Appraisal of Real Estate

The estimated market value may be arrived at based on a study of the market, current and potential income, and on replacement
cost.

Estimating Market Value Based on A Study of the Market

In estimating the market value of property based on a study of the market, the appraiser takes into consideration conformity or how
the property fits with other properties in the same neighborhood, the recent selling price for similar property in the locality, and the
physical condition of the subject property.

Estimating Market Value Based on Current and Potential Income

Based on current and potential income, market value of property is estimated using a gross rental multiplier.

GRM-is the quotient between prices of recently sold properties and the rental income realized therefrom.

Ex.An appraiser is estimating the market value of an apartment building from which annual rental income has been estimated at
P300,000. In going over recently sold apartment buildings in the locality, the appraiser has accumulated the ff. data:

Recently sold Selling Price e Annual Rental Income

Property A P 300,000 P 45,000

Property B 1,200,000 250,000

Property C 800,000 160,000

• GRM=selling price/annual rental income

• Ave.GRM=total GRM/no. of property

• Estimated MV of subject property=annual rental income

• GRM=selling price/annual rental income

Property A = 6.67

Property B = 4.8

Property C = 5.0

• Ave.GRM=total GRM/no. of property

=16.47/3

=5.49

• Estimated MV of subject property=selling price x GRM

Using capitalization rate

A capitalization rate may also be used in estimating the market value of a property.

• Capitalization rate= net income/market price

• MV for subj. property=income/capitalization rate

 Ex.Property A is on the market for P2,000,000. Annual net income derived therefrom is P260,000. The appraiser is
estimating the market value of property B from which annual net income of P310,000 can be realized.

Estimating market value based on replacement cost

 Sound value=replacement cost - accum. dep.

• Physical obsolescence – refers to obsolescence arising from physical features due to expensive internal sys. resulting in high
utility costs or recurring high maintenance costs with all these resulting in a decline in potential rental income there from.

• Locational obsolescence – refers to obsolescence arising from changes in zoning and uses of property , and property designs
for a market that has ceased to exist.

Functional obsolescence – form of obsolescence arising from changes in sys. and uses of a property to the extent that subj.
proper

Financing real estate acquisition

 When the real estate to be acquired is use as collateral for loans to be obtained, it is called leverage acquisition. In
some cases, the investor obtains a bridge loan. A bridge loan is one that is temporarily granted using another
property as collateral so that upon consummation of the purchase of the second property, the latter becomes the
collateral and the first property is freed of the lender’s lien.

 Acquisitions are financed in order to spread available capital over a no. of properties and to maximize the rate of
return thereon.

Ex.A 3y/o building being appraised can be constructed at the total current cost of P5,000,000. The building is expected to be
useful for 20yrs. Considering the age of the bldg., the appraiser arrives at his estimates as follows:

Replacement cost-new P5,000,000

Dep. for 3 yrs

(P5M x 3/20) 750,000

Sound value P4,250,000

An investor has P2,000,000. The ff. real properties are being sold to him.

Cost Annual Cash Selling Price after

Inflow (5yrs) 5yrs

Property A P 2,000,000 P 300,000 P 3,000,000

Property B 1,000,000 130,000 1,600,000

Property C 800,000 150,000 1,300,000

Totals P 3,800,000 P 580,000 P 5,900,000

 Selling price after 5 yrs P 3,000,000

Total annual cash inflows

(P 300,000 X 5yrs.) 1,500,000

Total cash inflows P4,500,000

Less – Cost 2,000,000

Gain P2,500,000

At the end of 5 yr. period, his profit must be P3,900,000 arrived at as follows:

Total selling price after 5 yrs. P5,900,000

Initial cost(P3.8M less financed

portion of P 1.8M) 2,000,000

Profit P3,900,000

Refinancing

-refers to obtaining a new loan to cancel an old one. This is usually done to take advantage of a lower rate of interest on the
new loan and/or a longer term. If there are two or more old loans, the weighted ave. interest thereon is compared with the
new interest rate.

The outstanding loans are as follows:

Loan Balance Interest Rate

Loan A P 80,000 12%

Loan B 120,000 10%

P200,000

The weighted ave. interest rate is computed as follows:

Loan A P 80,000/P 200,000 X 12% = 4.8%

Loan B P120,000/P 200,000 X 10% = 6.0

Weighted ave. interest rate = 10.8%

(if int. rate on a new loan is lower than 10.8%, it would be worth refinancing the old loans.)

Payment acceleration

- refers to making add’l pay’ts in order to reduce the bal. of the principal, increase the borrower’s equity and shorten the
pay’t period.

st nd
Assume that the investor accelerates pay’ts by P100,000 for the 1 and 2 yrs and interest is 16%. The sched. of pay’ts
would be as follows:
 Year Payments Applied to Applied to Balance of
Interest Principal Principal

P 2,500,000

Downpayment P 500,000 2,000,000

1st 610,819 320,000 290,819 1,709,181

100,000 100,000 1,609,181

2nd 610,819 257,469 353,350 1,255,831

100,000 100,000 1,155,831

rd
3 610,819 184,933 425,886 729,946

4th 610,819 116,791 494,028 235,917

5th 273,664 37,747 35,917 0

2,916,940 916,940 2,500,000

Advantages of payment acceleration

 It reduces the total interest charges and consequently, the real acquisition cost of the property.

 It enables the borrower to take hold of the title to property earlier and subsequently make use thereof in raising add’l capital
to finance other ventures.

Disadvantages:

 By reducing interest charges, the borrower forfeits himself of the tax benefit therefrom inasmuch as interest is deductible
from income tax purposes.

 It increases the borrower’s opportunity cost, that is, the benefits he may derive from the use of the amt. involved in other
forms of investments.

 Equity in the mortgaged property cannot be sold nor can it be withdrawn.

Net income

- refers to the excess of periodic rental income over the related operating expenses and interest charges. The
operating expenses that are deducted include charges even if they do not require cash outlay such as depreciation.

Net cash flow

is the difference between periodic collections and the related periodic cash outlays.
Ex. A loan of P800,000 was obtained on which the investors pays annual amortization of P150,000 including interest.

Contract price upon acquisition:

Land ---------------------------------------P500,000

Apartment building --------------------- 700,000

Estimated life,……………………………. 20 years

For the year 2001:

Rental income ---------------------------- 200,000

Operating expenses including

depreciation of P35,000 ------------------ 85,000

Interest charges on mortgage ----------------- 65,000

Income tax rate ----------------------------------------- 25%

Net income and net cash flow for the year 2001 are computed as follows:

Rental income ----------------------------- P200,000 P200,000

Operating expenses ---------------------- (85,000)

(P85,000 – Depreciation, P35,000) - (50,000)

Interest charges --------------------------- (65,000) (65,000)

Income before income tax -------------- P 50,000

Net cash inflow before income tax --- P 85,000

Income tax (P 50,000 x 25%) ------------ (12,500) (12,500)

Net income ---------------------------------- P 37,500

Net cash inflow after income tax ------- P 72,000

Real estate, refers to land and all permanent improvements thereon including buildings. It may be agricultural, industrial,
commercial, residential, or in the form of rental units. In addition to the foregoing, real estates may also be in the form of raw land.
Rental units include condominiums and apartments. In investing in real estate, the properties with the best potential for future
appreciation is chosen, Good tenants are accepted, and value is maintained through periodic maintenance.

Advantages of real estate:

 It is one of the few finite investments.

 It s one of the basic necessities of man.

 It is a tangible asset and can be directly controlled by the owner.

 It is a hedge against inflation.

 It can be used in financing.

  It can provide periodic income when leased out.

 Disadvantages of real estate:

 It requires a number of years to realize profit on the investment.

 It is immovable so that it is not easily transferred from one party to another.

 Mortgaging real property requires certain procedures adapted by lending institutions

such as credit investigation, property appraisal and maintenance of required deposits (in the case of banks).

 Upon death of the investor, real property automatically forms part of his estate which is subject to inheritance
tax.
 It involves big amount so that it is impractical

To dispose of it in case the investor is in need of all small amount of additional capital

 Its price adversely affected in times of crisis.

Carrying cost of real estate

The cost incurred in holding on to an investment

In real estate consist of cost incidental to ownership thereof such as property taxes, cost of regular inspection of the property, cost of
normal maintenance and insurance. In decision making, opportunity cost of capital is included in the computations.

Opportunity cost of capital

Refers to earnings that could be earned in other forms of investment but which are forgone by the investor by choosing one form of
investment.

Ex. Real estate investment of ₱500,000 brings in annual rental income of ₱52,000. Interest on time deposit is 7%. The opportunity
cost and differential income are arrived as follows:

Opportunity cost of capital = ₱500,0000 x 7% = ₱ 35,000

differential income = ₱52,000-35,000 = ₱ 17,000

factors considered in real estate acquisition

 LOCATION

 FRONTAGE and SHAPE OF THE LAND

 DRAINAGE and SEWERAGE SYSTEM

 WIDTH OF STREETS

 ELEVATION

 POSSIBLE EXPROPRIATION

 CLEAN TITLE

 ENCUMBRANCES
  IMPROVEMENTS
 FINANCING
 PROSPECTS

INTEREST, is the amount charged by a lender to a borrower for the use of his money and is quoted on an annual basis.

Ex.The buyer is misled by salesman who convince him to buy “without ten (10) annual amortizations were ₱500,000 and ₱ 88,492,
respectively , total interest charges must amount to ₱ 384,920 arrived at as follows:

Total int. charges = total amortization-cash price

=(₱88,492x10) – 500,000
= ₱ 384,920
Schedule of payments

period (a) (b) (c) (d)

Annual Applied to Applied to Balance
amortization interest principal of
(d) x 12% (a) – (b) principal

0 ₱ ₱ ₱ ₱
1 88,492 60,000 28,492 500,000
2 88,492 56,581 31,911 471,508
3 88,492 52,752 35,740 439,597
4 88,492 48,463 40,029 403,856
5 88,492 43,659 44,833 363,827
6 88,492 38,279 50,213 318,995
7 88,492 32,254 56,238 268,782
8 88,492 25,505 62,987 212,544
9 88,492 17,947 70,545 149,557
10 88,493 9,481 79,012 70,01
884,921 384,921 500,000 0

Interest at 16%

year payments Applied to applied balance

interest to of
principal principal

Downpayment ₱ ₱ ₱ ₱
First 500,000 320,000 500,000 2,500,000
Second 610,819 273,469 290,819 2,000,000
Third 610,819 219,493 337,350 1,709,181
Fourth 610,819 156,881 391,326 1,371,831
Fifth 610,819 84,251 453,938 980,505
610,818 1,054,094 526,567 526,567
3,554,094 2,500,000 0
 Interest at 18%

in
Year alance payments applied to applied to balance
interest principal of
principal

Downpayment ₱ ₱ ₱ ₱
First 500,000 360,000 500,000 2,500,000
Second 639,556 309,680 279,556 2,000,000
Third 639,556 250,302 329,876 1,720,444
Fourth 639,556 180,237 389,254 1,390,568
fifth 639,556 97,559 459,319 1,001,314
639, 554 1,197,778 541,995 541,995
3,697,778 2,500,000 0

Example: a real state valued at P 2,500,000 is being considered as an investment. The bank requires a 20% equity so
that loan able amount is 2,000,000 only. Interest rates vary 16% to 20% for a period of 5 years. The schedule of
payments are presented on the preceding pages.
In the given example, the annual amortization and the total interest charges vary as fallows:

At 16% Annual Difference Total interest Difference

amortization chargers
At 18% P 28,737 P 143,684
P 610,819 P 1, 054,094
At 20% P 29,203 P 146,019
P 639,556 P 1,197,778

P 668,759 P 1, 343, 797

Example : the investor of the preceding example makes a P 500,000 down payment on the load so that at the rate of 16% annual
amortization is reduced to P 458,114. the schedules of payments is as follows;

Year payments Applied to Applied to Balance of

interest principal principal

Downpayment: ₱ ₱ ₱ ₱

First 500,000 240,000 500,000 2,500,000

Second 500,000 205,102 500,000 2,000,000

Third 458,114 164,620 218,114 1,500,000

Fourth 458,114 117,188 253,012 1,281,856

Fifth 458,114 63,661 293,494 1,028,874

 458,114 790,570 340,453 735,379

458,114 394,926 394,926

3,290,570 2,500,000 0

Payback period ,Is the length of period it takes to recover investment.

Time Adjusted Rate of Return, is the rate at which investment is earning or the rate which equates the present value of net cash
returns with the investment

Example: An apartment building is constructed on land owned by the investor. The ff. data are given on a property:

Construction cost…………………… ₱ 380,000

Annual cash inflow…………………. ₱ 50,000

Estimated life……………................ 15 years

The payback period for the apartment building and the time adjusted rate of return are arrived as follows:

Payback period = Investment/ annual cash flow

= ₱ 380,000/₱ 50,0 = 7.606

A LANDLORD’s Problems

these may be in nature of difficulty in making collections, bad debts , excessive cost of repairs and maintenance, and property
damaged cause by tenants.

Screening Prospective Tenants

A. unwillingness to fill out written application or information sheets.

B. Inability to name any landlord as reference.

C. Referrals to Landlords who cannot be contacted

D. inability to pay the required deposit or undertaking to pay the same in installments.

E. No means of livelihood such as a job or self-employment but with exceptionally high income.

F. Too large a family for the rental unit.

G. Over-aggressive pressure exerted on the landlord to movie in much earlier than the landlord would prefer.

H. An attempt to barter service for a portion of the rental.

I. No bank account .*

Deposit Policies

A landlord should see to it that applicant makes the required deposit ranging from one to three months rental. It should be
maintained for the duration of occupancy and serve as a security in case a tenant delays in rental payments or in case he is to be
evicted for some violations of rental agreement.