Qualifying the Property PDF

Qualifying the 9 Property Learning Objectives After completing this lesson, students should be able to… Explain the role of an appraisal in determining a property’s market value Describe how loan-to-value ratios affect the lender’s ri...

Qualifying the 9 Property Learning Objectives After completing this lesson, students should be able to… Explain the role of an appraisal in determining a property’s market value Describe how loan-to-value ratios affect the lender’s risk List the steps in the appraisal process Discuss the three basic methods for estimating a property’s value: sales comparison, replace- ment cost, and income Define the five elements that are considered when evaluating a property’s suitability as a comparable Understand the difference between replacement cost and reproduction cost List the three different types of depreciation Calculate a property’s value using a gross income multiplier Prevent and/or respond to problems caused by a low appraisal Suggested Lesson Plan 1. Give students Exercise 9.1 to review the previous chapter, “Qualifying the Buyer.” 2. Provide a brief overview of Chapter 9, “Qualifying the Property,” and review the learning objectives for the chapter. © 2018 Rockwell Publishing  Financing Residential Real Estate Instructor Materials 3. Present lesson content: Lender’s Perception of Value – Appraisals and loan-to-value ratios Appraisal Standards The Appraisal Process EXERCISE 9.2 Appraisal process Appraisal Methods – Sales comparison method EXERCISE 9.3 Sales comparison method – Replacement cost method – Income method – Final value estimate EXERCISE 9.4 Types of depreciation Dealing with Low Appraisals – Preventing low appraisals – Request for reconsideration of value EXERCISE 9.5 Dealing with low appraisals 4. End lesson with Chapter 9 Quiz. Chapter 9 Outline: Qualifying the Property I. The Lender’s Perception of Value A. An underwriter will evaluate the property based on an appraisal: an estimate of the value of a property, performed by a professional appraiser B. An appraiser will focus on market value: the most probable price a property should bring in a competitive and open market where the parties act knowledgeably and without undue stimulus C. The lender focuses on the loan-to-value ratio: the relationship between loan amount and the property’s value 1. A higher LTV creates greater risk for a lender, since a buyer with a smaller down- payment is more likely to default 2. The LTV is based on either the sales price or the appraised value, whichever is lower 3. Lenders may be willing to make high-LTV loans but usually impose stricter qual- ifying standards to compensate for the higher risk 2  Chapter 9: Qualifying the Property II. Appraisal Standards A. To prevent unreliable appraisals, the federal government requires states to license and certify appraisers who perform appraisals for “federally related” loan transactions B. Some states require that all appraisers be licensed or certified C. Inflated appraisals played a role in the most recent mortgage and financial crisis; as a result, appraisal standards have been strengthened at both the federal and state level III. Appraisal Process A. There are eight steps in the appraisal process: defining the problem, determining the scope of work, collecting and verifying data, analyzing data, determining site value, applying the appropriate methods of appraisal, reconciling the results to arrive at a final value estimate, and issuing the appraisal report B. In some situations, an appraiser may perform an exterior-only inspection (“drive-by appraisal”) rather than a full inspection of the property, although this has become less common 1. Interior inspection required for FHA, VA, and higher-risk conventional loans EXERCISE 9.2 Appraisal process IV. Appraisal Methods A. Sales comparison method 1. Appraisers using the sales comparison method rely on the sales prices of compa- rable properties to estimate the value of the subject property 2. The sales comparison method uses the same principles as a competitive market analysis, although a CMA can use data from current listings and expired listings 3. To determine whether a recently sold property is comparable, an appraiser considers: the date of the sale, the location of the property, the physical character- istics of the property, the terms of sale, and the conditions of the sale 4. The sale should have occurred within the previous six months, although the ap- praiser may adjust the sales price for changes in value if the property was sold in a volatile market; older sales may be used in slow-moving markets 5. Comparable properties should be located in the same neighborhood and have similar size, design, and quality as the subject property 6. Comparable properties must have sold under normal market conditions: the buyer and seller are unrelated parties, fully informed and acting free of unusual pres- sure, and the property was on the open market for a reasonable period of time 7. If there are differences between the subject property and comparables, the ap- praiser may adjust the sales price of the comparables to reflect what they would have sold for were they more similar to the subject property 8. The appraisal report should include information about current market conditions; an addendum form may be used to supplement this information EXERCISE 9.3 Sales comparison method 3  Financing Residential Real Estate Instructor Materials B. Replacement cost method 1. There are three steps in the replacement cost method: estimating the cost of re- placing the improvements, deducting any depreciation, and adding the value of the land 2. The appraiser usually relies on the replacement cost (the cost of constructing a new building with equivalent utility) rather than the reproduction cost (the cost of building an exact replica using the same materials and techniques) 3. The easiest way to estimate the construction cost is the square foot method, in which the appraiser multiplies the estimated cost per square foot by the square footage of the building 4. There are three types of depreciation that must be estimated: physical deteriora- tion, functional obsolescence, and external obsolescence 5. Depreciation may be considered curable or incurable, depending on whether cor- recting the problem adds more value than the cost of the repair; curable physical deterioration is known as deferred maintenance 6. An appraisal may be “as is,” which means the appraisal is based on the property in its current condition, or “subject to,” which means the appraisal is based on the property as if all deferred maintenance was cured C. Income method 1. Value under the income method is calculated by dividing a property’s annual net income by the rate of return an investor would expect from the property 2. For residential rental properties, an appraiser will use a simplified version of the income method called the gross income multiplier method 3. The appraiser finds value by multiplying the property’s rent by a multiplier indi- cated by the relationship between other properties’ rents and values 4. An appraiser should use the property’s economic rent (the rent the owner would receive if the property were currently available) rather than contract rent (the rent the owner currently receives) D. Final value estimate 1. The appraiser will reconcile the values indicated by the various appraisal methods to arrive at a final estimate of value 2. The result is not an average of the figures; the appraiser may give more weight to certain methods based on the type of property EXERCISE 9.4 Types of depreciation V. Dealing with Low Appraisals A. A low appraisal can terminate a transaction, since the lender will adjust its loan amount based on the property’s appraised value, requiring the borrower to come up with a larger downpayment 4  Chapter 9: Qualifying the Property B. A real estate agent can seek to prevent low appraisals 1. An agent should use a CMA to help the seller price the property correctly 2. The agent should avoid including personal property as part of the sales price C. If a low appraisal occurs, an agent may request a reconsideration of value by provid- ing the lender with alternate comparables that suggest a higher value for the subject property EXERCISE 9.5 Dealing with low appraisals Exercises EXERCISE 9.1 Review exercise To review Chapter 8, “Qualifying the Buyer,” have students answer the following questions. 1. What are the three main categories regarding a person’s financial situation that an underwriter will consider? 2. Income is considered to have three dimensions. What are they? 3. Which of the following would be included in a loan applicant’s stable monthly income? Wages from temporary employment Social security benefits Year-end bonuses that have been received for ten years Self-employment income from a business started this year Dividends from investments Unemployment compensation 4. How is the net equity in a property calculated? Answers: 1. Credit reputation, income, and net worth 2. Quantity, quality (dependability), and durability (probability of continuance) 3. Stable monthly income: social security; bonuses for ten years; dividends Not stable monthly income: wages from temporary employment; self-employment income from new business; unemployment compensation 4. Start with market value, then subtract any liens and selling expenses 5  Financing Residential Real Estate Instructor Materials EXERCISE 9.2 Appraisal process Discussion Questions: 1. A lender is willing to make a loan with an 80% LTV. The sales price is $210,000. The appraised value is $200,000. What is the maximum loan amount? 2. On the board, write the eight steps in the appraisal process in an incorrect order, as in the example below, then ask the students for the correct order. Collect and verify data Apply appraisal method(s) Issue appraisal report Determine site value Define the problem Reconcile results to get final value estimate Determine scope of work Analyze data Answers: 1. Lenders base the maximum loan amount on the sales price or the appraised value, whichever is less. $200,000 × 0.8 = $160,000. 2. Correct order: Step 1 is Define the problem. Step 2 is Determine the scope of work. Step 3 is Collect and verify data. Step 4 is Analyze data. Step 5 is Determine site value. Step 6 is Apply appraisal method(s). Step 7 is Reconcile results to get final value estimate. Step 8 is Issue appraisal report. Here’s the list in the incorrect order given in the question, with the correct step numbers added: Collect and verify data: Step 3 Apply appraisal method(s): Step 6 Issue appraisal report: Step 8 Determine site value: Step 5 Define the problem: Step 1 Reconcile results to get final value estimate: Step 7 Determine scope of work: Step 2 Analyze data: Step 4 6  Chapter 9: Qualifying the Property EXERCISE 9.3 Sales comparison method Discussion Prompt: Indicate whether each of the following sales would be an appropri- ate comparable, and if so, whether any adjustment would be needed. 1. Sold 14 months ago and the market has been active since then 2. In same neighborhood as subject property, although almost half a mile away 3. Has two-car garage, while subject property has one-car garage 4. Seller financing included special incentives 5. Parties were related to each other Answers: 1. No – should not be used (in an active market, more recent sales should be available) 2. Yes – can be used 3. Yes – can be used, but adjustment will be needed 4. Yes – can be used, but adjustment will be needed 5. No – should not be used (price isn’t a reliable indication of market value) Activity: Ask students to evaluate their own house and the surrounding neighborhood as an appraiser might. (If they live in an apartment or condominium complex, they should examine a family member’s or friend’s house, if possible.) The “Key Considerations in a Sales Comparison Appraisal” list in the textbook can be used as a guide. For each item shown in bold type on the list, students should make some notes about that aspect of the house or the neighborhood. (A sentence or two for each one should be enough, and it isn’t necessary to use technical appraisal terminology.) To determine the square footage of the house (if they don’t already know it), they can measure its outside dimensions using a tape measure. EXERCISE 9.4 Types of depreciation Discussion Prompt: Which type of depreciation is at work in each of the following situ- ations? Is the depreciation likely to be considered curable or incurable? 1. Outdated kitchen appliances and bathroom fixtures 2. Economic distress in surrounding neighborhood 3. Roofing needs replacement 7  Financing Residential Real Estate Instructor Materials 4. Zoning changes allow new nearby industrial uses 5. Necessary to pass through living room to reach one of the bedrooms 6. Carpeting that’s in good condition but no longer in fashion Answers: 1. Functional obsolescence; curable 2. External obsolescence; incurable 3. Physical deterioration; curable 4. External obsolescence; incurable 5. Functional obsolescence; incurable 6. Functional obsolescence; curable EXERCISE 9.5 Dealing with low appraisals Match the correct term to each of the following statements. Personal property Appraiser Purchase price Comparable sales Loan officer Reconsideration of value ______ 1._An appraised value below this amount may place the transaction in jeopardy. ______ 2._An option that can be pursued after receiving a low appraisal, if evidence suggests a higher figure is appropriate. ______ 3._Including this in the purchase agreement, rather than selling it in a separate transaction, may lead to a low appraisal. ______ 4._Information a real estate agent can provide when asking an appraiser to reconsider his estimate of value. ______ 5._The person from whom an agent should request the addresses of the comparables used if an appraisal comes in low. Answers: 1. PURCHASE PRICE. A low appraisal (a valuation below the price agreed to by the buyer and the seller) can jeopardize completion of the transaction. 2. RECONSIDERATION OF VALUE. After a low appraisal, the parties and their agents may ask the lender for a reconsideration of value, to preserve the transaction. 8  Chapter 9: Qualifying the Property 3. PERSONAL PROPERTY. A sales price that covers personal property as well as the real property is likely to be higher than the appraised value, because appraisers don’t include personal property when they’re appraising real property. 4. COMPARABLE SALES. The appraiser may use the agent’s CMA when reconsidering a low appraisal. 5. LOAN OFFICER. The agent should obtain this information from the loan officer or underwriter, not the appraiser (who has a fiduciary relationship with the lender and cannot disclose this information). 9  Financing Residential Real Estate Instructor Materials Chapter 9 Quiz 1. A property’s maximum value is determined 6. Which of the following is not one of the three by the cost of obtaining an equally desirable basic methods of appraising real estate? property. This is known as the principle of: A. Income method A. anticipation B. Replacement cost method B. conformity C. Sales comparison method C. contribution D. Square foot method D. substitution 7. A key difference between an appraisal and a 2. Lenders will base the loan amount on the: competitive market analysis is that a CMA may A. appraised value use _____, while an appraisal may not. B. sales price A. current listings C. appraised value or sales price, whichever B. expired listings is less C. recent sales D. appraised value or sales price, whichever D. Either A or B is more 8. Which of the following is not one of the key 3. Which federal law requires appraisals used factors in determining whether a recent sale is in federally related loan transactions to be a suitable comparable? performed by state-licensed or state-certified A. Conditions of sale appraisers? B. Cost of construction A. Fair Credit Reporting Act C. Date of sale B. Financial Institutions Reform, Recovery, D. Location of property and Enforcement Act C. Real Estate Settlement Procedures Act 9. An appraiser should make adjustments to com- D. Truth in Lending Act pensate for inflationary or deflationary trends when using a comparable that sold in a market 4. Which of the following loans would be consid- with: ered the least risky to a lender? A. quickly falling prices A. $80,000 loan for a $100,000 property B. quickly rising prices B. $180,000 loan for a $200,000 property C. flat prices C. $255,000 loan for a $300,000 property D. Both A and B D. $380,000 loan for a $400,000 property 10. An appraiser finds that it would cost $380,000 5. Which of the following is the final step in the to construct an exact replica of the subject appraisal process? property. This is an example of: A. Apply the appropriate methods of ap- A. depreciated cost praisal B. replacement cost B. Define the problem C. reproduction cost C. Issue the appraisal report D. square footage cost D. Reconcile the results to arrive at a final value estimate 10  Chapter 9: Qualifying the Property 11. An older house has problems with peeling paint and warped siding. This is an example of: A. physical deterioration B. external obsolescence C. functional obsolescence D. incurable depreciation 12. The gross income multiplier method is appro- priate primarily when valuing a/an: A. single-family residence used as a rental B. ten-unit apartment building C. office complex D. owner-occupied single-family residence 13. The subject property rents for $1,500 per month. A nearby property rents for $1,450 and sold for $290,000. Another nearby property rents for $1,550 and sold for $310,000. What is the subject property’s most likely value? A. $290,000 B. $295,000 C. $300,000 D. $310,000 14. The process of analyzing value indicators from the various appraisal methods in order to arrive at a final value estimate is known as: A. extraction B. interpolation C. reconciliation D. regression 15. To help avoid a low appraisal, a real estate agent should: A. present sellers with a well-researched CMA B. help sellers set a realistic listing price for their home C. ignore the value of any personal property when suggesting a listing price D. All of the above 11  Financing Residential Real Estate Instructor Materials Answer Key 1. D. The principle of substitution states that 9. D. Markets with rapidly changing prices a property’s value cannot exceed the mean that all but the most recent of cost of obtaining an equally desirable comparables require an inflationary or property. deflationary adjustment. 2. C. The maximum loan amount is based 10. C. The reproduction cost of a building is on either the sales price or appraised the cost of building an exact replica. value, whichever is less. Most appraisers focus on the replace- ment cost, which is the cost of building 3. B. The Financial Institutions Reform, improvements with equivalent utility. Recovery, and Enforcement Act (or FIRREA) requires the use of a state- 11. A. Wear and tear that reduces the value of licensed or state-certified appraiser in a a property is considered to be physi- federally related transaction. cal deterioration. If the damage is not overly expensive to correct, the dete- 4. A. The loan with the lowest loan-to- rioration is considered curable (known value ratio (in this case, the 80% loan as deferred maintenance). of $80,000 for a $100,000 property) would be considered the least risky. 12. A. The gross income multiplier method is a variation on the income method 5. C. The final step in the appraisal process of appraisal and is generally used only is to issue the appraisal report, which when appraising residences used as lists the data and explains the reason- rentals. ing behind the final value estimate. 13. C. Both subject properties have gross rent 6. D. The square foot method is one particu- multipliers of 200 ($290,000 ÷ $1,450 lar method of estimating replacement = 200; $310,000 ÷ $1,550 = 200). cost, not a method of valuing property. Multiply the subject property’s rent by 200 to find its value ($1,500 × 200 = 7. D. A competitive market analysis may $300,000). include current listings or expired list- ings as well as recent sales. Appraisals 14. C. The process of reconciliation allows are limited to recent sales of compa- an appraiser to arrive at one final value rable properties. estimate out of the results of the vari- ous appraisal methods. 8. B. The cost of construction is not relevant to the sales comparison approach. The 15. D. All of these are steps a real estate five issues in identifying comparables agent can take to help avoid a low ap- are date of sale, property location, praisal. physical characteristics, terms of sale, and conditions of sale. 12  Chapter 9: Qualifying the Property PowerPoint Thumbnails Use the following thumbnails of our PowerPoint presentation to make your lecture notes. Financing Residential Real Estate Lesson 9: Qualifying the Property © 2018 Rockwell Publishing Introduction This lesson will cover: ⚫ lender’s perception of value ⚫ appraisal standards ⚫ the appraisal process ⚫ appraisal methods ⚫ how to deal with low appraisals © 2018 Rockwell Publishing Lender’s Perception of Value In addition to qualifying buyer, underwriter must qualify property being purchased. ⚫ Is property worth enough to serve as collateral for loan? © 2018 Rockwell Publishing 13  Financing Residential Real Estate Instructor Materials Lender’s Perception of Value Appraisal Evaluation of property for underwriting purposes is based on appraisal. ⚫ Appraiser analyzes property and prepares objective estimate of market value. © 2018 Rockwell Publishing Lender’s Perception of Value Appraised value & loan-to-value ratio Lender uses property’s appraised value to determine how much money to loan with the property as security. ⚫ Loan-to-value (LTV) ratio: expresses relationship between loan amount and property’s value. © 2018 Rockwell Publishing Lender’s Perception of Value LTV and risk Lower LTV = Lower Risk ⚫ Risk of default: ⚫ lower LTV = larger downpayment ⚫ borrower less likely to default ⚫ Risk of loss: ⚫ foreclosure sale proceeds more likely to cover debt © 2018 Rockwell Publishing 14  Chapter 9: Qualifying the Property Lender’s Perception of Value LTV and cost of loan Lenders tend to charge higher interest rates and loan fees on high-LTV loans. ⚫ Offsets additional risk for lender. © 2018 Rockwell Publishing Lender’s Perception of Value Maximum loan amount Lenders use LTVs to set maximum loan amounts. ⚫ Maximum LTV rules applied depend on type of loan. © 2018 Rockwell Publishing Lender’s Perception of Value Maximum loan amount Maximum loan amount for transaction based on: ⚫ sales price, or ⚫ appraised value, ⚫ whichever is less. © 2018 Rockwell Publishing 15  Financing Residential Real Estate Instructor Materials Appraisal Standards Accurate appraisal is essential element of loan underwriting. ⚫ If property overvalued: ⚫ loan amount larger than it should be ⚫ lender’s risk of loss is greater © 2018 Rockwell Publishing Appraisal Standards FIRREA In 1989, after S&L crisis, Congress passed Financial Institutions Reform, Recovery, and Enforcement Act. ⚫ FIRREA required states to pass appraiser licensing and certification legislation. © 2018 Rockwell Publishing FIRREA Rules for federally related loans Appraisals used in federally related loan transactions must be: ⚫ prepared by state-licensed or state- certified appraisers ⚫ in accordance with Uniform Standards of Professional Appraisal Practice © 2018 Rockwell Publishing 16  Chapter 9: Qualifying the Property FIRREA Rules for federally related loans Federally related loan: is one made by bank or savings and loan association that is regulated or insured by federal government. ⚫ Exemption for loans less than $250,000. ⚫ Some states have made licensing and certification mandatory for all appraisers. © 2018 Rockwell Publishing Appraisal Standards Mortgage crisis Despite reforms, inflated appraisals played significant role in mortgage crisis. New laws and regulations intended to: ⚫ improve accuracy of appraisals ⚫ make appraisers more independent, less influenced by lenders and brokers © 2018 Rockwell Publishing Appraisal Process Generally involves these steps: 1. define problem 2. determine scope of work 3. collect and verify data 4. analyze data 5. determine site value 6. apply appropriate appraisal methods 7. reconcile results 8. issue report © 2018 Rockwell Publishing 17  Financing Residential Real Estate Instructor Materials Appraisal Process Define problem Appraiser: ⚫ identifies subject property ⚫ determines purpose of appraisal ⚫ specifies “as of” date © 2018 Rockwell Publishing Appraisal Process Determine scope of work Scope of work includes: ⚫ information needed ⚫ type of analysis required ⚫ tasks involved © 2018 Rockwell Publishing Appraisal Process Collect and verify data Data required depends on type of property being appraised. Two general categories of data: ⚫ general data ⚫ specific data © 2018 Rockwell Publishing 18  Chapter 9: Qualifying the Property Appraisal Process Collect and verify data General data: information about factors outside subject property that affect property’s value. May include: ⚫ region’s economy ⚫ neighborhood information © 2018 Rockwell Publishing Appraisal Process Collect and verify data Specific data: information about subject property. May include: ⚫ site ⚫ house ⚫ other site improvements © 2018 Rockwell Publishing Appraisal Process Analyze data Analyzing data means judging relevance of each piece of data collected. © 2018 Rockwell Publishing 19  Financing Residential Real Estate Instructor Materials Appraisal Process Determine site value Site valuation: estimating value of subject property excluding value of any improvements. Vacant land: site value = property value © 2018 Rockwell Publishing Appraisal Process Apply appraisal methods Appraiser may apply up to three different appraisal methods. ⚫ Each method provides separate value indicator. © 2018 Rockwell Publishing Appraisal Process Reconcile results Reconciliation: appraiser weighs value indicators and decides on final estimate of property’s market value. © 2018 Rockwell Publishing 20  Chapter 9: Qualifying the Property Appraisal Process Issue appraisal report Last step is to prepare appraisal report, which presents value estimate and summarizes supporting data. © 2018 Rockwell Publishing Appraisal Process Property inspection Generally, appraisers gather data about property through in-person inspection. ⚫ A lender may consider exterior-only inspection (“drive-by appraisal”) adequate, or even allow property inspection waiver. ⚫ Less common after mortgage crisis. ⚫ Many loan types require in-person inspection of interior as well as exterior. © 2018 Rockwell Publishing Summary Value, Appraisal Process Market value Loan-to-value ratio (LTV) Maximum loan amount FIRREA Federally related loan transaction USPAP Scope of work General and specific data Site valuation Drive-by appraisal © 2018 Rockwell Publishing 21  Financing Residential Real Estate Instructor Materials Appraisal Methods Three ways to appraise real estate: ⚫ sales comparison method ⚫ replacement cost method ⚫ income method © 2018 Rockwell Publishing Appraisal Methods Sales comparison method Uses sales prices of comparables to estimate market value of subject property. ⚫ Preferred by appraisers. © 2018 Rockwell Publishing Sales Comparison Method Appraisal vs. CMA Competitive market analysis (CMA, also called broker price opinion or BPO): informal version of sales comparison method of appraisal. ⚫ Used by real estate agents. ⚫ May use current and expired listings as well as sales. ⚫ Appraisal only based on actual sales, not listings. © 2018 Rockwell Publishing 22  Chapter 9: Qualifying the Property Sales Comparison Method Identifying comparables Appraiser needs at least three good comparables. In choosing comparables, appraiser concerned with: ⚫ date of sale ⚫ location of property ⚫ physical characteristics of property ⚫ terms of sale ⚫ conditions of sale © 2018 Rockwell Publishing Identifying Comparables Date of sale More recent comparable sales provide more accurate reflection of current marketplace. ⚫ Sales should be within past 6 months. ⚫ In slow market, may have to use sales more than 6 months old and make adjustments. © 2018 Rockwell Publishing Identifying Comparables Location of sale Comparables should be from neighborhood where subject property is located. If none available: ⚫ appraiser can look in comparable neighborhoods, and ⚫ make appropriate adjustments. © 2018 Rockwell Publishing 23  Financing Residential Real Estate Instructor Materials Identifying Comparables Physical characteristics Comparable property should have physical characteristics similar to those of subject property. Comparable’s price adjusted: ⚫ down if subject property lacks feature ⚫ up if subject property has extra feature © 2018 Rockwell Publishing Identifying Comparables Terms of sale Appraiser must account for influence of terms of sale on price paid for comparable. USPAP requires appraiser to state whether market value estimate is stated in terms of: ⚫ cash, ⚫ cash-equivalent financing, or ⚫ other precisely defined terms. © 2018 Rockwell Publishing Identifying Comparables Conditions of sale Comparable reliably indicates value only if sale took place under normal conditions: ⚫ arm’s length transaction ⚫ both parties informed and free to act ⚫ property on open market for reasonable time © 2018 Rockwell Publishing 24  Chapter 9: Qualifying the Property Sales Comparison Method Adjustments Appraiser rarely can find three comparables exactly like subject property. Makes adjustments to account for differences in: ⚫ time ⚫ location ⚫ physical characteristics ⚫ terms of sale © 2018 Rockwell Publishing Sales Comparison Method Reconciliation Appraiser selects estimate of subject property’s value from within range established by adjusted selling prices of comparables. This process is called reconciliation. © 2018 Rockwell Publishing Sales Comparison Method Market conditions For most residential properties, appraiser report results using URAR form, which asks about supply and demand and market trends. Appraiser may also need to complete addendum reporting on foreclosures, which gives lender picture of local housing market. © 2018 Rockwell Publishing 25  Financing Residential Real Estate Instructor Materials Summary Sales Comparison Method Comparable sales CMA Date of sale Location Physical characteristics Terms of sale Conditions of sale Adjustments Market Conditions Addendum © 2018 Rockwell Publishing Appraisal Methods Replacement cost method Replacement cost method: based on premise that property’s value won’t exceed cost of replacing it. © 2018 Rockwell Publishing Replacement Cost Method Three steps Step 1: Estimate cost of replacing building and any other improvements on property. Step 2: Estimate and deduct any accrued depreciation. Step 3: Add value of lot to depreciated value of improvements. © 2018 Rockwell Publishing 26  Chapter 9: Qualifying the Property Replacement Cost Method Estimating replacement cost Replacement cost: how much it would cost to construct new building with equivalent utility. Reproduction cost: how much it would cost to construct exact replica of building at current prices. © 2018 Rockwell Publishing Replacement Cost Method Estimating replacement cost Comparative unit method (square foot method): simplest way to estimate replacement cost. ⚫ Get cost/sq. ft. for recently built comparables. ⚫ Multiply by number of sq. ft. in subject building. ⚫ Make appropriate adjustments. © 2018 Rockwell Publishing Replacement Cost Method Estimating depreciation Depreciation: loss in value from: ⚫ physical deterioration ⚫ functional obsolescence ⚫ external obsolescence © 2018 Rockwell Publishing 27  Financing Residential Real Estate Instructor Materials Estimating Depreciation Physical deterioration Physical deterioration: includes wear and tear or other damage that reduce value of property. © 2018 Rockwell Publishing Estimating Depreciation Functional obsolescence Functional obsolescence: loss in value due to inadequacies such as poor design or outmoded features. © 2018 Rockwell Publishing Estimating Depreciation External obsolescence External obsolescence: loss in value due to factors outside property: ⚫ deteriorating neighborhood, zoning changes, poor access to schools, shopping, employment ⚫ also called economic obsolescence © 2018 Rockwell Publishing 28  Chapter 9: Qualifying the Property Estimating Depreciation Curable or incurable Depreciation is either: ⚫ curable: cost of correcting could be recovered in sales price when property sold ⚫ incurable: cost of correcting too much to recover when property sold © 2018 Rockwell Publishing Estimating Depreciation Curable or incurable Physical deterioration or functional obsolescence may be curable or incurable. ⚫ Curable depreciation due to physical deterioration, a.k.a. deferred maintenance. ⚫ External obsolescence always incurable. © 2018 Rockwell Publishing Estimating Depreciation As is or subject to Appraisal submitted to underwriter in one of two ways: ⚫ “as is” ⚫ “subject to” © 2018 Rockwell Publishing 29  Financing Residential Real Estate Instructor Materials Estimating Depreciation As is or subject to “As is” appraisal: reports deferred maintenance, gives final value estimate for property in current condition. “Subject to” appraisal: reports what value would be if deferred maintenance were corrected. © 2018 Rockwell Publishing Replacement Cost Method Adding land value Last step in replacement cost method: ⚫ adding value of land to depreciated value of improvements ⚫ land value estimated by sales comparison method © 2018 Rockwell Publishing Summary Replacement Cost Method Replacement cost Reproduction cost Comparative unit (square foot) method Physical deterioration Functional obsolescence External obsolescence Curable and incurable depreciation Deferred maintenance As is or subject to © 2018 Rockwell Publishing 30  Chapter 9: Qualifying the Property Appraisal Methods Income method Income method: based on idea that relationship exists between income that property generates and its value. For single-family rental properties, appraisers use simplified version called gross income multiplier method. © 2018 Rockwell Publishing Income Method Gross income multiplier method With this method, appraiser looks at relationship between rental property’s income and price paid for property. May use annual or monthly multipliers: ⚫ Annual = Sales price ÷ Annual rental income ⚫ Monthly = Sales price ÷ Monthly rental income © 2018 Rockwell Publishing Gross Income Multiplier Method Choosing appropriate multiplier Appraiser locates at least 3 or 4 comparables. ⚫ Calculates annual or monthly multipliers for comparables. ⚫ Uses comparables’ multipliers as basis for selecting multiplier for subject. © 2018 Rockwell Publishing 31  Financing Residential Real Estate Instructor Materials Gross Income Multiplier Method Using multiplier to estimate value Finally, appraiser multiplies subject property’s rent by chosen multiplier to find property’s value. © 2018 Rockwell Publishing Gross Income Multiplier Method Economic rent vs. contract rent Appraiser should use subject property’s economic rent to calculate value. ⚫ Economic rent: rent property could generate in current market if it were available. ⚫ Contract rent: rent owner is actually receiving. © 2018 Rockwell Publishing Appraisal Methods Reconciliation & final value estimate Reconciliation: when applying more than one appraisal method, appraiser must analyze and interpret results to decide on final value estimate for subject property. © 2018 Rockwell Publishing 32  Chapter 9: Qualifying the Property Appraisal Methods Reconciliation & final value estimate Final value estimate: ⚫ not an average of value indicator figures ⚫ appraiser gives greater weight to more reliable value indicators © 2018 Rockwell Publishing Summary Income Method Income method Gross income multiplier method Annual multiplier Monthly multiplier Economic rent Contract rent Reconciliation Final value estimate © 2018 Rockwell Publishing Dealing with Low Appraisals Low appraisal: estimate of value below purchase price agreed upon between buyer and seller. ⚫ If sale contingent on financing, buyer may not have to complete the sale. ⚫ Low appraisal would mean smaller loan, bigger downpayment. © 2018 Rockwell Publishing 33  Financing Residential Real Estate Instructor Materials Dealing with Low Appraisals Possible solutions Possible solutions after low appraisal: ⚫ buyer pays over value ⚫ seller lowers price to appraised value ⚫ compromise price ⚫ request for reconsideration of value © 2018 Rockwell Publishing Dealing with Low Appraisals Preventing low appraisals Prevent low appraisal by helping seller price property correctly: ⚫ perform careful CMA ⚫ price personal property separately © 2018 Rockwell Publishing Preventing Low Appraisals Perform careful CMA Agent needs to be familiar with most comprehensive and accessible sources of information about sales and listings. © 2018 Rockwell Publishing 34  Chapter 9: Qualifying the Property Preventing Low Appraisals Price personal property separately Underwriting guidelines require appraisers to exclude value of personal property from final value estimate. ⚫ Value of fixtures is included. © 2018 Rockwell Publishing Dealing with Low Appraisals Request for reconsideration of value When appraisal comes in low: ⚫ ask lender for information ⚫ evaluate appraisal ⚫ update CMA ⚫ submit request for reconsideration only if lender likely to grant it ⚫ don’t do anything to encourage a specific value outcome (prohibited by federal law) © 2018 Rockwell Publishing Dealing with Low Appraisals Request for reconsideration of value Ask loan officer for: ⚫ final value estimate ⚫ value indicated by sales comparison method ⚫ addresses of comparables used by appraiser © 2018 Rockwell Publishing 35  Financing Residential Real Estate Instructor Materials Dealing with Low Appraisals Request for reconsideration of value Some lenders have their own form for requests for reconsideration. If not, present your information in same format used in “Sales Comparison Analysis” section of URAR form. Include cover letter. © 2018 Rockwell Publishing Summary Dealing with Low Appraisals Low appraisal Financing contingency CMA Personal property Fixtures Request for reconsideration of value © 2018 Rockwell Publishing 36