example, building permit, survey, payroll, taxes and

Chapter 7 Unit 3: Three Approaches to Value Flashcards

The Cost Approach: Reproduction Costto replace with the same materials as the original construction Incurable vs. Curablethe deterioration of an improvement that it is not economically feasible to repair or correct is considered incurable, as defined by an adverse gap between the cost to repair and the ending value resulting from the repair.The Cost Approach: Quantity Survey Method The quantity and quality of all materials (such as lumber, brick, and plaster) and the labor are estimated on a unit cost basis. These factors are added to indirect costs (for example, building permit, survey, payroll, taxes and builders profit) to arrive at the total cost of the structure.Because of the detail and the time consumed, this method is usually used only in appraising historical properties. It is however the most accurate method of appraising new construction.The Sales Comparison Approachis primarily used for appraising residential property and vacant land. This approach compares the subject property to similar properties and makes adjustments on the basis of the date of the sale, the location, the physical features and/or amenities.External Obsolescence: Curable vs Incurable External obsolescence is generally considered incurable since this form of value loss is beyond the control of the individual property owner. Moreover, the costs to cure would be virtually impossible to calculate or even apply.Depreciationis the loss in value to a property due to any cause or any condition that adversely affects the value of an improvement.The Cost Approach primarily relies on1. the original cost of the property's land and improvements2. the cost to reproduce or replace the property's improvements3. the degree to which the improvements have depreciated.A property owner must spend $10,000 to pave his driveway. Upon completion of construction, his property value will increase by $7,500. In this case the deficiency would be considered to be Incurable deterioration Income approach formulas: To solve for Value: I / R = V (Income divided by Cap Rate = Value) Mike wanted a capitalization rate of 14% if he bought Joe's property. If three units rented for $450 per month, two units @ $550, and one unit @ $600 per month, what is the maximum amount Mike could pay in order to net the cap rate he wants?$261,429$450 x 3 = $1,350$550 x 2 = $1,100$1,350 + 1,100 + 600 = $3,050$3,050 x 12 = $36,600$36,600 ÷ 0.14

= $261,429

Income Approach Formulas: To solve for Cap Rate (rate of

return, or R):

I / V = R (Net Income divided by Value = Cap Rate) The Cost Approach: Replacement Costto replace with current materials and methods with similar utility and function to the original improvement Physical Depreciationis a reduction in utility or value resulting from an impairment of physical condition, which deterioration can be divided into either curable (painting/routine maintenance) or incurable types (20-year-old foundation and framing).Physical depreciation is a form of depreciation caused by the action of the physical elements, such as wind or snow, or just ordinary wear and tear.The Sales Comparison Approach: Substitution The underlying premise of the Sales Comparison Approach is the principle of substitution. This principle holds that if a buyer will pay a certain price for a property, he or she will pay a similar price for a 'substitute' property of similar characteristics.

Income Approach Formulas: To solve for Income (Net

Operating Income):

V x R = I (Value x Cap Rate = Net Income) Economic LifeThe length of time during which an improvement will contribute to the value of a property. Economic life ends when the improvement no longer represents the "highest and best use" of the property.The Cost Approach: Square Foot CostUsing outside measurement, how many square feet times a cost for either replacement or reproduction of the improvement.External Obsolescenceis a loss of value resulting from extraneous factors that exist outside of the property itself. It is a type of depreciation caused by environmental, social, or economic forces over which an owner has little or no control.The Income Capitalization Approachis a value based on the present value of the rights to future income. This is for income generating properties.For appraisal purposes, depreciation is divided into 3

classes according to its cause:

physical deteriorationfunctional obsolescenceexternal obsolescence The Income Capitalization Approach: Steps 1. Estimate the annual Potential Gross Income. This is equal to the number of units times the annual market rent for each unit, plus non-rental income.2. Deduct an allowance for vacancies to arrive at Effective Gross Income.3. Deduct the annual operating expenses from Effective Gross Income to derive Net Operating Income (NOI).If you are given the monthly income and no other information in a problem, you must assume that it is the Net Operating Income. You must multiply monthly income times 12 to derive the annual net income, and then finish the problem.4. Estimate the rate of return that an investor would demand for this investment. This rate of return is

called the Capitalization (Cap) Rate.5. Divide the Cap Rate into the Net Operating Income to identify the property's value, or I / R = V where I is Net Operating Income; R is the cap rate; and V is the value.Physical Lifeis the actual age or life of a structure that is considered habitable. Thus the physical life is defined by the durability of its structural components.Steps in Sales Comparison Approach1. Identify elements of comparison and value adjustment2.Select comparable sales3. Adjust comparable sale prices to approximate subject4. Reconcile adjusted sale prices; obtain indicated value of subject Cost can be determined by one of three methods: 1. Square Foot cost2. Unit in Place3. Quantity Survey method The Cost Approach: Unit in PlaceIn the "Unit In Place Method", the replacement cost of a structure is estimated based on the construction cost per

unit of measure of individual building components, including material, labor, overhead and builder's profit.Most components are measured in square feet, although items such as plumbing fixtures are estimated by cost. The sum of the components is the cost of the new structure.