1
Q
Supply & Demand
A
The availability of certain properties interacts with the strength of the demand for those properties to establish prices. When demand for properties exceeds supply, a condition of scarcity exists, and real estate values rise. When supply exceeds demand, a condition of surplus exists, and real estate values decline. When supply and demand are generally equivalent, the market is considered to be in balance, and real estate values stabilize.
2
Q
Supply
A
the amount of property available for sale or lease at any given time
3
Q
Demand
A
the amount of property buyers and tenants wish to acquire by purchase, lease or trade at any given time.
4
Q
Price
A
the amount of money or other asset that a buyer has agreed to pay and a seller has agreed to accept to complete the exchange of a good or service. It is a quantification of the value of an item traded.
5
Q
Economic Principles Underlying Real Estate Value
A
Supply & Demand
Unity
Transferability
Anticipation
Substitution
Contribution
Change
Highest & Best Use
Conformity
Progression & Regression
Assemblage
Subdivision
6
Q
Costs
A
To produce a good or service, a supplier incurs costs, or those expenses necessary to generate and deliver the item to the market. The essential production costs are the costs of capital, materials, and supplies; labor; management; and overhead.
7
Q
Market
A
a place where supply and demand encounter one another: suppliers sell or trade their goods and services to demanders, who are consumers and buyers. It is a transaction arena where the price mechanism is constantly defining and quantifying the value produced by the relative elements of supply and demand.
8
Q
Supply, Demand, Price Interrelationships
A
In a market economy, the primary interactions between supply, demand and price are:
- if supply increases relative to demand, price decreases
- if supply decreases relative to demand, price increases
- if demand increases relative to supply, price increases
- if demand decreases relative to supply, price decreases
9
Q
Price Trends
A
- if price decreases, demand is declining in relation to supply
- if price increases, demand is increasing in relation to supply
10
Q
Market Equilibrium
A
a market tends toward a state of equilibrium in which supply equals demand, and price, cost, and value are identical
11
Q
Economic Characteristics of Real Estate
A
- subject to the laws of supply and demand
- governed in the market by the price mechanism
- influenced by the producer’s costs to bring the product to market
- influenced by the determinants of value: utility, scarcity, desire, and purchasing power
12
Q
Factors Influencing Supply
A
- development costs, particularly labor
- availability of financing
- investment returns
- a community’s master plan
- government police powers and regulation
13
Q
Factors Affecting Residential Demand
A
- quality of life
- neighborhood quality
- convenience and access to services and other facilities
- dwelling amenities in relation to household size, lifestyle, and costs
14
Q
Factors Affecting Retail Demand
A
- sufficient trade area population and income
- the level of trade area competition
- sales volume per square foot of rented area
- consumer spending patterns
- growth patterns in the trade area
15
Q
Factors Affecting Office Demand
A
- costs of occupancy to the business
- efficiency of the building and the suite in accommodating the business’s functions
- accessibility by employees and suppliers
- matching building quality to the image and function of the business
16
Q
Factors Affecting Industrial Demand
A
- functionality
- the availability and proximity of the labor pool
- compliance with environmental regulations
- permissible zoning
- health and safety of the workers
- access to suppliers and distribution channels
17
Q
Base Employment & Total Employment
A
These two types of employment are the engines that drive demand for real estate of all types in a market. employment creates the purchasing power necessary for households to acquire dwellings and retail products.
18
Q
Base Employment
A
the number of persons employed in the businesses that represent the economic foundation of the area.
19
Q
Total Employment
A
includes base, secondary, and support industries. creates a demand for a labor force.
20
Q
Vacancy
A
the amount of total real estate inventory of a certain type that is unoccupied at a given time
21
Q
Absorption
A
the amount of available property that becomes occupied over a period of time.
22
Q
Local Market Influences
A
- cost of financing
- availability of developable land
- construction costs
- capacity of the municipality’s infrastructure to handle growth
- governmental regulation and police powers
- changes in the economic base
- in- and out-migrations of major employers
23
Q
National Trends
A
Regional and national economic forces influence the local real estate market in the form of:
- changes in money supply
- inflation
- national economic cycles
24
Q
Governmental Influences
A
Governments at every level exert significant influence over local real estate markets.
- Local zoning powers
- Local control and permitting new development
- Local taxing power
- Federal influence on interest rates
- Environmental legislation & regulations
25
Real Estate Value
the present monetary worth of benefits arising from the ownership of real estate.
26
Benefits that contribute to real estate value
- income
- appreciation
- use
- tax benefits
27
Appreciation
an increase in the market value of a parcel of land over time, usually resulting from a general rise in sale prices of real estate throughout a market area. Such an increase, whether actual or projected, is another investment benefit that contributes to real estate value.
28
Utility
The fact that a property has a use in a certain marketplace contributes to the demand for it. Use is not the same as function. For instance, a swampy area may have an ecological function as a wetland, but it may have no economic utility if it cannot be put to some use that people in the marketplace are willing to pay for.
29
Transferability
How readily or easily title or rights to real estate can be transferred affects the property's value. Property that is encumbered has a value impairment since buyers do not want unmarketable title. Similarly, property that cannot be transferred due to disputes among owners may cause the value to decline, because the investment is wholly illiquid until the disputes are resolved.
30
Anticipation
The benefits a buyer expects to derive from a property over a holding period influence what the buyer is willing to pay for it. For example, if an investor anticipates an annual rental income from a leased property to be one million dollars, this expected sum has a direct bearing on what the investor will pay for the property.
31
Substitution
According to the principle of substitution, a buyer will pay no more for a property than the buyer would have to pay for an equally desirable and available substitute property.
32
Contribution
focuses on the degree to which a particular improvement affects market value of the overall property. In essence, the contribution of the improvement is equal to the change in market value that the addition of the improvement causes. what the market recognizes as the change in value, not what an item cost. If continuous improvements are added to a property, it is possible that, at some point, the cost of adding improvements to a property no longer contributes a corresponding increase in the value of the property. When this occurs, the property suffers from diminishing marginal return, where the costs to improve exceed contribution.
33
Change
Market conditions are in a state of flux over time, just as the condition of a property itself changes. These fluctuations and changes will affect the benefits that can arise from the property, and should be reflected in an estimate of the property's value. For example, the construction of a neighborhood shopping center in the vicinity of a certain house may increase the desirability of the house's location, and hence, its value.
34
Highest & Best Use
This principle holds that there is, theoretically, a single use for a property that produces the greatest income and return. A property achieves its maximum value when it is put to this use. If the actual use is not the highest and best, the value of the property is correspondingly less than optimal. must be legally permissible, physically possible, financially feasible, and maximally productive.
35
Conformity
This principle holds that a property's maximal value is attained when its form and use are in tune with surrounding properties and uses.
36
Progression and regression
The value of a property influences, and is influenced by, the values of neighboring properties. If a property is surrounded by properties with higher values, its value will tend to rise (progression); if it is surrounded by properties with lower values, its value will tend to fall (regression).
37
Assemblage
the conjoining of adjacent properties, sometimes creates a combined value that is greater than the values of the unassembled properties. The excess value created by assemblage is called plottage value.
38
Subdivision
The division of a single property into smaller properties can also result in a higher total value. For instance, a one-acre suburban site appraised at $50,000 may be subdivided into four quarter-acre lots worth $30,000 each. This principle contributes significantly to the financial feasibility of subdivision development.
39
Market Value
an estimate of the price at which a property will sell at a particular time. This type of value is the one generally sought in appraisals and used in brokers' estimates of value.
40
Reproduction Value
the value based on the cost of constructing a precise duplicate of the subject property's improvements, assuming current construction costs.
41
Replacement Value
the value based on the cost of constructing a functional equivalent of the subject property's improvements, assuming current construction costs.
42
Salvage Value
refers to the nominal value of a property that has reached the end of its economic life. an estimate of the price at which a structure will sell if it is dismantled and moved.
43
Plottage Value
an estimate of the value that the process of assemblage adds to the combined values of the assembled properties.
44
Assessed Value
the value of a property as estimated by a taxing authority as the basis for ad valorem taxation.
45
Condemned Value
the value set by a county or municipal authority for a property which may be taken by eminent domain.
46
Depreciated Value
a value established by subtracting accumulated depreciation from the purchase price of a property.
47
Reversionary Value
the estimated selling price of a property at some time in the future. This value is used most commonly in a proforma investment analysis where, at the end of a holding period, the property is sold and the investor's capital reverts to the investor.
48
Appraised Value
an appraiser's opinion of a property's value.
49
Rental Value
an estimate of the rental rate a property can command for a specific period of time.
50
Leasehold Value
an estimate of the market value of a lessee's interest in a property.
51
Insured Value
the face amount a casualty or hazard insurance policy will pay in case a property is rendered unusable.
52
Book Value
the value of the property as carried on the accounts of the owner. The value is generally equal to the acquisition price plus capital improvements minus accumulated depreciation.
53
Mortgage Value
the value of the property as collateral for a loan.
54
Market Price
as opposed to market value, is what a property actually sells for.
55
Appraisal
an opinion of value supported by data and performed by a professional, disinterested third party
56
Brokerβs Opinion of Value
may resemble an appraisal, but it differs from an appraisal in that it is not necessarily performed by a disinterested third party or licensed professional and it generally uses only a limited form of one of the three appraisal approaches. In addition, the opinion is not subject to regulation, nor does it follow any particular professional standards.
57
Steps in Appraisal Process
1. Identify the purpose
2. Assimilate relevant data
3. Assess the highest and best use
4. Estimate the value of the land
5. Apply the three approaches to
estimating value
6. Reconcile the values from the
approaches
7. Compile the report
58
Sales Comparison Approach
serves as the basis for a broker's opinion of value. It is based on the principle of substitution-- that a buyer will pay no more for the subject property than would be sufficient to purchase a comparable property-- and contribution-- that specific characteristics add value to a property.
59
Steps in a Sale Comparison Approach
1. Identify comparable sales.
2. Compare comparables to the subject and make adjustments to comparables.
3. Weight values indicated by adjusted
comparables for the final value estimate of the subject.
60
Qualifications for a Comparable
- resemble the subject in size, shape, design, utility and location
- have sold recently, generally within six months of the appraisal
- have sold in an arm's-length transaction
An appraiser considers three to six comparables, and usually includes at least three in the appraisal report.
61
Adjusting Comparables
adjustments can be made only to the comparables' prices, not to the subject's. Adjustments are made to the comparables in the form of a value deduction or a value addition.
62
Adding or Deducting Value to a Comparable
If the comparable is better than the subject in some characteristic, an amount is deducted from the sale price of the comparable. This neutralizes the comparable's competitive advantage in an adjustment category.
63
Adjustment Criteria for Comparables
- time of sale: An adjustment may be made if market conditions, market prices, or financing availability have changed significantly since the date of the comparable's sale. Most often, this adjustment is to account for appreciation.
- location: An adjustment may be made if there are differences between the comparable's location and the subject's, including neighborhood desirability and appearance, zoning restrictions, and general price levels.
- physical characteristics: Adjustments may be made for marketable differences between the comparable's and subject's lot size, square feet of livable area (or other appropriate measure for the property type), number of rooms, layout, age, condition, construction type and quality, landscaping, and special amenities.
- transaction characteristics: An adjustment may be made for such differences as mortgage loan terms, mortgage assumability, and owner financing.
64
Weighting Comparables Rule
As a rule, the fewer the total number of adjustments, the smaller the adjustment amounts, and the less the total adjustment amount, the more reliable the comparable.
65
Comparative Market Analysis (CMA)
A broker or salesperson who is attempting to establish a listing price or range of prices for a property uses a scaled-down version of the appraiser's sales comparison approach
66
Cost Approach
generally aims to estimate either the reproduction cost or the replacement cost of the subject property.
67
Depreciation
the loss of value in an improvement over time. only applies to the improved portion of real property. The loss of an improvement's value can come from any cause, such as deterioration, obsolescence, or changes in the neighborhood.
68
Three Causes of Depreciation
physical deterioration, functional obsolescence, and economic obsolescence.
69
Physical Deterioration
wear and tear from use, decay, and structural deterioration. Such deterioration may be either curable or incurable.
70
Functional Obsolescence
occurs when a property has outmoded physical or design features which are no longer desirable to current users.
71
Economic Obsolescene
the loss of value due to adverse changes in the surroundings of the subject property that make the subject less desirable. Since such changes are usually beyond the control of the property owner, it is considered an incurable value loss.
72
Curable Deterioration
occurs when the costs of repair of the item are less than or equal to the resulting increase in the property's value.
73
Incurable Deterioration
the repair will cost more than can be recovered by its contribution to the value of the building.
74
Steps in a Cost Approach
1. Estimate land value.
2. Estimate reproduction or replacement cost of improvements.
3. Estimate accrued depreciation.
4. Subtract accrued depreciation from
reproduction or replacement cost.
5. Add land value to depreciated reproduction or replacement cost.
75
Unit Comparison Method
The appraiser examines one or more new structures that are similar to the subject's improvements, determines a cost per unit for the benchmark structures, and multiplies this cost per unit times the number of units in the subject. The unit of measurement is most commonly denominated in square feet.
76
Unit-in-Place Method
The appraiser uses materials cost manuals and estimates of labor costs, overhead, and builder's profit to estimate the cost of constructing separate components of the subject. The overall cost estimate is the sum of the estimated costs of individual components.
77
Quantity Survey Method
The appraiser considers in detail all materials, labor, supplies, overhead and profit to get an accurate estimate of the actual cost to build the improvement. More thorough than the unit-in-place method, this method is used less by appraisers than it is by engineers and architects.
78
Cost Indexing Method
The original cost of constructing the improvement is updated by applying a percentage increase factor to account for increases in nominal costs over time.
79
Accrued Depreciation
The sum of depreciation from all causes: deterioration, obsolescence, or changes in the neighborhood.
80
Economic Age-Life Method
This method assumes that depreciation occurs at a steady rate over the economic life of the structure. Therefore, a property suffers the same incremental loss of value each year.
81
Economic Life
the period during which the structure is expected to remain useful in its original use.
82
Income Capitalization Approach
Income Approach
used for income properties and sometimes for other properties in a rental market where the appraiser can find rental data. The approach is based on the principle of anticipation: the expected future income stream of a property underlies what an investor will pay for the property. It is also based on the principle of substitution: that an investor will pay no more for a subject property with a certain income stream than the investor would have to pay for another property with a similar income stream.
83
Steps in Income Capitalization Approach
1. Estimate potential gross income.
2. Estimate effective gross income.
3. Estimate net operating income.
4. Select a capitalization rate.
5. Apply the capitalization rate.
84
Estimate Potential Gross Income
the scheduled rent of the subject plus income from miscellaneous sources such as vending machines and telephones.
Scheduled rent + Other income =
Potential gross income
85
Estimate Effective Gross Income
potential gross income minus an allowance for vacancy and credit losses.
Potential gross income - Vacancy & credit losses =
Effective gross income
86
Estimate Net Operating Income
effective gross income minus total operating expenses.
Effective gross income - Total operating expenses =
Net operating income
87
Fixed Expenses
those that are incurred whether the property is occupied or vacant, for example, real estate taxes and hazard insurance.
88
Variable Expenses
those that relate to actual operation of the building, for example, utilities, janitorial service, management, and repairs.
89
Operating Expenses
typically include an annual reserve fund for replacement of equipment and other items that wear out periodically, such as carpets and heating systems.
90
Capitalization Rate
an estimate of the rate of return an investor will demand on the investment of capital in a property such as the subject.
91
Applying Cap Rate
An appraiser now obtains an indication of value from the income capitalization method by dividing the estimated net operating income for the subject by the selected capitalization rate
πππΌ / πππππ‘ππππ§ππ‘πππ πππ‘π = Value
92
Formula for Value
Income / Rate = Value
93
Gross Rent Multiplier (GRM)
Gross Income Multiplier (GIM)
simplified income-based methods used primarily for properties that produce or might produce income but are not primarily income properties. Examples are single-family homes and duplexes. The methods consist of applying a multiplier to the estimated gross income or gross rent of the subject. The multiplier is derived from market data on sale prices and gross income or gross rent.
94
Steps in Gross Rent Multiplier Approach
- First, select a gross rent multiplier by examining the sale prices and monthly rents of comparable properties which have sold recently. The gross rent multiplier for a property is:
Price / Monthly Rent = GRM
- Second, estimate the value of the subject by multiplying the selected GRM by the subject's monthly income.
GRM x Subject monthly rent = estimated value
95
Steps in Gross Income Multiplier Approach
1. select a gross income multiplier by examining the sale prices and gross annual incomes of comparable properties which have sold recently. The gross income multiplier for a property is:
Price / Gross Annual Income = GIM
2. estimate the value of the subject by multiplying the selected GIM by the subject's gross annual income:
GIM x Subject gross annual income = estimated value
96
Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA)
This act included provisions to regulate appraisal.
Illinois Real Estate Exam Prep
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