Licensing Education STUDY GUIDE. The Manitoba Real Estate Association

Transcription

1 Licensing Education STUDY GUIDE The Manitoba Real Estate Association NOTE: This Study Guide replaces the Assignment Booklet referred to in the Appraisal workbook. It does not have to be returned to the Association for marking as answers are provided. PRINCIPLES OF APPRAISAL Study Guide (2012 Edition) 1

2 CONTENTS Unit 5: The Cost Approach 3 Examination Study Tips 3 Exercises 4 Unit 6: The Direct Comparison Approach 19 Examination Study Tips 19 Exercises 20 Unit 7: The Income Approach 29 Examination Study Tips 29 Exercises 30 Answers to Exercises 39 The Cost Approach 40 The Direct Comparison Approach 51 The Income Approach 56 Page 2

3 UNIT 5 THE COST APPROACH EXAMINATION STUDY TIPS - Advantages and disadvantages page 50 of Canadian - Steps page 168/169 of Canadian - Cost and Value equal see Curiosity on page 5-13 of Workbook LEARN AS IT IS NOT IN ENCYCLOPEDIAS - Three types of depreciation: physical, functional, and external as in example on page 18 of Canadian - See example of cost approach on page 170 of Canadian; and example of depreciation on page 18 of Canadian - Problem on exam walks you through the steps in the Cost Approach: - STEP 1: Determine Site Value; this will involve determining time adjustment and reconciling your findings; see COMPARATIVE SALES METHOD SITE VALUATION in Canadian - STEP 2: Determine Reproduction Cost New of building isolate building cost of three examples and RECONCILE; may also be required to calculate based on square footage and cost to build; see COMPARATIVE SQUARE METRE/FOOT METHOD in Canadian - STEP 3: Calculate Depreciation: (may be in two parts for building and other); remember that formula is: Effective Age Economic Life (or total life expectancy) x Reproduction Cost New = Depreciation; set up as in example on page 18 of Canadian - TIP: if problem states that item is five years old and will last another 5 years, then total life expectancy is 10 and formula is 5/10 x RCN - Subtract total depreciation from RCN and add site value to get value by cost approach 3

4 EXERCISES Task 1: Estimating Site Value 1. What are the five steps in the cost approach? 2. Explain the process of estimating the value of a site by the comparative sales method. 3. Why is it important for time to be adjusted for first? 4

5 4. For valuation purposes, sites are analyzed on the basis of units of comparison. What unit of comparison is used to express values of residential lots? What unit of comparison is used to value commercial or industrial sites? 5. The following time resales all occurred within the same neighbourhood. Based on this information, what is the indicated percentage increase in value per month for the neighbourhood? Sale 1 sold 8 months ago for $124,000 and resold 4 months later for $128,000 Sale 2 sold 6 months ago for $126,000 and resold last month for $135,000 Sale 3 sold 10 months ago for $118,000 and resold this week for $136,640 5

6 6. Given the following MLS statistics relating to average sale prices in the area, what percentage increases are indicated for each time period? (a) Average sale price: 6 months ago for $192,800 2 months ago for $204,600 (b) Average sale price: 12 months ago $172,800-3 months ago for $198,500 (c) Average sale price: 14 months ago $163,500 5 months ago $186, You are analyzing market sales to derive a realistic time adjustment percentage factor to apply to comparable sales sold within the last year. You locate the following sales: Sale #1: Sold February 1, 1997 for $40,000 and resold on June 1, 1997 for $42,400 Sale #2: Sold March 30, 1997 for $52,000 and resold on September 1, 1997 for $56,000 Sale #3: Sold January 15, 1997 for $46,000 and resold on November 15, 1997 for $53,500 What is the approximate percentage increase per month? 6

7 8. Estimate the value of a 15 m x 36 m residential lot by comparison to the following residential lot sales and show your calculations and reconciliation. (Use plus or minus percentage adjustments) (a) 18 m x 36 m sold for $45,000 10% superior to subject (b) 22 m x 36 m sold for $50,000 similar to subject (c) 12 m x 36 m sold for $25,400 8% inferior to subject (d) 15 m x 36 m sold for $35,800 5% superior to subject 7

8 9. Estimate the value of a commercial site 30 m x 61 m using the following comparable sales and assuming that land has shown an increase in price by 10% per year. Make the time adjustment first, and then make all other adjustments to the time adjusted sale price. Sale Lot Size Price Date of Sale Location 1 33 m x 61 m $46,000 Current 5% superior 2 30 m x 67 m $38,000 6 months ago 10% inferior 3 36 m x 58 m $45,000 1 year ago 8% superior 8

9 10. Given the following market sales data, find the land value for an industrial site 30 m x 77 m. Use plus and minus percentage adjustments. Make the time adjustment first, then make all other adjustments to the time adjusted price. Land values have increased 10% in value during the past year. Show calculations and reconciliation. Sale Land Area Price Date of Sale Location 1 2,903 m 2 $45,600 1 year ago 10% inferior 2 2,090 m 2 $33,000 1 year ago 10% inferior 3 2,556 m 2 $39,600 1 year ago 10% inferior 4 2,185 m 2 $42,500 Current similar 9

10 11. In appraising a residential site 18 m x 30 m you locate the following comparable sales: Sale Size Price Sale Date Location 1 18 m x 30 m $45,600 1 year ago 10% superior 2 15 m x 30 m $33,000 ½ year ago 10% inferior 3 18 m x 30 m $39,600 ½ year ago 10% inferior 4 18 m x 30 m $41,400 1 year ago equal to subject Land has increased in value by 10% during the past year. (a) What unit of comparison is indicated? (b) What is the market value of this site? Show your calculations in tabular form. 10

11 TASK 2: ESTIMATING REPRODUCTION COST NEW 1. Under what circumstances are cost and value equal? 2. Mr. and Mrs. McGregor own a bungalow measuring 9.5 metres by 16 metres. Based on the information provided, complete the following and calculate the reproduction cost new of this bungalow. Structure Measurement Total Sq. M Repro. Cost/Sq. M Repro Cost New Main bldg 9.5 m x 16 m $ Addition 4.5 m x 8.5 m $ Garage 2.5 m x 7.2 m $ Other Improvements: Storage Shed $9,000 Reproduction Cost New: 11

12 3. Based on the following comparables, estimate today's reproduction cost new of a 10 year old bungalow with outside measurements 11.3 m x 10.1 m at ground level. It has no garage and the basement is unfinished. Sale #1: Sale #2: Sale #3: 1050 Riverside Drive This bungalow sold about one week ago for $136,000. The value of the site on the date that this new property sold was estimated at $38,000. It had a recreation room which accounted for $8,000 of the building cost. It had no garage. It had an area of square metres Braemar Road A newly built square metre bungalow sold three weeks ago for $129,400. It had a finished recreation room which accounted for $8,000 of the building cost. It had a frame detached garage, which cost $3,000 to build. The estimated value of the site is $43, Northside Drive A new bungalow sold last week for $124,000. The estimated value of the site at the time this new property sold was $35,000, and the other site improvements were estimated at $1,500. Like the subject property, it did not have a garage. It had an area of 114 square metres. Estimate reproduction cost new of building here: 12

13 TASK 3: ESTIMATING ACCRUED DEPRECIATION 1. In measuring depreciation, describe the meaning of the following terms. (a) Physical depreciation (b) Functional obsolescence (c) Locational obsolescence (d) Curable (e) Incurable 13

14 2. Describe what is meant by the following terms. (a) Economic Life (b) Remaining Economic Life (c) Effective Age (d) Actual or chronological Age 14

15 3. You are asked to appraise a 15 year old 6 room bungalow in a neighbourhood of similar properties. You valued the site by the Direct Sales Comparison Method at $ (See Task 1, Problem # 11) You estimated the reproduction cost new of the bungalow at $ by the quantity survey method (See Task 2, Problem # 4). On inspection you find that the interior requires repainting; the eaves and downspouts need replacing, and some hardwood flooring requires replacing, sanding, and refinishing. In estimating the curable physical deterioration, you arrive at the following: Item RCNew Cost to Cure Painting Interior $1,600 $1,750 Eaves & Downspouts Hardwood Flooring $1, You estimate the reproduction cost new, effective age, and normal life expectancy of each of the following short lived items: Item RCNew Effective Age Normal Life Expectancy Heating 1, years 20 years Kitch Built-ins 1, years 20 years Tiled Floor years 12 years Finished Floors years 20 years Exterior Painting 1,000 1 year 4 years Roof Covering 1, years 20 years Light Fixtures years 20 years Hot Water Heater years 20 years Assuming that the items of deferred maintenance were corrected, you estimate the bungalow will have an effective age of 10 years and a remaining economic life of 40 years. (a) Calculate the total accrued physical depreciation using the economic age-life depreciation method (modified) 15

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17 (b) Calculate the depreciated cost of other improvements as follows: Estimated Reproduction Cost New of other improvements $5,000 Estimate Accrued Depreciation: Item RCN Eff.Age/Life Exp Deprec. Driveway $1,000 15/20 Fencing $2,000 10/25 Wood Deck $2,000 5/15 Total $5,000 Depreciated Cost of Other Improvements: (c) Calculate the value of the building. (d) Calculate the market value of the bungalow including the site by the cost approach. 17

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19 UNIT 6: DIRECT COMPARISON APPROACH EXAMINATION STUDY TIPS - Advantages and disadvantages page 50 of Canadian - Steps page 195 of Canadian - Characteristics of a good comparable page 195 of Canadian under Step 1 - When plus and minus adjustments page 196, 2 nd paragraph under Preparing Adjustments; all adjustments are made to the sale price of the comparable; remember that if comparable is better or has something that subject does not have you subtract; if the comparable is inferior to the subject or the subject is better than the comparable or the subject has something that the comparable does not have you add: you are trying to make the subject look like the comparable so that you have an estimate of value for the subject since you now know the adjusted value of the comparable which you made to look like the subject - Elements of Comparison: time, location, lot size, and physical as shown in Example on page In case study, if time adjustment is not given as a $ or % - you will have to calculate it using formula: o ((New or current old) old) x 100 (to convert decimal to %) # of months o TIP (# of months): e.g., if sold in April and then in Sept, # of months is 5 (Sept is 9 th month and April is 4 th month: 9 4 = 5 months - If adjustments (other than time) are given in percentages do not convert to dollars just total the percentages and apply it to the TIME ADJUSTED PRICE (per front metre) - If adjustments (including time) are given in dollars do not convert to percentages just add the dollars up - Remember: Reconcile do not average results - Reconcile: pick best, state why and use adjusted $ to determine value 19

20 EXERCISES Task 1: Review Questions 1. What basic principle of real property value is the Direct Comparison Approach based on? 2. List the five steps in the Direct Comparison Approach. 3. List four items of importance in judging the quality of comparable sales data. 4. List and briefly describe the four main elements of comparison. What is the recommended sequence of these adjustments and why? 20

21 5. What principle of value underlies the adjustment process? 6. Briefly describe the two commonly used methods of adjusting for differences between the subject property and comparable properties. 7. Adjustments are made to comparable properties using several important rules and guidelines. What are these rules and guidelines? 21

22 8. Why is "time" adjusted for first? What principle of value is involved here? 9. What situations would normally require an adjustment for "Location"? 10. List four advantages and four disadvantages of the Direct Comparison Approach. 22

23 Task 2: Case Studies 1. The subject property is being appraised as at December 15th, 200x. A comparable property has been chosen which sold for $158,000 and is very similar to the subject property except that it sold 8 months before. Prices have increased over the past year and the appraiser needs to know the time adjustment factor to be applied to the comparable property. The appraiser has found three properties which have sold during the past year and has confirmed that no changes were made to the properties between the sale and resale that affected their values. The details of the three properties are as follows: Sale #1: Sold in April for $153,000 Resold in September for $160,500 Sale #2: Sold in May for $153,500 Resold in December $164,200 Sale #3: Sold in January for $148,000 Resold in December for $163,000 Based on the analysis of these three properties, what is the time adjustment factor that the appraiser should use on the comparable property? 23

24 2. In estimating the market value of a single family dwelling, you analyze 8 sales and you list the following features with respect to each property. Sale #1 - Sale #2 - Comparable in all respects to the subject property except that it has central air conditioning. Sold recently for $137,500 Same as Sale #1 except that it was sold a year ago. Selling price was $136,100 Sale #3 - Same as Sale #1 except that it sold two years ago. Sale price was $134,400 Sale #4 - Same as Sale #1 except in a poorer location. Sold for $134,900. Sale #5 - Same as Sale #1 except that it has no central air conditioning. Sold for $136,600 Sale $6 - Similar to Sale #1 except that it has a detached garage whereas Sale #1 has no garage. Sold for $139,300. Sale #7 - Similar to Sale #1 except in the same poorer location as Sale #4. Sold for $135,200 Sale #8 - Similar to Sale #1 except that it too had a detached garage. Sold for $139,500. On further investigation, you conclude that: (a) A property with air conditioning is worth $1,000 more than one not having air conditioning (b) Prices have increased by $1,500 each year for the last two years. (c) Properties in poorer locations sell for $2,500 less than those in better locations. (d) Properties with garages sell for $2,000 more than those having no garage. Task: Tabulate your analysis of these comparable sales showing all necessary adjustments and estimate the value of the subject property by the Direct Comparison Approach. 24

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26 3. You are appraising a 25 year old bungalow with an attached garage on a standard size lot. It has a finished recreation room which adds about $8,500 to its value; the kitchen has recently been modernized at a cost of $10,000, but the home still has the old gravity type furnace which would cost about $6,000 to replace with a modern forced air unit. Similar properties are now selling for $6,000 more than last year. What is the indicated market value of the subject based on the following comparables? (Show your calculations in tabular form.) Sale #1 - This bungalow with attached garage sold a year ago for $135,500. Its age, condition, construction, design, and lot size was the same as the subject, but was located in a better area requiring an adjustment of $2,000. The furnace is a modern forced air unit; however, the kitchen is obsolete. It has a finished recreation room. Sale #2 - Sold last month for $133,000. It was in the same location and had the same size lot. Its condition was superior to the subject by $2,400 but its age, construction, and design were the same. It was heated by a modern forced hot air unit and it had an attached garage similar to that of the subject which had been added just prior to sale at a cost of $6,600; however, homes with an attached garage usually sell for $8,000 more on this account. It had no recreation room and its original kitchen would be considered functionally obsolete in terms of today's standards. Sale #3 - Sold one month ago for $134,500. It was in the same location and its condition, age, construction, design, and lot size was the same as the subject. It had a private drive but no garage. The kitchen had been modernized and a recreation room finished, but it too had an old obsolete gravity type furnace similar to that in the subject property. 26

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29 UNIT 7: THE INCOME APPROACH EXAMINATION STUDY TIPS - Advantages and disadvantages page 50 of Canadian - Steps page 330 of Canadian - Based on theory that value of property is the present value of the future income that the property is capable of producing - Two types of return: return OF investment and return ON investment See Capitalization: Overall Capitalization Rate on page 123 of Canadian; remember when you yourself invest in something you want a return OF the money you invested plus you want to earn money ON your investment - Factors of Production: page 245 of Canadian; understand why land is a residual factor - Case Study is Reconstructed Operating Statement page 555 of Canadian o Reasons for reconstructing operating statement: page 556, right hand column under Estimating Operating Expenses o Items not included: Example on page 557 of Canadian o How to treat certain items such as free suite to janitor, etc. : Example on page 557 of Canadian and example on page 558 o Review example on page 558 of Canadian o Calculating Capitalization Rate: Rate = NOI value (note that NOI is net operating income which is income expenses) o When calculating gross income, remember that it is 100% occupancy at market rent and remember that it is annual ( multiply by 12 if given as monthly) o When calculating net operating income, deduct any expenses that you do not include such as depreciation and total the rest; make any other adjustments or additions as explained in the problem 29

30 o Value is then: net operating income capitalization rate 30

31 Task 1: Review Questions 1. List the five steps in the Income Approach. 2. Define the following: (a) Rehabilitation: (b) Remodelling: (c) Modernization: 3. What is potential gross income? 4. What is effective gross income? 31

32 5. What is net income? 6. Provide four reasons why an appraiser must reconstruct the owner's operating income and expense statements before determining the value of a property by the income approach. 7. In reconstructing the operating expense statement for appraisal purposes, certain operating expenses which appear in the owner's income statement must be omitted. Briefly describe four such items. 32

33 8. An investor in real estate is entitled to two types of return. What are they? 9. Define: (a) Discount rate: (b) Recapture rate: (c) Overall rate: 10. If the net operating income before depreciation of a building is $56,000 annually and the overall capitalization rate which is expected of this type of property is 12%, what is the value of the property? 33

34 11. If an income producing property sell for $560,000 and the net operating income before depreciation attributable to this property is known to be $50,000 annually, what overall capitalization rate is indicated? 12. If an income producing property is offered for sale at a price of $825,000, what is the annual net operating income before depreciation that the property must be producing if an investor expects a 15% capitalization rate? 13. If an income property sells for $730,000 and the net operating income before depreciation attributable to this property is known to be $68,000 annually, what overall capitalization rate is indicated? 34

35 Task 2: Case Studies 1. Broker/Owner Johnson, of ABC Realty Inc., is undertaking an appraisal involving a 30-unit apartment building. While using several methods to establish a capitalization rate, he has asked for your assistance in determining the cap rate based on comparable sales. Following are six comparable properties that have sold in the past two months. Johnson has provided the sale price and the net operating income (reconstructed) for each. Sale Sale Price NOI Cap Rate #1 $2,100,000 $196,300 #2 1,980, ,450 #3 1,700, ,050 #4 1,863, ,550 #5 1,986, ,490 #6 2,150, ,600 (a) In the space provided above, calculate the capitalization rate for all six properties. Cap rates are typically rounded to two decimal places. (b) If Sale #1 was judged the most comparable, what capitalization rate would you select? (c) If the subject property has a net operating income of $187,000, what is its estimated value? Show all calculations. 35

36 2. A six storey office building contains 1200 square metres of total area on each floor. Net rentable area on each floor is 80%. First floor space of a comparable type is renting at $80.00 per square metre per year; top floor space in a comparable type is renting for $75.00 per square metre per year. The space on floors 2 5 inclusive is competitive with space renting at $60.00 per square metre on the market. An office building survey just recently completed by the local Chamber of Commerce indicates vacancy at 3% for top floors, 5% for middle floors, and 2% for ground floor space. Annual service income on a net basis from lobby concessions is $50,600. Required: Develop a forecast of Effective Gross Income. 36

37 3. You are employed by ABC Realty Inc. Broker/Owner Johnson has been asked to estimate the value of 4261 Lakeshore Blvd. and felt it was an opportune chance to expand your knowledge of the income approach. Basic details of the property being appraised follow. Income An investor owns a recently constructed income property consisting of eight residential units. The current rent is $84,361, but potential rental income is $85,000. Additional income derived from extra parking spaces and coin-operated laundry facilities amounts to $385 per month. Vacancy factor and credit losses total 5% of gross potential income. Operating Expenses The following expenses can be entered directly on the reconstructed worksheet. Payment Type Annual Payment Property Tax $6,988 Water 1,800 Fire Insurance 2,500 Repairs and Maintenance 5,050 Electricity for Common Areas 1,200 Landscaping Contract 1,900 Janitor's Salary 10,000 These expenses must be annualized: - Every five years, halls are repainted at a cost of $3, Every seven years, exterior trim is repainted at a cost of $2,100 - Every four years, all suites are painted and decorated at a cost of $900 each suite. Capitalization Rate Three highly comparable properties have been sold in the immediate area and you have obtained net operating incomes. Sale Sale Price NOI Overall Cap Rate #1 $527,860 $49,870 #2 499,329 47,500 #3 542,600 50,960 Task 1: Calculate the cap rate that Broker/Owner Johnson should use. 37

38 Task 2: Determine the market value of the subject property using the following format. Round calculations to the nearest dollar. Potential Rental Income Plus: Other Income + Total Potential Gross Income Less: Vacancy and Credit Losses Effective Gross Income Operating Expenses Net Operating Income - = - = Indicated Value by the Income Approach 38

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40 ANSWERS TO EXERCISES 40

41 Task 1: Estimating Site Value THE COST APPROACH 1. The five steps in the cost approach are: - Estimate the value of the site - Estimate the reproduction cost new - Estimate the accrued depreciation - Estimate the total depreciated cost - Add the value of the site to the total depreciated cost to arrive at an estimate of the market value of the property 2. The Comparative Sales Method is based on a comparison of the property being appraised with the most recent sales data available on similar properties, preferably in the same neighbourhood. The steps are: - select a sufficient number of good comparable sites that recently sold in the area - gather all of the necessary data on these sales to be able to make a proper comparison - compare each of the comparable sales with the subject for differences that may exist - make the necessary adjustment to the sale price of each comparable for these differences - reconcile the adjusted sale prices of the comparables into an indication of the value of the subject 3. Time is adjusted first to bring all sales to the same economic base as the subject and then adjust for other differences 4. For valuation purposes, sites are analyzed on the basis of units of comparison: Residential lots: price per front metre Commercial or industrial sites: price per square metre 5. #1: 128, ,000 = 4, ,000 = 3.23% 4 =.81% per month #2: 135, ,000 = 9, ,000 = 7.14% 5 = 1.43% per month #3: 136, ,000 = 18, ,000 = 15.80% 10 = 1.58% per month Use 1.5% or 1.4% per month because sale #2 was the most recent resale period. 6. a. 204, ,800 = 11, ,800 = 6.12% 4 = 1.53% per month b. 198, ,800 = 25, ,800 = 14.87% 9 = 1.65% per month c. 186, ,500 = 22, ,500 = 14.0% 9 = 1.55% per month 41

42 7. Sale #1: 42,400 40,000 = 2,400 40,000 = 6% 4 = 1.5% per month Sale #2: 56,000 52,000 = 4,000 52,000 = 7.7% 5 = 1.54% per month Sale #3: 53,500 46,000 = 7,500 46,000 = 16.3% 10 = 1.63% per month What is the approximate percentage increase per month? 1.5% 8. Estimate the value of a 15 m x 36 m residential lot by comparison to the following residential lot sales and show your calculations and reconciliation. (Use plus or minus percentage adjustments) Answer: a. 18 m x 36 m sold for $45,000 10% superior to subject b. 22 m x 36 m sold for $50,000 similar to subject c. 12 m x 36 m sold for $25,400 8% inferior to subject d. 15 m x 36 m sold for $35,800 5% superior to subject NOTE: For residential properties, the unit of comparison is front metre. Sale # (a) (b) (c) (d) Front metre Sale Price 45,000 50,000 25,400 35,800 Price per FM 2,500 2,273 2,117 2,387 Adjustment - 10% 0 + 8% - 5% Adj. Price/FM 2,250 2,273 2,286 2,268 Sale (b) required no adjustments and thus more weight is given to it. Therefore use $2,273 per front metre x 15 = $34,095. Accordingly, the market value of the subject site is $34,

43 9. Estimate the value of a commercial site 30 m x 61 m using the following comparable sales and assuming that land has shown an increase in price by 10% per year. Make the time adjustment first, and then make all other adjustments to the time adjusted sale price. Sale Lot Size Price Date of Sale Location 1 33 m x 61 m $46,000 Current 5% superior 2 30 m x 67 m $38,000 6 months ago 10% inferior 3 36 m x 58 m $45,000 1 year ago 8% superior Answer: NOTE: Commercial property unit of comparison is square metres. Sale Sq. metres 2,013 2,010 2,088 Sale Price 46,000 38,000 45,000 Sale Price/sq.m Time adjust 0 +5% +10% Time adj $ Loc. Adj. - 5% +10% - 8% Adj. $/sq. m Most weight given to sale #1 since it was the most recent sale. This is supported by sales #2 and #3. Therefore, use $21.71 per square metre. Applying this to the subject site 30 x 61 = 1,830 sq. metres x $21.71 = $39,729, rounded to $39,

44 10. Given the following market sales data, find the land value for an industrial site 30 m x 77 m. Use plus and minus percentage adjustments. Make the time adjustment first, then make all other adjustments to the time adjusted price. Land values have increased 10% in value during the past year. Show calculations and reconciliation. Sale Land Area Price Date of Sale Location 1 2,903 m 2 $45,600 1 year ago 10% inferior 2 2,090 m 2 $33,000 1 year ago 10% inferior 3 2,556 m 2 $39,600 1 year ago 10% inferior 4 2,185 m 2 $42,500 Current similar Answer: Sale # Area 2,903 2,090 2,556 2,185 Sale Price 45,600 33,000 39,600 42,500 $ per sq. m $ Time Adj. +10% +10% +10% 0 Time Adj. $ $ Loc. Adj. +10% +10% +10% 0 Adj. $ per sq. m Sale #4 is best as it required no adjustments. Therefore, use $19.45 per square metre. The value of the subject property is: 30 x 77 = 2,310 square metres x $19.45 = $44, or $45,000 (rounded) 44

45 11. In appraising a residential site 18 m x 30 m you locate the following comparable sales: Sale Size Price Sale Date Location 1 18 m x 30 m $45,600 1 year ago 10% superior 2 15 m x 30 m $33,000 ½ year ago 10% inferior 3 18 m x 30 m $39,600 ½ year ago 10% inferior 4 18 m x 30 m $41,400 1 year ago equal to subject Land has increased in value by 10% during the past year. (a) For residential property: price per front metre (b) The market value of this site is: Sale # Front metres Sale Price $45,600 33,000 39,600 41,400 $ per FM $2,533 2,200 2,200 2,300 Time Adj. +10% +5% +5% +10% Time adj $/FM 2,786 2,310 2,310 2,530 Loc. Adj -10% +10% +10% 0 Adj. $/FM $2,507 2,541 2,541 2,530 All sales suggest a sale price of around $2,500 per front metre. Based on sales 2 and 3, which were the most recent, use $2,541 per front metre. Therefore, value of the subject is 18 x 2,541 = $45,738 or $45,700 rounded. 45

46 TASK 2: ESTIMATING REPRODUCTION COST NEW 1. Circumstances are cost and value are equal when: - the improvement is new - the improvement must represent the highest and best use - the improvement is not affected by functional or locational obsolescence - the expected return from the improvement justifies its cost 2. Mr. and Mrs. McGregor own a bungalow measuring 9.5 metres by 16 metres. Based on the information provided, complete the following and calculate the reproduction cost new of this bungalow. Structure Measurement Total Sq. M Repro. Cost/Sq. M Repro Cost New Main bldg 9.5 m x 16 m 152 $ $83,600 Addition 4.5 m x 8.5 m $ $18, Garage 2.5 m x 7.2 m 18 $ $3,870 Other Improvements: Storage Shed $9,000 Reproduction Cost New: $114,

47 3. Based on the following comparables, estimate today's reproduction cost new of a 10 year old bungalow with outside measurements 11.3 m x 10.1 m at ground level. It has no garage and the basement is unfinished. Sale #1: Sale #2: Sale #3: 1050 Riverside Drive This bungalow sold about one week ago for $136,000. The value of the site on the date that this new property sold was estimated at $38,000. It had a recreation room which accounted for $8,000 of the building cost. It had no garage. It had an area of square metres Braemar Road A newly built square metre bungalow sold three weeks ago for $129,400. It had a finished recreation room which accounted for $8,000 of the building cost. It had a frame detached garage, which cost $3,000 to build. The estimated value of the site is $43, Northside Drive A new bungalow sold last week for $124,000. The estimated value of the site at the time this new property sold was $35,000, and the other site improvements were estimated at $1,500. Like the subject property, it did not have a garage. It had an area of 114 square metres. Estimate reproduction cost new of building here: Answer: Sale # SP Land Bldg Adj. Adj $ Area $/sq. m 1 136,000 38,000 98,000-8,000 90, ,400 43,000 86,400-11,000 75, ,000 35,000 89,000-1,500 87, Area of subject building: 11.3 x 10.1 = square metres Use $ per square metre as Sale #3 required the fewest adjustments and was almost the same size as the subject property. Therefore, the RCN of the subject property is x $ = $87, or $87,600 (rounded) 47

48 TASK 3: ESTIMATING ACCRUED DEPRECIATION 1. Physical depreciation: The impairment of the physical condition of an improvement due to wear and tear, decay, and structural defects. Functional obsolescence: The loss of utility and hence value due to poor design, unacceptable style, etc. Locational obsolescence: The loss of value due to negative influences from external factors; e.g., railway tracks, commercial uses directly adjacent to the property, etc. Curable: Refers to items that a typical buyer would repair or replace immediately Incurable: Refers to those items that have suffered loss of value, but are not economically sound to cure. 2. Economic Life: The period of time over which a new structure may reasonably be expected to be competitive in the market for the use for which it was designed. Remaining Economic Life: The period of time from the date of appraisal to the expiration of the economic life of the structure. Effective Age: The age of structure based on the use and care it has received. Actual or chronological Age: The actual number of years that have passed since the structure was built. 48

49 3. You are asked to appraise a 15 year old 6 room bungalow in a neighbourhood of similar properties. You valued the site by the Direct Sales Comparison Method at $ (See Task 1, Problem # 11) You estimated the reproduction cost new of the bungalow at $ by the quantity survey method (See Task 2, Problem # 4). On inspection you find that the interior requires repainting; the eaves and downspouts need replacing, and some hardwood flooring requires replacing, sanding, and refinishing. In estimating the curable physical deterioration, you arrive at the following: Item RCNew Cost to Cure Painting Interior $1,600 $1,750 Eaves & Downspouts Hardwood Flooring $1, You estimate the reproduction cost new, effective age, and normal life expectancy of each of the following short lived items: Item RCNew Effective Age Normal Life Expectancy Heating 1, years 20 years Kitch Built-ins 1, years 20 years Tiled Floor years 12 years Finished Floors years 20 years Exterior Painting 1,000 1 year 4 years Roof Covering 1, years 20 years Light Fixtures years 20 years Hot Water Heater years 20 years Assuming that the items of deferred maintenance were corrected, you estimate the bungalow will have an effective age of 10 years and a remaining economic life of 40 years. (a) Calculate the total accrued physical depreciation using the economic age-life depreciation method (modified) 49

50 Answer: Estimated Value of Site: $45,700 Estimated Reproduction Cost New of Improvements: $87,600 Estimate Accrued Depreciation: 1. Curable Physical Deterioration: RCN C to C Painting Interior $1,500 $1,750 Eaves and downspouts Hardwood Floors $1, $3,300 $2,800 $2, Incurable Physical Deterioration: (a) Short Lived Component RCN EA. LE Dep % Dep $ Heating 1, ,050 Kitchen Built-in 1, ,125 Tiled Floors Finished Floors Exterior Painting 1, Roof Covering 1, Light Fixtures Hot Water Heater ,050 4,788 $4,788 (b) Long Lived Reproduction Cost New of bungalow 87,600 Less RCN from: Physical Curable 3,300 Physical Incurable 7,050 10,350 Total long lived 77,250 Effective Age = 10 years, REL = 40 years 10/50 x 77,250 = $15,450 Total Physical Deterioration: $23,038 50

51 (b) Calculate the depreciated cost of other improvements as follows: Estimated Reproduction Cost New of other improvements $5,000 Estimate Accrued Depreciation: Item RCN Eff.Age/Life Exp Deprec. Driveway $1,000 15/ Fencing $2,000 10/ Wood Deck $2,000 5/ Total $2,217 (2,217) Depreciated Cost of Other Improvements: $2,783 (c) Calculate the value of the building. Depreciated Cost of Building: 87,600 23, 038 = $64,562 (d) Calculate the market value of the bungalow including the site by the cost approach. Value of Site $45,700 Depreciated Cost of Building $64,562 Depreciated Cost of other Improvements $ 2,783 Market Value by the cost approach $113,045 or $113,000 (rounded) 51

52 THE DIRECT COMPARISON APPROACH 1. The Direct Comparison Approach is based on the Principle of Substitution 2. The five steps in the Direct Comparison Approach are: Locate and select all available comparable sales Collect pertinent information on each comparable Analyze all relevant data, including differences that exist between the comparable and subject (e.g., time of sale, motivation, length of time on market, etc.) Compare each comparable to the subject and make the necessary adjustments Reconcile the data and arrive at a reasonable value estimate. 3. Four items of importance in judging the quality of comparable sales data are: Within the local market area At or near the date of the appraisal. Truly comparable in that it would appeal to the same type of purchaser who would consider buying the subject property being appraised. For example, if the appraisal is for a single family home, then a duplex or condominium would not normally be a good comparable. A bona fide arm's length transaction. 4. The four main elements of comparison are: Time, location, lot dimensions, physical characteristics, motivating forces. Time is adjusted first to bring all comparable sales to same economic base as subject 5. The principle of contribution underlies the adjustment process. 6. The two commonly used methods of adjusting for differences between the subject property and comparable properties: Dollar Adjustments: the appraiser estimates the dollar amount allocated to each factor of adjustment to indicate what a typical buyer would pay under the current conditions for the items requiring adjustment. Percentage Adjustments: factors such as time, location, and availability of views are best handled by "+" or "-" percentage adjustments. With percentage adjustments, it is important to remember to make the calculations on the time adjusted price, not the sale price. 52

53 7. Adjustments are made to comparable properties using the following important rules and guidelines. a. Adjustments are usually shown in dollar amounts, but percentages are permissible. b. Adjustments are either a minus adjustment or a plus adjustment. If the feature in the comparable is poorer than the subject property, a plus adjustment is made. If the feature in the comparable property is better than the subject property, a minus adjustment is made. c. The adjusted amount represents the value of the item being adjusted, not its cost. d. The sum of all adjustments, when added or subtracted from the selling price, determines the adjusted sale price. 8. "Time" is adjusted for first because the subject property is being appraised today and the sale prices of all comparables must be adjusted to today's date what would the comparable sell for if offered for sale under current market conditions. Price changes between the two dates must be taken into account. The Principle of Change is at work here. 9. Location generally refers to the particular locale, but can also refer to specific amenities within a particular area. For example, in some new subdivisions, lot values are established on a per lot basis with added values based on selected features such as adjacent to a park or golf course, river-front or lake-front property, or having a particular view. 10. Four advantages and four disadvantages of the Direct Comparison Approach are: Advantages: - It reflects market behaviour. - It is widely used and understood. - It is accorded greatest weight by the courts. - It requires least adjustment if sufficient data is available. Disadvantages: - If inadequate data is available, it may be impossible to apply. - Adjustments must be made no two properties are ever identical. - Sales are always historical. - Accuracy of the method depends upon the appraiser's ability to recognize differences, and to make the proper adjustments. - It is sometimes difficult to ascertain circumstances surrounding a sale. 53

54 Task 2: Case Studies 1. The subject property is being appraised as at December 15th, 200x. A comparable property has been chosen which sold for $158,000 and is very similar to the subject property except that it sold 8 months before. Prices have increased over the past year and the appraiser needs to know the time adjustment factor to be applied to the comparable property. The appraiser has found three properties which have sold during the past year and has confirmed that no changes were made to the properties between the sale and resale that affected their values. The details of the three properties are as follows: Sale #1: Sold in April for $153,000 Resold in September for $160,500 Sale #2: Sold in May for $153,500 Resold in December $164,200 Sale #3: Sold in January for $148,000 Resold in December for $163,000 Based on the analysis of these three properties, what is the time adjustment factor that the appraiser should use on the comparable property. Answer: (1) 160, ,000 = 7, ,000 = 4.90% 5 =.98% (2) 164, ,500 = 10, ,500 = 6.97% 7 =.99% (3) 163, ,000 = 15, ,000 = 10.12% 11 =.92% Use 1% per month. 54

55 2. The value of the subject property is estimated as follows: (1) (2) (3) (4) (5) (6) (7) (8) Sale Price 137, , , , , , , ,500 Sale Date recent 1 yr ago 2 yr ago recent recent recent recent recent Time Adj 0 1,500 3, Adjusted SP 137, , , , , , , ,500 Location , ,500 0 Garage , ,000 Air Condit -1,000-1,000-1,000-1, ,000-1,000-1,000_ Total Adj -1,000-1,000-1,000 +1, ,000 +1,500-3,000 Adj. SP 136, , , , , , , ,500 All sales were around $136,000. Therefore the value of the subject property by the Direct Comparison Approach is $136,

56 3. The market value of the subject is estimated as follows: Sale #1 Sale #2 Sale #3 Sale Price 135, , ,500 Sale Date 1 year ago 1 month ago 1 month ago Time Adjust +6, Location -2, Condition , Rec Room , Kitchen +10, , Garage ,000 Furnace -6,000-6, Total Adjustments +8, ,600 +8,500 Adj. Sale Price $143,500 $143,600 $143,000 Reconciliation: Sale #3 required the fewest number of adjustments and was most comparable to the subject property. The adjusted sale price for Sale #3 is supported by the adjusted sale prices for Sales #1 and #2. Therefore, market value of subject property is $143,000 or $143,500 56

57 THE INCOME APPROACH 1. The five steps in the Income Approach are: - Estimate the potential annual gross income at 100% occupancy and deduct an allowance for vacancies and bad debts. - Estimate the total annual operating expenses - Calculate the net operating income - Select the appropriate capitalization rate - Using the appropriate method of capitalization, discount the net income into value. 2. Definitions: a. Rehabilitation: is restoration to good condition without changing plan, form, or style b. Remodelling: is changing the plan, form, or style to correct functional or economic deficiencies c. Modernization: is the replacement, in modern style, of outmoded aspects of the structure and equipment. 3. Potential gross income is the income that a property will produce with 100% occupancy at market rent, assuming typically competent and prudent management. This income is generally derived by multiplying the rental value per unit by the number of units in the building and adding any ancillary income such as from parking or laundry. 4. Effective gross income is: Potential gross income allowance for vacancies and bad debts 5. Net income is: Effective Gross Income operating expenses 6. Four reasons why an appraiser must reconstruct the owner's operating income and expense statements before determining the value of a property by the income approach are: a. Expenses are most often recorded on a cash basis (i.e., recorded when paid), whereas appraisers look at expenses on an accrual basis (i.e., recorded when incurred). b. The building may not have competent management and, therefore, the expenses may not be typical. c. The statements may include expenses that are not necessary to maintain the income flow or may exclude expenses that are necessary. d. The statements may show expenses that are incurred in some years but not in others (e.g., painting). All such expenses should be analyzed so that typical buyers are not misled when examining statements for years in which these expenses do not occur. 57

58 7. In reconstructing the operating expense statement for appraisal purposes, the following operating expenses which appear in the owner's income statement must be omitted: Business Tax: This tax is levied on the business being conducted on the property, and should be accounted for only when appraising the business and not when appraising the real property, which is the case here. Depreciation or Capital Cost Allowance: CCA is an allowable expense for income tax purposes and will invariably appear in the owner's expense statement. This item is omitted in the appraiser's reconstructed statement but provision is made in the capitalization rate to recapture the capital invested. To include it in the expense statement as well would amount to double recovery. Interest on Mortgage or Loan: This is not a direct cost of calculating net operating income. Though interest charges may be tax deductible, they benefit the owner and not the property. Capital Improvements (Capital Outlays): These are expenditures that enhance the value of the property and are designed to increase its income producing potential. As such, they are not operating expenses necessary to maintain the potential gross income. 8. An investor in real estate is entitled to two types of return: - return OF investment - return ON investment 9. Definitions: a. Discount rate: the rate of return ON the invested capital b. Recapture rate: the rate of return OF the invested capital c. Overall rate: a blend of the discount rate and the recapture rate in the same proportion as the ratio that the land value bears to the building value 10. If the net operating income before depreciation of a building is $56,000 annually and the overall capitalization rate which is expected of this type of property is 12%, the value of the property is: V = I/R = 56,000 / 0.12 = $466, If an income producing property sell for $560,000 and the net operating income before depreciation attributable to this property is known to be $50,000 annually, the overall capitalization rate is: R = I / V = 50,000 / 560,000 = 8.93% 12. If an income producing property is offered for sale at a price of $825,000, the annual net operating income before depreciation that the property must be producing if an investor expects a 15% capitalization rate is: I = V x R = 825,000 x 15% = $123,750 58

59 13. If an income property sells for $730,000 and the net operating income before depreciation attributable to this property is known to be $68,000 annually, the overall capitalization rate is: R = I / V = 68,000 / 730,000 = 9.32% Task 2: Case Studies 1. (a) The capitalization rates for the six properties are: Sale Sale Price NOI Cap Rate #1 $2,100,000 $196, or 9.35% #2 1,980, , or 9.77% #3 1,700, , or 9.65% #4 1,863, , or 9.26% #5 1,986, , or 9.29% #6 2,150, , or 8.54% (b) If Sale #1 was judged the most comparable, the capitalization rate would be: 9.35% (c) If the subject property has a net operating income of $187,000, its estimated value is: Value is $187, = $2,000,000 59

60 2. Net rentable area for each floor is: 1200 x 80% = 960 square metres Potential Income: 1 st Floor: 960 x $80.00 = 76,800 Less vacancy at 2% = 1,536 Effective Income = 75,264 2 nd 5 th Floors: 4 x 960 x $60.00 = 230,400 Less vacancy at 5% = 11,520 Effective Income = 218,880 Top Floor: 960 x $75.00 = 72,000 Less vacancy at 3% = 2,160 Effective Income = 69,840 Total Effective Income = $363,984 + Annual Service Income = 50,600 Effective Gross Income = $414,584 60

61 3. You are employed by ABC Realty Inc. Broker/Owner Johnson has been asked to estimate the value of 4261 Lakeshore Blvd. and felt it was an opportune chance to expand your knowledge of the income approach. Basic details of the property being appraised follow. Income An investor owns a recently constructed income property consisting of eight residential units. The current rent is $84,361, but potential rental income is $85,000. Additional income derived from extra parking spaces and coin-operated laundry facilities amounts to $385 per month. Vacancy factor and credit losses total 5% of potential rental income. Operating Expenses The following expenses can be entered directly on the reconstructed worksheet. Payment Type Annual Payment Property Tax $6,988 Water 1,800 Fire Insurance 2,500 Repairs and Maintenance 5,050 Electricity for Common Areas 1,200 Landscaping Contract 1,900 Janitor's Salary 10,000 These expenses must be annualized: - Every five years, halls are repainted at a cost of $3, Every seven years, exterior trim is repainted at a cost of $2,100 - Every four years, all suites are painted and decorated at a cost of $900 each suite. Capitalization Rate Three highly comparable properties have been sold in the immediate area and you have obtained net operating incomes. Sale Sale Price NOI Overall Cap Rate #1 $527,860 $49, % #2 499,329 47, % #3 542,600 50, % Task 1: Calculate the cap rate that Broker/Owner Johnson should use. Answer: See table above. Use cap rate of 9.45% 61

62 Task 2: Determine the market value of the subject property using the following format. Round calculations to the nearest dollar. Potential Rental Income $85,000 Plus Other Income + 4,620 Gross Potential Income $89,620 Less: vacancy and credit losses (5%) - 4,481 Gross Operating Income $85,139 Less: Operating Expenses - 32,138 Net Operating Income $53,001 Indicated Value by the Income Approach: (53, = $560,857) or $561,000 (rounded) where Operating Expenses are: (6 marks) Property Tax $6,988 Water 1,800 Fire Insurance 2,500 Repairs & Maint 5,050 Electricity 1,200 Landscaping 1,900 Janitor's salary 10,000 Hall repainting 600 Exterior Trim 300 Painting of Suites 1,800 32,138 62