The Valuation The Valuation ProcessProcess

& &Appraisal ReportsAppraisal Reports

Wayne Foss, MBA, MAI, CREFoss Consulting GroupEmail: wfoss@fossconsult.com

2

Valuation ProcessValuation Process Definition:

– A systematic procedure employed to provide the answer to a client’s questions about the value of real property

Process has many uses– provides a framework for estimating market value (or other types of

value)– provides a model for performing

• market research• analysis of data• applying appraisal techniques

– provides a checklist for appraisers and users of appraisal services– complies with the Uniform Standards of Professional Appraisal

Practice

3

Identification of real estate

Identification of property rights to be

valued

Use of appraisal

Definition of Value

Date of value

estimate

Description of scope of appraisal

Other limiting

conditions

Reconciliation of Value Indications and Final Value Estimate

Report of Defined Value

The Subject MarketSubject and ComparablesRegion, City, Neighborhood

Highest and Best Use AnalysisLand as though vacant Property as improved

Sales Comparison Income CapitalizationCostApplication of the Three Approaches

Land Value Estimate

Definition of the Problem

The Valuation Process

General Specific Competitive Supply and DemandPreliminary Analysis and Data Selection and Collection

4

Procedure: Procedure: Step OneStep One

Definition of the Problem– Identification of:

• the Client and other Intended Users• the Intended Use of the Appraiser’s Opinions and conclusions• the Purpose of the Assignment

type and definition of value definition of the question to be answered for the client limiting conditions and/or special assumptions

• the Effective Date of the Appraiser’s Opinion and Conclusion Sets the basis of market conditions on the as-of date As-is or Subject to (remodeling, repair, physical changes) Current Retrospective Prospective Statement of dates

Two dates for each report: date of the opinion and date of the report

5

Procedure: Procedure: Step One con’tStep One con’t

Definition of the Problem, con’t– Identification of:

• the basic characteristics of the property The Real Estate - physical entity; “dirt + box” Location Real Property Interest to be Valued

Bundle of Sticks; which rights are to be included in the valuation Fee Simple, Leased Fee or Leasehold Whole Interest Partial or Fractional Interest

Any personal property, trade fixtures or intangible items Easements, Restrictions, Encumbrances, Leases etc.

• Scope of Work Necessary to Complete the Assignment• Any Extraordinary Assumptions • Any Hypothetical Conditions• Other Limiting Conditions

6

Procedure: Procedure: Step TwoStep Two

Preliminary Analysis and Data Selection and Collection– Plan the Work Schedule– Selection and Collection of Data

• General Data Economic, Governmental and Environmental forces

• Specific Data Subject property: Land and Improvements Comparable Data:

Land & Improved Sales Rental and Capitalization Rate Data

– Competitive Supply and Demand Data• Identification of the subject’s market

Geographic, Property Type and category Potential Users, Potential Buyers

7

Procedure: Procedure: Step ThreeStep Three

Highest and Best Use Analysis A Four Step Process

– Legal Use– Physically Possible– Financially Feasible– Maximally Productive

Conclusions Developed for– Land as Though Vacant– Property As Improved

Conclusion stated in terms of:– Use (Which legal use produces the highest value)– Timing for the Use– Typical Market Participants for the Use

8

Procedure: Procedure: Step FourStep Four

Land Value Estimate– Needed for

• The Cost Approach• Income Capitalization Residual Techniques• Property Tax Assessments• Condemnation

Six Procedures to estimate Land Value– Sales Comparison– Allocation– Extraction– Subdivision Development– Land Residual Technique– Ground Rent Capitalization

9

Land Value Estimate:Land Value Estimate:Sales Comparison Sales Comparison

ApproachApproachSubject Data #1 Data #2 Data #3 Data #4

4122 S. Western 2656 S. Western 2105W. Jefferson 2215 S.Vermont 3401 S.Western

ZONING: C2-1VL C2-1 C201 CM-1 C2-2INTENDED USE: Motel Church Retail Store HoldSALE DATE: 12/18/2002 10/3/2002 11/15/2001 2/6/2001SALES PRICE: $525,000 $245,000 $425,000 $600,000LAND AREA (SF.): 33,830 24,700 11,702 14,490 10,963

PRICE/SF: N/A $21.26 $20.94 $29.33 $54.73

** ADJUSTMENTS% **CASH EQUIVALENCY 0% 0% 0% -20%MARKET CONDITIONS 0% 0% 0% 0%SALES CONDITIONS 0% 0% 0% 0%

ADJUSTED $/ SF $21.26 $20.94 $29.33 $43.78 IMPROVEMENTS 0% 0% 0% 0%LOCATION 0% 10% -20% -10%FRONTAGE/EXPOSURE 5% -5% 0% -30%PHYSCIAL FEATURES 5% 0% 0% 0%LOT SIZE: 0% 0% 0% 0%

TOTAL% ADJ.: 10% 5% -20% -40%

ADJUSTED $/SF: $23.38 $21.98 $23.46 $26.27

LAND VALUATION:ESTIMATED

SUBJECT (SF) X PRICE/ SF = VALUE ROUNDED

33,830 $23.00 $778,090 $780,000

10

Land Value Estimate:Land Value Estimate:Allocation ApproachAllocation Approach

Subject Area Area 1

Lot Value: No sales $75,000

Total Value: $200,000 $300,000

Pctg. Land: 25%

$200,000 x 25% = $50,000

11

Land Value Estimate:Land Value Estimate:Extraction ApproachExtraction Approach

Sales Price $250,000

Less Improvement Value

Cost New: $200,000

Less Depreciation: $ 50,000

Depreciated Improvements: $150,000

Land Value $100,000

12

Land Value Estimate:Land Value Estimate:Subdivision DevelopmentSubdivision Development

Average Sales Price: $351,017Time Period (Monthly)

10/1/02 10/31/02 11/30/02 12/31/02 1/31/03 2/28/03Cash Flow from Sales:Pre-Sale Open Escrows: 6 Total Monthly Sales Closings: 10 4 4 4 2Unsold Units: 14 10 6 2 0Monthly Gross Sales Revenue: 3,510,169$ 1,404,068$ 1,404,068$ 1,404,068$ 702,034$

Monthly Expenses: Real Estate Taxes: (4,811)$ (3,436)$ (2,062)$ (687)$ -$ Insurance: (700)$ (500)$ (300)$ (100)$ -$ Maintenance/HOA: (2,100)$ (1,500)$ (900)$ (300)$ -$ Sales & Marketing Costs: (280,814)$ (112,325)$ (112,325)$ (112,325)$ (56,163)$ Entrepreneurial Profit: (351,017)$ (140,407)$ (140,407)$ (140,407)$ (70,203)$ Total Estimated Costs: (639,441)$ (258,169)$ (255,994)$ (253,819)$ (126,366)$

Net Monthly Cash Flow: 2,870,727$ 1,145,899$ 1,148,073$ 1,150,248$ 575,668$

Present Worth Monthly Factor at End of Period - 10%: 0.9917 0.9835 0.9754 0.9674 0.9594

Present Value of Monthly Cash Flows: 2,800,107$ 1,108,543$ 1,119,831$ 1,112,750$ 552,296$

Summation of Cash Flows, Phase II: $6,693,526Conclusion (Rounded):$6,695,000

13

Land Value Estimate:Land Value Estimate:Land Residual TechniqueLand Residual Technique

Net Operating Income $100,000

Less Income to Improvements

Improvement Value: $500,000

Rate to Building (RB) X 12% $ 60,000

Income to Land $ 40,000

Land Value $40,000 10% = $400,000

14

Land Value Estimate:Land Value Estimate:Ground Rent CapitalizationGround Rent Capitalization

Income to the Land $ 100,000

Rate to the Land (RL) 10%

Land Value $1,000,000

15

Procedure: Procedure: Step FiveStep Five

Research which leads to the

Application of the Three Approaches

– Cost Approach

– Sales Comparison Approach

– Income Capitalization Approach

16

Cost ApproachCost Approach

Land and Buildings Value is the sum total of cost to buy or create

component parts Summation concept Physical Concept Current Costs used ‘adjusted’ to recognize depreciation and obsolescence

– Physical depreciation (immediate and/or deferred)– Functional Obsolescence (curable or incurable)– External (always incurable)

17

Sales Comparison Sales Comparison ApproachApproach

Premise: Current Value is best indicated by recent sales prices of highly similar (comparable) property

Value in Exchange Closed Sales are primary Listings and Offers are secondary Buyer and Seller - meeting of the minds Considers the subject as a hypothetical sale

18

Income ApproachIncome Approach

Value is the present worth of anticipated benefits What it cost to create makes no difference. Estimate anticipated benefits; may be qualitative or

quantitative Estimate “capitalization” rate from market information Value = Income ÷ Rate. So we apply the Rate to

expected Income benefits to find the present worth or value of the property now.

19

Procedure: Procedure: Step SixStep Six

Reconciliation of Value Indications and Final Estimate of Value– Result in 3 different value indications– Which one is right?– Appraiser needs 1 value estimate

All Approaches to Value:– Consider market information– Rely on judgement and careful analysis– Simulate market participant behavior– Result in a slightly different answer because market

information is not perfect and our ability to analyze it is not perfect

These differences must be reconciled to a final single value estimate amount

20

Procedure: Procedure: Step SevenStep Seven

Report of Defined Value– Uniform Standards of Professional Appraisal Practice

– Three Types of Report Formats• Self-Contained• Summary• Restricted

Supplemental Standards– Code of Professional Ethics & Standards of Professional Appraisal

Practice of the Appraisal Institute– Other Appraisal Organizations

• American Society of Appraisers• American Society of Farm Managers & Rural Appraisers• International Association of Assessing Officers• International Right of Way Association• National Association of Independent Fee Appraisers• National Association of master Appraisers

21

ReportingReporting USPAP Standards Rule 2-1

– Each written or oral real property appraisal report must• Clearly and accurately set forth the appraisal in a manner that will not be

misleading;• Contain sufficient information to enable the intended users of the

appraisal to understand the report properly; and• Clearly and accurately disclose all assumptions, extraordinary

assumptions, hypothetical conditions, and limiting conditions used in the assignment.

22

Report ContentReport Content USPAP Standards Rule 2-2

– State the identity of the client and any intended users, by name or type– State the intended use of the appraisal– Describe information sufficient to identify the real estate involved in the

appraisal, including the physical and economic property characteristics relevant to the assignment

– State the real property interest appraised– State the type and definition of value and city the source of the definition– State the effective date of the appraisal and the date of the report– Describe the scope of work used to develop the appraisal– Describe the information analyzed, the appraisal methods and techniques

employed, and the reasoning that supports the analyses, opinions, and conclusions; exclusion of the sales comparison approach, cost approach, or income approach must be explained;

– State the use of the real estate existing as of the date of value and the use of the real estate reflected in the appraisal; and, when an opinion of highest and best use was developed by the appraiser, describe the support and retionale for that opinion;

– Clearly and conspicuously:• State all extraordinary assumptions and hypothetical conditions; and• State that their use might have affected the assignment results; and

– Include a signed certification in accordance with Standards Rule 2-3

23

Appraisal MythsAppraisal Myths You can look up property value in a table or

book An appraisal valuation amount is good for

several years Good appraisals rely on formulas Techniques and principles used on one

location can not be used in another location

24

So That’s The Appraisal Process

Wayne Foss, MBA, MAI, CRE, Fullerton, CA USAPhone: (714) 871-3585 Fax: (714) 871-8123 Email: wfoss@fossconsult.com