Real Property Valuation

Objectives I. Explain the basic concepts of value and valuation

1.1 What is property valuation/property appraisal?
• Property valuation/property appraisal is the act or the process of developing an opinion
of property value.
• It involves selective research into appropriate market areas, assemblage of pertinent
data, the use of appropriate analytical techniques, the application of knowledge,
experience and professional judgment to develop value opinion.
• It is not simply a mathematical process. It is much more than that, and probably the
larger part of the valuation process depends upon the appraiser forming opinion.
• The appraiser has to look at a wide range of facts and try to predict the future.
 It is some times said that valuation is an art and some times that it is a science. In fact, it
is a mixture of both, an art and a science.
 The scientific part of valuation is
 the analysis of data and
 the mathematical calculation of data;
 The art is the skill of knowing which information to use to assist valuation and the
process of making judgments and forming opinions.
1.2 Real Estate, Real Property and Personal Property
 An important distinction is made in between real estate and real property in real estate
valuation.
 Even if these concepts are different, some countries laws and court decisions treat them
as similar for legal purposes.
Real Estate
 Real estate is the physical land and the fixtures attached to the land, e.g, structures.
 It is immobile and tangible.
 All permanent building attachments like plumbing, electrical wiring, heating system etc,
as well as built- in items such as cabinets and elevators are usually considered as part of
real estate.
 Real estate includes all attachments above and below the ground.
Real Property
 Real property includes all interests, benefits, and rights inherent to the ownership of
physical real estate.
 The total range of ownership of interests in real property is called bundle of rights.
1.3 Distinction among Price, Cost and Value
 Price –a particular purchaser agrees to pay and a particular seller agrees to accept under
the circumstance surrounding their transaction.
  Cost: - refers to the cost for production, not exchange
 Value: - the relationship among price, market and cost includes the concept of value.
 Value can have many meanings in property valuation. The applicable definition depends
on the context and usage.
 In the market place, value is usually considered as an anticipation of benefits to be
obtained in the future.
 Since value changes over time, valuation reflects value at a particular point in time.
 1.5 Uses of Valuation
a) General use of an appraisal
 Transfer of ownership
 To determine a listing price/ asking price- to how much a seller has listed a property for,
 To support a sales price- the amount it actually sells for
 To establish a basis for reorganizing or merging the ownership of multiple properties
b) Litigation
 To estimate the market value of a property in contract, disputes, divorce settlements
 To estimate damages created by environmental violations or accidents
c) Financing and credit
 To estimate the value of collateral offered for a proposed mortgage loan
 Loan must not exceed a given percentage of property value
 To provide an investor with a sound basis for deciding whether to invest in a property
d) Government
 To estimate assessed value for property taxes
 To determine gift or inheritance taxes
 To determine compensation when private property is acquired for public use
e) Investment decision making
 To estimate the market value of real estate as part of a portfolio
 Track property performance over time
 Determine real estate’s contribution to overall portfolio return
Users of Valuation
 Property investors
 Sellers
 Buyers
 Mortgage lenders
 Commercial lenders
 Equity investors: investors financing through borrowing and their own money
 Tax authorities
1.6 Foundations/Principles of Valuation
The major principles that govern property valuation are:
 Progression: A property’s value may increase due to the existence of similar properties
in similar locations, containing greater quality.
 Regression: A property’s value may decrease due to the existence of similar properties
in similar locations, containing lower quality.
 Conformity: A property is most likely to appreciate in value along with other, similar
properties in the same neighborhood.
 Substitution: A prudent purchaser would pay no more for a home than it would cost
him or her to build another one.
 Change: No condition remains the same indefinitely; change is part of the economic
cycle. Property values are affected by change in several forces.
 Anticipation: Market value often is affected by expectations about future events.
 Contribution: Improvements add to market value of a property as a factor of current
supply and demand, and not necessarily on the basis of actual cost.
 Plottage: Land values tend to increase when adjacent lots are combined into single
ownership and put into a single zoning or use.
 Highest and best use: real estate valuation is maximized when land is utilized in the
best possible way.
 Competition: Opportunities for profitable investment lead to competition.
 Balance : value is achieved and maintained when all elements are in proper proportion.
 Externalities: the principle of externalities holds that factors external to the property can
have either positive or negative effective on its value.
Objective 2. Analyze Relevant Data to Conduct Valuation of Property
 2.1 The Valuation Process
Introduction
 It is a systematic procedure that an appraiser follows to provide answers to a client’s
questions about real property value.
 It is a systematic and logical method of collecting, analyzing, and processing data into
intelligent and well reasoned value estimates.
 It begins when the appraiser agrees to take an assignment and ends when the
conclusions of the appraisal are reported to the client.
Step 1. Definition of the problem
 The definition of the problem should include the following:
 Identification of the client and intended users of the appraisal
  Intended use of the appraisal
 Purpose of the appraisal (including the definition of value)
 Date of the opinion of value
 Identification of the characteristics of the property (including its location, the
property rights to be valued, and other features).
 Extraordinary assumptions
 Hypothetical conditions
Step 2: Scope of Work
 The scope of work is the amount and type of information researched and the analysis
applied in an assignment.
 The appraiser is responsible for determining the appropriate scope of work in the
appraisal assignment, given
 the client's intended use and
 the nature of the problem to be solved.
 In the appraisal report, the scope must be clearly disclosed. It is often important for the
appraiser to indicate what was not done in the appraisal.
Step 3: Data Collection and Property Description
 Following the preliminary analysis (i.e., the identification of the appraisal problem and
determination of the scope of work), the appraiser should collect data on
 the market area,
 the subject property, and
 comparable properties in the market
 The data needed by appraisers can be divided into
 general data and
 specific data
Types of Data
In most appraisal analyses more than one type of data will need to be gathered and examined,
including the following:
 General data
 Specific data
 Competitive supply and demand data
 Specific data comprises information on the subject property, comparable properties, and
market transactions.
 The specific data about a subject property provided in land and building descriptions
helps the appraiser to select specific data pertaining to comparable sales, rentals,
construction costs, and local market characteristics
  Market data on competitive supply and demand allows the appraiser to estimate current
and future demand for property
 Competitive Supply Inventory
 The supply inventory includes all competitive properties:
 Rental units
 Properties that have been sold
 Properties being offered for sale
 Properties that will come on the market
 Competitive Demand Study
 the appraiser analyzes the prospective demand for the subject property. The appraiser
cannot assume the current use is necessarily the use for which the most demand will
exist in the future
Sources of Data
 Sources of general data include federal government publications, regional and local
government offices, trade associations, and private research firms.
 Sources of specific data are public records (e.g., recorded leases), newspapers (e.g.,
advertised sale prices and rentals), multiple listing services, cost estimating manuals, and
market participants such as brokers, lenders, contractors , owners, and tenants.
Step 4: Data Analysis
 Once the appropriate data on the market area, subject property, and site has been
collected and reviewed for accuracy, the appraiser begins the process of data analysis.
 It has two components. These are:
 market analysis and
 highest and best use analysis
Step 5: Land Value Opinion
 Land valuation is directly related to highest and best use analysis.
 What do you think is the difference between land and site from appraisers’ point of
view?
 Land includes the earth’s surface, both land and water, and anything that is
attached to it, whether by the course of nature or by human being.
 Site refers to land that is improved so that it is ready to be used for a specific
purpose
 Land value can be a major component of total property value.
Step 6: Application of the Approaches to value
 The three important methods/approaches to property value are:
• Cost approach
• Sales comparison approach
 • Income capitalization approach
Step 7: Final Reconciliation of Value Indications
 The final analytical step in the valuation process is the reconciliation of the value
indications derived into a single monetary figure or a range of values in which the value
will most likely fall.

Step 8: Report of Defined Value

 The assignment is not complete until the conclusion is stated in a report and presented
to the client.
 The reported value is the appraiser's opinion and reflects the experience and judgment
that has been applied to the study of the assembled data.
 The appraisal report is the tangible expression of the appraiser's work and the last step
in the valuation process.
 The conclusions of an appraisal may be communicated to the client in writing or orally.
Objective 3 Explain the basic concepts, characteristics, levels and types of real property
Market Analysis
3.1 Market Analysis
 Market analysis is the analysis of supply and demand factors that affect the market for
the subject property.
 It is important portion of the valuation process.
 Any imbalance in supply and demand should be reflected in comparable sales or leases
of existing properties.
 However, if the market has changed recently, older sales will not provide' evidence of
this change, so market analysis becomes doubly important.
 Two general levels of market analysis
 Broad market analysis ., e.g., the study of single-family homes in Bahir Dar.
 Specific market analysis e.g., the study of supply and demand for 20- to 30~year-old
single-family homes located in in Bahir Dar town.
3.2 Levels of Market Analysis
• Inferred Analysis describes what has historically occurred (based on general
trend ) to make general projections in the marketplace.
• Fundamental Analysis- Detailed analysis of supply and demand factors to derive
specific conclusion.
3.3 Six Step Market Analysis Process
Practically speaking most real estate market analysis can be undertaken in a six step processes.
1. property productivity analysis
2. market delineation-
 3. demand analysis and forecast,
4. competitive supply analysis and forecast,
5. supply and demand study, and capture estimation.
6. Forecast Subject Capture (determining the competitive rating to forecast
1. Property Productivity Analysis – surveying the assets of the subject property like listing of
features, attributes, and legal rights that will contribute to value.
2. Market Delineation- the analyst decides who the likely buyers for the subject are and what
those buyers want, i.e., what attributes would attract a buyer
3. Forecast Demand- the analyst investigates the current demand for the product.
4. Estimate competitive supply- estimating the number and size of properties that are
currently competitive with the subject property-both existing and soon to be completed.
5. Equilibrium or residual analysis- the analyst compares supply and demand factors to draw a
conclusion about the market for the subject property. If there is excess supply, this step will
identify it.
6. Forecast the amount that the subject will capture- the analyst estimates how much of the
demand tell subject property will satisfy. For example, if the subject property is new construction
in an oversupplied market, how will it be received
Objective 4. Apply the various Methods of Valuing Property and Distinguish the
conditions under which each method can be applied
4.1 Sales Comparison Approach
 It is a valuation technique in which the value of the subject property is determined by
comparing the properties recently sold in the market to the subject property.
 It is assumed that the subject property will be sold for an amount similar to the adjusted
price of the comparable properties.
 It is preferable when there are sufficient recent and reliable market data on properties
that are similar to the subject.
 It is not advisable to use sales comparison approach when there is shortage of market
data on comparable properties.
Procedures in Sales Comparison Approach
 Research the market for information on sales and listings
 Verify the information
 Select relevant units of comparison
 Analyzing and adjusting comparable sales
 Reconciliation of value indications in sales comparison approach
 Adjustment can be made on
• Property rights conveyed
• Financing terms
 • Conditions of sale- arms length or not
• Date of sale – market condition
• Expenditures made immediately after purchase
• Location
• Physical characteristics
 If the comparable sales are inferior to the subject property with respect to the elements
of comparison, the comparable sales data will be adjusted to upward.
 If the comparable sales are superior to the subject property, the comparable sales price
must be adjusted downward.
• Appraisers commonly use three types of quantitative adjustments.
 These are:
 Lump sum/monetary- to adjust each sale for any property difference.
 Percentage- differences in market conditions and location.
 Units of comparison- e.g. Price per square foot
Qualitative Analysis
 After an appraiser has applied quantitative adjustments to the comparable properties or
when quantitative adjustments cannot be made, qualitative analysis including
 Relative comparison analysis – inferior vs. Superior to the subject
 Ranking analysis- ranking comparable in ascending or descending
 Personal interviews- interviewing market participants
Real property rights conveyed
Example 1. Suppose a fee simple estate in land improved with office building with an area of
100,000 square meter as subject property and a 100,000 square meter office building which is
leased in a long term (10 years lease period) base at the time of sale as comparable property.
Estimate the adjustment that will be made provided that the market rent is 25 birr per square
meter, the contract rent is 24 birr per square meter, and the market shows that the vacancy rate
is 5, 000 birr and the management expense is 4, 000 birr. In addition to this, the rate of discount
is given as 15%.
 The market rent is higher than the contract rent which shows that there should be an
upward adjustment in sales price.
 Potential Income = (100, 000 birr/m2 )* 25 birr
= 2,500,000 birr
 Actual Income = (100, 000 birr/m2 )* 24 birr
= 2,400,000 birr
 Annual gain (due to rent difference)= 2,500,000 birr-2,400,000 birr=100,000 birr
 Loss in vacancy= 5, 000 birr
 Loss in mgmt. expense = 4, 000 birr
  Thus, annual rent loss =100,000- 9,000 birr
 The present value of 91,000 birr for 10 years period @15%
 This indicates that an upward adjustment of 368,145.8 birr is required.
Financing terms
Example 2. an appraiser might find a comparable sale of a single-family residence that was sold
for 110,000 with a down payment of 25,000 and a seller financed mortgage of 85,000 for a 20-
year term at 10% interest. If the market-derived rate is 13%, the sale can be adjusted to cash
equivalency as follows:
 The adjustment is downward since the market interest ate is higher than the mortgage
rate. Hence the subject property’s value is less than the subject property.
 Mortgage: 85,000, 20 years, 10% , Monthly payment: 820.27
 85, 0000, 20 years 13%, Monthly payment: 995.84
 Find the difference =175.57
 Thus, the PV of 175.57 @ market rate of 13%, = 2,023 Birr
 thus it is 85,000-2,023= 82,977 Birr
Sequence of Adjustment
 Sales price of comparable property
+/- property rights conveyed
+/- condition of sale
+/- financing terms
= Normal sales price
+/- adjustment immediately after purchase
+/- Market conditions
= Market adjusted normal sales price
+/- Location
+/- Physical characteristics
+/- Economic characteristics
+/- Legal characteristics
+/- Use
+/- Non-reality component
= Final adjusted sales price of comparable
Methods Used in Sales Comparison Approach
 Appraisers can use the three methods in sales comparison approach in order to estimate
the value of the subject property.
These are:
A. Area method
B. Assessment value method
 C. Net capitalization method
A. Area Method
 To estimate the value of the subject property in this method, the appraiser should have
the sales price and the area of the comparable properties
Example
 Estimate the value of the subject property which includes a residential area of 1,000 sq.m
and commercial area of 500 sq.m based on the following given data of comparable
properties using area method of sales comparison approach as of January 1, 2004.
Table 1 Sales price of comparable properties
 The exact choice of this estimated market value of the subject property depends on how
the subject property compares with the comparable properties.
 It will be the mean value if the subject property is as good as the comparable
properties.
 It will be the maximum value if the subject property is better than the
comparative properties.
 It will be the minimum values if the subject property is slightly inferior to the
comparable properties.
B. Assessment Value Method
 In this method an appraiser is required to identify the ratio of the sales price to assessed
value of comparable properties
Value of the subject property= (Assessed value of the subject x PAV of comparables)
Example
 Find the estimated market value of the above subject property, discussed in the area
methods, with assessment value of 7,000,000 birr based on the following assessment
value data of comparable properties using the assessment value method
 As table 7 summarizes, the mean, maximum and minimum estimated market values of
the subject property are 14,350,000 Birr, 17,920,000 Birr and 11,970,000 birr respectively.
 The choice of the exact value of the subject property depends on how the subject
property is compared with the comparable properties as we discussed in the area
method.
 It will be the mean value if the subject property is as good as the comparable
properties
 It will be the maximum value if the subject property is better than the
comparative properties
 It will be the minimum values if the subject property is slightly inferior to the
comparable properties
C. Net Capitalization Method
  In this method, the appraiser is required to determine the
 Net operating income (NOI) and
 Yield of comparable properties
Example
 Find the estimated value of the subject property discussed in the above two methods
with market rents, operating and maintenance (O&M) costs, and property tax of
1,275,000 birr, 350,000 Birr and 184,000 Br respectively based on the following in come
and expense data of comparable properties using the net capitalization method.
As it is shown in table 10 above, the subject property has an estimated market value 14,529,412,
Birr, 11,578,128 Birr and 18,073,171 Birr calculated based on mean, maximum and minimum net
capitalization rates respectively using this method
Reconciliation of the three value indications
 If we consider the subject property as good as the comparable properties, the estimated
market value of the subject property will be the average of the above three mean values.
4.2 Cost Approach
 A value indication in cost approach is derived for a property by estimating the current
cost to construct a reproduction of or replacement for the existing structure plus any
profit or incentive, deducting depreciation from the total cost and adding the estimated
sit/land value.
 Under this approach the property is valued as a function of what it would cost to buy the
land and construct the buildings.
Procedure/Steps in Cost Approach
1. Determine the applicable cost reproduction cost or replacement cost
2. Determine the total cost of improvements (direct cost, indirect cost,
entrepreneurial profit).
3. Estimate the amount of depreciation
4. Estimate of depreciated cost of improvement (total cost of improvement-
depreciation)
5. Estimate site value improvement
6. Calculate the indicated value of the property (land value + depreciated cost of
improvements).
Direct costs:
 Direct construction costs include the costs of material and labor as well as the
contractors profit required to construct.
Indirect Costs
 Expenditures or allowances that are necessary for construction but are not part of the
construction contract. ( Architectural and engineering fees, plan checks, surveys)
Entrepreneurial Profit
 A market derived estimate of what the entrepreneur expects to receive for his or her
contribution, i.e. the value of entrepreneurial services.
Methods of Estimating Construction Cost
 Comparative (square foot) method
 Quantity survey method
 Unit - in - place method
 Trended historical cost (index) method

1. Comparative (Square foot) Method

 The cost per square foot of the building is obtained found from similar developments in
the area or from published sources.
Example: An appraiser is using the cost approach to confirm the value received through direct
sales comparison. The appraiser has got three new homes recently sold in the area to estimate
the cost per square foot. The lots are all valued at 50,000 birr and the cost of one bathroom is
estimated to be 4,000 birr.
2. Quantity Survey Method
 It is the most comprehensive and accurate method of estimating building cost, which will
more often be applied by a contractor or professional cost estimator than appraiser.
 It is an item by item inventory of all costs, including contactors profit. It is the most
accurate method if it is done by the quantity surveyor.
 Example: The following two tables summarize a general contractor’s cost break down
(direct and indirect costs) for an apartment building which has 149,000 birr site value.
Determine the value of the property assuming that the entrepreneurial profit is 15% of
the sum of direct costs, indirect cost and site value.
3 Unit-in –Place Method
 It is a simplification of the quantity survey method. It is also called the segregated cost
method.
 It finds the sum of the cost of installed materials using convenient units of measurement
such as the cost to install foundation, roof, plumbing, wiring, heating and exterior wall
and etc
 The cost of building each unit would be specified with the sum of the units representing
the total cost of each building.
 This method is also very detailed next to quantity survey method and needs
sophisticated estimating skills.
4 Trended Historical Cost or Index Method
 Cost index trending may be used to convert historical data into a current cost estimate.
  If the historical construction cost is known, a cost index can convert that cost into an
indication of cost new for the date of appraisal.
 The index approach is used in a situation when the original construction of the existing
improvement is already known.
 It is most commonly used in the case of unique buildings.
Example: Suppose the contract cost for constructing a building in January 1994 was 1,000,000
birr. The index for January 1994 is 285.1 and the current index is 327.3 as it is obtained from the
cost manual. Determine the current cost of the subject building using the trended historical cost
or index method.
 The current cost of the subject building is:
(327.3/285.1)=1.148
1.148 X 1,000,000 birr= 1,148,000 birr
 In other words, a building that cost Birr 1,000,000 in 1994 would cost about Birr
1,148,000 today.
Depreciation
A. Physical Deterioration
 A loss in value due to use or forces of nature (physical).
 Physical deterioration can be classified as curable and incurable deterioration
 Curable/deferred maintenance/occurs when the value added by the repair equals or
exceeds the cost to cure the defects.
 It applies to items in need of immediate repair at the time of appraisal.
 Examples: Broken windows
 Incurable physical deterioration occurs when the value added by the
repair is less than the cost to cure the defects as of the valuation date, i.e.,
it is not economically feasible to repair. Two types
 Short lived items - not ready to be replaced on the date of appraisal.
 Have useful life shorter than the remaining economic life of the entire building.
 Example: A roof may have an expected economic life of 20 years while the building may
last for 50 years.
 Long lived item- not treated as deferred maintenance or short lived item.
 Has an expected physical life that is equal to or greater than the remaining economic
life of the property /not normally replaced
 Example- damaged foundation
B. Functional Obsolescence
 It reflects its overall usefulness or desirability, i.e., its ability to satisfy the wants and
needs of the market place.
 Examples
  Excessive floor space
 Inappropriate building layout, and disjointed production flow:
 excessive windows and openings,
 poor insulation
 inadequate heating system
 Excessive height
C. External Obsolescence
 Economic obsolescence is a loss in value caused by the negative influences of the
subject property.
 Example
• Change in attractiveness of the location
• Change in government restrictions and regulations: change in restriction of the
amount of pollutant permitted in manufacturing.
• Physical site restriction: if expansion is not possible
• Change in sources of supply: a steel mill may have been located close to an ore
deposit to save on transportation costs. If the ore supply runs out, the mill may
suffer from the problem of external obsolescence
Important Terminologies
 Economic life – the life of the property
 Remaining economic life- the period of time from the valuation date
 Actual age /historical age or chronological age
 Effective age - the actual condition
 Effective age + remaining economic life = Total economic life
Methods of Estimating Depreciation
A. Market extraction method
B. Age - life method
C. Breakdown method
B. Market Extraction Method
 Uses comparable sales data to estimate depreciation.
 It includes the following steps
1. Identify and verify sales of similar/comparable properties
2. Adjust the comparable sales
3. Determine the depreciated value of improvements
4. Estimate the RCN for each comparable at the time of sale.
5. Estimate total depreciation
6. Convert the total depreciation into percentages by dividing each estimate of total
depreciation by the cost new of each comparable sale.
Example 1:
 Suppose that a comparable property was sold for 350,000 birr and the site value
appropriate for this comparable was estimated at 100,000 birr. The cost to build the
property new today is estimated at 300,000 birr. The effective age of the property is 10
years old. Estimate the total depreciation of the subject property which has an
effective age of 15 years old and its cost of improvement is 280,000 birr at the date of
appraisal based on this information.
Sales price of the comparable --------------------------- 350,000
Less: Estimated site/land value ------------------------ 100,000
Depreciated cost of improvement ----------------------- 250,000
Cost of improvement new ------------------------------- 300,000
Less: Depreciated cost of improvement ---------------- 250,000
Total depreciation ----------------------------------- ------ 50,000
Rate of depreciation
 (Total dep. ÷ RCN) X 100= (50,000 ÷ 300,000)X 100= 16.7 %
Annual dep. of comparable is 16.7% ÷ 10= 1.67 %
 Since the eff. age of the building is 15 years, the dep. rate is
1.67% X 15 years= 25.05 %
 The total depreciation of the subject property is
0.251 X 280,000 birr= 70,280 birr
B. Age - Life Method
Depreciation = Effective age X Total cost of the property
Total Economic life
Example 1:
Suppose that a residence property has an actual age of 15 years, an estimated effective age of
10 years and a remaining economic life of 40 years. The replacement cost new of the property is
500,000 birr.
Example 2:
 A house similar to the subject property in size, layout, and other physical
characteristics has typical economic life of 50 years. The subject’s actual age is 20
years. Its effective age based on its condition, design and environment is 18 years
because it is in poor condition and is located near to the gasoline service station.
The total replacement cost of and land value of the subject is given as 668,175
birr and 180,000 birr respectively. Determine total depreciation using age life
method and estimate the indicated value of the house using the cost approach.
 Total depreciation = (18/50) X 668,175 birr
= 0.36 X 668,175 birr
= 240, 543 birr
 Depreciated cost of improvement = 668,175 birr – 240,543 birr
= 427, 632 birr
Thus, the value of the property using the cost approach:
Total replacement cost ------------------------------ 668,175
Less: Total depreciation ------------------------------ 240, 543
Depreciated cost of improvement ------------------ 427, 632
Plus: Land value -------------------------------------- 180,000
Indicated value of the property --------------------- 607, 632 birr
C. Breakdown Method
 It breaks down total depreciation into three categories:
 Physical deterioration
 Curable – deferred maintenance
 Incurable – short lived
 Incurable – long lived
 Functional obsolescence
 Curable – deficiency
 Curable – modernization
 Curable – super adequacy that is economically feasible to cure
 Incurable – deficiency that is not economically feasible to cure
 Incurable- super adequacy that is not economically feasible to cure
 External obsolescence
 Locational
 Economic
Example 1:
 During physical inspection of the subject property, you notice a 10 years old
single family residence needs repair of a broken window pane, painting of all
exterior wood and trim, and replacement of several wood boards on the exterior
of the home. From your cost files and conversations with several building
contactors, you estimate the cost to repair the window pane at 75 birr, the cost to
paint the homes exterior at 1,700 birr and the cost to replace the deteriorated
wood boards at 225 birr. Estimate of total curable physical deterioration, or
deferred maintenance.
Total curable physical deterioration = 75 br+1,700 br+225br= 2000 br
Example 2: A store building has a remaining economic life of 30 years and an effective age of
20 years. Present reproduction cost of the structure is 230,000 birr. The roof is 75% deteriorated.
A new roof will cost 10,000 birr. The air conditioning and heating systems are 40% depreciated.
Their installed cost new is 8,000 birr. What is the total amount of physical deterioration?
Solution:
Depreciation on roof (0.75 X10,000 br)------------------------ 7,500
Depreciation on air conditioning & heating (0.4x8,000)------- 3,200
Depreciation on the rest of the building ---- ------------------- 84,800
( 20/50)x(230,000-10,000-8,000)
Total physical deterioration -------------------------- ------- 95,500 birr
Methods of Land (Site) Valuation
There are four recognized methods of appraising land.
1. The market or direct sales comparison method
2. The allocation or abstraction method
3. The development method and
4. The land residual method

A. The Market /Direct Sales Comparison Method

 It is the most preferred and reliable method for site valuation
 It is similar to valuing an existing house, comparing the subject to recently closed sales
of vacant lots. 
 As no two houses are the same typically, no two vacant lots are the same
 The most common differences include the size, width and depth of lot, location,
Through investigation, it was found that prices have been increasing approximately 1% a month
during the past year. Sale No. 1 is believed to be located in an area inferior to the subject. This
lot would sell for about Birr500 more if located in the subject’s block. Sale No. 2 is located in an
area believed to be about Birr250 better than the subject while Sale No. 3 is also in a superior
location, by the same Birr 250 adjustment. The shape and topography of Sales No. 1 and No. 2
are better than the subject by an amount estimated to be Birr 500 and Birr 100 respectively. Sale
No. 3’s topography and utility appear about the same as the subject.
B. The Allocation/ Extraction method
 It is used to obtain land value where there are no vacant land sales.
 Procedures
a. Sales of houses in the same neighborhood on lots with similar characteristics are obtained.
b. An estimate of the cost new of the improvements is made.
c. Deducted depreciation from cost new
d. The depreciated cost of the improvements is deducted from the selling price of the property.
e. The difference represents an approximation of land value.
Example: The area of the appraised property is 6,500 sq. ft. The lot size of the property is
6,000 sq. ft. with a single family residence and sold for Birr 83,000. The sale building has an
estimated cost new of Birr 61,000 and an accrued depreciation estimated at Birr 20,000. Find the
land value?
Note: It is calculated by subtracting cost of improvements from sales price of property
Price of sale property ..................................................... Birr 83,000
Less depreciated value of improvements:
Cost new .................................Birr 61,000
Less accrued depreciation .............Birr 20.000
Depreciated value ................................................. Birr 41,000
Indicated land value .............................................. Birr 42,000
Divide by lot size ................................................ ÷ 6000 sq.ft.
Indicated lot value/sq.ft. .............. ........................ Birr 7.00/sq.ft.
C. The Land Development Method
 This method is used only to estimate the value of vacant land that is ready to be
subdivided.
 It is generally used when there are no sales of comparable land or when a detailed
analysis of the project is desired.
 The land development method shows how the raw land value relates economically to its
anticipated market value as developed land.
Procedures in the land development method
 Estimate the number of lots to be developed, allowing for zoning, lot size requirements,
and the land area needed for streets, parkways, and other open space,
 Estimate the typical current price that the lots could be sold for, based on sale price for
comparable subdivision lots,
 Obtain a total financial amount to be realized from the gross sales by totaling the
estimated prices of the lots
 Account for all direct and indirect costs of development,
 Allow for the developer’s profit(to cover work effort, overhead costs, and return on
capital) as percentage of gross sales or a percentage of the capital interested in the raw
land.
 After deducting all these development costs and profits from the gross revenue, the
remaining amount constitutes the value of the raw land.
Example: Valuing Land ready for Subdivision
 Suppose that you were valuing a 12 hectares of land, approved for development into 50
single-family residential lots. Similar lots nearby, ready to build on, are selling for 60,000
each. You project sales revenues and expenditures as follows. A developer’s return of
30% on the raw land investment, which is both a return on the developer’s capital and
also payment for the developer’s risk, entrepreneurial skills, and overhead costs.
 • Projected sales: 50 lots at 60,000.............................3,000,000
Less: development costs
Direct Expenses:
Design and engineering…………20,000
Clearing and grading…………..100,000
Utilities and streets……………..500,000
• Subtotal…………………………………..…………. 620,000
Indirect Expenses
Studies and repots……………….10,000
Legal costs and fees………….…100,000
Construction financing costs……150,000
Property taxes…………………….50,000
Sales and promotion……………..150,000
• Subtotal………………………………………………..460,000
Total deductions from sales……………………………………. Birr 1,080,000
Equals: net proceeds before raw land and
entrepreneurial costs…………………….……...……..Birr 1, 920, 000
 These net proceeds represents the land purchase price plus the entrepreneurial’s return
of 30%, for a total that is 130% of the land value.
 LV+30%LV= Birr 1, 920, 000
 LV= 1,920,000/1+30% =1,477,000
LV = 1,920,000/1.3
LV=1,476,923 birr
Advantage of the cost approach
 It is often the best approach in the appraisal of special purpose properties and
properties that are not frequently exchanged in the market.
 It is the best approach if the purpose is for insurance purpose.
 It can often be a convincing test of value for new construction.
Disadvantage of cost approach
 It is difficult to accurately estimate accrued depreciation, and as buildings get older the
possibility of error becomes greater.
 It relies on the assumption that cost equals value, which is not always true.
 It usually does not incorporate the income generating potential of the asset.
 It doesn’t take into account the factors of risk and uncertainty associated with realizing
the economic benefit.
 4.4 Income Capitalization Approach
  The value of the property in this approach is a function of the income stream that is
expected to produce.
 It is more suitable for types of properties purchased and held for the purpose of
producing income.
 It is also the preferred approach for the appraisal of land where reliable sales data for
comparable properties are not available.
 This approach is limited
 When the income estimates are weak
 When sales data are not available to extract capitalization rate
 When buyers consider other issues more than the property’s income potential
Procedures in Income Approach
1. Research the income and expense data of the subject property
2. Estimate the potential gross income (PGI) of the subject property
3. Estimate vacancy and collection loss
4. Deduct vacancy and collection loss form potential gross income and there by determine
effective gross income (EGI).
5. Estimate the total operating expenses of the subject property
6. Subtract the estimated total operating expenses from the estimated effective gross
income and arrive at net operating income (NOI) of the subject property.
7. Apply one of the two methods (direct capitalization or yield capitalization) of income
capitalization
Methods of Income Capitalization
Direct Capitalization
 Direct capitalization is a method of income capitalization used to convert a single year’s
income expectancy of the subject property in to a value indication.
 It has only three working parts:
 Net operating income,
 Overall capitalization rate, and
 Property value.
Example:
 Suppose that an investor is considering the purchase of a rental property with a net
operating income of birr 50,000. Suppose also that this investor has a desired rate of
return (capitalization rate) of 10%. Determine the market value of this property based on
the above information.
Market value = NOI/capitalization rate
MV=50,000/0.1
MV= 500,000 birr
Derivation of Overall Capitalization Rates
 Overall capitalization rates can be estimated with various techniques. The techniques
used depend on the quantity and quality data available.
 When supported by market data, accepted techniques include derivation from:
 Comparable sales
 Effective gross income multipliers and net income ratios
 Band of investment-mortgage and equity components
 Band of investment-land and building components
 The debt coverage formula
Yield Capitalization
 A method of converting future economic benefits, especially periodic income
stream/cash flow and reversion of ownership into present value.
 Cash flow refers to the periodic income attributable to the interests in real property.
 The procedure used to convert these future economic benefits into present value is
called discounting.
 The required rate of return (or yield rate) used in this method is referred to as the
discount rate.
 The standard formula of discounting future value into present values is:
 Where
 “r” is the rate of return on capital per period (discount rate) that will satisfy the
investor and
 “n” is the number of periods that the payment will be deferred.
 is the discount factor
 If there are cash flows for several years such as CF1, CF2,CF3…… CFn, the present value of
such cash flows can be calculated as
 Discounted cash flow (DCF) analysis is appropriate for any pattern of regular or irregular
income.
 In DCF analysis, an appraiser can discount each payment of income and reversion
separately and add all the present values together to get the present value of the
property being appraised.
 The DCF formula treats the reversion as a cash flow that can be valued separately from
the income stream.

 Using this formula the estimated value of the property which generates income might
be:
 Where
 represents the discounted reversion value (salvage value)
  (r-g) is the exist yield
 “g” is the rate of inflation or growth rate
 “r” is the discount rate/yield rate.
 NOI is the net operating income of the property
 “n” is the number of years
Example 1:
 Suppose a property to be appraised is expected to produce a first-year net operating
income of 100,000 birr, which is expected to increase at 3 percent per year over a six-
year holding period. At the end of the holding period, it is anticipated that the property
can be sold for 1,000,000 birr net of sales expenses. The appropriate yield rate for this
investment is concluded to be 13 percent. Determine the market value of the property
using DCF technique.
Advantage
 It is forward looking rather than historical results.
 It is relying on the fundamental expectations of the business or asset
 It focuses on cash flow generation and less affected by accounting practices
 It permits any or all of those variables to change over time
 It considers the time value of money that involves the various types of risks.
Disadvantage
 Since it is an attempt to estimate intrinsic value, it requires far more inputs and
information than other valuation approaches
 If future cash flows are not accurately predicted, this method cannot be applicable.
 The discount rate assumption relies on the market for competing investments at the
time of analysis, which would likely change, over time.
 Straight line assumptions about income increasing over certain years are generally based
upon historic increase in market rent but never factors the cyclical nature of many real
estate markets
 Terminal value usually represents larger percentage of the total DCF valuation.
4.5 Reconciliation of Value Indication
 Each approach may have one or more methodologies that are utilized in estimating the
value of a property. They may produce different value for a single subject property.
 In a perfect world, all the methods used would result in the same value.
 Unfortunately, given the property valuation, it is inevitable that each methodology will
generate a unique value estimate that differs from the other methodologies.
 Thus, appraisers should resolve the difference among value indicators and end up with a
single or a range of values.
  In real estate appraisal, the process of resolving the difference among value indicators is
called reconciliation.
 Reconciliation can be defined as the last phase of any valuation assignment in which
two or more value indications derived from market data are resolved into final value
opinion which may be either
 a single point estimate or
 a final range of values
 In the process of reconciliation, the appraiser should consider the relative applicability
of each of the three approaches to arrive at the final value estimate of defined value.
 In addition to this, the appraiser should consider the various factors influencing value
that are either not reflected or only partially reflected.

Reconciliation Criteria
 In theory, the different valuation approaches and methods used should produce a
relatively narrow range of value indications. This is not always the case. Value indications
may be divergent.
 The following are reconciliation criteria with which an appraiser forms a meaningful final
value opinion:
 Appropriateness
 Accuracy and
 Quantity of evidences
Objective 5. Describe how a Professional Property Valuation Report is developed
5.1 Appraisal Report
 The process and the result may be communicated to the client or other users either
through orally or in writing.
 The appraisal report must include certain minimum elements that are required to satisfy
practical, professional, and legal requirements.
Oral Reports
 when the circumstances or the needs of the intended user do not permit or demand a
written report.
 Expert testimony presented in court is considered an oral report.
 Each oral report must include the underlying bases of the appraisal, especially any
extraordinary assumptions or hypothetical conditions used.
Written Report
 Written report may be form or narrative report.
 The type of a report that will be prepared determines the extent of file documentation.
  A self-contained appraisal report includes detailed descriptions of the data,
reasoning, and analyses used to arrive at the value conclusion. In this case, the
appraiser is expected to have less file documentation.
 A restricted appraisal report contains virtually none of this information which
needs the appraiser to keep more file documentation.
 The summary appraisal report contains some, but not all, of the descriptive
information gathered in the appraiser's analysis.
The Basic Appraisal Report Format
 The appraisal report should be formal organized report.
 The structure of the report should be as user friendly as possible, logical, sequential in
the presentation of the valuation conclusion and precise in value statements.
 The appraisal report must contain three categories of information:
 Appraisal-specific information
 Item-specific information
 Supporting documentation
Appraisal specific information: it includes
 USPAP report format option employed
 Identify the client and other intended users
 Intended use of the appraisal
 Ownership interest
 Definition of value
 Effective date of appraisal
 Scope of work
 Professional assistance provided by others
 Valuation approach employed
 Markets researched
 Limiting conditions and hypothetical conditions
 Location of the property
 Responsible parties present at inspection
Item specific information
 Item description
 Quantity and quality characteristics
 Physical attributes with material effect on value
 Economic attributes with material effects on value
 Condition and Age of property
 Description of authentications, grading or tests performed
  Significant client information regarding the item
 Comparable market data and value issues (if item specific in nature)
 Photographs
Supportive Documentation: it can be attached to the report as addenda.
 The appraiser’s professional profile
 Professional profiles of those providing significant personal property appraisal
assistance
 Copies of authentications
 Glossary or abbreviations used
 Bibliography of reference resources
 Diagrams or sketches
 Photographs
 Most appraisal reports have four major parts. These are:
 Introduction,
 Premises of the appraisal,
 Presentation of data, and
 Analysis of data and conclusions
 In addition to these, several reports include the addendum or appendix which includes
additional information which supplements the description in the major report parts
information.