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Chapter 7

Broker

Sales Comparison, Cost Depreciation and Income Approaches


Learning Objectives

Describe the assumptions underlying the sales comparison approach

Calculate the various adjustments necessary under the sales comparison approach

Distinguish between fixtures and trade fixtures

Construct a sales comparison adjustment grid using the proper sequence of adjustments


Learning Objectives

Distinguish among normal sale price, market conditions-adjusted normal sale price, and final adjusted sale price

List the steps in the cost-depreciation approach

Distinguish between reproduction cost and replacement cost

Describe the 3 methods for estimating cost

Distinguish among the types of accrued depreciation


Learning Objectives

Calculate an accrued depreciation adjustment using the lump-sum age-life method

Define effective age and economic life

Perform a GRM analysis

Distinguish among potential gross income, effective gross income, and net operating income

Distinguish among the 3 types of operating expenses


Learning Objectives

Develop a reconstructed operating statement

Calculate a market-derived capitalization rate

Calculate value using the income approach formula


Sales Comparison Approach

Basic premise

Market value can be inferred from the sales of

comparable properties

Underlying assumptions

Market price is valid evidence of market value

Principal of substitution

Methods of adjustment

Comparable inferior add (CIA)

Comparable better subtract (CBS)

Most reliable approach for single-family homes



Elements of comparison

Conditions of sale

Financing terms

Sales concessions

Market conditions

Personal property

Location



Elements of comparison

Financing terms

– Mortgage assumption

– Seller financing

– Contract for deed

– Wraparound loan



Conditions of sale All secondary sources of data must be

confirmed thru a primary source

Examples (undue stimuli)

– Pending foreclosure

– Loss of job

– Bankruptcy

– Non arm’s-length transaction

Adjustments are difficult, possibly impossible to make—comp should not be used



Financing terms Institutional financing or market financing

Nonmarket financing

Mortgage assumption

Seller financing

Contract for deed



Sales Concessions

Interest rate buydowns

Seller-paid loan discount points & origination fees

Seller-paid closing costs for buyer

Refunds of buyers expenses

Inclusion of non-realty items



Market conditions

Time

Successive sales analysis (formula)

– Resale price

– Minus initial sale price

– Equals difference in price

– Divided by initial sale price

– Equals percentage change

– Divided by # of months between sales

– Equals monthly rate of change

Personal Property



Personal property

Items not permanently attached to the real estate

Fixture – originally personal property, not permanently attached to real estate

Trade fixture – personal property attached to the real estate used in the tenant’s business

Remains personal property

USPAP requires appraiser to identify items included in appraisal:

Personal property

Trade fixtures

Intangible items



Location Proximity to schools, shopping & recreation

Buffer from external diseconomies – crime

Government services – police, fire protection

Considerations outside the property

– External economies and diseconomies

Property (physical) characteristics

– Size (square footage)

– Age and condition of improvements

– Construction quality

– Architectural style

– Age and amenities


Methods of Adjustment Normal sale price

The price the comp would have sold for if the

transaction would have been consistent with the

market (conditions of sale, financing, sales

concessions)

Market conditions - adjusted normal sale price

The price the comp would have sold for in

today’s market (inflation/deflation)

Final adjusted sale price

The price the comp would have sold for it were

exactly like the subject property

(location/physical condition)

Formula: Market Conditions Adjustment


Resale

Price −Initial

Price ÷Initial

Price =% of

Chg

Months

btwn

Sales

Monthly

Rate of

Chg

÷ =

A) $182,900-$167,000 $167,000=.0952096 28= .0034

B) $172,200-$158,500 $158,500=.0864353 26= .0033

C) $174,000-$160,000 $160,000=.0875000 22= .0040

÷÷÷ ÷

÷

Monthly Rate of Change = .0036

.0034 + .0033 + .0040 = .0107 3 = .0036÷

÷

.0034

.0033

.0040


Cost Approach

Four Steps

1) Estimate the Current Reproduction (or

Replacement) Cost

2) Estimate the Depreciation and Deduct it from

the Cost

3) Estimate Value of Site and Nonstructural Site

Improvements

4) Add the Value of the Site, Nonstructural Site

Improvements to the Depreciated Cost new


Cost Approach

Step One – Estimate the Cost

Three methods

Quantity Survey - detailed inventory of everything

required to reproduce a building (most detailed)

Unit-In-Place - cost is calculated for each

individual component

Comparative Square-foot (Unit Comparison)

– Cost per square or cubic foot

– Benchmark properties - basis for comparison


Cost Approach

Step Two – Estimate the Depreciation and

Subtract from the Cost

Depreciation - The loss of value due to any cause

Accrued Depreciation - The total loss in value from

all types

Land does not depreciate


Cost Approach

Three types of depreciation

Physical Deterioration - wear and tear

Functional Obsolescence - does not meet current standards or an overimprovement

External (Economic) Obsolescence -influence outside property boundaries

Ways to accrue depreciation

Breakdown method

Market extraction method

Lump-sum age-life method


Cost Approach

Depreciation can be Curable – The cost to correct

is less than the added value

Incurable – The cost to correct is greater than the added value


Age-Life Depreciation

Effective Age

÷

Economic Life

X

Reproduction (or replacement) cost new

=

Accrued Depreciation


Cost Approach

Accrued depreciation using annual

depreciation

Economic Life - Estimated time in years that an

improvement can be profitably useful

Effective age - as it appears to be

Cost new ÷ economic life = annual depreciation

Yearly depreciation X effective age = accrued

depreciation


Cost Approach

Step Three - Estimate the Value of the

Site and Site Improvements

Value of the land

– Determined by Comparable Sales

approach

– Land does not depreciate


Cost Approach

Step Four

Depreciated Cost

(Step 2)

+

Value of the Site and Site Improvements (Step 3)

=

Value of Property


Income Approach

Value - Present worth of Future income of the

subject property


Gross Income Multiplier (GIM) or

Gross Rent Multiplier (GRM)

Gross Rent Multiplier (GRM) - Estimates value

from monthly rental income only

Sales price ÷ monthly rent = GRM

Gross Income Multiplier (GIM) - Estimates

value from all sources including rental income

plus any other source

Sales price ÷ annual rent - GIM


GIM/GRM

Step 1 : Estimate Gross Rent (or Income) for

Subject Property

Step 2 : Calculate Average Multiplier (GRM or

GIM) using several comps

Sale price divided by gross rent (or income) of

comparable properties and then average

Step 3 : Estimate Value of Subject Property

Average multiplier times monthly gross rent (or

annual income) from subject property


Income

Three types Potential Gross Income (PGI) - Annual

income the property would produce if fully rented and there are no collection losses

Effective Gross Income (EGI) - Income after vacancy and collection losses are subtracted and other income is added

Net Operating Income (NOI) - Income remaining after subtracting all operating expenses


Operating Expenses

Three categories

Fixed Expenses (FE) - e.g. taxes and insurance

Variable Expenses (VE) - e.g. utilities, maintenance

Reserve for Replacements (R) - e.g. roof covering, air-conditioning

Operating expenses do not include

Depreciation

Interest on loans

Mortgage Payments (Debt Service)

Income Taxes


Income Capitalization Approach

Overall Capitalization Rate

(OAR) - average rate of return

received on similar properties

__I__

R x V


Income Capitalization ApproachMath Concept

Net Operating Income (the "I" in IRV)

Potential Gross Income PGI (or GI)

Vacancy and Collection loss allowance

Other Income

- V&C

+ OI

(% or $)

Effective Gross Income EGI

{ Fixed Expense}

Operating

Expenses { Variable Expense}

- OE (or

EXP)

{ Reserves }

Net Operating Income NOI


Income Capitalization Approach

Estimating Value

“IRV FORMULA"

Net Income divided by Rate = Value NOI R = V

Net Income divided by Value = Rate NOI V = R

Rate times Value = Net Income R x V = NOI

I

R V

Note: When the rate goes up, the value goes

down (and vice-versa) (see math supplement)


Income-Capitalization Approach

Reconstructed operating statement Appropriate items

– Vacancy and collection losses

– Reserves for replacement

– Management fee

Inappropriate items

– Depreciation

– Personal expenses

– Federal income taxes

– Debt service

Broker - Gold Coast Schools - Enhance Your Florida Career!€¦ · · 2017-10-26Contract for...

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