Value and Its Factors PDF
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This document is an overview of value, price, and cost factors as they relate to property valuation. It discusses the concept of value and how outside factors influence its determination.
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Value and Its Factors Value vs. Price vs. Cost ○ Value Depends on when, how, and to whom you're buying or selling a property. How much something is worth now, based on its future benefits Not a fixed fact b...
Value and Its Factors Value vs. Price vs. Cost ○ Value Depends on when, how, and to whom you're buying or selling a property. How much something is worth now, based on its future benefits Not a fixed fact but a guess or estimate of what a property, good, or service will be worth in the future. It’s not a set amount—it depends on the situation. Basis of Value When valuing something, you need to explain how you're measuring the value; whether for today or in the future, whether how it will be used. Always clarify which type of value you’re talking about—whether it’s the market value, investment value, or something else. Market Value It’s the price a property could sell for based on similar properties in the area, not only for its physical condition but for its utility as well. ○ Price The amount that either the buyer is willing to pay, or the seller is asking for a product or service, based on their agreement in a specific situation. Finalized once the transaction happens, making the sale price a historical fact, whether kept public or private. May or may not be related to value as the situation affects the agreement of the price. Intersection of supply and demand. ○ Cost The price paid or the amount used to produce something. After buying or producing something, the amount spent is final, making it a historical fact that doesn’t change. When you buy something, the price you pay is now the cost of that thing for you. Reproduction Cost Amount to make an exact copy of something, using the same materials and methods as the original. Replacement Cost Amount to make something similar using modern materials and technology that would still serve the same purpose. ○ Market Where the trade happens, may be local, regional, national, or international. In a market, everyone can freely trade without too many rules stopping them, as long as they follow the basic laws. Factors that Influence Value ○ Utility Key criterion. The usefulness of a property; how well it satisfies human wants, needs, or desires. The more useful something is, the more valuable it can be. Relative, depends on the person and situation. Long Term Assessment, usually measured by how long a property will last or its potential. Some properties are more useful when used alone, while others work better when used with other properties. Amenity A benefit that makes a property more attractive or enjoyable but isn’t essential to using it, may be natural or man-made. ○ Scarcity Supply-related. If something is rare or hard to find, it can be more valuable. When there’s less of something, people often want it more. ○ Desire Demand-related. How much people want something. If many people want it, the value goes up. ○ Effective Purchasing Power Whether people can actually afford to buy something. Even if something is useful, rare, and wanted, its value depends on if people can pay for it. Supply How many properties are available in a given market at a given time. Demand How many people want or are interested to purchase a property in a given market at a given time. Valuation Definition ○ Process of estimating a property's value based on research, analysis, and reasoning, resulting in a valuation report. ○ Formal vs. Informal Formal When you estimate using careful and methodological use of data, often comes with a written report from a professional. Informal When you estimate the value of something through quick judgment or gut feeling based on general knowledge and experience. ○ Valuer’s Role Figure out what would happen if the property were exposed to the market, even if the market seems irrational. They just report what the market is actually doing. Acceptance of Instructions Before taking a job, a valuer must understand the task, have the right skills, and if working internationally, ensure they can team up with someone who knows the local market and laws. ○ Valuation Report Communicates the processes undergone and the conclusions. Truths Against Myths ○ Myth 1: A valuation is an objective search for “true” value Truth 1.1: All valuations are biased. The only questions are how much and in which direction. Truth 1.2: The direction and magnitude of the bias in your valuation is directly proportional to who pays you and how much you are paid. ○ Myth 2: A good valuation provides a precise estimate of value. Truth 2.1: There are no precise valuations. Truth 2.2: The payoff to valuation is greatest when valuation is least precise. ○ Myth 3: The more quantitative a model, the better the valuation. Truth 3.1: One’s understanding of a valuation model is inversely proportional to the number of inputs required for the model. Truth 3.2: Simpler valuation models do much better than complex ones Real Estate Federations ○ International International Valuation Standards Council (IVSC) The International Real Estate Federation (FIABCI) The International Federation of Surveyors (FIG) ○ Regional The Union of Pan-American Valuation Organizations (UPAV) The Royal Institution of Chartered Surveyors (RICS) The Appraisal Institute (AI) The European Group of Valuers’ Associations (TEGoVA) Valuation as Profession ○ Why? Variety. Money. Sociability. Travel. Lifestyle. ○ How is it used? Selling properties at market value. Updating a buy-sell agreement. Developing an estate plan or tax plan to protect your wealth Valuation Process ○ Definition of the Assignment Identify Property Knowing which property is being valued, wherein property meant ownership in legal terms. Four general property types, based from IVSC: ○ Real Property (GN 1) ○ Personal Property (GN 3, 4, 5) ○ Businesses (GN 6) ○ Financial Interests Identify Property Rights Understanding the set of legal rights related to the property. Restriction on Ownership states that all estates are subject to the four powers of government: ○ Taxation (assessment) ○ Eminent domain (compulsory purchase) ○ Police power (zoning regulations) ○ Escheat (government appropriation) Use of the Valuation Knowing how the valuation will be used. Define Value Value is the price that buyers and sellers are likely to agree on when trading a good or service. Types: ○ Market Value Estimated Price: The amount someone thinks the property will sell for. Property or Asset: What is being sold or exchanged. Valuation Date: The time at which the price is estimated. Willing Buyer and Seller: Both parties must want to buy or sell. Fair Deal: Neither party should be forced to sell or buy. Proper Marketing: The property should be advertised or listed correctly. Informed Parties: Both buyer and seller should have enough knowledge to make a good decision. Sensible Actions: Both buyer and seller should act reasonably. No Pressure: Neither side should feel forced to make the deal. ○ Non-Market Value Value in Use: The value of a property for a specific use by a particular user. Investment Value: The value of a property to an investor based on their investment goals. Going Concern Value: The value of a business as a whole, rather than its individual parts. Insurable Value: The value defined by an insurance contract or policy. Assessed or Taxable Value: Value determined by laws for assessment or taxation purposes. Salvage Value: The value of a property’s materials if sold for disposal, excluding land. Liquidation or Forced Sale Value: The value from a sale within a short time frame, lower than market value. Special Value: Extraordinary value above market value. Mortgage Lending Value: Value determined by assessing long-term sustainability, market conditions, and current or alternative uses. Disclosure Requirements ○ A Statement of Contingent and Limiting Conditions must be included in reports for valuations based on criteria other than Market Value. ○ This statement should not justify unreasonable departures from established standards. ○ Unreasonable assumptions cannot be made, even when performing a valuation on a basis other than Market Value, if facts can be verified at the valuation date. ○ All assumptions used in the valuation must be disclosed in the report. Date of Value Determining the specific date the value should apply to. Scope of the Assignment Understanding the boundaries of the task, what is included and excluded. Other Limiting Conditions Valuations may be constrained by: Clients, the Valuer, and Local statutes Outside Assistance ○ A Valuer must ensure that any external help has the required skills and ethical standards. ○ Client consent is needed when outside assistance is used. ○ The identity and role of external assistants must be disclosed in the Valuer’s report. ○ Preliminary Analysis and Data Selection and Collection Valuers don't directly determine the value of a property; the market does. Valuers interpret and convert market data into usable information for valuation purposes. Different types of property require different data. ○ Highest and Best Use Most profitable or valuable use of a property, which is Physically possible (can be done on the property), Legally permissible (allowed by laws and zoning regulations), Financially feasible (makes sense economically), Appropriately justified (based on demand or market conditions), Results in the highest value (brings the most profit or value). Key Questions: Is the suggested use a reasonable and likely one? Is the use legal, or is there a reasonable likelihood that a legal entitlement for the use can be obtained? Is the property physically suited to the use or can it be adapted to the use? Is the suggested use financially feasible? Of those uses that meet the above tests, is the selected HABU the most productive use? Physical Similarities vs. Use Differences Even similar properties can have different best uses due to factors like zoning laws or location. Importance for Market Value Knowing the highest and best use (HABU) is key to determining market value. Once the best use is identified, comparable properties are used to set the value. Foundation for Comparables After identifying the HABU, valuers compare the property with similar ones sold or leased for the most profitable uses. ○ Application of the Approaches to Value Sales Comparison Approach Income Capitalization Approach Cost Approach ○ Reconciliation of Value Indicators and Final Value Estimate Reconciliation Process Determining the final value of a property after considering different valuation methods. What to consider: ○ Definition of specific type of value. ○ Purpose and intended use of the valuation. ○ Relevant information as of the valuation date. ○ Value estimates from valuation methods Valuation Conclusions Different valuation methods may provide different estimates of value. Each method has strengths and weaknesses, so all methods need to be considered in the reconciliation process. Conclusion of Value: Final value conclusion is determined by carefully considering the results from all valuation methods used. Appraiser may: ○ Assign weights to each method. This means giving more importance to the methods that are more relevant or reliable for the specific property. ○ Use only one method. If one method is deemed the most accurate for the type of property being valued, it may be used exclusively. ○ Apply valuation discounts. Sometimes, adjustments like marketability discounts are applied if the property is hard to sell or if there are other factors that reduce its value (e.g., a property that can’t be easily sold in the market might be worth less due to its illiquidity). ○ Report of Defined Value Final step in the valuation process, where the findings, analyses, opinions, and conclusions from the valuation are formally communicated IVS 3, Valuation Reporting Guidelines for creating the valuation report and ensures the process follows ethical standards. Compliance Statement The report must include a statement confirming that the valuer has adhered to the ethical and professional requirements set by the IVS Code of Conduct. This statement helps ensure that the process has been conducted in a fair, unbiased, and professional manner. Disclosure Transparency ○ The report must clearly communicate the analyses, opinions, and conclusions, ensuring no misleading information and disclosing factors that may impact objectivity. Clear Description ○ It should outline the scope, purpose, and intended use of the valuation, and disclose any assumptions, hypothetical scenarios, or limitations. Potential Conflicts of Interest ○ Any relationships that may cause bias must be disclosed. Internal/External Valuer ○ If the valuer is an employee or has worked with the client before, this must be mentioned. Limitations ○ Any service limitations, whether external or internal, must be disclosed. Third-Party Assistance ○ The identity and role of any external assistants must be mentioned. Publication Restrictions ○ A restriction against publishing the valuation without the valuer's consent should be included. Departure from IVS ○ Any deviations from International Valuation Standards must be disclosed. Minimum Content of the Report Identification of the valuer and confirmation of competence Identification of the client and any other intended users Purpose of the valuation Identification of the asset or liability to be valued Basis or bases of value Valuation date Extent of investigation Nature and source of the information to be relied upon Assumptions and any special assumptions Restrictions on use, distribution or publication Confirmation that the valuation will be undertaken in accordance with the IVS Valuation approach and reasoning Amount of the valuation or valuations and the applicable currency Date of the valuation report Data for Valuation Types of Data ○ General Data Information about external factors influencing value, such as social, economic, governmental, and environmental forces. Economic Trend International Economic Trends ○ In the global economy, the economic well being of one nation may directly and indirectly affect other nations. ○ Indicators: Trade balance, foreign exchange rates, commodity prices, and wages. National and Regional Economic Trends ○ The state of the national economy is basic to any real estate appraisal, reflecting the economic condition of the various geographic regions in a country. ○ Indicators: Gross Domestic Product (GDP), employment rates, housing starts, and interest rates. Local Market Considerations ○ Local trends are more likely to influence property values directly than regional trends. ○ Indicators: Population growth, job stability, wage rates, and household income. Trends Affecting Rural Land ○ Factors like climate, weather, and rural land usage, affects property values in rural areas. ○ Indicators: Business size, farming technology, government subsidies, and competition from imports. Demographics The population of a market and its geographic distribution are basic determinants of the need for real estate. Real estate is built or improved based on the demand from people who can afford it. Demand for housing is characterized by the age, size, income, and other characteristics of households. As the population changes, and technological advances happen, the types of properties people need also change. Two Types of Demographic Demand for Space ○ Households generate demand for space for basic human needs such as housing. ○ Employment generates demand for space used in producing goods and services. Government Regulations Zoning laws, environmental regulations, and transportation planning all impact the use and value of real estate. Trends in Building Activity Building Costs Taxes Property taxes are based on assessed values, ad valorem (“according to value”) taxes, which may not be exactly the same as market value. Financing Depends on the borrower’s ability to qualify for a loan. The cost and availability of loans affect the real estate market. When interest rates are high, borrowing becomes harder, reducing demand for property. ○ Specific Data Details about the property being appraised, comparable sales and rental properties, and relevant local market characteristics ○ Competitive Supply and Demand Data Market data helping the appraiser estimate current and future trends. Data Collection ○ Basic Steps List required data and its sources. Collect data on the property's highest and best use. Gather regional, city, and neighborhood data, not just a site inspection. Collect specific data on the property, including location, lot, and nearby buildings. Gather data for each appraisal technique, including sales, cost, and income/expense data for similar properties. ○ Sources For General Data: Government Publications: Housing, demographics, construction, zoning, and forecasts. Trade Associations & Research Firms: Industry news, reports, and directories. Internet: Key tool for data research. For Specific Data: Public Records: Deeds, recorded leases, and assessor offices in some countries. Newspapers: Advertised sale prices and rentals. Multiple Listing Services (MLS) and Cost-Estimating Manuals. Market Participants: Brokers, lenders, contractors, owners, and tenants. National Property Databases Google Tools: Useful for generating real estate referrals and leads, with the highest number of real estate searches. For Competitive Supply and Demand: Field Inspections: Inventory competitive properties in the market area. Interviews: Engage with owners, managers, brokers, developers, and city planners. Building Permits & Plat Maps: Examine permits and maps for insights into future supply. Proprietary Data: Access data on vacancy, absorption, and turnover rates from research firms. Demographic & Economic Data: Use population, employment, and income statistics to estimate demand. Personal Observation: Observe local changes (e.g., new roads) to gauge demand. ○ Geographic Information System (GIS) A computer-based system for collecting, managing, analyzing, and displaying geographic data. Purpose: Burrough (1986): A tool for collecting, storing, and displaying location data. Aronoff (1989): Handles geo-referenced data through input, management, manipulation, and output. Importance: Tracks where things happen (location-based data). Identifies patterns and relationships in data to solve real-world spatial problems. Benefits Improved Efficiency: Increases productivity, reduces workforce needs. Reduced Costs: Saves money through better resource management and improved transportation. Income Increases: Enhances customer and property tracking, enables new products/services. Data Organization ○ Without organization, it's hard to make sense of the information. ○ Organizing large data through systems like adjustment grids or spreadsheets for easy comparison. ○ Units of Comparison Appraisers break the information down into smaller, easier-to-compare units. ○ Grid Analysis Organizes data in a grid to show adjustments for attribute differences. Goal To determine the value of the subject property relative to existing lots by comparing it to their prices and valuation factors. Procedure Identify and tabulate the sale price of the comparable lots and their characteristics based on valuation factors. Disregard first the sign for the adjustment factors. Now, how to identify the sign is based on whether your subject property is superior or inferior relative to the comparable lot. In any comparison approach, you want your comparison variables to be of equal footing, it’s like you want to normalize your data so that you could compare them properly. You’re adding or subtracting value to the comparable lot because you want to account for the superiority or inferiority of your subject property. You’re adjusting it to the level of your property. ○ If your subject property is superior, or if the comparable lot is inferior, the adjustment factor is additive. ○ If your subject property is inferior, or if the comparable lot is superior, the adjustment factor is subtractive. Adjust the pricing of the comparable lots by multiplying its sale price to the sum of the adjustment factors. ○ Example: Your subject property has a pool, while the comparable lot doesn’t. Therefore, your subject property is superior in terms of value. If the comparable lot is priced at 1000, and has an adjustment factor of 10%, then the computation would be: 1000 x (+)10% = 1000 x (1.1) = 1100 ○ This tells us that if the comparable lot also has a pool, it would be priced at 1100 instead of just 1000. Since you already accounted for the factors for both lots, you can now compare them properly. Lastly, to determine the value of the subject property, get the weighted average. You apply weights to each adjusted price of the comparable lots by multiplying it. Then, you sum up the results and divide by the sum of the weights to get the final value of your subject property. ○ Graphic Analysis Uses graphs to show trends and price patterns, but only with sufficient data. Valuation Approaches Valuations, whether estimating market or non-market value, require applying one or more valuation approaches Valuation Methods ○ Cost Approach Contractor’s Method Figuring out how much a property is worth based on how much it would cost to build a new one; useful when there aren't enough recent sales of similar properties. Summary of Procedure: Value of the land Current cost of constructing buildings Estimate depreciation, or any loss in value, from ○ Physical deterioration Caused by wear and tear, regular use, and exposure to the elements, leading to a loss in value. ○ Functional obsolescence Loss of desirability as it becomes outdated or less useful due to a design flaw or because it doesn't meet the current needs or standards. ○ External obsolescence Loss of desirability caused by things outside the property that make it less valuable, such as changes in the economy, new laws, or nearby developments. Subtract depreciation from Cost Add land value to result from previous step Formula: Property Value = Land Value + Reproduction Cost − Depreciation Cost-Estimation When using this method, the appraiser estimates the cost of improvements as of the appraisal date, by considering direct and indirect costs. Direct Cost ○ Costs directly involved in building the property, including materials, labor, and contractor’s profit. Indirect Cost ○ Related to the construction process but aren't part of the building itself, including overhead and other fees necessary for the project. ○ Total indirect costs are often estimated as a percentage of direct costs. ○ Entrepreneurial Profit Profit a developer expects for taking on the risk of the project. Market Value - Total Cost of Development Traditional Methods: ○ Comparative-Unit Through comparison with similar projects, with cost per unit area. Unit costs decrease as the size of the building increases (larger buildings generally cost less per square meter to build). ○ Unit-in-Place Through adding up the cost of each individual component installed. ○ Quantity-Survey Most detailed and accurate method, where all materials, labor, and quantities are calculated individually, but is time-consuming and expensive. ○ Direct Market Comparison Approach Values a property by comparing it to similar properties that have recently been sold or are listed for sale. Principle of substitution states that a buyer will not pay more for a property than it would cost to buy a similar one. Adjustments are made to account for differences in features, size, or condition between the properties for fair and true value comparison. ○ Income Approach Land Residual Technique A way of estimating the value of land by looking at its income potential. Procedure ○ Consider the income the property generates (e.g., rent or business profit) and subtract related expenses (e.g., maintenance, management). ○ Then, subtract the required return on improvements (like buildings or structures) based on their value. ○ The remaining income after deducting improvement costs is considered the income generated by the land itself—this is the residual income. ○ Convert the residual income into a land value using a capitalization rate (a percentage indicating how much income the land generates relative to its value). Applicability ○ Only in testing the feasibility of alternatives uses a particular site in highest and best use analysis or when land sales are not available. Limitations ○ Speculative and can be unreliable because it requires multiple assumptions, such as: The value of the building is known or can be estimated. The net operating income (income after expenses) can be estimated. Market data for both building and land capitalization rates are available. Ground Rent Capitalization When the land can independently generate rental income, wherein the rental income is capitalized (converted into a present value) to estimate the market value of the land, provided there is enough market data. Procedure ○ A market-derived capitalization rate is applied to the ground rent of the property to calculate its value. Applicability ○ When you can find comparable rents and rates from the analysis of similar leased land sales. Limitations ○ Special Lease Terms Ground leases may have special terms that aren't representative of the general market. These terms could distort the market value if not considered carefully. ○ Outdated Rent Rates: Ground leases might have been signed many years ago, and the rents in those agreements could be outdated. Current market conditions may differ significantly. ○ Capitalization Rate Issues: It can be difficult to obtain accurate capitalization rates based on current market conditions, which can affect the accuracy of the value estimate. ○ Adjustment for Property Rights: If the current rent under the ground lease doesn't match market rent, an adjustment may be needed to reflect the property rights accurately. Steps: Calculate the land value using direct capitalization. ○ Income from Land = Land Value x Land Capitalization Rate Determine the value of the improvements. ○ Return Generated by Improvement = Land Value - Income from Land ○ Direct Capitalization of Improvement = Return Generated by Improvement/Capitalization Rate for Improvement Calculate the total subject property value ○ Total Subject Property Value = Land Value + Direct Capitalization of Improvement