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Chapter 7

Valuation Using the Sales

Comparison and Cost
Real Estate
FIN 331
Fall 2015
A.Valuation calculations are required when a:
1. property acquisition is contemplated or
2. a structure is
a. modernized
b. renovated
c. abandoned
d. demolished
3. site is developed
4. property is used as collateral for a loan
Value Concepts
A. Market value:
1. Most probable selling price, assuming
“normal” sale conditions.
2. Value for the “typical” market participant may
not be fundamental value.
B. Investment value:
1. Value to a particular individual (investor).
C. Transaction price:
1. Price actually paid for a specific property
Value Concepts
A. True Value
1. In perfectly competitive markets, transaction
prices should be identical to true or intrinsic
2. Prices are continuously revealed by prices of
perfect substitutes (similar dynamics to stock
3. Result: we are all price takers.
Users of Appraisals
A. Buyers
B. Sellers
C. Mortgage Lenders
D. Corporate acquisitions, mergers or
E. Courts
1. Divorces
2. Eminent domain cases
3. Settlement of estates
4. Bankruptcy

A. Appraisals
1. An unbiased written estimate of the fair
market value of a property
a. Appraiser’s final estimate of property value
b. Data upon which the estimate is based
c. Assumptions and calculations used to arrive at
the particular estimate
2. Why Do We Have To Estimate Market
a. To get an estimate of the probable selling price
under current market conditions
b. Lenders require an estimate of market value to
make a reasonable mortgage decision
c. Real estate markets are assumed to reflect near
perfect competition; the implication is that
transaction occur at or very near true (or intrinsic)
d. Question: Are we all price takers?
Uniform Standards of Professional
Appraisal Practice (USPAP)
A. Required & followed by all states &
federal regulatory agencies
1. Appraisers are state certified
2. MAI designation?
B. Imposes ethical obligations & minimum
appraisal standards
C. Maintained by the Appraisal Foundation
Non-profit industry group that Congress (in 1989)
charged with setting minimum requirements for all
(state) certified appraisers
A. The Appraisal Process: Uniform Standards of
Professional Appraisal Practice (USPAP)
1. Identify the appraisal problem
a. Client & intended uses of appraisal
b. Date of valuation
c. Rights to be valued (fee simple, etc.)
d. Type of value to be estimated: market, insurance, or
taxable value?
e. Important assumptions or conditions
2. Determine the required scope of work
a. Time & personal requirements
b. Outline of proposed appraisal report
c. Data & procedures used to complete required tasks
3. Collect Data and Describe Property
a. Market Data: general characteristics or
b. Property Data: Site, building and location characteristics
c. Comparable Property data: market information on
4. Perform data analysis
a. Market analysis: Effects of demand & supply
b. Highest & best use; use which is
legally/physically/financially permissible
c. Highest & best use as though vacant: considers any
possible use
d. Highest & best use as improved: must consider any cost
of demolition

5. Determine value of land:

a. Important to value separately from
6. Apply 3 Approaches to Valuation
a. Sales comparison approach
b. Cost approach
c. Income approach
7. Reconcile indicated values from 3 approaches
a. Weight based on relative reliability of the three
8. Report final value estimate
a. Report writing is an extremely important function
b. Must meet requirements of 1 of 3 reporting options
1) Self-contained report: full narrative description of process
2) Summary report: summary of conclusions, principal points
of process
3) Restricted report: minimal discussion, limited to use by
B. Three Types of Appraisal Reports
1. Self-contained report
a. Contains full detail & information used to estimate
market value
b. Usually takes a full narrative (long & formal) approach
2. Summary appraisal report
a. Summarizes conclusions of the appraisal
b. Majority of data & techniques are kept in appraiser’s
work file
c. For homes, usually use “form” instead of narrative
reporting option
1) Ex., Uniform Residential Appraisal Report (Exhibit 7-12)
1. Restricted appraisal report
a. Provides minimal discussion of the appraisal
1) refers to internal file documentation
b. Tells client what the property is worth
c. Client cannot give appraisal to anyone else
d. Usually least expensive of the three options
Sales Comparison Approach to
Estimating Market Value
A. Sales Comparison Approach
1. Basic Idea: Value of RE can be determined
by analyzing the sale prices of similar
2. Why? In a competitive market, close
substitutes should sell for similar prices
3. Major difficulty? How many truly close
substitutes exist & how many of these have
sold recently?
Sales Comparison Approach to
Estimating Market Value
A. Steps in Sales Comparison Report
B. Selecting Comparable Sales
1. Must be properties that prospective buyers
would consider substitutes
2. Should be arms-length transactions
a. Fairly negotiated prices that occurred under
“normal” conditions
b. For example, not a distressed sale
3. Select to minimize required physical and
locational adjustments
C. Data Sources
1. Public records (e.g., county property tax
2. Multiple listing service
3. Private vendors (title companies, others):
CoStar for commercial properties
4. Zillow
Sales Comparison Approach to
Estimating Market Value
D. Adjustments to Comparable Sale Prices
1. Convert characteristics of each comparable
to an approximation of subject
2. Sequence of adjustments
a. Transactional adjustments: nature of the deal
(see list top of page 171)
b. Property adjustments: unique feature of property
3. Recent price trends
Cost Approach to Estimating
Market Value
A. Procedure
1. Estimated reproduction cost of
− Estimated accrued depreciation
= Depreciated cost of building improvements
+ Estimated value of site
= Indicated value by the cost approach
2. The Major Assumption?: Cost of creating a
property is related to its market value
Cost Approach to Estimating
Market Value
B. Two concepts of cost:
1. Replacement cost: Cost to create something of
equal utility (functionality)
2. Reproduction cost:
a. Cost of an exact physical replica
b. Complication in application?
C. Methods to estimate replacement cost
1. Quantity survey method
2. Cost per square foot or cubic foot
3. Unit in place
Cost Approach to Estimating
Market Value
D. Sources replacement cost estimates
1. R.S. Means www.rsmeans.com
2. Marshall and Swift www.marshallswift.com
3. Consulting firms
4. Builders/contractors
Cost Approach to Estimating
Market Value
E. Special Issue of Accrued Depreciation –
Commercial Property
1. Difference between replacement cost & market
value of improvements
2. Types of accrued depreciation that must be
a. Physical deterioration: Loss in market value due to
aging, decay & ordinary use
b. Functional obsolescence: Loss in value due to
changes in tastes, preferences, technological
innovations, or market standards
c. External (economic) obsolescence: loss of value due
to neighborhood changes
Homework Assignment
A. Key terms: Accrued depreciation,
Appraisal, Comparable properties, Market
value, Property adjustments,
Replacement cost, Reproduction cost,
Restricted appraisal report, Transactional
B. Study questions: 2, 3, 4, 7, 8, 12