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Lecture 4


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Administrative Studies
ADMS 3810

LECTURE 4: VALUATION AND THE APPRAISAL PROCESS In considering the subject of real estate valuation, two particular questions must be asked: 1. Can the specific elements or factors that contribute to the value of a parcel of real estate be identified? 2. What methods can be used to arrive at an estimate of value for a parcel of real estate? An appraisal is first and foremost opinion. It is based on the analysis of facts but is itself an opinion. The appraisal is of a specific property as of a specific date. APPRAISAL PROFESSION The Appraisal Profession in Canada is governed by the Canadian Uniform Standards of Appraisal Practice (CUSPAP) which has been adopted by the Appraisal Foundation made up of the various appraisal institutes in Canada and U.S. These regulations constitute both a code of ethics and standards of practice under which appraisers should operate. CHARACTERISTICS OF VALUE Real Property Values are affected by four characteristics: 1. Utility – The ability of a good or service – in this case real property – to satisfy a need. 2. Scarcity – Relative availability of a particular good or commodity. Land need not be scarce in an absolute sense in order to have value, but its value is highly affected by the scarcity of certain property types (uses) within a given area. 3. Effective Demand – In order for real property to have value, effective demand for the property must exist. 4. Transferability – The absence of legal constraints on the owner’s right to sell or convey his property right to another. FORCES AFFECTING VALUES In general, four primary forces exist that influence real estate values 1. Physical-Environmental – Location, size, shape, area, frontage, topsoil, drainage, contour, topography, vegetation, accessibility, utilities, climate and view. 2. Economic – Reflect how the property interacts or fits within the economy of the regional and neighborhood. Such factors as community income, the availability and terms of mortgage, credit, price levels tax rates, and labour supply represents economic forces affecting values. 3. Social – Attitudes toward household formation, population trends, neighborhood character, architectural design, and utility have an impact on value. Subjective. 4. Governmental – The impact of local, state and federal governments and are collectively referred to as public policy. Zoning and building codes, real property taxation, public housing, and police and fire protection. Reasons for An Appraisal 1. Transfer of Ownership: To determine the terms of a sale price for a proposed transaction. 2. Financing and Credit: To establish the basis for a decision regarding the insuring or underwriting of a loan on real property. 3. Just Compensation in Expropriation Proceedings: To estimate market value of a property as a whole before the taking. 4. Tax Matters – To estimate assessed value. 5. To set rental schedules and lease provisions. 6. To determine feasibility of a construction or renovation program. 7. To facilitate corporation or third-party company purchase of the homes of transferred employees. 8. To serve the needs of insured, insurer and adjuster. 9. To aid in corporate mergers, issuance of stock, or revision of book value. 10. To estimate liquidation value for forced sale or auction proceedings. 11. To counsel a client on investment matters, including goals, alternatives, resources, constraints and timing. 12. To advise zoning boards, courts an planners, among others, regarding the probable effects of proposed actions. 13. To arbitrate between adversaries. 14. To determine supply and demand trends in a market. 15. To determine the status of real estate markets. MARKET VALUE Market value is the major focus of most real property appraisal assignments. Developing an estimate of market value is the purpose of most appraisal assignments. “The highest price in terms of money which a property will bring in a competitive open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently, knowledgeably, and assuming the price is not affected by undue stimulus.” “The price at which a willing seller would sell and a willing buyer would buy, neither being under abnormal pressure.” “The price expected if a reasonable time is allowed to find a purchaser and if both seller and prospective buyer are fully informed.” Assumptions made in these definitions: • Buyer and seller are motivated by self-interest • Buyer and seller are informed and are acting prudently • The property is exposed for a reasonable time on the open market • Payment is made in case, in its equivalent, or in specified financing terms • Specified financing may be the financing actually in place or on terms generally available for the property type in its local on the effective appraisal date • The effect, if any, on the amount of market value of atypical financing, services of fees shall be clearly and precisely revealed in the appraisal report. VALUE, PRICE AND COST Value – The power of a good or service to command other goods in the marketplace. It is the present worth of the future cash flow, or benefits since not all property provide cash flows. Price – The amount of money that is actually paid, asked or offered for a good or service. As such, price represents two people’s estimates of value in terms of money. Such an estimate may be greater than, equal to, or less than the objective value of the good or service in question. Cost – The cost of a particular commodity is a historical figure, a price paid in the past, or the cost to construct a building today. A property’s cost may have no effect on its value today. VALUE INFLUENCES AND PRINCPLES Anticipation – an estimate of value should always be based on future expectations, rather than past performances. Change – Change is inevitable and is seen in all the forces affecting value. The Appraisal Principles: 1. Supply and Demand – In a completely free economy, the interaction of supply and demand would be the sole determinant of value. 2. Competition and Excess Profit – The Expresses a principle of a free enterprise system: abnormal profits cannot be expected to continue indefinitely into the future. 3. Substitution – The key concept of substitution states that when two parcels of property have the same utility, the property offered at the lower price will sell first. 4. Surplus Productivity and balance – Of the four factors of production, land is assumed to be the last one to be paid. This is so because it plays a passive role, and a return must first be paid to the other three factors – capital, labour and entrepreneurship – in order to induce them to utilize the land. 5. Conformity – Suggests that maximum value accrues to a parcel when a reasonable degree of social and economic homogeneity are present in a neighborhood. 6. Contribution – The concept is an application of the law of marginal utility. The concept says that changes in an existing improvement or in a portion of an improvement can only be justified in a financial sense if the increase in cash flow represents a fair return on the additional investment. 7. Externalities – This principle suggests that positive and negative economies can be generated by factors external to a specific property. E.g. The location of retail site within easy access to a major thoroughfare. 8. Highest and Best Use – Land is valued on the basis of the use that, at the time the appraisal is made, is likely to produce the greatest return. The highest and best use of a parcel of land is likely to change over time. Must be: • Physically possible • Legally possible • Produce the maximum return • Financially Feasible THE APPRAISAL PROCESS Definition of the Problems: The particular parcel of real estate must be identified. Then the particular legal rights or estates to be appraised must be identified. The date of valuation also is important. A clear understanding must exist both as to the purpose or objective of the appraisal and the type of value sought. Finally, any limiting conditions must be clearly stated. Preliminary Analysis, Data Selection and Collection • General Market Data • Specific Site Data Highest and Best Use Analysis Application of the Three Approaches to Value 1. Cost Approach 2. Market Comparison Approach 3. Income Approach Value Reconciliation and Final Value Conclusion. THE SALES COMPARISON APPROACH Relies on the principle of substitution, stating that a property is worth approximately the same as another property
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