Chapter 8: Valuation Using the Sales Comparison and Cost Approaches
Who Uses Market Value Appraisals? • Buyers • Sellers • Corporate acquisitions, mergers or dissolutions • Courts • Divorces • Eminent domain cases • Settlement of estates • Bankruptcy • Mortgage Lenders
Why are Appraisals Necessary? • Few transactions available to indicate value • Every property is unique • Unique location • Many and varied attributes • Large value of the asset makes errors costly
Value Concepts • Market value: • Most probable selling price, assuming “normal” sale conditions. • Value for the “typical” market participant. • Investment value: • Value to a particular individual (investor). • Transaction price: • Price actually paid for a specific property.
Uniform Standards of AppraisalPractice (USPAP) 1. Define the Problem • Specific property • Rights to be valued • Type of value (market, insurance, taxable) • Date of valuation
Uniform Standards of AppraisalPractice (USPAP) 2. Selection and collection of data • Property market data • Vacancy rates • Rental rates • Prices per square foot • Property specific data • Subject property • Comparable properties • Required yields or rates of capitalization
USPAP (continued) 3. Highest and best use • That use which is: • Legally permissible • Physically possible • Financially feasible • Most profitable (yields highest residual value to land) • Highest and best use as though vacant: Considers any possible use • Highest and best use as improved: Must consider any cost of demolition
USPAP (continued) 4. Estimate value by three methods • Sales comparison approach • Income approach • Cost approach 5. Reconcile resulting values 6. Prepare appraisal report • Narrative report • Form report • Letter
Highest & Best Use May Change Over Time Existing Use Proposed Use
Sales Comparison Approach • Basic Idea: • Value of RE can be determined by analyzing the sale prices of similar properties. • Why? • Because in a competitive market close substitutes will sell for similar prices.
Identify Elements of Comparison & Value Adjustment Select Comparable Sales Adjust Comparable Sale Prices w.r.t. Subject Reconcile Adjusted Sale Prices; Obtain Indicated Value Sales Comparison Appraisal Approach Exhibit 8-3
Identify Elements of Comparability • Same subdivision? • Same price range? • Same size? • Same style? • Same vintage? • Other?
Which is Most Comparable to the Subject Property? A Subject Property B C
Selecting Comparables • Must be properties that prospective buyers would consider substitutes • Must be true sales • Must be arms-length transactions • Select to minimize adjustments • Data sources: • Public records (county property tax assessor) • Multiple listing service (must have sale price) • Private vendors (title companies, others)
Adjustment of Comparables • Goal: To convert each comparable to an approximation of the subject. • Sequence of adjustments • Transactional Adjustments • Conditions of sale (arm’s length or not?) • Financing terms • Market conditions • Property Adjustments • Location • Physical characteristics • Legal characteristics • Use • Nonrealty items (personal property)
Object of Adjustments Subject Comp 1 Comp 2
Example of Sales Comparison Approach • You are appraising a property located adjacent to a high speed freeway • Improvements consist of a one-story frame dwelling with 8 rooms and 2 baths in a total area of $2,000 sq. ft. • Of average quality construction, home was in good condition at time of inspection • Floor plan and items of equipment are typical for this class of property
Investigation disclosed the following transactions involving comparable properties in the neighborhood of the subject and in a similar value range as the subject
Info on 4 Comparables (1) One year ago a 2,400 sq. ft. property not adjacent to freeway sold for $160,000. Improvements were nearly identical to subject dwelling in all but size. (2) This year a 2,400 sq. ft. property not adjacent to freeway sold for $150,500. This dwelling was highly similar to subject in all respects except for size. (3) A 2,000 sq. ft. property not adjacent to the freeway sold 1 year ago for $150,000. These improvements are highly similar to subject. (4) A 2,400 sq. ft. property sold this year for $140,300. Located adjacent to the freeway, it was very similar to subject except for size.
Example, Cont. • Problem: Based on the information given, develop an indication of the value of the subject, showing the source of each adjustment. Adjustment factors: The indicated adjustments are for: time, location relative to freeway, and size. They are derived as follows:
Adjustment Factors • Time: Sale 1 (1 year ago) $ 160,000 Sale 2 (current) 150,500 Difference $ -9,500 • Location: Sale 2 (not adjacent to freeway) $ 150,500 Sale 4 (adjacent to freeway) 140,300 Difference $ -10,200 • Size: Sale 1 (2,400 sq. ft.) $ 160,000 Sale 3 (2,000 sq. ft.) 150,000 Difference $ -10,000
Example, Cont. Note: Adjustments can be positive or negative. They are all negative here because subject property is inferior to the comparables in all ways that matter to the market
In the Real World... • Of course, in "real life" situations, indicated values never line up identically as in above example. • How many attributes of the homes should the appraiser attempt to price?
Exhibit 8 - 4 Repeat - Sale Analysis for Market Conditions Adjustment Price at Monthly Previous Price Change per Rate of Date of Sale Today Month Increase Property Previous Sale (SP ) (SP ) (SP - SP )/mos. (% of SP ) 1 2 2 1 1 A 12 mos. ago $191,000 $197,900 $5 75 0.30 % B 18 mos. ago 158,600 $167,000 $467 0.29 % C 24 mos. ago 148,900 $162,000 $546 0.37 % Average monthly rate of increase = 0.32 % Using Repeat Sales to Adjustfor Market Conditions Note: It will often be difficult to find a sufficient number of comparable that have sold twice. Thus, we must often rely on publicly available house price indices to estimate price appreciation for a typical house in the subject’s neighborhood
Main Transaction Adjustment:Adjusting for Market Conditions Using a Price Index • Sources of Price indexes • Freddie Mac Freddie Mac: CMHPI Data • Office of Federal Housing Enterprise Oversight (OFHEO) OFHEO -- House Price Index (HPI) • Associations of Realtors NAR: Research • Application: Derive monthly rates of change from most relevant series, and apply to comparables.
Sale Price +/- Financing Terms and Sale Conditions = Normal Sale Price +/- Market conditions = Market-Adjusted Normal Sale Price +/- Location +/- Physical Characteristics +/-Nonrealty items = Final Adjusted Sale Price of Comp. Exhibit 8-6: Sequence of Adjustments
Exhibit 8 - 8 Sale Comparison Approach: Adjustment Grid Comparable Comparable Comparable Element of Comparison Subject Sale No. 1 Sale No. 2 Sale No. 3 Transaction Price $ 169,900 $ 167,200 $ 157,100 +/ - Conditions of sale Arm’s length 0 0 0 +/ - Fina ncing terms Conventional 0 0 0 Normal Sale Price $ 169,900 $ 167,200 $ 157,100 +/ - Market conditions Today 0 +1,500 +1,900 Market - Adjusted Normal Sale Price $ 169,900 $ 168,700 $ 159,000 +/ - Location Suburban 0 0 0 Physical Characteristics +/ - Site 0.5 Acres 0 +5,000 +2,000 +/ - Construction quality Siding/good - 1,500 0 - 3,000 +/ - Effective age 3 years +3,750 +8,750 +15,000 +/ - Living area 1,960 sq.ft. - 4,800 - 5,600 +6,800 +/ - Bath 2.5 0 0 - 2,000 +/ - Porch, Patio, Deck None 0 0 - 3,200 +/ - Fence, Pool, etc. None 0 - 7,000 - 7,000 Final Adjusted Sale Price $ 167,350 $ 169,850 $ 167,600 Adjustment Grid
Exhibit 8 - 9 Reconciliation of Adjusted Final Sale Prices Source Final Adj. Weight Weighted Price Sale Price Comparable Sale No. 1 167,350 X 60% = 100,410 Comparable Sale No. 2 169,850 X 20% = 33,970 Comparable Sale No. 3 167,600 X 20% = 33,520 Indicated Value (using the sales comparison approach) = 167,900 Reconciliation
Cost Approach • Procedure Estimated reproduction cost of improvements − Estimated depreciation = Depreciated cost of building improvements + Estimated value of site = Indicated value by the cost approach
Cost Approach(continued) • Two concepts of cost: • Replacement cost: Cost to create something of equal utility (functionality) • Reproduction cost: Cost of a physical replica
Cost Approach(continued) • Methods to estimate cost • Quantity survey method • Cost per square foot or cubic foot • Unit in place • Sources • R.S. Means www.rsmeans.com • Marshall and Swift www.marshallswift.com
Accrued Depreciation • Accrued depreciation: Difference between market value and cost • Types of accrued depreciation: • Physical deterioration • Functional obsolescence • External obsolescence
Types of Accrued Depreciation (cont.) • Physical deterioration: Loss in value due to aging, decay and ordinary use • Functional obsolescence: Loss in value due to changes in tastes, preferences, technological innovations, or market standards
Types of Accrued Depreciation (cont.) 3. External obsolescence: Loss in value due to changes beyond property boundaries (neighborhood change) • Increased traffic • Conversion to rental • Environmental degradation • Decline in demand
Appendix: Regression-Based Appraisal Value = B0 + B1 x1 + B2 x2 + B3 x3 +… Bn xn + e • Bs are constant coefficients representing dollar value contributed per unit of xi • Bi may be the value of having a particular attribute if xi is a 0/1 attribute variable. • xi is a feature of the structure (size, age, quality, location) • Known as an hedonic equation
Estimated Regression Model Statistics Dependent variable (Y) is sale price…equation is estimated with a sample of comparable sales transactions
Revolution in Sales Appraisal: Automated Valuation Systems (AVMs) • Freddie Mac: Home Value Suite • Based on model developed over millions of sales • Combines complex regression with repeat sales and other statistical techniques such as Bayesian analysis • Regression combines “hedonics” with repeat sales
AVMs Near You • http://www.smarthomebuy.com • http://zillow.com