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Lecture 3 2024-Valuation Process

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Class Discussion
Balemi et al (2021). “Covid-19.s impact on real estate markets:
review and outlook”
 What commercial real estate sector was most hit by
the pandemic?
 How does this impact property values and why?
 How did covid impact the housing markets?
 How did covid impact the Mortgage Markets?
Real Estate Valuation
BUQS3022
Lecture 3
The Valuation Process
Course Instructor:
Prof Kola Akinsomi
The Valuation Process
 What is the Valuation Process?
• The valuation process is a systematic procedure an
appraiser follows to provide answers to a clients
questions about real property value.
 The objective of most appraisal assignments is to
develop an opinion of market value.
 The Valuation process contains all the steps appropriate
to appraisal assignment.
The Valuation Process
The Appraisal Process
 Step 1: Problem Definition
Real estate identification
Use of appraisal
Value definition
Effective Date
Identification of property characteristics
The Appraisal Process
Step 2: Scope of Work Determination
 Scope of work is the most critical decision an
appraiser will make in performing an
assignment.
 Solving an appraisal problem involves:
1. Identifying the problem
2. Determining the solution
3. Applying the solution
The Appraisal Process
• Step 3: Preliminary Analysis & Data Collection.
– Information
• General – trends
Social, Economic, Governmental and Environmental
data
• Specific – property and comparable
Legal, Physical, locational, cost, income and expense
information
• Supply & Demand – future changes
Supply includes vacancy rates, absorption rates,
competitive properties
 Demand incudes population income, employment.
The Appraisal Process
•
Step 4: Highest and Best Use Analysis
“the reasonably probable and legal use of vacant
land or an improved property, which is physically
possible, appropriately supported, financially
feasible, and that results in the highest value”.
–
–
Vacant vs. improved
Vacant may be highest and best use.
1. Identify use with highest overall return
2. Helps identify comparable properties
The Appraisal Process
• Step 5: Land Value Estimate
– Sales comparison
– Allocation (ratio)
– Extraction (less improvements)
– Subdivision & development
– Land residual technique (NOIland)
The Appraisal Process
• Step 5: Application of Three Approaches:
 Sales Comparison (VSC)
 Cost (VC)
 Income (VI)
The Appraisal Process
• Step 6: Reconciliation
 Using various estimates of value under a
number of methods determine one estimate
of value.
 How?
The Income Approach
• Should look familiar!
• GI=GO (DCF model)
N
V0  
t 1
NOI t

NSPN
1 y  1 y 
V0  NOI
R
t
N
The Income Approach
• Gross income multipliers
SP
IM 
GI *
• Potential or effective gross income
The Sales Comparison Approach
• Underlying economic theory: Similar
goods sell for similar prices.
• Applicable to all property types but works
best for property types with frequent
transactions.
• Data, data, data..
Sales Comparison
• Procedure:
– Research market/gather data
– Verify information
– Select units of comparison (ft^2, apt. unit, etc)
– Develop comparable analysis
– Compare comps to subject with respect to elements of
comparison & make adjustments
– Reconcile
Sales Comparison
• Sequence of adjustments:
– Financing terms
– Conditions of sale
– Market conditions
– Location
– Physical characteristics
Sales Comparison
• A(n)
adjustment will be made to the
comparable price when the comparable
property is superior to the subject property.
• Net adjustments lead to the adjusted sales price.
Sales Comparison
Uses and limitations:
– Good data = good results
– An easy “amateur” appraisal
– Financing advantage
– No data = no use
The Cost Approach
• Underlying economic theory: No prudent
buyer would pay more than it would cost to
purchase the land and develop.
• Applicable to all property types but does
not have the ease of sales comparison.
• Data, data, data..
Cost Approach
• Procedure:
– Estimate site value
– Estimate hard and soft costs of improvements
including reasonable profit
– Estimate accrued depreciation in the structure
– Add site value to improvement depreciated
cost
Cost Approach
Direct (hard) costs
– Building permits
– Labor
– Materials
– Equipment
– Security
– Contractors profit
Cost Approach
Indirect (soft) costs:
– Consulting
– Engineering and architecture
– Cost of carry (fees, points, interest, lease-up)
– Selling expenses
– Leasing commissions
Cost Approach
Comparative Unit Method:
– Determine (find) estimate of cost per unit of
area
– Aggregate cost per unit
– Size matters
– Use of benchmark building
• Adjust for size, finish quality, time, etc.
Cost Approach
Unit in Place Method:
– Each category (section) of the building’s cost
is estimated.
– Foundation, sprinkler, roof, framing, on a
square foot cost basis
Cost Approach
Quantity Survey Method
– Most complex and time consuming
– No aggregation of data according to size
– Number of labor hours, direct cost supplies
are estimated and the cost of each is applied.
– Rarely used.
Cost Approach
Depreciation:
– Non-accounting sense
– Three major types:
• Physical deterioration
• Functional obsolescence
• External obsolescence
– Economic life, effective (actual) age,
remaining economic life
Cost Approach
Market Extraction Method (depreciation):
– Transaction prices of similar properties with
respect to age/depreciation
– Sale price minus land = depreciable cost (1)
– Estimate the replacement cost (2)
– (2)-(1) = total depreciation
Cost Approach
• Age-Life Method (depreciation)
– Estimate total economic life of similar
properties
– Estimate effective age
– Compute ratio of effective age (subject) to
total economic life
– Apply ratio to development cost
Cost Approach
• In summary:
V0 Vland  Development Cost Accrued Depreciation
• Useful when there is not an active market for the
subject property type
Appraisal Method Summary
• Comparable sales
– Like goods sell for like prices
– Requires transaction data on “similar” properties
• Income approach
– Value is PV(future benefits)
– Most relevant for income producing real estate
• Cost approach
– Buyers will not pay more than the cost
– Utilizes industry cost estimators
Thanks for Listening!
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