Real Estate Transactions - Part 2 - Chapters 29-30 Flashcards
Understand the purpose and function of an appraisal to provide an opinion of a property’s value on a specific date
An appraisal is an individuals opinion of a property’s value on a specific date, reduced to writing in an appraisal report. The appraisal report contains data collected and analysed by the appraiser which substantiates the appraiser’s estimate of the property’s value.
Recognize the six steps of the appraisal process, concluding with the creation of an appraisal report
The appraisal process has SIX steps:
- Identifying and defining the appraisal effort to be undertanken by the appraiser
- data collection, including both General Data on the area surrounding the property, and Specific Data on the improvements and property lot
- analyzing the data
- applying the THREE approaches to value (Market Comparison-Comps, Cost Approach, Income Approach)
- reconciling the approaches and determining the final value of the property
- creating the complete appraisal report
Differentiate the three appraisal approaches used to analyze the property data collected
When applying the data collected, each of the THREE appraisal approaches are used:
- The Comparative market approach - where appraiser looks for COMPS in the neighborhood
- The Cost Approach - where the appraiser sets a property’s value by calculating the construction cost to replace the improvements as today’s prices
- The Income Approach - where the appraiser determines the property’s value based on future income and operating expenses of the property.
Advise on the elements of a completed appraisal report
As the final step in the appraisal process, the appraiser creates a completed appraisal report. The types of appraisal reports include:
- short summary report - a filled in form using checks and explanations
- letter form - a brief written report
- self-contained or narrative - an extensive written report
The following information is included in the appraisers report:
- property description
- purpose and scope of the appraisal
- description of neighborhood
- the date on which the value is estimated
- qualifying conditions and assumptions
- factual data, photos and maps with analyses
- the estimate of value
- the name address type of license and signature of appraiser
Discuss appraiser licensing requirements
All appraisers are required to hold a license or certification issued by the CALBRE. The license/certification categories are:
- Trainee appraiser - allows the trainee to work on the appraisal of properties under the direct supervision of an appraiser licensed to appraise those properties
- Residential appraiser - allows the appraisal of 1-4 residential units up to $1 million and non-residential property up to $250,000.
- Certified Residential appraiser - allows for the appraisal of 1-4 res units of ANY DOLLAR AMOUNT and non-residential property up to $250,000.
- Certified General appraiser - allows for the appraisal of ANY TYPE of real estate and transaction value or complexity.
Avoid activities which violate appraisal independence
Appraisers are required to maintain independence and its unlawful to violate independence by:
- Coercing any appraisal professional to appraise a property at a value based on any factor other then the independent judgement of appraiser
- Mis-characterizing the appraised value of a property to secure a mortgage
- Influencing or encouraging an appraiser to meet a targeted value for a property
- Withholding or threatening to withhold payment for an appraisal report or service.
Factors and Forces used in the appraisal process to determine a property’s value
Factors used in the appraisal process to determine a property’s value are known as the ELEMENTS of VALUE and can be memorized by “DUST”:
- Demand - number of buyers for the property
- Utility - the property’s possible uses
- Scarcity - the availability of similar properties
- Transferability - the seller’s ability to transfer good title to a buyer clear of all encumbrances itemized in a title insurance policy.
There are also FORCES that influence VALUE and can be memorized by ‘PEGS’:
- Physical considerations - the property’s proximity to commercial amenities, access to transport, freeway availability, beaches, lakes, hills
- Economic considerations - rents in the area, vacancies and the percentage of home ownership, as well as employment opportunities lost or gained
- Government considerations - property taxes, zoning, building codes, local services like police/fire
- Social considerations - crime rates, school ratings, shopping and recreational opportunities
What are the economic concepts used in the appraisal of real estate?
Several economic concepts are used in the appraisal of real estate. These principals are referred to as PRINCIPALS of APPRAISAL and include:
- Principal of Supply and Demand - as supply decreases, home values increase
- Principal of Change - a property is constantly in a state of change aka experiences a ‘life cycle’ with 4 stages:
- Development - building houses and neighborhood
- Stability - property reaches level of completion
- Decline - oldest bldg decline, lower socio move in
- Revitalization - neighborhood suitable for renewal
- Principal of Conformity - when houses/community are similar commonly maintained to preserve maximum value. Further categorized by:
- Regression - best improved house sells for less
- Progression - worst house sells for more
- Principal of Highest and Best Use - says the greatest value of the property is realized when its use is maximized. Test for highest and best use requires that the use be “PLEM”:
- Physically possible
- Legally permissible
- Economically feasible
- Maximum productivity is achieved
- Principal of Contribution - value of one improvement is measured in terms of its contribution to the whole property value, not just the cost of the improvement.
- Principal of Substitution** - It is the most common principal, saying that a buyer will not pay more for a property if it will cost less to buy a similar property of equal desirability.
Appraisal Approach - market comparison approach
The market comparison approach is the most commonly used approach to establish the FMV of real estate. The appraiser gathers data on comparables (COMPS) then compares them to the property to establish the value.
Appraisal Approach - cost approach
** Estimate the existing cost then take into account Depreciation
The Cost Approach is an appraisal method used by an appraiser to arrive at a property’s value based on the present cost of constructing the present improvements AND acquisition of the land. The Cost approach is best used when valuing new buildings and special or unique structures, such as churches and factories. Also, an appraiser uses Cost Approach more often when COMPS are not sufficient or the property has no income. Estimating the cost of improvements involves the calculation of DIRECT (labor and materials) and INDIRECT COSTS (permits, governmental fees, insurance, taxes, admin costs, financing charges).
Estimated replacement cost of existing improvements is determined by using one of 4 methods:
- comparative-unit method - estimate the cost in terms of dollars per square foot based on similar structures adjusted for physical differences.
- unit-in-place method - estimates the unit costs for building components, like foundation, floors, walls as well as labor and overhead.
- quantity survey method - the most comprehensive and accurate method of estimating cost, taking every aspect into account
- index method - designed for use in updating historic costs or backdating current costs such as in probate valuations when needed to establish a value at earlier date.
After estimating replacement costs, then they deduct any value related loss, known as DEPRECIATION. There are three types:
- Physical deterioration - due to wear and tear
- Functional deterioration - due to outdated style or non-usable space, like antique fixtures, one car garage, or outdated kitchen
- Economic obsolescence - due to changes in property’s neighborhood, external, like increased noise from a freeway that is built next to property,
Appraisal Approach - income approach
- Gross Rent Multiplier
- Capitalization Method
There are two methods for calculating the property’s value under the Income Approach. Typical property’s appraised using the income approach are apartments, offices, industrial buildings, commercial units, other income producing property.
- The Gross Rent Multiplier (GRM) method - uses the market rent of the subject property which is then multiplied by a factor, the GRM) to arrive at the value of the property. The GRM factor is determined by comparing the subject property to similar properties that have recently been sold.
- The Capitalization method which is outlined in three steps to establish value:
* Determine the property’s effective gross income EGI, which is its gross income minus vacancies and collection losses.
* Deduct operating expenses (both Fixed costs like property taxes, insurance, security, management fees, and Variable costs like utilities, maintenance) from the Effective Gross Income (EGI) to determine the property’s Net Operating Income (NOI).
* Mathematically divide the NOI by the Capitalization Rate (cap rate) Cape rate is comprised of a prudent investor’s expected annual RATE of RETURN on monies invested, and a RATE of RECOVERY of their invested monies allocated to the improvements also called depreciation.
Thus the FMV of the property is NOI/Cap Rate. Example, a property’s NOI is $100,000 and Cap Rate is 10%, the property value under Income Approach would be $1,000,000.
fair market value
The Fair Market Value (FMV) is the most common types of values assigned to a property. The FMV of a property is the price a reasonable unpressured buyer would pay for property on the open market.
appraisal report
An appraisal report is documentation of an appraiser’s finding including the purpose and scope of the appraisal.
Understand the steps escrow takes to facilitate the closing of a real estate sale
Escrow is a process of employing an independent agent to manage and coordinate the closing of a real estate transaction through the exchange of documents and money between two parties such as a buyer and a seller. Escrow activity employed to close a RE transaction consists of:
- One Person, such as a seller or buyer, delivering written documents or money, called INSTRUMENTS, to an escrow company for the purpose of fully performing their obligations owed to another person under an agreement entered into before the escrow is opened for a sale, a mortgage origination or leasing of RE
- The Escrow Company, who receives and delivers the documents and money to another person, such as the buyer, seller, or third parties, on the occurrence of a specified event or the performance of prescribed conditions, such as the receipt of reports or the issuance of a title insurance policy.
Distinguish the various services rendered by escrow and the duties of an escrow officer.
The services rendered by escrow agents typically include:
- receiving funds and gathering necessary documents, called Instruments
- preparing documents necessary for conveyancing and mortgaging a property required for escrow to close
- calculating prorations and adjustments
- disbursing funds and transferring documents when all conditions for their release have been met.
