniques

would all have the same ending valuation?

Not always. In fact, not usually.

One, or more, of the approaches used may not be as

relevant to the value

Lack of comp sales

Individual nature of a property

Lack of income production

The appraiser must use their judgement to determine

the weight of each approach to arrive at a final value

Step 6: Reporting

The appraiser must provide the client with the

necessary information, usually in the form of a
written report

This report basically contains everything

considered, as well as the methods and reasoning
used in arriving at a final value estimate

Format of the report depends on the property type

and purpose of the appraisal

Chapter 10

PROPERTY AND
ASSET MANAGEMENT

41

42

Property Management

The role of the property manager is to manage

the property with the objective of securing the
highest net return for the property owner over the
propertys useful life

Regardless of whether is it the owner doing it, or they

hire someone

What Might a Manager Do?

Marketing

Leasing

Collect rents

Interact with tenants

Property maintenance

Accounting

Etc.

44

Management Agreement

Establishes the relationship between the owner

and the manager. The agreement should address
the powers of the manager relating to

Rent setting

Lease signings

Rent collections

Power to spend money on behalf of the property

Authority to hire, fire, and supervise personnel

45

Management Agreement,
cont.

The agreement should specify the compensation

to the manager

Percentage of gross income

Fixed amount

Fee schedule for certain tasks

Hourly rate

46

Functions of a Property
Manager

Administration

Day to day concerns of the property

Marketing and advertising

Signs on the property

Neighborhood flyers

Bulletin boards

Internet sites

Listing with leasing companies

Newspaper advertisements

Open house days or weekends

47
Functions of a Property Manager, cont.

Tenant selection

Profit maximization

The best tenant, not just the one who will pay the most

Compliance with fair housing laws

Put more emphasis on tenants prior, instead of

current, landlord

A current landlord might have a vested interest in getting

rid of a tenant

48
Functions of a Property Manager, cont.

Lease negotiations

Amount of security deposit

Day rent is due

Day rent is considered late

Nature of tenancy (stated period, period-to-period,

etc.)

Is the lease renewable?

49
Functions of a Property Manager, cont.

Lease negotiations, cont.

Tenant maintenance responsibilities

How many people may occupy the premises?

Who is responsible for insurance?

Assigning and subletting

Local disclosure laws

Are pets allowed?

50
Functions of a Property Manager, cont.

Move-in inspections

Documentation of condition of property at start

of lease

Critical for claims against security deposit

Property maintenance

Maintenance to conserve the property

Rehabilitation and renovation to compete in

changing market

51
Functions of a Property Manager, cont.

Rent Collection

Handle eviction process if rent is unpaid

Move-out Inspection

Will go smoothly if there is a well

documented move-in inspection

52
Functions of a Property Manager, cont.

Security deposit returns

Compliance with local laws

53
The Role & Functions of an Asset Manager

The functions of an asset manager include:

Facilities management

Acquisition of additional space for the firms

operations

Financing decisions relating to needed space

Disposition of corporate real estate assets

Management

Strategize regarding real estate

needs of the firm

Sale leaseback

Location(s)

Amenities/Improvements

Whatever will make the best use of the

investment

Acquisition

Target space requirements

Site selection

Negotiation

Financing

Purchase?

Lease?

How to structure financing

Negotiations

New build?

How to structure financing

Sale leaseback?

Disposition

Redeployment of property

Lease to someone else

Renovation

Divesting property

Sale