Property Types & Appraisal Basics

Chapter X: Property Types & Appraisal Basics

Introduction

Real estate appraisal is founded on a robust understanding of property characteristics and market❓ dynamics. Accurately classifying property types and applying fundamental appraisal principles are crucial for generating credible value opinions. This chapter provides a comprehensive overview of common property types and introduces basic appraisal concepts and methodologies.

1. Property Types

Real property exhibits a wide range of characteristics influencing its marketability and value. Categorizing properties based on their use, design, and intended function is essential for selecting appropriate valuation❓❓ techniques and comparable data.

1.1 Residential Properties

Residential properties are designed and used primarily for dwelling purposes. These include:

• Single-Family Residences: Detached dwellings intended for occupancy by one household. Valuation often relies on the Sales Comparison Approach (see section 2.2.1).
• Multi-Family Residences: Properties containing multiple dwelling units, such as apartments, duplexes, and townhouses. Valuation may involve The income capitalization approach❓❓ in addition to the Sales Comparison Approach.
• Condominiums: Individually owned units within a larger complex, with shared ownership of common areas. Appraisal considerations include unit size, location within the complex, amenities, and association fees.
• Manufactured Housing: Dwellings constructed in a factory and transported to a site. Appraising manufactured homes requires consideration of foundation type, compliance with HUD standards, and market acceptance.
• Vacant Land Zoned Residential: This can be valued with the Sales Comparison Approach with adjustments for size, location, and zoning.

1.2 Commercial Properties

Commercial properties are used for business purposes, generating income or providing services. Key categories include:

• Office Buildings: Structures designed for office space, ranging from small single-tenant buildings to large multi-tenant complexes. Valuation considers factors such as location, occupancy rates, lease terms, and operating expenses.
• Retail Properties: Properties used for selling goods and services directly to consumers, including shopping centers, freestanding retail stores, and restaurants. Key valuation metrics include sales per square foot, traffic counts, and tenant mix.
• Warehouses: Buildings designed for storage and distribution of goods. Appraisal considerations include ceiling height, loading dock capacity, and proximity to transportation infrastructure.
• Apartment Buildings: While containing residential units, apartment buildings are often considered commercial properties due to their income-generating potential and investment characteristics.

1.3 Industrial Properties

Industrial properties are used for manufacturing, processing, or assembling goods. They include:

• Manufacturing Plants: Facilities designed for production processes, often requiring specialized equipment and infrastructure. Valuation considers factors such as building size, layout, power capacity, and environmental compliance.
• Distribution Centers: Properties used for receiving, storing, and shipping goods. Appraisal considerations include location, accessibility, and efficiency of operations.
• Research and Development Facilities: Buildings designed for scientific research and technological development. Valuation may require specialized expertise to assess the value of unique features and equipment.

1.4 Special-Purpose Properties

Special-purpose properties have limited alternative uses due to their unique design, configuration, or functional characteristics. Examples include:

• Churches: Religious facilities with specific architectural and design requirements.
• Schools: Educational institutions with classrooms, libraries, and other specialized spaces.
• Hospitals: Healthcare facilities with complex infrastructure and equipment.
• Golf Courses: Recreational properties with unique land configurations and irrigation systems.
• Funeral Homes: Facilities designed for funeral services and related activities.

Valuation of special-purpose properties often requires specialized expertise and may involve cost-based approaches or consideration of alternative uses. Due to the limited market data, it can be difficult to find comparable properties.

2. Appraisal Basics

2.1 Definition of Value

Value, in the context of real estate appraisal, represents the most probable price a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Key aspects of this definition include:

• Market Value: The most probable price, not necessarily the highest possible price.
• Competitive and Open Market: A market with sufficient buyers and sellers, where information is readily available.
• Fair Sale: A transaction free from coercion, duress, or undue influence.
• Prudent and Knowledgeable Buyers and Sellers: Parties who are well-informed and acting in their own best interests.

2.2 Appraisal Approaches

Appraisers typically employ three primary approaches to value: the Sales Comparison Approach, the Cost Approach, and the Income Capitalization Approach.

2.2.1 Sales Comparison Approach

This approach estimates value by comparing the subject property to similar properties that have recently sold. Key steps include:

1. Identifying Comparable Sales: Selecting properties with similar characteristics, location, and market conditions.
2. Verifying Data: Confirming sale prices, dates, and terms with reliable sources.
3. Adjusting for Differences: Making adjustments to the sale prices of comparables to account for differences in features, location, and market conditions relative to the subject property. Adjustments can be quantitative (e.g., dollar amounts) or qualitative (e.g., ratings such as “superior” or “inferior”).

The formula used to calculate adjusted sale price is:

Adjusted Sale Price (ASP) = Sale Price (SP) + Adjustments (A)

Where ‘A’ can be positive (if the comparable is inferior to the subject property) or negative (if the comparable is superior to the subject property) for a specific feature or characteristic.

For example, if a comparable property sold for $250,000 but lacked a garage, and a garage is estimated to add $15,000 to the value, the adjusted sale price for that comparable would be:

ASP = $250,000 + $15,000 = $265,000

Example: A single-family home is being appraised. Three comparable properties have recently sold. The appraiser identifies key differences and makes the following adjustments:

Based on these adjusted sale prices, the appraiser may conclude that the subject property’s value is approximately $300,000.

2.2.2 Cost Approach

This approach estimates value by determining the cost to reproduce or replace the subject property, less depreciation. Key steps include:

1. Estimating Reproduction or Replacement Cost: Determining the cost to build an exact replica (reproduction) or a functionally equivalent structure (replacement) using current materials and construction methods.
2. Estimating Accrued Depreciation: Assessing the loss in value due to physical deterioration, functional obsolescence, and external obsolescence.
3. Estimating Land Value: Determining the value of the land as if vacant and available for its highest and best use.
4. Calculating Value: Adding the land value to the depreciated cost of the improvements.

The formula for the Cost Approach is:

Value = Cost of New Reproduction or Replacement - Accrued Depreciation + Land Value

Depreciation can be calculated using various methods, including the straight-line method:

Annual Depreciation = (Cost - Salvage Value) / Useful Life

Where Salvage Value is the estimated value of the asset at the end of its useful life, and Useful Life is the estimated period over which the asset will be productive.

Practical Application: The cost approach is often used for new or unique properties where comparable sales data is limited, such as special-purpose properties.

2.2.3 Income Capitalization Approach

This approach estimates value based on the income-generating potential of the property. Key steps include:

1. Estimating Potential Gross Income (PGI): Determining the total potential income the property could generate if fully occupied.
2. Estimating Effective Gross Income (EGI): Subtracting vacancy and collection losses from PGI to arrive at the effective gross income.
3. Estimating Operating Expenses (OE): Determining the expenses associated with operating the property, such as property taxes, insurance, and maintenance.
4. Estimating Net Operating Income (NOI): Subtracting operating expenses from EGI to arrive at the net operating income.
5. Selecting a Capitalization Rate (Cap Rate): Determining the rate of return an investor would require for investing in the property.
6. Calculating Value: Dividing the NOI by the cap rate.

The formula for the Income Capitalization Approach is:

Value = Net Operating Income (NOI) / Capitalization Rate (Cap Rate)

Example: An office building generates an NOI of $100,000 per year. The appraiser determines that a reasonable cap rate for similar properties is 8%. The estimated value of the property would be:

Value = $100,000 / 0.08 = $1,250,000

Practical Application: The Income Capitalization Approach is most commonly used for income-producing properties, such as office buildings, retail centers, and apartment complexes.

2.3 Reconciliation

Reconciliation is the process of analyzing and weighing the indications of value derived from the different appraisal approaches to arrive at a final value opinion. It involves considering the strengths and weaknesses of each approach and assigning appropriate weight based on the reliability and relevance of the data.

2.4 Basic Math Skills

Appraisal involves basic math skills and a solid grasp of the order of operations (PEMDAS/BODMAS).

Order of operations (PEMDAS/BODMAS)

• P: Parentheses
• E: Exponents
• M: Multiplication
• D: Division
• A: Addition
• S: Subtraction

Calculating Area and Volume

• Area of a rectangle = length x width
• Area of a triangle = ½ x base x height
• Area of a circle = πr² (π ≈ 3.1416)
• Volume of a cube or cuboid = length x width x height
• Percentage change = ((Final value – Starting value) / starting value) x 100

3. Conclusion

Understanding property types and appraisal basics is crucial for successful real estate valuation. By mastering these concepts, appraisers can effectively analyze property characteristics, apply appropriate valuation techniques, and generate credible value opinions that meet the needs of clients and stakeholders. Remember that real-world applications often require specialized knowledge and adaptation of these fundamental principles.