FUNDAMENTALS OF REAL ESTATE

PRINCIPLES AND PRACTICES

What is real estate appraisal?

 As defined in USPAP : a process of estimating and supporting an opinion of value
 a written report

 More of an art than science or combination just like accounting

o Requires subjective judgments
o Involves estimates
 Market value
 Market rent
 Reproduction cost new
 Replacement cost new
 Depreciation
 Effective age
 Interest rate
 recapture rate
 opinion on value

What is real estate appraisal and characteristics of MARKET VALUE

 Generally, It is an estimation of the value of a property. It is an opinion of the appraiser

 Value MUST be objective to the public, client,

 However, subjective to the appraiser because it is his or her opinion.

 Value is just an estimate like zonal value, market value of the assessor, salvage value, going
concern value, just compensation value, rental value, goodwill value, depreciated value,

 Value based on market reaction – an active market – more sellers more buyers

 Perfect market - more sellers and more buyers

 Imperfect market – few sellers more buyers; or more sellers less buyers

 Sellers market – few sellers more buyers

 Buyers market – few buyers more sellers

 Accuracy of the appraised value is based on appraiser’s education, experience, honesty,

competence, skill gained thru the years and his personal judgment based on his ocular
findings and investigation of the forces that may affect value of the subject property.

 Wisdom in appraisal is gained through TIME and EXPERIENCE

Purposes of Appraisal
1. Generally, market value determination
2. Purchase or sale of real estate
3. Market rent or economic rent determination
4. Financing and credit
5. Corporate mergers, acquisitions, liquidations or bankruptcies
6. Partition of estate
7. Eminent domain (expropriation cases)
8. Government valuation (local and national taxes)
9. Highest and best-use analysis
10. Insurance
11. Valuation of land and development cost in joint venture agreement
12. and many more . . .

Definition and Characteristics of Market Value

 The Appraisal Institute in America defines market value as -
1. the most probable price in terms of money
2. that a property will bring in a competitive
and open market,
3. under all conditions requisite to a fair sale,
4. the buyer and seller each acting prudently and knowledgeably,
5. and assuming the price is not affected by
undue stimulus.

 The Philippine Valuation Standard defines market value as -

1. The estimated amount for which the property should exchange
2. on the date of valuation
3. between a willing buyer and a willing seller
4. in an arm’s-length transactions
5. after proper marketing
6. wherein the parties had each acted knowledgeably, prudently
7. and without compulsion

Market Value, Price and Cost

 Market value
o JUST AN ESTIMATE
 Price -
o the amount for which the property is actually sold.
o It is the transaction price or SELLING PRICE
 Cost -
o Say For the house and lot
 the amount of money used to construct improvements
plus the value of the land
 o For the lot
o Purchase price plus expenses on the purchase
o Ex. DST, transfer tax, registration fee

Value in Use/ Value in Exchange

 Value in use –
o Concerned mainly within the property itself.
o The value to the owner
o Subjective value

 Value in exchange –
o involves forces outside of the property
o its value to others
o the target of appraisal –
o an exchange value or market value or objective value.
o Estimated value in an arms length transaction
 Buyer and seller
 Acting in their own self-interest
 Knowledgeable in the legal uses of the property

What is accounting and its similarity with appraisal?

 Both Art -
o Gathering and recording of data
o Classifying
o Summarizing data
o Interpretation
 Both in conformity with the Code of Conducts

Dissimilarity
Computation of depreciation
o Accounting - actual age is used
o Appraisal - effective age

Valuation
 In accounting
Acquisition cost less Accrued depreciation = Net Book Value
 In appraisal
Replacement Cost New less Depreciation = Market Value

 Appraised value less NBV = Increment

EXPENSES
 Expense in accounting BUT not in appraisal
Interest expense
Depreciation expense

 Expense in appraisal BUT not in accounting

Reserve for replacements
SAY reserve for future replacement of air-conditioners in hotels
Used in income approach to value

Factors affecting appraisal report’s accuracy

1. Data gathered by the appraiser
2. Experience and education of the appraiser
3. Credibility of the appraiser

Forces that affect values of properties

 Governmental or police power - land-use plan, restriction on use
 Physical – size, shape, elevation, soil quality
 Social - social preference
 Economics - utilities, facilities, neighbourhood quality, employment, purchasing power, etc

Elements of value – D.U.S.T

 Demand
 Utility - criterion of value
 Scarcity
 Transferability

Properties subject for appraisal:

 Real estate –
o Land, building and other structures (artificial attachment)
o Machinery equipment (artificial attachment)
o Plants and trees (natural attachment)
 Real property –
o rights and interests, and benefits
o related to the ownership of real estate.
o Kinds of rights : fee simple, leased fee estate, leasehold, subleasehold
 Personal property
Tangibles such as chattels
Intangibles such as a patent, goodwill, copyright, concession
Attachment vs. Severance
o From tree to lumber : real estate becomes personal property by SEVERANCE
o Lumber is used in the building. Lumber becomes real estate by ATTACHMENT

Fixture vs. Trade fixture

 Fixture, regardless of amount, is real estate
 Trade fixture, regardless of amount, is personal property
 Classification does not depend on the cost but in the –
intention of the parties, and method of attachment

Purposes of Appraisal
13. Generally, market value determination
14. Purchase or sale of real estate
15. Market rent or economic rent determination
16. Financing and credit
17. Corporate mergers, acquisitions, liquidations or bankruptcies
18. Partition of estate
19. Eminent domain (expropriation cases)
20. Government valuation (local and national taxes)
21. Highest and best-use analysis
22. Insurance
23. Valuation of land and development cost in joint venture agreement
24. and many more . . .
THREE APPROACHES IN VALUING REAL ESTATE PROPERTY

1. Market Data or Sales Comparison Approach –

Applicability : vacant lots or even lot with improvement
Uses the principle of substitution – meaning, the value of the subject property is dictated by
the cost in acquiring another similar property with the same legal uses and characteristics

Formula : Value of comparable + or - Adjustments = Market Value of Subject

Purpose of Adjustment :
 To equalize comparable to the market value of the property
Kinds of adjustment
1. Time element ( say, the comparable was actually sold a year ago)
2. Terms of sale or discount factor ( market value is in terms of CASH)
3. Location
4. Physical
TIP :
 If comparable is superior DEDUCT your adjustment ( in percent x comparable)
 If comparable is inferior ADD your adjustment

2. Cost Approach to Value - for lot with improvement

Uses also the principle of substitution – meaning, the value of the subject property is dictated
by the cost in acquiring another similar property with the same legal uses and characteristics
for the lot component and for the improvement the estimated replacement cost new is
estimated less the estimated depreciated as observed ( not the historical depreciation)
Formula :
 Replacement Cost New say FA 100sqm x P30K - P3,000,000.00
 Less : Observed depreciation, say 30% 900,000.00
 Depreciated Value of the house - 2,100,000.00
 Add : Estimated land value ( 200sqm x P15K/sqm) - 3,000,000.00
MARKET VALUE of house and lot - P5,100,000.00

You can use also sales comparison approach here

Example : There 3 model houses in a subdivision, and you are appraising Model B
Therefore, you can look at some for sale properties or sold properties in
the same subdivision with the same model

3. Income Approach to Value

 Applicable to commercial or industrial property with potential income – say rental income
or residential apartments
 One year net operating income is capitalized ( Income / Rate = Value) to arrive at the
value of land and improvement
 The value arrived here should be compared to the value by sales comparison or cost
approach to more or less determine if the land is being utilized in its highest and best-use
 More often than not, COST APPROACH yields a bigger amount than income approach
 If value by income approach is greater than cost approach then there is surplus
productivity and it goes to the land
 Example :
 You have P20M cash ( value) and you want to invest it in realty and satisfied with a 10% (rate)
yearly net operating income. So how much should be the income?

 Formula : Value x Rate = Income or P20M x 10% = P2M per year

Using the 10% rate

 How much are you going to buy a property with a yearly NOI of P1.5M if you desire a 10%
return
Solution : Value = Income / Rate or P1.5M / 10% = P15M

DISCOUNTED CASH FLOW

 You can use also a discounted cash flow in income approach
 Applicable if stream of income is not CONSTANT
 Study math of investment formula

Case No. Value of house and lot with 15-year stream of income from Globe

Depreciated Value of the house

+ Estimated land value
+ Discounted value of 15-year rental income
ESTIMATED VALUE OF LAND AND BLDG.

4. FIRST CONSIDERATION IN VALUATION

 The legal and highest and best-use of the land

5. OVER-IMPROVEMENT or UNDER-IMPROVEMENT is a violation of the highest and best-use

principle

6. ASSUMPTION and LIMITING CONDITION ( protection of the appraiser)

Assumptions are suppositions taken to be true
Examples :
 The area per title is correct. The selling prices comparables with for sale sign or
advertised or given by fellow appraisers and brokers are true and correct

 Ownership is assumed at fee simple

 The lot is appraised as if vacant based on its legal use

Limiting Conditions
 No survey was made
 Encumbrances which may adversely affect values are disregarded
TABLE APPRAISAL ( must be disclosed in the certification that no ocular was made)
 Nowadays it is much easier to appraised property even without seeing it personally – best
effort
 Google map is a great help for us, likewise lot plotting by computer is available – its free
 Market comparables are loaded with the help of ads in internet – Lamudi, Property 24,
Locanto, Carousel, etc
 FB, social media is a great help too. Association of broker or appraiser can be of help too
 Site identification is much easier now using the google map, the coordinates, and the street
view
 For those who is knowledgeable in photoshop – lot overlay is an added feature of our
appraisal

USUAL CONTENTS OR PARTS OF AN APPRAISAL REPORT

a. The cover, the face of the report say, showing the picture of the subject property
b. The transmittal letter
c. Assumption and limiting condition
d. The body of the report – information per title, per TD, per actual inspection, location and
neighbourhood, utilities and community facilities, highest and best-use of the lot, general and
specific data, ongoing and future development, market comparables, bir zonal values,
marketability (positive and negative factors), tax analysis in case of sale, certification of value
e. Attachment : title, tax dec, lot plan by computer lot plotting, overlay map, location/vicinity
map, pictures of property and notable improvement that has an effect on value and the
qualification of the appraiser

APPRAISER’S COMPENSATION
o Generally,
o based on the time required
o extent and scope of work
o reputation of the appraisal company

Example:
o A typical house and lot located in Quezon City, which can be completed in 3 days:
 Salary of the appraiser - 3 days x P800.00 - P2,400.00
 Out-of-pocket expenses
o Transportation - gasoline expenses - 800.00
o Meals - one day - 300.00
o Printing cost - complete report - 300.00
o Office overhead share - rental, etc. - 1,500.00
 Total before profit and tax - 5,300.00
 Add : provision for profit and tax (50% ) - 2,650.00
 Total - 7,950.00
Rounded to - P8,000.00