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Real Estate Exam 2
Test 2
25
Real Estate & Planning
Undergraduate 2
10/23/2011

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Term
Market Value
Definition
Most probable selling price, assuming normal sale conditions

Value the typical market participant places on a property
Term
Investment Value
Definition
Value each individual places on a property
Term
Transaction Price
Definition
Price actually paid for a specific property
Term
Why estimate market value?
Definition
In real estate:
Every property is unique (heterogeneous)
Markets are local, illiquid, highly segmented and informationally inefficient
Term
Who uses market value appraisals?
Definition
Buyers
Sellers
Corporate acquisitions,Mergers & dissolutions
Courts
Montage lenders
Term
Uniform Standards of Appraisal Practice USPAP
Definition
Maintained by the appraisal foundation, required & followed by all states and federal regulatory agencies
Term
USPAP framework for appraisal processs
Definition
1. Identify the appraisal problem
2. Determine the scope of the work
3. Collect data and describe property
4. Perform data analysis
5. Determine value of land
6. Apply 3 approaches to valuation: Sale comparison approach, Cost approach, Income approach
7. Reconcile indicated values from 3 approaches
8.Report final value estimate
Term
Three approaches of estimating value
Definition
Sale Comparison approach, Cost approach, Income approach
Term
Sale Comparison approach to estimating value
Definition
Value of property is determined by analyzing sale prices of similar properties

Assumes in competitive markets close substitutes will sell for similar prices
Term
Sale Comparison approach - selecting comparables
Definition
Must be properties that prospective buyers would consider substitutes

Should be arms length transactions - normal conditions

Should select minimal physical and location adjustments
Term
Sale Comparison approach - Adjustments to comparable sales prices
Definition
Sequence of adjusments:
Transactional adjustments
Property adjustments
Term
Cost approach to estimating value
Definition
Estimated reproduction costs of improvements - estimated accrued depriciation = depreciated cost of building improvements + Estimated value of site = indicated value of cost approach

*Major assumption: the cost of creating a good equals its value
Term
2 concepts to cost
Definition
Replacement cost: cost to create something of equal utility

Reproduction cost: cost of an exact physical replica
Term
Methods to estimate replacement cost
Definition
Quantity survey method
Cost per square foot
Unit in place
Term
Accrued depreciation
Definition
No tax depreciation
Difference between replacement cost & market value of improvements

Physical depreciation
Functional Obsolescence
External Obsolescence
Term
Income approach to estimating value
Definition
Rationale: Value of a property is the present value of its anticipated income

Often called income capitalization
Term
2 basic approaches to income evaluation
Definition
1. Direct capitalization with an overall rate
2. Discount all future cash flows at required yield (discount rate)
Term
Income evaluation approach - Direct Capitalization
Definition
Find value as multiple of first year net income

Cap rate is obtained from sales of comparable properties

Similar in spirit to valuing a stock
Term
Income evaluation approach - Discounted Cash Flow
Definition
Forecast net cash flows for a standard holding period

Discount all future CF's at market required yield (discount rate)

Value is defined as the present value of the expected cash flows during the holding period

DCF models require: Estimate of expected holding period
Estimates of net cash flows over period
Appraiser to select appropriate yield at which to discount all future cash flows
Term
Estimating Net Operating income
Definition
Term
Potential Gross Income (PGI)
Definition
Rental income assuming %100 occupancy
Important issue - contract rent or market rent
Term
Types of commercial leases
Definition
Straight Lease: Level lease payments

Step up or graduated lease: Rent increases on predetermined schedule

Indexed Lease: Rent tied to an inflation index

Percentage lease: Rent includes part of tenant sales
Term
Vacancy & Collection loss
Definition
based on
historical experience of subject property
competing properties in the market
Natural vacancy rate
Term
Miscellaneous income - Commercial leases
Definition
Garage rentals & parking fees
Laundry and vending machines
Clubhouse rentals
Term
Operating Expenses
Definition
Ordinary and regular expenditures to keep a property functioning completely

Fixed: Insurance & property taxes
Variable: Utilities & maintenance

Does not include mortgage payments tax depreciation and capital expenditures
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