Real Property Valuation 2024 PDF

School of Land Administration Department of Land Administration and Surveying Course Title: Real Property Valuation Course Code: LaAd3083 Instructor: Aberu Demsew 2024 1  Objectives of the Unit At the end of th...

School of Land Administration Department of Land Administration and Surveying Course Title: Real Property Valuation Course Code: LaAd3083 Instructor: Aberu Demsew 2024 1  Objectives of the Unit At the end of this unit, you will be able to  Understand the meaning of property valuation.  Identify the difference between Real Estate, Real Property and Personal Property  Understand the Purpose of Valuation  Identify the difference between Price, Cost and Value  Identify the different types of value  Describe the factors that can create value  Understand the force that influence value of the property  Describe the foundation/principles of valuation  Understand the misconception of valuation 2  1.1. Introduction  In our complex society, there are various occasions when formal or informal appraisals are needed.  Such occasions can be divided in to two major categories: market transactions and legal transactions  Most of the market transactions requiring valuations are connected with Sale, Purchase, Finance/mortgage, etc.  In legal transactions, our society requires valuations for different purposes, including Expropriation and compensation various taxation purposes, and use as evidence in civil lawsuits involving real property 3  1.2. Meaning of property valuation What is property valuation/property appraisal?  Property valuation/property appraisal is the act or the process of developing an opinion of property value.  It involves selective research into appropriate market areas, assemblage of pertinent data, the use of appropriate analytical techniques, the application of knowledge, experience and professional judgment to develop value opinion.  It is not simply a mathematical process. It is much more than that, and probably the larger part of the valuation process depends upon the appraiser forming opinion.  The appraiser has to look at a wide range of facts and try to predict the future. 4  Cont…  It is some times said that valuation is an art and some times that it is a science.  In fact, it is a mixture of both, an art and a science.  The scientific part of valuation is the analysis of data and the mathematical calculation of data;  The art is the skill of knowing which information to use to assist valuation and the process of making judgments and forming opinions. 5 Real Estate, Real Property and Personal Property  An important distinction is made in between real estate and real property in real estate valuation.  Even if these concepts are different, some countries laws and court decisions treat them as similar for legal purposes. Real Estate  Real estate is the physical land and the fixtures attached to the land, e.g, structures.  It is immobile and tangible.  The legal definition of real estate includes: Land All things that are a natural part of land such as trees, minerals All things that are attached to land by people, such as buildings, improvements 6  Cont… All permanent buildingattachments permanent building attachments likelike plumbing, plumbing, electrical electrical wiring, wiring, heating heating system system etc, as well asetc, as well built- as built- in items such in as items such cabinets and as cabinets elevators are and elevators usually are as considered usually part of real estate. considered as part of real estate. Real Realestate includes estate all attachments includes above and all attachments belowand above the below ground. Realground. the property  It includes all interests, Real benefits, and rights inherent to the property ownership of physical real estate. It includes all interests, benefits, and rights inherent to  The total range of the ownership of physical ownershipreal of interests estate. in real property is called bundle of rights. The total range of ownership of interests in real property is called bundle of rights. 7  Cont…  It contains all the interests in real property including the right to Use real estate Sell real estate Rent and lease real estate Enter in it Give it away  Each right can be separated from the bundle and can be traded in the market.  Real estate appraisers not only distinguish between real estate and real property but also differentiate between real estate, personal property and trade fixtures. 8  Personal property  It includes movable items of property that are not permanently affixed to, or part of, the real estate. Examples: furniture and furnishings not built into the structure such as refrigerators and freestanding shelves, items such as bookshelves installed by a tenant that, under specific lease terms, may be removed at the termination of the lease. Trade fixtures  Unlike fixtures, which are regarded in law as part of the real estate, trade fixtures are not real estate endowed with the rights of real property ownership  They are personal property regardless of how they are affixed. 9  Cont…  A trade fixture is to be removed by the tenant when the lease expires. Examples of trade fixtures: Restaurant booths Gasoline station pumps Storage tanks Fitness equipment in a health club Plumbing, lightening, heating, and air conditioning in an industrial building 10  1.3. Purpose of Valuation  Valuation is the art or science of estimating the value of a property for specific purpose.  The expression specific purpose refers to the fact that properties may be used for different purposes such as Residential Commercial Industrial etc  This means there is a wide range of reasons for requiring valuation of a property.  It is possible to have different values for one property at one particular moment in time depending up on the purpose of the valuation.  The purpose for which valuation is required and the type of property that is to be valued will determine the nature of the valuation instruction, including the techniques employed and the basis on which value is to be determined. 11  Cont…  Purpose for which valuation may be required include : 1. Transfer of ownership 2. Financing and credit 3. Litigation 4. Tax matters 5. Investment counseling, decision making and accounting 12  1. Transfer of ownership  To help prospective buyers set offering prices  To help prospective sellers determine acceptable selling prices  To establish a basis real property exchange  To establish a basis for reorganizing or merging the ownership of multiple properties. 2. Financing and credit  To develop an opinion of the value of the security offered for a proposed mortgage loan.  To provide an investor with a sound basis for deciding whether to purchase real estate mortgages, bonds or other types of security.  To establish a basis for a decision to insurance. 13  3. Litigation 3.1. Eminent domain proceedings  To develop an opinion of market value of a property as a whole before taking  To develop an opinion of market value of the remainder after taking  To estimate the damages to a property created by taking 3.2. Property divisions  To develop an opinion of the market value of a property in contract dispute  To develop an opinion of market value of real estate as pert of portfolio  To develop an opinion of market value of partnership interests 3.3. Environmental litigation  To estimate damages created by violating environmental laws  To estimate damages created by environmental accidents 14  4. Tax matters  To develop an opinion of assessed values  To determine gift and inheritance taxes 5. Investment counseling, decision making and accounting  To set rent schedules and lease provisions  To determine the feasibility of construction or renovation program  To serve the needs of insurers, policy makers, etc  To facilitate corporate mergers  To develop an opinion of liquidation value for forced selling or auction proceedings  To advise clients by considering their investment goals, alternatives, resources, constraints and timing of their activities 15  Cont…  To advise zoning boards, courts, planners on the probable effects of proposed actions  To assist in arbitrating valuation issues  To analyze supply and demand trends in a market 16  1.4 Nature of Value 1.4.1 Distinction among Price, Cost and Value  Market- is a set of arrangements in which buyers and sellers are brought together through the price mechanism.  Markets exist in many forms. A market may be defined in terms of : Geography  Local Market: A market within a specific locality or region.  National Market: A market that spans an entire country.  Global Market: A market that includes international buyers and sellers. 17  Cont.. Products or product feature  Commodity Market: Markets for raw materials like oil, gold, and agricultural products.  Financial Market: Markets for financial instruments such as stocks, bonds, and currencies.  Consumer Market: Markets for goods and services purchased by individuals for personal use. Number of available buyers and sellers  Perfect Competition: A theoretical market with a large number of buyers and sellers, each with a negligible impact on the market price.  Monopoly: A market with only one seller, giving them significant control over price.  Oligopoly: A market with a few dominant sellers, leading to limited competition. 18  Cont…  Monopsony: A market with only one buyer, giving them significant power in setting prices. Or some other arrangements  A Real estate market is a market formed by the interaction of individuals who exchange real property rights for other assets such as money.  Specific real estate markets are defined on the basis of Location Property type Income producing potential of the property Typical investor characteristics Typical tenant characteristics Other attributes recognized by those participating 19  Cont…  Appraisers have to make careful distinctions among the terms price, cost and value.  Price –a particular purchaser agrees to pay and a particular seller agrees to accept under the circumstance surrounding their transaction.  Once finalized, price refers to a sale or transaction price and implies an exchange.  It is an accomplished fact.  Cost: - appraisers used the term cost in relation to production, not in exchange.  Cost may be either an accomplished fact or a current estimate  In real estate market, cost represents the total expenditure incurred on: 1, construction and 2. development of real estate. 20  Cont…  Construction cost normally includes the direct costs of labor and materials, indirect costs which are expenditures that are necessary for construction but are not typically part of construction contract. Example: Architectural fees, property taxes, administrative expenses, etc  Development cost is the cost to create a property, including the land, and bring it to an efficient operating state. It includes acquisition costs, actual expenditures, and the profit required to compensate the developer 21  Cont…  Value: - the relationship among price, market and cost includes the concept of value.  Value can have many meanings in property valuation.  The applicable definition depends on the context and usage.  In the market place, value is usually considered as an anticipation of benefits to be obtained in the future.  Since value changes over time, valuation reflects value at a particular point in time. 22  Cont…  Value as a given time represents the monetary worth of property, goods, or services to buyers and sellers.  To avoid confusion, appraisers don’t use the word value alone. Instead, they use the word Market value Use value Investment value Assessed value and other specific kinds of value. 23  Types of Value 1. Market value  Market value is the focus of most property valuation assignments.  Several appraisers debate on the definition of the term market value.  However, the definition which includes most widely accepted components of market value is:  Market value is the most probable price, as of a specified date, in cash or in other terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a faire sale, with the buyer and seller each acting prudently, knowledgeably and for self interest, and assuming that neither is under undue duress. 24  Cont…  This definition indicates the situation that market value is based on the objective observation of the collective actions of the market.  According to the agency that regulates the Federally Insured Financial Institutions in the United States:  Market value is the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably and assuming the price is not affected by undue stimulus. 25  Cont…  What implicit in this definition are buyer and seller are typically motivated; both parties are well informed or well advised, and acting in what they consider their best interest; a reasonable time is allowed for exposure in the open market, payment is made in terms of cash or in terms of financial arrangements comparable there to and the price represents the normal consideration for the property sold unaffected by special financing amounts and/or terms, services, fees or credits incurred in the transaction 26  Cont…  According to the International Valuation Standards Committee, market value is defined for the purpose of international standards as follows; Market value is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and seller in an arm’s-length transaction after a proper marketing where in the parties had each acted knowledgeably, prudently and without compulsion.  Arms-length transaction means a transaction between unrelated parties under undue duress. 27  2. Use Value  Use Value represents a value of a specific property for a specific use.  It is not based on the highest and best use of the property.  In estimating use value, the appraiser focuses on the value the real estate contributes to the enterprise.  The property designed for certain purpose may have one use value before a major change and another use value afterward.  Limited purposes properties such as house of worship, museums, schools, public buildings, clubhouse etc may be appraised based on their current use. 3. Investment value  It represents the value of a specific property to a particular investor based on that person’s investment requirement  It shows the subjective relationship between a particular investor and the given investment. 28  Cont…  It differs in concept from market value, although investment value and market value indication sometimes may be similar.  If the investor’s requirement is typically of the market, investment value will be the same as market value.  When measured in monetary units, investment value is the price an investor would pay for an investment in light of its perceived capacity to satisfy individual’s desire and investment goals.  Specific investment criteria must be known to determine an opinion of investment value. 29  4. Going Concern Value  Going concern- is an established and operating business with an indefinite future life.  The physical real estate assets of certain property such as Hotels, Motels, Restaurants, and Manufacturing enterprises are integral part of an ongoing business 30  Cont…  The value of such properties (including all the tangible and intangible assets of the going concern as if sold in aggregate) is referred to as going concern value.  Going concern value includes the incremental value of the property associated with the business concern. 5. Assessed value  Assessed value- refers to the value of the property determined for taxation purpose.  Assessed value can be a percentage of market value or ratio of cost to value.  Assessed value may not conform to market value but it is usually calculated in relation to market value base.  special value is an amount that reflects particular attributes of an asset that are only of value to a special purchaser 31  Cont…  A special purchaser is a particular buyer for whom a particular asset has special value because of advantages arising from its ownership that would not be available to other buyers.  Synergistic value is an additional element of value created by the combination of two or more assets or interests where the combined value is more than the sum of the separate values 32  Factors that Create Value  There are four interdependent factors which create value of a property. These are: 1. Utility 2. Scarcity 3. Desire 4. Effective purchasing power 1. Utility - refers to the ability of the product to satisfy human wants, need or desire.  All properties have to have utility to tenants, owner investors or owner occupants. For instance, residential properties satisfy the need for shelter and commercial properties generate income. 33  Cont…  The influences of utility on property value depends on the features of the property. Size utility, design utility, location utility and other forms of utility can influence property value. 2. Scarcity - is the present or anticipated supply of an item relative to the demand for it.  If demand is constant, scarcity of a commodity makes it more valuable.  No object including real estate can have value unless scarcity is coupled with utility. 3. Desire - An item must be needed by potential buyer to have value. 34  Cont… 4. Effective purchasing power- is the ability of an individual or group of individuals to participate in the market for acquiring goods or services in a market.  A valid opinion of the value of a property includes an accurate assessment of the market’s ability to pay for the property.  The complex interaction of the four factors that create value is reflected in the basic economic principle of supply and demand.  The supply and demand for the property, in any given situation, are affected by the utility of a property, its scarcity or abundance, the intensity of human desire to acquire it and the effective purchasing power 35  Forces that Influence Value of a Property  There are four forces that affect the value of a property. These are 1. Social forces 2. Economic forces 3. Government forces 4. Physical/Environmental forces. 1. Social Forces-The value of a property may be affected by: Total population It’s composition by age and gender The rate of household formation The rate of household dissolution etc 36  2. Economic Forces  The economic forces that can affect the value of a property are: Employment Wage level Industrial expansion Economic base of the region and the community Price level The cost and availability of mortgage credit The stock of available vacant and improved property New development under construction Occupancy rate The rental and price pattern of existing properties Construction cost etc. 37  3. Government Forces  The value of a property can be affected by political and legal activities at all levels of the government.  Some of the factors which may affect the value of a property are: Public services such as fire and police protection, utilities, refuse collection and transport network Local zoning, building codes National, state and local fiscal policies Special legislations that affect value, such as legislation affecting the type of loans, loan terms, and investment power of mortgage lending institutions. 38  4. Physical/Environmental Forces  There are many natural and man made physical or environmental factors that affect the values of a property. These are: Location Climatic conditions such as rain fall, snow, temperature, humidity Topography and soil type Natural barriers to future development such as rivers, mountains, lakes, oceans Transportation systems Toxic contaminants The nature and desirability of the immediate area surrounding the property 39  Foundations/Principles of Valuation  The major principles that govern property valuation are: Progression: A property’s value may increase due to the existence of similar properties in similar locations, containing greater quality. Regression: A property’s value may decrease due to the existence of similar properties in similar locations, containing lower quality. Conformity: A property is most likely to appreciate in value along with other, similar properties in the same neighborhood. If the neighborhood consists of 2,000 square feet, three- bedroom, two-bath homes 10 years old, improving property above that standard may not be profitable. 40  Cont…  Substitution: A property’s greatest potential market value is limited by the market value of other similar properties.  A prudent purchaser would pay no more for a home than it would cost him or her to build another one.  Change: No condition remains the same indefinitely; change is part of the economic cycle.  Property values are affected by change in several forces. These include Local economic and demographic trends, Physical age and condition of the property and surrounding properties, Character of a neighborhood or city, and Natural events like disasters 41  Cont…  Anticipation: Market value often is affected by expectations about future events.  For example, if an investor believes that a particular area is likely to experience growth in the coming years, that would mean property value would rise in that area.  If rezoning is proposed in an area, properties in the affected area could experience rise or fall in property value in anticipation of the change.  Contribution: Improvements add to market value of a property as a factor of current supply and demand, and not necessarily on the basis of actual cost. 42  Cont…  For example, a swimming pool which costs 10,000 birr to install may not necessarily increase the value of the residential property by 10,000 birr. The contribution of the swimming pool to the value of the property may be higher than its cost, Equal to its cost, or Lower than its cost depending on current demand and supply of residential property in that area.  Plottage: Land values tend to increase when adjacent lots are combined into single ownership and put into a single zoning or use.  Highest and best use: real estate valuation is maximized when land is utilized in the best possible way. 43  Cont…  To reconcile a property's highest and best use, the appraiser must answer the following four questions:  Is the use physically possible-suited to the size, shape, and terrain of the parcel?  Is the use legally permissible-conforming to zoning, private restrictions, environmental regulations, and other governmental controls?  Is the use financially feasibie-resulting in a positive net return to the property?  Is the use maximally productive-producing the highest rate of return or highest value for the property? 44  Cont…  Competition: Opportunities for profitable investment lead to competition. That means profit tends to increase competition among sellers.  Balance : The principle of balance relates both to the property as well as the environment in which the property is located.  In property itself, balance means that the highest market value will result when the size and type of improvements are proportional to each other as well as the land.  Externalities: the principle of externalities holds that factors external to the property can have either positive or negative effect on its value. 45  Myths of property valuation  Property valuation is a complex process, and there are several myths and misconceptions surrounding it.  Understanding these common misconceptions can help property owners, buyers, and valuers make more informed decisions and better navigate the complexities of property valuation.  Some myths associated with property valuation:  Myth 1. A well-researched and well-done valuation is timeless  Reality: The value obtained from any valuation model is affected by market-wide information.  As a consequence, the value will change as new information is revealed.  Given the constant flow change of the financial and real estate markets, a valuation done on property ages with time, and has to be updated to reflect current information 46  Cont…  Myth 2. A good valuation provides a precise estimate of value  Reality: Even at the end of the most careful and detailed valuation, there will be uncertainty about the final numbers, coming from the assumptions that we make about the future of the company and the economy.  It is unrealistic to expect an absolute certainty in valuation, since there will always be a certain bias in estimation of future cash flows and discount rates.  This means that you have to give yourself a reasonable margin for error in making valuations. 47  Cont…  Myth 3: The appraised value of a property will vary, depending upon whether the appraisal is conducted for the buyer or the seller.  Reality: The appraiser has no vested interest in the outcome of the appraisal and should render services with independence, objectivity and impartiality - no matter for whom the appraisal is conducted.  Myth 4: Market value should approximate replacement cost.  Reality: Market value is based on what a willing buyer likely would pay a willing seller for a particular property, with neither being under pressure to buy or sell.  Replacement cost is the money amount required to reconstruct a property in-kind 48  Cont…  Myth 5: You generally can tell what a property is worth simply by looking at the outside of the property.  Reality: Property value is determined by a number of factors, including location, condition, improvements, amenities, and market trends  Myth 6: An Appraisal is the same as a home inspection.  Reality: An Appraisal does not serve the same purpose as an inspection.  The Appraiser forms an opinion of value in the Appraisal process and resulting report.  A home inspector determines the condition of the home and its major components and reports these findings. 49  o u! k Y h a n T 50