Real Estate Financial and Investment Analysis 1

APPRAISAL THEORY AND PRACTICE

WHAT IS THE OBJECTIVE OF AN APPRAISAL?

- - ESTIMATE FAIR MARKET VALUE

Real Estate Financial and Investment Analysis 2

WHAT IS FAIR MARKET VALUE?

• VALUE IN CASH OR EQUIVALENT

• COMPETITIVE MARKET CONDITIONS

• USUAL FINANCING TERMS

• ARMS LENGTH

• KNOWLEDGEABLE, INFORMED BUYER AND SELLER

• NO UNDUE STIMULUS OR DURESS

Real Estate Financial and Investment Analysis 3

WHO USES APPRAISALS?

• IS THERE A DIFFERENCE BETWEEN INVESTMENT AND FAIR MARKET VALUE?

• WHAT CREATES VALUE IN THE MARKET PLACE?

Real Estate Financial and Investment Analysis 4

AN OVERVIEW OF THE THREE METHODS OF APPRAISAL

• SALES - COMPARISONS

• INCOME - CAPITALIZATION

• COST - REPLICATION

Real Estate Financial and Investment Analysis 5

SALES - COMPARISONS

• WHAT IS IT?

• WHERE IS IT MOST APPLICABLE?

• WHAT ARE THE ADVANTAGES AND DISADVANTAGES?

Real Estate Financial and Investment Analysis 6

SIMPLE SALES - COMPS EXAMPLE

PROPERTY # DESCRIPTION OBSERVEDSALES PRICE

1 3 Bedrooms, Garage, Interior lot,Ranch style

$46,000

2 3 Bedrooms, No Garage, Cornerlot, Ranch style

$43,000

3 2 Bedrooms, No Garage, Interiorlot, Ranch style

$35,000

4 2 Bedrooms, No Garage, Cornerlot, Ranch style

$36,000

5 2 Bedrooms, Garage, Corner lot,Ranch style

$40,000

Question: What is the Fair Market Value for a 3 bedroom,ranch style house with a garage on a corner lot inthis neighborhood?

Real Estate Financial and Investment Analysis 7

SALES COMPARABILITY: APPRAISAL - SIMPLE ADJUSTMENT PROCESS

1) REAL ESTATE STRATIFICATION

2) TEMPORAL FACTOR

3) GEOGRAPHY

4) LAND USE / PROPERTY TYPE

5) VALUE CLASSES

6) TERMS OF SALES

7) PROPERTY CHARACTERISTICS

Real Estate Financial and Investment Analysis 8

VALUATION BY STATISTICAL INFERENCE:

An Extension of the Sales-Comparable Approach

The Hedonic Method

Parcel Services CharacteristicsFMV

Real Estate Financial and Investment Analysis 9

HEDONIC APPROACH -- STATISTICAL INFERENCE APPRAISAL AND

COMPUTER ASSISTED MASS APPRAISAL

STEPS

• DEFINE SALES SAMPLE

• SELECT PARCEL CHARACTERISTICS

• CODE PARCEL CHARACTERISTICS

• ALALYZE MULTIVARIATE REGRESSION RESULTS

• REFINE MULTIVARIATE REGRESSION RESULTS

- REVISE SAMPLE

- REVISE VARIATES

• VERIFY FINDINGS AND RESULTS

Real Estate Financial and Investment Analysis 10

ESTIMATE OF THE MARKET VALUE FUNCTION(Obtained by Two-Stage Least Squares)

V = 524 - 0.31 Q - 2.07 AGE - 78.7 log t(0.09) (0.26) (9.12)

+ 92.3 BT + 115 log LS + 27.7 G + 40.1 D1968(3.60) (5.44) (4.63) (6.31)

+ 90.8 D1969 - 30.1 Dum + 45.3 Dgmv - 15.3 Dtem(7.14) (7.00) (8.07) (5.81)

R2 = 0.75

Real Estate Financial and Investment Analysis 11

where:

Q(TX/BR )

= Property tax bill (in dollars) divided by the number of bedrooms

log t = Log of distance, measured from the center of the municipality tocenter city Philadelphia (i.e., an accessibility index, in miles)

log LS = Log of the lot size (in acres)G = Number of car-garage spaces

BT = Number of bathroomsAGE = Age of the house (in years)

D1968 = Dummy variable for time: if sale occurred in 1968, D1968 = 1;otherwise D1968 = 0

D1969 = Dummy variable for properties sold in 1969Dum = Dummy variable for property location: if property is located in

Upper Merion, Dum = 1; otherwise Dum = 0Dtem = Dummy variable for properties located in Tredyffrin, Easttown,

or MalvernDgmv = Dummy variable for properties in Gladwyne, Merion, or

VillanovaV = market value (in 100 dollars)

Real Estate Financial and Investment Analysis 12

INTERPRETATION OF VALUE ESTIMATE

• TAXATION CAPITALIZATION

• ACCESSIBILITY

• PROPERTY CHARACTERISTICS

• OTHER VARIABLES

Real Estate Financial and Investment Analysis 13

INCOME - CAPITALIZATION APPROACH

• WHAT IS THE RATIONALE FOR USING AN INCOME CAPITALIZATION APPROACH?

• WHARE ARE LIKELY ADVANTAGES OF THIS METHOD?

• DISADVANTAGES?

• HOW DOES THIS METHOD COMPARE TO THE SALES-COMP APPROACH?

• WHAT INFORMATION DO YOU NEED TO CONDUCT THE INCOME-CAPITALIZATION METHOD OF APPRAISAL?

1.

2.

3.

4.

Real Estate Financial and Investment Analysis 14

ESTIMATING GROSS INCOME

Real Estate Financial and Investment Analysis 15

ESTIMATING ANNUAL OPERATING EXPENSES

Real Estate Financial and Investment Analysis 16

THE CAP RATE:WHAT IS IT AND HOW IS IT USED?

CAP RATE

NOI

FMV

Market Data?

Market Data?

INCOME APPROACH SCHEMATIC

Real Estate Financial and Investment Analysis 17

HOW ARE CAP RATES AND INTEREST RATES RELATED?

Real Estate Financial and Investment Analysis 18

COST - APPROACH

• WHY DO WE USE THE COST APPROACH?

• WHAT ARE ITS LIMITATIONS AND ADVANTAGES?

• HOW DOES THE COST APPROACH COMPARE TO THE SALES AND INCOME APPROACHES?

• BASIC ASSUMPTIONS: PERFECTLY COMPETITIVE MARKET!

• C - D = V

Real Estate Financial and Investment Analysis 19

FOUR BASIC DATA ELEMENTS OF COST APPROACH

1.

2.

3.

4.

Real Estate Financial and Investment Analysis 20

COST APPROACH EXAMPLE

BUILDING COST (NEW) $100,000LAND IMPROVEMENTS 10,000

$110,000LESS DEPRECIATION -30,000

$80,000LAND VALUE (ESTIMATE) 15,000

"INDICATED" FMV USING COST APPROACH $95,000

Real Estate Financial and Investment Analysis 21

WHERE IS THE COST APPROACH MOST EFFECTIVE AND WHY?

Real Estate Financial and Investment Analysis 22

REPLACEMENT COST VS. REPRODUCTION COST

Real Estate Financial and Investment Analysis 23

METHODS FOR ESTIMATING COSTS

• QUANTITY SURVEY

• UNITS-IN-PLACE

• UNITS-COMPARISON

• BASE-BUILDING METHOD / INDEX ADJUSTMENT

Real Estate Financial and Investment Analysis 24

DEPRECIATION CONSIDERATION

• PHYSICAL

• TECHNOLOGICAL

• ECONOMIC

Real Estate Financial and Investment Analysis 25

SOME OTHER TECHNIQUES

• GROSS OR NET INCOME MULTIPLIER METHODS

• RESIDUAL CAPITALIZATION

• MORTGAGE EQUITY CAPITALIZATION