Pearson VUE Exam Prep: Property Value and Appraisal PDF

This resource is from (National Portion), (Property Value and Appraisal)  Bookmark this resource Pearson VUE Exam Prep: Property Value and Appraisal STUDY SHEET Top Takeaways Salespersons can expect to see 11 questions related to property value and appraisal on the lice...

This resource is from (National Portion), (Property Value and Appraisal)  Bookmark this resource Pearson VUE Exam Prep: Property Value and Appraisal STUDY SHEET Top Takeaways Salespersons can expect to see 11 questions related to property value and appraisal on the licensing exam. Brokers will see 10 questions. Concept of Value Market Value vs. Market Price Market value: The most probable price a property will sell for in an open market if neither the buyer nor the seller is under duress Value: A property’s objective worth, which may not equal price or cost Cost: Amount to create or recreate a property if it were destroyed Market price: Amount a buyer paid for a property and a seller accepted Characteristics of Value Four characteristics of value: Demand, utility, scarcity, and transferability Demand: How popular or desirable a property is Utility: The property’s function Scarcity: Relates to market supply Transferability: The ease with which another person can purchase the property; a property with a title defect may suffer a loss of value because of the difficulty in transferring title to another Other types of value: Value in use: What a property is worth to the person using it Assessed value: What the local taxing authority thinks is the property is worth Mortgage value: Price at which the property can be loaned on or sold for at a foreclosure sale Insured value: Cost to replace or rebuild a property Investment value: A return on investment a property may provide Principles of Value Certain economic principles of value have an effect on a property’s value. Some of these are: The principle of conformity: A property's value is determined in part by how well it conforms to its surrounding area. The principle of competition: A property's value is determined in part based on what else is available. The principle of substitution: A reasonable person won’t pay more for a property if a comparable one can be had for less. The principle of contribution: The value of any given change to the property is dependent on the property’s value as a whole. Because of this, the same improvement to two different houses may result in an increase in value in one while the other sees no appreciable change. Highest and best use: This is the most profitable (legally permitted and possible) use of a property.  When vacant land is appraised, the appraiser should consider the highest and best use. Plottage: This is when joining two adjacent parcels increases the overall property value beyond what each parcel would be worth if sold separately. Regression: A property’s value declines due to neighboring properties’ decline in value. Progression: A property’s value increases due to an increase in surrounding property values. Anticipation: The expectation of events may prompt changes in property value. For example, a suburban residential property that’s located near the site of a proposed public transportation facility may see an increase in value before the actual benefit is realized. Market cycles and other factors also affect property value. Reduced consumer confidence makes new buyers wary of purchasing and homeowners hesitant to trade up. Higher unemployment reduces the number of buyers, putting downward pressure on housing prices. Higher taxes decrease buying power; lower taxes increase buying power. Higher interest rates reduce buyer affordability; lower interest rates increase buyer affordability. Supply and demand significantly affect property value. More demand than supply means buyers are competing for the same properties, driving prices up. Less demand, or fewer buyers, puts downward pressure on housing prices. Appraisal Process Purpose and Steps to an Appraisal A real estate appraisal is an estimate or opinion of a property’s value, determined for a specific purpose, as of a specific date, and based on proven facts. Appraisals help determine mortgage value, investment value, or insured value. Most states prohibit licensees from performing appraisals and from calling any valuation they assign to a property an appraisal. Typically, only licensed appraisers may perform appraisals. Lenders or appraisal management companies generally select and hire appraisers, but the buyer generally pays. The real estate industry most often uses property appraisals to ensure that the property’s value supports a given loan amount. Appraisers and appraisals are subject to federal and state laws that relate to housing, civil rights, and health and safety. Appraisers follow the Uniform Standards of Professional Appraisal Practice (USPAP) and use these steps: State the problem. This means identify the specific property, the rights associated with it, the purpose of the appraisal, and what type of value needs to be estimated. Identify data needed. Gather and analyze data. Appraisers look at general city, neighborhood, demographic, and other data, as well as property-specific data. Determine highest and best use. What would the best use of the property be if there were no existing building on it? This matters more for commercial properties, though residential properties in a mixed- use neighborhood can be impacted. Estimate the land value (as if the land were vacant). Use one or more of the three approaches to valuation (sales comparison, cost, or income approach), depending on property type. Reconcile values to determine the final appraised value. This isn’t an average of the various estimates calculated. Through a reconciliation (correlation) process, the most weight may be given to one or two of the comparable properties or even to the appraisal method used (sales comparison, income, or cost approach) and how well it matches the subject property. Develop and deliver the appraisal report. Federal Oversight of the Appraisal Process Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) implemented  congressional oversight of appraisals. FIRREA standards require that real estate appraisals be: Presented in writing. Prepared in accordance with USPAP standards. Performed by licensed individuals whose competency has been verified. Appraisals for federally related transactions (any transaction for sale, lease, purchase, investment, or exchange of real property in which a federal financial agency or regulatory authority is involved) must be performed by a state-licensed or state-certified appraiser. Properties valued at $400,000 or less are exempt from federal appraisal requirements unless state law requires a licensed appraiser for any federally related transaction, regardless of value. Purchases financed with a loan insured by the Federal Housing Administration (FHA) must be appraised by a state licensed appraiser who’s approved by the U.S. Department of Housing and Urban Development. Purchases financed with a loan guaranteed by the U.S. Department of Veterans Affairs (VA) must be appraised by a VA certified and state licensed appraiser. Lenders who want to sell their conventional mortgage loans to Fannie Mae must comply with Appraiser Independence Requirements (AIR). The intent of this 2010 legislation is to ensure that appraisals reflect an accurate, unbiased property value. To comply with AIR, lenders must select appraisers who are: Licensed or certified in the subject property’s state. Knowledgeable about the local market. Qualified to appraise the subject property. Able to access the data needed to perform the appraisal. AIR permits lenders to select residential appraisers from an approved list or panel if the lender employee(s) involved in the selection have no involvement in loan approval. To help ensure they’re in compliance with AIR standards, some lenders contract with third-party companies to manage appraisals. Methods of Estimating Value and Broker Price Opinions (BPOs) Sales Comparison Approach (Market Data) The sales comparison appraisal approach, used primarily for residential properties, is based on the principle of substitution. It uses the prices for which similar properties have sold recently to estimate the market value of the property being appraised. The similar properties are referred to as comps or comparables. The property being appraised is called the subject property. Since comparable properties are never exactly the same as the subject property, comparable properties must be selected and compared both qualitatively and quantitatively. Bracketing is the process whereby an appraiser determines a probable range of values for a property by comparing a group of comparable sales to the subject. The appraiser attempts to include both superior and inferior characteristics such as age, transaction price, etc. Appraisers will adjust the price at which each comparable sold (either by a specific dollar amount or by a percentage) in order to make the subject property’s appraised value reflect the differences in features, location, condition, and even timing of the sale. So if the subject property has 2,400 square feet of living space and the comparable has 2,600 square feet, the appraiser will subtract from the comparable’s sales price to reflect the value of the 200-square-foot difference. Appraisers look for the most recent sales of the most similar houses possible. The fewer adjustments that need to be made, the less subjective the appraiser needs to be with respect to the value (not cost) of those differences. Appraisers use two categories of comparison. Elements look at physical, locational, and transactional characteristics. Units look at the numbers, such as price per square foot, per apartment unit, per acre, etc. Appraisers will make adjustments for a number of factors, applying the elements of comparison in this specific order:  1. Financing terms and cash equivalency Example: A house that sold for $300,000, but the seller paid $12,000 toward customary buyers’ closing costs has the equivalency of $288,000. 2. Conditions of sale 3. Market conditions at the time of contract and closing 4. Location 5. Physical characteristics Cost Approach This approach is based on the concept that the entire property is worth the sum of the value of the land and the value of the improvements on that land. Appraisers use and rely upon this approach when the property is unique and isn’t being used to generate rental income. A movie theater, hospital, church, or school fall into this category. It’s also used in newly constructed or high-value unique homes. The formula to estimate value is: The value of land (as though it were vacant with no improvements on it) plus the depreciated cost of recreating the existing improvement equals market value. There are three causes of depreciation: external depreciation, functional obsolescence, and physical deterioration. External depreciation, also known as economic obsolescence, is caused by factors outside the property (e.g., a nearby airport causes noise). Functional obsolescence is a form of depreciation or loss in value caused by defects in design and can occur with outdated structures or systems, or when a property is overbuilt for the area. Physical depreciation occurs with wear and tear, damage, and improper maintenance. Curable depreciation refers to an item of physical deterioration or functional obsolescence where the cost to cure the item is less than or the same as the anticipated increase in the property’s value after the item is cured. Incurable depreciation includes items not practical to correct. The replacement cost approach bases value on cost to build a functionally equivalent property. The reproduction cost approach determines cost to build an exact replica of the property with the same materials and deficiencies. The cost approach assumes the land is vacant and bases opinion on highest and best use. Income Approach This approach bases the property’s current value on potential income that the property can generate for residential investment rental properties, like single-family homes or residential buildings that comprise two- to four-family units. This is the most reliable approach to value when the property being appraised has rental income-generation as its primary purpose, which includes shopping centers, apartment buildings, and office buildings. The investment value determined by an appraiser tells an investor the expected rate of return for a property. The income approach often uses capitalization rate to help estimate value. Capitalization method formulas, depending on the information you’re given, include: Value = income ÷ rate of capitalization Rate = income ÷ value Income = value × rate Gross Rent and Gross Income Multipliers Two additional methods for estimating value within the income approach exist: the gross income multiplier and the gross rent multiplier. Gross rent multiplier (GRM) is used for the appraised value of a property comprising four or fewer units.  GRM = value ÷ gross monthly rent Value = gross monthly rent × GRM Gross monthly rent = value ÷ GRM Gross income multiplier (GIM) is used for the appraised value of a property comprising five or more units. GIM = value ÷ gross annual income Value = gross annual rent x GIM Gross annual rent = value ÷ GIM Comparative Market Analysis (CMA) Real estate licensees perform comparative market analyses (CMAs) to help clients make price decisions. They help seller clients decide how to price the property and buyer clients decide how much they’re willing to pay. CMAs are not appraisals; instead they’re an informal estimate of market value. Real estate licensees generally select comparable properties that have recently sold, are currently on the market for sale (active listings), and/or are similar and were offered for sale but did not sell (expired listings). Licensees may also review similar listings that are under contract (pending), though this is more difficult because the final sales price isn’t yet known. Recent sales carry more weight as comparables than older sales (properties that have sold in the last three to six months). When comparing a market analysis, licensees adjust only the comparable sales price, not the subject property’s list price (or potential list price). If a comparable is inferior to the subject property (e.g., next to a busy street), adjust upward. If it's superior (e.g., in a secluded, quiet neighborhood), adjust downward. Licensee should use the CMA to provide a price range for sellers; licensees shouldn’t suggest a specific listing price. Comparables that are most similar to the subject property carry the most weight in determining price range. Broker’s Price Opinion Broker’s price opinion (BPO): In states that permit real estate licensees to perform BPOs, a licensee uses the BPO process to determine a property’s potential selling price or estimated value. Like a CMA, the BPO is an informal estimate of market value. The primary difference between a BPO and a CMA is that the BPO is usually prepared for a lender, relocation company, insurer, or investor rather than a client. Lenders may order a BPO on a property that’s nearing or in foreclosure to determine an estimate of price if the property must be sold as a foreclosure or if the seller asks permission to sell the property as a short sale. Insurers and investors may also use BPOs. In a drive-by BPO (aka exterior BPO) the licensee will drive by the property to get a general idea of its current condition and marketability and then perform some online research to prepare a report for the lender. When performing an interior BPO, the licensee also enters the property to determine its general condition, including style, age, number of rooms, and estimated square footage. When preparing a BPO, licensees will perform a review of comparable properties similar to that of a CMA. The report presented to the lender typically will state a range of potential value, not a specific value. Assessed Value and Tax Implications Property taxes are calculated based on three factors: The county assessor’s estimate of a property’s market value, which may be determined every year, every other year, or at random intervals, for tax purposes; some states reassess property values any time property changes ownership. The property’s assessment ratio, which varies by tax jurisdiction, e.g., county, city, and neighborhood. For example, one state or county may determine that property taxes will be calculated on 70% of the property’s market value. The assessed value (i.e. the property’s value as determined by the assessor) multiplied by the assessment ratio results in the property’s taxable value.  The assessed value multiplied by the jurisdiction’s tax rate results in the amount of taxes owed to that jurisdiction. A single property may be taxed by multiple jurisdictions. For example, John Smith’s home may receive a single tax bill with assessments from the county, the city, the local library, and the local school district. Governments like property taxes as a revenue base because they’re a stable, reliable revenue source. For more information, consult your Pearson VUE Candidate Information Bulletin.  Bookmark this resource