Chapter 5

Controls and Encumbrances

On Ownership

Chapter 5: Objectives

• After completing this chapter, students will be able to:– Determine land controls and restrictions

set by the government.– Determine financial interests in a property

through different types of liens.

Key Terms

• Ad valorem• Appurtenant

Easement• Assessed Value• CC&Rs• Condemnation• Conditional Use• Dominant Tenant• Dominant Tenement• Easement

• Eminent Domain• Encroachment• Encumbrance• Escheat• General Lien• Involuntary Lien• License• Lien• Lis Pendens

Key Terms

• Mills

• Mortgage

• Mortgagee

• Mortgagor

• Non-Conforming Use

• Plat

• Police Power

• Restrictive Covenant

• Rezoning

• Servient Tenant

• Servient Tenement

• Special Assessment

• Specific Lien

• Spot Zoning

• Subdivision Regulations

• Variance

• Voluntary Lien

cont.

Public Sector Controls

• Government has four powers (PETE)– Police power– Eminent domain– Taxation– Escheat

Police Power

• The constitutional power of government to enact and enforce laws that protect the public’s health, safety, morals, and general welfare– Zoning laws– Building codes– Subdivision regulations– Environmental protection laws

Zoning Laws

• Land use controls that impact real estate since they may limit (or enhance) development and likewise affect property values

• Early zoning laws established 4 categories:– Residential– Commercial– Industrial– Agricultural/rural

• Modern zoning has numerous subcategories:– R-1—Single-family detached homes– R-2—Row houses, duplexes, and single-family

detached

Zoning Laws

• Each type of zone has size and building height limits and setback and side yard rules

• Exceptions to zoning laws:– Nonconforming uses– Variances (use variance and area variance)– Conditional uses

cont.

Zoning Laws

• Rezoning: A revision in zoning law, usually changing an entire zone or area from one type to another

• Spot zoning: Similar to rezoning, but typically has small or individual land parcels as its subject rather than an entire zone or area

cont.

Case StudySingle-Family Dwelling with Garage

Converted to Living Area

Chris Carter, a residential appraiser, is performing a site inspection of a residential dwelling. He has been engaged by Quality Gear and Bearing Credit Union, which is considering the owner’s application for a cash-out refinance mortgage loan.

 

As he always does, Carter questions the property owner about any recent improvements to the property. The owner responds that “we converted the attached garage to a family room about three months ago.” The owners are very proud of the finished result, as they did the work themselves over a period of several weekends.

Case StudySingle-Family Dwelling with Garage

Converted to Living Area

Point Break

What should this information prompt the appraiser to question?

• Was a building permit obtained?

• Did the property owner check zoning compliance?

Case StudySingle-Family Dwelling with Garage

Converted to Living Area

While performing the zoning analysis of the subject property, Carter determines the location of the property within a medium-density residential district. The use of the property conforms to that designation. However, the site requirements of the zoning designation indicate a minimum six-foot side yard set back for an accessory use, such as an attached garage. A residential dwelling however, must provide at least an eight-foot side yard set back from the property line. Appraiser Carter finds that the side wall of the new family room (formally the garage) is only six feet from (what appears to be) the property line and is no longer in compliance. In the course of performing the inspection, he asks the property owner if they acquired a building permit for the work. The owner tells Chris Carter that they did not obtain a permit.

Case StudySingle-Family Dwelling with Garage

Converted to Living AreaPoint Break

How would this information impact the property’s complying with zoning? What could eliminate the problem? What should appraiser Carter do with this information?

• Being two feet over the side yard setback would make the property an illegal

use • Obtaining a zoning variance (The property would then be designated as a

legal non-conforming use)

• Disclose the circumstance in the report

• Analyze the impact on value of the circumstance

• An extraordinary assumption might be used if such use would still lead to

credible results

Building Codes

• Establish standards for construction, which require builders to use particular methods and materials

• Mainly enforced through the permit system• Americans with Disabilities Act (ADA)

– Applies to public buildings as well as commercial and professional facilities

– Implements building standards regarding parking, ramps, accessibility, and elevators

Subdivision Regulations

• State and local laws that must be complied with before land can be subdivided– Size of lots in a subdivision– Location of streets, sidewalks, and sewer and

water lines

• Plat—A detailed survey map of the subdivision, which shows the boundaries for the lots, streets, etc.

EnvironmentalProtection Laws

• State and federal laws

• May involve blocking or restricting the use of land where there are environmental concerns

• Laws that affect real property include:– Clean Air Act– Clean Water Act– National Environmental Policy Act (NEPA)

Eminent Domain

• The government’s constitutional power or right to take, appropriate, or condemn private property for public use– Condemnation is the action of taking private

property for public use, with just compensation, through the government’s power of domain (also called appropriation)

Taxation

• Real property is taxed by state and local governments

• Real estate taxation is also known as ad valorem tax– “According to value”– Tax rate is most frequently stated in terms of mills

(dollars per thousand of assessed value)

• Additional levies may be present (e.g., school, libraries, police and fire protection)

• Special assessments

Practice Problems

1. The appraised value of a property is $156,000, the

assessment ratio is 35%, and the mills are 51.75. What

are the semi-annual taxes?

The answer is $1,412.78. First, determine the assessed value:

$156,000 x 0.35 = $54,600.

Divide by 1,000 and multiply by the mills to determine the

annual taxes: $54,600 / 1,000 = 54.6 x 51.75 Mills =

$2,825.55 Annual Tax / 2 = $1,412.78 Semi-Annual Tax.

Practice Problems

2. Annual taxes for a property are $8,574.51. What is the

tax assessor’s appraised value if mills are 57, and the

assessment ratio is 35%?

The answer is $429,800. First, divide the annual taxes by the mills and

multiply by 1,000 to determine the Assessed Value: $8,574.51 / 57

= $150.43 x 1,000 = $150,430.

Next, divide the assessed value by the assessment ratio to

determine the tax assessor’s appraised value:

$150,430 / 0.35 = $429,800 Appraised Value.

Practice Problems

3. The annual tax for a property is $5,568.00. If the

assessor’s appraised value of the property is $290,000

and the assessment ratio is 40%, what is the tax rate

per thousand dollars of value?

The answer is 48 Mills. First, multiply the appraised value by the

assessment ratio: $290,000 x 0.40 = $116,000 Assessed Value.

Next, divide the assessed value by 1,000: $116,000 / 1,000 = 116.

Finally, divide the annual tax by 116 to determine the tax rate per

thousand dollars of value (mills): $5,568 / 116 = 48 Mills.

Escheat

• The governmental power that provides for property ownership to pass on to the state when a property owner dies intestate and with no living heirs– Intestate means the decedent did not have a

last will and testament

Encumbrances

• Non-possessory interest in real property– Non-financial encumbrances– Financial encumbrances (liens)

Non-Financial Encumbrances

• Restrictive covenants– A binding promise (to do or not do something)

concerning the use of real property– CC&Rs– May be terminated by termination date,

release, abandonment, or changed circumstances

• Easements– A right to use another’s real property for a

particular purpose

Easements vs. Licenses

• A license is revocable permission to use another’s land and not a right

• Easements are normally for an indefinite period of time; licenses are usually temporary

• Easements are created by written agreement or action of law; licenses may be created orally

• Easements must run with the land; licenses do not have to run with the land

Classifications of Easements

• Appurtenant easement– Burden one parcel of land (servient tenement)

for the benefit of another parcel of land (dominant tenement)

• Easement in gross– Benefits a person or entity only and not a

parcel of land– There is no dominant tenement in this

scenario, only a dominant tenant

Creation of Easements

• Easements by express reservation

• Easements by express grant

• Easements by implication

• Easements by necessity

• Easements by prescription – Open and notorious use of the land, hostile

and adverse use of the land, and continuous use for a specified number of years

Termination of Easements

• Release

• Merger

• Abandonment

• Failure of purpose

FinancialEncumbrances—Liens

• Liens provide security for a debt, giving the creditor (lien holder) the right to foreclose on the debtors property, if the debt is not paid

• Liens may be:– Voluntary (e.g., a mortgage) or involuntary– General (attaches to all property owned by

the debtor) or specific (attaches to specific property)

Involuntary Liens

• Vendor’s liens (specific)

• Mechanic’s liens (specific)

• Judgment liens (general)

• Tax liens (specific)– Special assessments

• Attachment liens

Lien Priority

• As a general rule, liens are given priority according to the order in which they attached to the property

• Note: Real property taxes always have the highest lien priority and are paid before any other lien

Classification of Liens

Voluntary Involuntary General Specific

Property Tax Lien X X

Special Assessment X X

Mortgage X X

Vendor’s Lien X X

Mechanic’s Lien X X

IRS Lien X X

Judgment Lien X X

Chapter 5 Quiz

1. The basis for governmental regulation of the use of private property is

a. eminent domain.

b. the National Environmental Policy Act.

c. police power.

d. the zoning clause.

Chapter 5 Quiz

2. A section of the neighborhood has recently been rezoned for residential use only. Zachary’s store is located in this section. Because the property was used as a store prior to the zoning, he will be allowed to continue to use his property as a store. This is known as a

a. conditional use.

b. nonconforming use.

c. spot zone.

d. variance.

Chapter 5 Quiz

3. An easement allows the present and any future owner of “Lot D” to drive across a neighbor’s property “Lot S” to reach her own property. This is an example of a(n)

a. appurtenant easement.

b. defeasible easement.

c. easement in gross.

d. encroachment.

Chapter 5 Quiz

4. Ben’s property has an easement in gross that allows Ben to hunt on his neighbor’s land. When the neighbor sells his land to Ben, the easement terminates through

a. abandonment.

b. destruction of the dominant tenement.

c. failure of purpose.

d. merger.

Chapter 5 Quiz

5. If a tax assessor estimated the market value of a property to be $340,000, what are the annual real property taxes if the assessment ratio is 35% and mills are 51.7?

a. $5,932.60

b. $6,152.30

c. $6,847.21

d. $7,166.55

Chapter 5 Quiz

6. Which is NOT a power of government?

a. deed restrictions

b. eminent domain

c. escheat

d. police power

Chapter 5 Quiz

7. A cost for an improvement that is divided among several property owners on a street and billed by a jurisdiction would be an example of

a. escheat.

b. improvement burden.

c. special assessment.

d. special tax bill.

Chapter 5 Quiz

8. The county is taking part of Bill’s land for a new park. What is this process called?a. annexation

b. condemnation

c. eminent domain

d. involuntary takeover

Chapter 5 Quiz

9. Which established power to the government for taking private property with the payment of just compensation?

a. allodial system

b. comprehensive plan

c. covenants, conditions, and restrictions

d. Fifth Amendment of the U.S. Constitution

Chapter 5 Quiz

10. If semi-annual taxes for a property are $1,260, what is the assessed value of the property if the tax rate is 48 mills?

a. $37,000

b. $41,600

c. $52,500

d. $63,900

Chapter 5 Quiz

11. Which statement is FALSE regarding a gross easement?

a. A dominant tenant’s rights can be assigned but do not automatically run with the land.

b. If the servient property is transferred, the easement terminates.

c. It always has both a dominant tenant and a servient tenant.

d. There is no dominant tenement.

Chapter 5 Quiz

12. A non-possessory interest in real property is also called a(n)

a. encumbrance.

b. leasehold estate.

c. license.

d. servient tenement.

Chapter 5 Quiz

13. Which is an involuntary, specific lien?

a. easement created by an express agreement

b. IRS lien

c. mechanic’s lien

d. mortgage

Chapter 5 Quiz

14. When liens are paid off out of the proceeds of a foreclosure sale,

a. a judgment lien generally has lowest priority.

b. a lien for real property taxes always has highest priority.

c. a mortgage always has highest priority.

d. priority depends on the amount of the lien.

Chapter 5 Quiz

15. Which would most likely result in a general lien?

a. IRS lien

b. mechanic’s lien

c. mortgage

d. real estate tax lien

Chapter 6

Transfer of Interests—Instruments and Agreements

Chapter 6: Objectives

• After completing this chapter, students will be able to:Recognize various legal instruments and

documents used to transfer or convey various types of property.

Key Terms

• Accession• Accretion• Adverse Possession• Alienation• Alluvion• Assignment• Avulsion• Breach of Contract

• Breakpoint Rent• Consideration• Contract• Deed• Descent• Devise• Earnest Money• Equitable

Key Terms

• Grantee

• Grantor

• Gross Lease

• Habendum Clause

• Installment Sales Contract

• Lease

• Net Lease

• Novation

• Option

• Overage Rent

• Power of Attorney

• Reliction

• Right of First Refusal

• Vendee

• Vendor

cont.

Deeds

• Instruments that convey a grantor’s interest, if any, in real property to a grantee– Grantee: Party receiving the interest– Grantor: Party conveying the interest

• Also called conveyance

Title

• Title: The actual lawful ownership of real property and refers to holding the bundle of rights conveyed– Not a document, but a theory pertaining to ownership

• Equitable Title: An interest in property created on the execution of a valid sales contract or an installment sales contract, where actual title will be transferred by deed at a future date (e.g., closing)

Essential Elementsof a Valid Deed

• Competent grantor• Identifiable grantee• Act (words) of

conveyance (granting clause)

• Consideration• Legal description

• Habendum clause• Limitations• Exceptions and

reservations• Signatures• Delivery and

acceptance

Deed Recording—Placement on Public Record

• After delivery and acceptance, the document should be filed in the appropriate county office where the property is located– Constructive notice: Something that could

be known because it is on record, even if it might not have been actually seen

– Actual notice: Direct knowledge of the conveyance

Types of Deeds

• General warranty deed

• Full covenant and warranty deed

• Special warranty deed

• Bargain and sale deed

• Quitclaim deed

General Warranty Deeds

• Deeds in which the grantor warrants the title against defects that might have arisen before or during the grantor’s period of ownership

• Also called standard warranty deeds or simply warranty deeds

• Warranties:– Covenant of seizen, covenant against encumbrances,

covenant of quiet enjoyment, covenant of warranty forever

Full Covenantand Warranty Deeds

• Contain the strongest and broadest form of guarantee of title of any type of deed and provide the greatest protection of any deed to the grantee

• In addition to the covenants common to the general warranty deed:– Covenant of right to convey– Covenant of further assurances

Special Warranty Deeds

• Used when the grantor warrants the title only against defects arising during the time the grantor owned the property, but not before that time

• Grantor:– Guarantees there aren’t any encumbrances

he created– Promises to defend title against anyone

claiming under him

Bargain and Sale Deeds

• Implies that the grantor has a right to convey the property, but there are no warranties with it

• Other types of similar non-warranty deeds (judicial deeds):– Executor’s deed– Administrator’s deed– Guardian’s deed– Sheriff’s deed– Referee’s deed

Quitclaim Deeds

• Makes no warranties regarding the title, if any, held by the grantor.

• Conveys interest in land the grantor has at the time the deed is executed

• Often used to remedy clouds on a title

• Also called deed of release

Methods ofTransferring Ownership

• Alienation: The process of transferring ownership interests in property– Voluntary alienation (free will transfer)– Involuntary alienation (transfer against the

will of the owner—e.g., eminent domain, foreclosure)

– Devise (death with a will) or descent (death without a will)

Contracts

• An agreement between two or more parties to do, or not do, something

Contracts cont.

Contracts cont.

Essential Elementsof a Contract

• Competent parties

• Lawful and possible objective

• Consideration

• Description

• Mutual agreement (meeting of the minds)

• Written format and signatures

Breach of Contract

• When one party to a contract fails to perform with no legal cause– Substantial performance: Promisor does not

perform all contractual obligations but does enough so that the promisee is required to fulfill her obligation

– Material breach: A breach of contract important enough to excuse the non-breaching party from performing any contractual obligations

Contract Clauses

• Time is of the essence

• Conditions

Remedies forBreach of Contract

• Cancellation

• Compensatory damages

• Injunction

• Liquidated damages

• Reformation

• Rescission

• Specific performance

Discharge of Contracts

• Agreement of parties

• Partial performance

• Full performance

• Impossibility of performance

• Operation of law– Alteration of contract– Bankruptcy– Statute of limitations

Assignment and Novation

• Assignment– One of the parties (assignor) transfers rights

or interests under a contract to another person (assignee)

• Novation– The substitution of a new contract for an

earlier contract

Real Estate Sales Contracts

• Contracts in which a seller (vendor) promises to convey title to real property to a buyer (vendee) in exchange for the purchase price

• Serves three purposes:– Buyer’s initial offer– Receipt for any earnest money deposit– Contract between the buyer and seller

The Offer

• Must have intent to contract

• Must have definite terms

• Earnest money is an inducement to have the offer accepted and is a means of showing the seller the buyer is serious and able to follow through with the necessary financing

Termination of an Offer

• Lapse of time

• Death or incapacity

• Revocation

Requirements forAcceptance of an Offer

• Acceptance must be communicated to the offeror

• Acceptance must be made in the manner specified

• Acceptance must not vary the terms of the offer

Essential Elementsof a Sales Contract

• Names and signatures of all parties

• Specific property to be sold

• Interest in the property to be sold

• Terms of the sale as clearly as possible

• Total purchase price and method of payment

Other Contract Provisions

• As-is clause

• Escape clause

• Contingencies

• Disclosures

Options

• Contracts that give one party the right to do something without obligating him to do so

• Unilateral contract

• Most common type is a lease with an option to purchase

• The optionee pays the optionor for the option right (option money)

Right of First Refusal

• A right to have the first chance to buy or lease property if the owner decides to sell or lease it

• Also called first right of refusal or right of redemption

• No money involved and no predetermined price

• Could go on for many years

Installment Sales Contract

• An agreement in which the buyer (vendee) makes payments to the seller (vendor) in exchange for the right to occupy and use the property, but no deed or title is transferred until all, or a specified portion of, payments have been made

• Also called a land contract or a contract for deed

Leases

• Contracts in which one party pays the other rent in exchange for possession of real estate

• Must:– Contain all elements necessary for a valid

contract in order to be legal and enforceable– Be in writing if the term will last for more than

(usually) one year

Structures of Leases

• Gross lease: Landlord pays for all expenses related to the ownership of the property

• Net lease: The lessee pays some or all of the expenses that are typically paid by the lessor– Single net, double net, triple net, absolute net

Types of Leases

• Flat

• Variable

• Step

• Revaluation

• Annual increase

• Percentage

Flat Lease

• An arrangement where the rent payments to the lessor are consistent throughout the duration of the lease term

• Most common type of lease in short-term residential situations

• Also called level lease or level payment lease

Variable Lease

• A lease with rental payments made at regular intervals, but payment amounts may change

• Common mechanisms that trigger a change include Consumer Price Index, or variations in the owner’s expenses in net lease scenarios

• Also called an index lease

Step Lease

• Provides for the rent amount to change over time, usually at a predetermined percentage at a predetermined interval

• Any interval can be specified, but annual increases (or decreases) are the most common

• Also called a step-up lease, step-down lease, or graduated rental lease

Revaluation Lease

• Has rental payments that change over time at a set interval– The amount of the change is determined usually by a

revaluation of the market rent, allowing the owner to maintain rents at market rates based on the current market

• Rarely, if ever, seen with residential properties• Most often found in long-term scenarios, or

short-term leases where there are renewal options

Annual Increase Lease

• Operates similarly to a step-up lease with one major exception:– Rather than a percentage increase, the

periodic increase specified in the lease is a specific dollar amount

• Could be found with any type of property

Percentage Lease

• Lessees pay a base or guaranteed minimum (breakpoint rent), plus a percentage of the sales their business has generated (overage rent)– Rent may also be purely based on a

percentage of the sales volume

• Most common to retail lessees and most high-profile retail environments (e.g., malls, shopping complexes)

Lease Terms ofInterest to the Appraiser

• Amount of agreed-upon rent• Term of lease (e.g., month-to-month or defined

term, such as one year)• Provisions for rent or terms to change• Beginning and ending date of the lease• Personal property included in the lease• Expenses paid by the landlord and those paid by

the tenant• Other services or amenities provided by the

landlord

Chapter 6 Quiz

1. In a real estate transaction, the grantor is the ________ and the grantee is the ________.

a. buyer / seller

b. lender / buyer

c. seller / buyer

d. seller / lender

Chapter 6 Quiz

2. All are essential elements for a valid deed EXCEPT

a. competent grantor.

b. delivery and acceptance.

c. grantee’s signature.

d. legal description.

Chapter 6 Quiz

3. Which clause includes the words “to have and to hold”?

a. conveyance

b. granting

c. habendum

d. recital

Chapter 6 Quiz

4. When a party signs a document before a notary public stating it was signed voluntarily, it is an

a. accreditation.

b. acknowledgment.

c. alliance.

d. appurtenance.

Chapter 6 Quiz

5. Which is an example of voluntary alienation?

a. avulsion

b. condemnation

c. dedication

d. foreclosure

Chapter 6 Quiz

6. When someone dies without a will, he is said to have died

a. devise.

b. escheat.

c. intestate.

d. testate.

Chapter 6 Quiz

7. If one party to a contract fails to perform his contractual obligations without a legal excuse, it is a(n)

a. assignment.

b. breach of contract.

c. lack of substantial performance.

d. novation.

Chapter 6 Quiz

8. Where applicable, a particular jurisdiction’s statute of frauds requires contracts conveying real estate to be

a. recorded.

b. reviewed by an attorney.

c. verbal.

d. written.

Chapter 6 Quiz

9. Kim signs a contract agreeing to buy a property from Bob, but Bob does not actually own the property. This contract is

a. unenforceable.

b. valid.

c. void.

d. voidable.

Chapter 6 Quiz

10. Lyle contracts to buy Julia’s house, but only if he can sell his house. This type of provision written into a sales contract is called

a. a contingency clause.

b. good consideration.

c. right of specific performance.

d. time is of the essence clause.

Chapter 6 Quiz11. Carol and Leslie enter into a contract stating

that Carol will pay Leslie $650 per month for the next 20 years. Carol will live in the house and pay all expenses including property taxes, insurance, and maintenance costs. Leslie will continue to hold the title until the property is paid off by Carol. What kind of contract do they have?

a. installment sales contractb. land leasec. lease purchase agreementd. option agreement

Chapter 6 Quiz

12. A contract clearly states that $5,000 would be kept by the seller should the buyer breach the contract. The $5,000 is considered

a. the broker’s commission.

b. the down payment.

c. earnest money.

d. liquidated damages.

Chapter 6 Quiz

13. A contract written for the exchange of illegal substances would be void because

a. consideration was not listed.

b. incompetent parties.

c. legality of object.

d. no signatures.

Chapter 6 Quiz

14. When a new person takes the place of one of the parties to a contract and the withdrawing party is relieved of all liability, it is called

a. accord and satisfaction.

b. assignment.

c. novation.

d. substantial performance.

Chapter 6 Quiz

15. Sam offers to sell his house to Brenda for $200,000 if Brenda will pay $45,000 in cash and give Sam a 15-year mortgage for the balance at 11% interest. Brenda responds, “I accept your offer, provided that I have to pay only $40,000 down.” This is a

a. counteroffer.

b. defeasible offer.

c. partial acceptance.

d. unilateral acceptance.

Chapter 6 Quiz

16. When a contract is terminated and each party returns whatever consideration the other had provided, it is called

a. cancellation.

b. repudiation.

c. rescission.

d. a tender offer.

Chapter 6 Quiz

17. An option agreement isa. bilateral in nature.

b. not a contract.

c. the same concept as a right of first redemption.

d. supported by consideration.

Chapter 6 Quiz

18. Which type of lease would provide the lessee with the least expense and risk?

a. absolute net—annual increase

b. gross—flat

c. Net—variable

d. triple net—flat

Chapter 6 Quiz

19. A month-to-month lease gives the lessor

a. greater control when it comes to adjusting the rent.

b. less chance of risk that the tenant will leave.

c. a lower rate of rent in short term situations.

d. no opportunity to change the terms of the lease.

Chapter 6 Quiz

20. In a percentage lease, the amount of rent that is the base or guaranteed minimum the lessee will pay is called

a. breakpoint rent.

b. market rent.

c. overage rent.

d. starting rent.

Chapter 6 Quiz

21. Christopher is leasing property from Patricia via an annual increase lease. Which is a characteristic of an annual increase lease?

a. Adjustments to rent are based on fluctuation of market rental rates and owner’s expenses.

b. Annual increase leases only are used with gross leases and reflect change in the Consumer Price Index.

c. Rent increases are a predetermined dollar amount at specified periodic intervals.

d. Rental rate is adjusted by a specified percentage with each adjustment.

Chapter 6 Quiz

22. In a triple-net lease scenario, which is NOT a typical expense of the lessee?

a. fire insurance on the building

b. property taxes

c. repairing a leaky faucet

d. replacing the roof on the structure

Chapter 6 Quiz

23. Phillip is leasing an office suite from National Office Properties, Inc., the property owner, via a net/net lease. In this arrangement, the lessor has

a. been granted a leasehold estate. b. conveyed a temporary possessory

interest. c. no remaining property rights.d. permanently surrendered the leased

fee estate.

Chapter 6 Quiz

24. Which is an advantage to the lessee in a percentage lease?

a. If the specified sales volume is not reached, the lease is automatically terminated.

b. Lessor is conveying all property rights during the lease period.

c. Overage rent will always increase at a specified percent each year.

d. Owner of the leased facility is motivated to promote and maintain the property.

Chapter 6 Quiz

25. Why would an appraiser be interested in expenses being paid by the landlord when reviewing a lease agreement?a. Clarifies, if in fact, the landlord possesses the

leased fee estate

b. defines whether the lease is flat or variable

c. determines the breakpoint rent from overage rent

d. indicates operating expenses for estimating net operating income

Chapter 7

Concepts and

Types of Value

Chapter 7: Objectives

• After completing this chapter, students will be able to:Identify various concepts and types of value.

Key Terms

• Arm’s Length Transaction

• Assessed Value• Cost• Going Concern Value• Insurance Value• Investment Value• Liquidation Value

• Loan Value• Market Price• Market Value• Price• Salvage Value• Value• Value in Use

Value—A Broad Concept

• Common responses to the term “value”– Price someone paid– Total invested cost– Reproduction or replacement cost– Income potential based on a particular

investor’s expectations

Take a moment and consider how value is defined in terms of real property.

Cost, Price, and, Value

• Cost– The amount required to create, produce, or

obtain a property (a fact or estimate of fact)

• Price– The amount asked, offered, or paid for a

property

• Value– The monetary relationship between properties

and those who buy, sell, or use those properties

Market Value

• What a typical buyer would be willing to pay (the most probable selling price) as of a certain date under certain conditions

• Also called value in exchange

• “Certain date” refers to the effective date of the appraisal– Most commonly a current date– May also be retrospective or prospective

Specific Conditions of an Arm’s Length Transaction

1. Typical terms and financing

2. No unusual concessions

3. Parties are not related

4. Parties are acting in their own best interest

5. Parties are not under undue haste or duress

6. Parties are reasonably informed and/or knowledgeable

7. Property has been exposes, typically, for a reasonable period of time

Diagnose the Condition

In each of the following scenarios, it appears the property is

selling or has sold above or below market value. In the blank,

insert the number of the condition affecting it.

Diagnose the Condition

1. ____ The property is selling because the sellers are getting a divorce.

2. ____ The parties to the transaction are parents selling to their child.

3. ____ The seller paid a large amount in points and closing costs.

4. ____ The seller is taking a first mortgage back for the buyer who filed

bankruptcy six months ago.

5

3

2

1

Diagnose the Condition

5. ____ The seller is selling a property without a real estate broker and set

the asking price without an appraisal or independent value opinion.

6. ____ The property sold today and was just listed yesterday.

7. ____ The seller had two offers but took the lower one because it was from

their favorite non-profit organization.

6

7

4

Other Types of Value

• Loan value

• Insurance value– Replacement cost (functional equivalent)– Reproduction cost (exact replica)

• Investment value

• Assessed value

Other Types of Value

• Liquidation value

• Value in use

• Going concern value

• Salvage value

cont.

Case Study 7.1Single-Family Priced and Selling Below Market Value

Challenge: Market Price versus Market Value

Appraiser Brett Weller is engaged by Allied-Gulf Mortgage Company to appraise a

single-family dwelling in a residential neighborhood. The house is owned by an

elderly gentleman, George Cline. He lives in another state and is selling the house

on his own, without a real estate broker.

The property is under contract to sell to Lisa Wells for $28,000. In reviewing the

transaction documents accompanying the appraisal engagement, appraiser Weller

becomes curious. He knows that the subject area is a highly desired established

market, typically comprised of houses in the $100,000 to $200,000 price range. An

appointment to inspect the property is arranged for the following day. On arrival, the

property appears to be well maintained, which is consistent with the other properties

in the neighborhood.

Case Study 7.1

• What was the asking price?• How was that price established?• Is the seller related to the buyer in any

way?• Are there any other conditions to the

transaction, making it something other than an arm's length transaction?

Point BreakWhat question(s) should appraiser Weller be prompted to ask the owner?

Case Study 7.1

Appraiser Weller interviews Mr. Cline who reveals he has owned the home

for many years, purchasing it for his sister to live in. She has recently died

and, having no further use for the property, he is disposing of it. Mr. Cline

has never had the property appraised and has relied on the county

auditor’s tax appraisal for pricing the property. From that information, he

interprets that $28,000 is the auditor’s market value of the property. Ms.

Wells is the first potential buyer who looked at the property.

Case Study 7.1 cont.

• How was the property marketed?• How long has the property been

on the market?• When the contract terms were agreed

upon, how long had the property been marketed?

Point BreakThis information implies that what should be investigated?

Case Study 7.1

It was learned from the interview with Mr. Cline that the property was

advertised in the local newspaper, with the price, property address, and a

photo included. The buyer, Lisa Wells, made an appointment and viewed

the property within one hour of the newspaper hitting the newsstands. She

wrote a full-price offer on the spot. It was at this point that appraiser Weller

looked in his appraisal work file and noticed that $28,000 was the county

auditor’s assessed value.

Case Study 7.1 cont.

• Nothing, without client consent.

Point BreakWhat can appraiser Weller discuss with Mr. Cline about the transaction and the sale price??

Case Study 7.2Single-Family Dwelling Selling for More-than-Market Value

Due to Buyer’s Motivation

Challenge: Market Price versus Market Value

Residential appraiser Betty Conrad has accepted a new appraisal assignment. The subject

of the appraisal is a single-family dwelling, listed for approximately 90 days now with a

reputable broker at a price of $120,000. Per the sales agreement, which was furnished by

the lender/client, the sale price is $118,000. Other than window coverings, no other chattel

items are included with the sale. There are no seller concessions. The buyers, John and

Carol Patrice, are represented by a buyer’s agent.

On inspecting the property, appraiser Conrad finds the subject to be a well maintained

three-year-old ranch-style dwelling that contains approximately 1,200 square feet. It has

three bedrooms, two baths, and an attached two-car garage. The house is built on a crawl

space and located in a suburban subdivision with predominately similar ranch homes.

Conrad has noticed a new dwelling, nearly identical to the subject, listed next to the

subject.

Case Study 7.2

• There are no untypical terms• There are no untypical concessions• There is no relationship between the parties• The buyer is represented by a buyer's agent; the

buyer should be informed and knowledgeable• The property has been exposed to the market for a

reasonable time period• Conrad should check the data for the listed house

next door

Point BreakIdentify the conditions of an arm’s length transaction that are evident so far. What else should Conrad do?

Case Study 7.2

Returning to her office following the site inspection, appraiser Conrad begins

her research for similar comparable properties. Two comparables are

immediately located. The first is located on the same street as the subject

and sold nine months ago for $92,000. Conrad had driven past this

comparable on her way to the inspection and noted that it was inferior to the

subject property in age, location, condition, and amenities, due to having

only a one-car attached garage. The second comparable is similar in all

ways to the subject property except age, which is ten years. It sold 30 days

ago for $102,500. Stored data did not reveal any other properties sold in this

subdivision within the past 12 months.

Case Study 7.2 cont.

• Go out in distance*• Go out in time*

* These options could present a problem for the secondary mortgage market)

Point BreakAn exhaustive research of the stored data reveals no other ranch-style comparables in the past twelve months within the immediate subdivision, what should happen now??

Case Study 7.2

Appraiser Conrad moves out to the next subdivision to locate a comparable

property. This subdivision has houses of a very similar style and age to the

subject; however, it is in a different and somewhat superior, market-preferred

school district. A similar style dwelling is located, which sold forty-five days

ago for $115,000. Further research of the property data indicates this

comparable was new and solid brick, as opposed to the subject’s frame

construction—and it was built on a full basement.

Case Study 7.2 cont.

• The indicated value range is somewhere below $115,000 and somewhere above $102,500—the buyer may have overpaid

Point BreakWhat does the data appear to indicate?

Case Study 7.2

Realizing the data does not support the sales price and, in at least one case,

adjustments are somewhat excessive, appraiser Conrad begins a survey of

local brokers for very recent sales that have not yet been submitted to the

MLS. She recalls the listing next door to the subject. The MLS indicates it is

being offered at $109,000. Since it is new, the landscaping is minimal and

the driveway is gravel, as opposed to the subject’s paved driveway.

However, it is an identical design and floor plan and is being built by the

same builder. Asking the listing broker, she finds this property closed just

yesterday at $105,000.

Case Study 7.2 cont.

• Determine if the transaction next door was arm’s length

• Determine the circumstances of the subject's transaction with someone familiar, such as the broker, lender, etc.

Point BreakWhat is/are the appraiser’s next step(s)?

Case Study 7.2

Appraiser Conrad decides to call the buyer’s agent and ask about any

unusual circumstances of their offer. The buyer’s agent tells her that he

performed a CMA for the buyers, which indicated that a reasonable offering

range was between $102,000 and $106,000. However, the buyers had lost

two other properties by making low offers in the negotiation and insulting the

sellers. Having already sold their present home, they need to quickly secure

another property. The couple ignored the agent’s recommendation and

submitted an offer of $118,000, which is nearer the listing price of $120,000.

Case Study 7.2 cont.

• Duress• Influenced by the fear of losing this

property is they offered too far below the listing price, and the need to purchase a home quickly

Point BreakWhat considerations of an arm’s length transaction are influenced in this transaction?

Case Study 7.2

The final opinion of value indicated by the analyzed data was $105,000. As

the buyers were only seeking a 50% LTV mortgage, their loan was

approved, and the transaction closed.

Case Study 7.2 cont.

• It is not an arm’s length transaction• It should not be stored as an arm’s length transaction• The appraiser should document the transaction and retain so

that if another property is appraised in which this sale might appear to be a comparable, the appraiser can discuss in that report the reason for not utilizing the sale

• USPAP would likely be violated if the appraiser did not verify the sale as representing an arm’s length transaction

• Using this transaction as a comparable could skew the market unless an adjustment could be supported for the purchaser's motivation, which would be difficult

Point BreakWhat does this transaction represent? Should this transaction be stored in sales data? What would happen if another appraiser found this data in public record and used it as a comparable sale in another appraisal assignment?

Chapter 7 Quiz

1. If the client is using an appraisal to determine what a property would be worth in a less than typical marketing period, the appropriate type of value would likely be

a. duress value.

b. investment value.

c. liquidation value.

d. time-adjusted market value.

Chapter 7 Quiz

2. Which is NOT a condition of a typical arm’s length transaction?

a. no atypical concessions

b. no marketing

c. no relationship of the parties to the transaction

d. no unusual terms

Chapter 7 Quiz

3. Market price is what thea. appraiser thinks the property should

sell for.

b. property is listed for.

c. property should have sold for.

d. property sold for.

Chapter 7 Quiz

4. An appraiser identifies the definition of market value to be used in an assignment during problem identification and must additionally

a. cite the source of the definition in the appraisal report.

b. document the author of the definition in the work file.

c. obtain permission from the client to use the specific definition.

d. use the specific USPAP definition of market value for financing transactions.

Chapter 7 Quiz

5. A property that sold below market value due to a pending foreclosure is influenced mostly by

a. acceleration and depression.

b. cash equivalency.

c. haste and duress.

d. relationship to the lender.

Chapter 7 Quiz

6. A transaction with no atypical conditions is best described as

a. arm’s length.

b. established market value.

c. liquidated.

d. sterile.

Chapter 7 Quiz

7. The amount to create, produce, or obtain a property is known as

a. cost.

b. price.

c. reproduction.

d. value.

Chapter 7 Quiz

8. An appraiser is appraising a structure built and used as a special use property. Since the value opinion is to reflect the property’s special use for the particular owner, the appropriate type of value is

a. going concern.b. market.c. reproduction.d. value in use.

Chapter 7 Quiz

9. Going concern value is most accurately described as a valuation of the

a. business assets.

b. liquid and solid assets.

c. real and personal property.

d. tangible and intangible assets.

Chapter 7 Quiz10. The highest and best use for a parcel of land

that is improved with an old building has changed, and it has been determined the improvements should be razed. The building has many ornate stained glass windows and extensive black walnut wood trim. What value type would be an appropriate in this assignment?

a. liquidationb. replacement c. reproductiond. salvage