Real Estate Chapters 5-7

Chapter 5 Market Determinants of Value Test Problems 1. The “gravity” that draws economic activity into clusters is: c. Demand for access or proximity. 2. Spatial or distance relationships that are important to a land use are called its: a. Linkages. 3. Cities have tended to grow where: a. Transportation modes intersect or change. 4. The economic base multiplier of a city tends to be greater if the city is: a. Larger. 5. The best example of a base economic activity would be a: e. Regional sales office. 6. Important supply factors affecting a city’s growth or growth potential include all except the: a. Unemployment rate. 7. Which of these are true about agglomeration economies? e. All of the above. 8. Which of these influences will decrease the level of a bid-rent curve at the center of the city? a. Faster travel time. 9. In a system of bid-rent curves, assuming that households are identical except for the feature noted, which of these prospective bidders will bid successfully for the sites nearest to the CBD? a. Households with the greatest number of commuting workers. 10. A large university is an example of what kind of economic phenomenon? c. Industry economies of scale. Study Questions 1. List five major economic base activities for your city of residence. Solution: Is MSA specific. 2. Find the historical population figures for your community for the 20th century. Create a chart by ten-year intervals. Determine the most rapid periods of growth, and try to discover what caused them. (One source of the necessary population numbers is the U.S. Census home page, www.census.gov. Look in the right-hand column in Data Finders to find QuickFacts, and select your state and county. At the top of the large table of current information that appears select your county or city. Then click on “Browse more datasets and look down the page for the heading “Historical Population Counts.”) Solution: The solution to this question is MSA specific. 3. On the U.S. Census web site, use the approach shown in the chapter in Explore the Web to access the American Community Survey. For your county, and for your state find the distribution of income for all households. Graph the distributions using percentage for each income interval. Which is higher, county or state?. Solution: This solution is MSA specific. However, as an example, in Alachua County , Florida and for Florida, the distributions are as shown below. 4. Alachua County, a university community has a higher concentration of lower income households than the state, reflecting, in part, student households. . Identify at least five locational attributes that are important in the location of a fast-food restaurant. Compare notes with someone in the industry such as a local restaurant manager or owner. Solution: Likely locational requirements for a fast-food restaurant could include these: visability, high traffic counts, easy entry and exit from the site, good proximity to households or places of work, and a location that affords a “locational monopoly” in that a competitor cannot “intercept” the available market. 5. Perfect Population Projections Inc. (PPP) has entered into a contract with the city of Popular, Pennsylvania, to project the future population of the city. Popular has become a popular place in recent years as indicated by the following data: Total Population 50,000 53,000 57,000 65,000 70,000 ? Year 2005 2006 2007 2008 2009 2010 Total Employment 25,000 26,500 28,500 32,500 35,000 ? Basic Employment 6,250 6,625 7,125 8,125 8,750 9,000* Nonbasic Employment 18,750 19,875 21,375 24,375 26,250 ? *Estimated from surveys The contract states that PPP must project Popular’s population for the year 2005 using both a simple linear method and an economic base analysis. The ratio of population to total employment is 2.0833. Your help is needed! Solution: Using a simple linear method, the growth trend in the population would be extended (extrapolated) one year. The extrapolation could be done graphically, which amounts to drawing a line through the dots, and extending them one year. This would result in a population for 2010 of approximately 75,000. Alternatively, it could be done by simple linear regression, resulting in an estimated annual incremental growth of 5,900. Thus the population by linear projection would be approximately 76,000. On the other hand, a projection using the economic base approach starts with the ratio of population to base employment. For Popular, this ratio is unvarying at 8.00. By the logic of the model, this ratio will continue. Thus, a projected employment of 9,000 for 2005 implies a population of 9,000 x 8 = 72,000. CHAPTER 6 Forecasting Ownership Benefit and Value: Market Research Test Problems 1. Factors that affect housing market segmentation include all except: d. Household unemployment status. 2. The process of creating a “market-defining story” includes all of these questions except: d. What is the price? 3. The cycle of real estate market research starts with: a. Creating a market defining story. 4. Features of an office building that may be important to one market segment or another include: e. All of the above. 5. A strong assertion about the large amount of data seemingly available for real estate market research is that most of it is: c. Irrelevant to a given analysis. 6. The approach to real estate market research advocated in this chapter starts with the: e. The nature of the property. 7. A powerful tool for managing, manipulating, and displaying location-specific data is: d. Geographic information systems. 8. Avery sophisticated, data intensive, and statistically intensive method of examining market segmentation is known as: d. Psychographic research. 9. Causes of real estate cycles include: d. Both a and b, but not c. 10. Data used in the market research cases in this chapter that are publicly available over the Internet include all of the following except: d. Data on job location from the National Transportation board. Study Questions 1. On the U.S. Census web site, use the approach shown in Explore the Web, Chapter 5, to access the latest American Community Survey. For your county, find the distribution of reported house values for owner occupied residences. Solution: Is county specific. Below is an example result for Alachua County, Florida 2. If you were looking for an apartment at this time, what are six non-locational requirements that you would consider important? Solution: Six non-locational requirements include an appealing floor plan and layout, community amenities, security features, desirable tenant mix, adequate parking, and construction quality. 3. Select a site in your city that is in a mixed use or non-residential area, and either is vacant or appears to be ready for change (e.g., structure partially used or vacant, or in need of refurbishing). Go the site during the morning commuting period, on a business day. Situate yourself at or near the site and observe the activity at and around the site. Pay particular attention to why people pass the site-where they are coming from and where they are going. Note any nearby land uses or pedestrian flows that could potentially involve the site. Then explore the area around the site for a block or so in each direction, and record on a simple map the main patterns of traffic flow, and the broad variations in the land uses. Finally, after at least one observation session of 30 minutes, record your main impressions, and any thoughts you have concerning the potential use of the site. (Hint: A good way to select a site might be to go to a commercial broker or appraiser and ask them about a site that they are intrigued with. It gives you an interesting industry contact, and another perspective on the problem.) Solution: Is city specific. 4. Select a property of interest to you, or to an industry contact, for which market research would be interesting. Examine the property, collect what information is available about it, and then write a market defining story for the property using the questions from the chapter as a guide. Solution: Is case specific. 5. University City is a town of more than 200,000 persons, with over 50,000 university and community college students. It has over 30,000 apartment units which, with one or two exceptions, are garden apartments with a maximum of three floors. Except for buildings within or immediately adjacent to the university medical center, the football stadium, and the two graduate student dorms, only two other buildings in the University City exceed five floors. A developer proposes to introduce two 24-story apartment buildings halfway between the downtown and the university, which are about 2.5 miles apart. One tower, would be targeted to undergraduate students and the other to graduate students. The downtown consists of little more than government offices, mostly local and county. What questions should the developer ask in order to create a “market defining story” for the twin towers? Solution: This story needs to answer the following questions: 1. What is the real estate product under consideration? 2. Who are the customers (target market)? 3. Where are the customers? (What is the market area?) 4. What do the customers care about? (What aspects of the product?) 5. Who are the competitors? CHAPTER 7 Valuation Using the Sale Comparison and Cost Approaches Test Problems 1. The final price for each comparable property reached after all adjustments have been made is termed the: b. Final adjusted sale price. 2. Which of the following is not included in accrued depreciation when applying the cost approach to valuation? d. Tax depreciation 3. The final price after reconciliation of the answers obtained from two or more approaches is termed the a. Final estimate of value. 4. A new house in good condition that has a poor floor plan would suffer from which type of accrued depreciation? d. Incurable functional obsolescence 5. To reflect a change in market conditions between the date on which a comparable property sold and the date of appraisal of a subject property, which type of adjustment is made? b. Market conditions. 6. In appraising a single-family home, you find a comparable property very similar to the subject property. One important difference, however, concerns the financing. The comparable property sold one month ago for $120,000 and was financed with an 80 percent, 30-year mortgage at 5.0 percent interest. Current market financing terms are 80 percent, 30-year mortgage at 7 percent interest. The monthly payments on the market financing would be $638.69, while the monthly payments on the special 5.0 percent financing are $515.35. Assume the borrower's opportunity cost rate is 7 percent. The approximate present value of the present savings on the non-market financing is ______, and this amount should be _______ to the transaction price of the comparable. Difference in payments: $638.69 - $525.35 = $123.34 The present value of the payment savings assuming the loan remains outstanding the entire 30 years is $18,538.94. N= 360 I/YR = 7/12 PV = 0 PMT = 123.34 FV = 0 This $18,538.94 should be subtracted from the sale price of the comparable property. d. $18,539, subtracted. 7. You find two properties that have sold twice within the last two years. Property A sold 22 months ago for $98,500; it sold last week for $108,000. Property B sold 20 months ago for $105,000; it sold two weeks ago for $113,500. What is the average monthly compound rate of change in sale prices? e. none of the above Unfortunately, “none of the above” is not one of the choices listed in the book. Note that 0.42% is the correct answer with no compounding. Property A: $108,000/$98,500 = 1.096447 Property B: $113,500/$105,000 = 1.08095 Average monthly increase with no compounding: Property A: 0.096447/22 = 0.00438 Property B: 0.08095/20 = 0.00405 0.00843/2 = .004215 or 0.42% Average monthly increase with compounding: Property A: 1.096447(1/22) = 1.004194 or 0.004194 Property B: 1.08095(1/20) = 1.00390 or 0.00390 0.008094/2 = .004047 or 0.40% 8. A comparable property sold 10 months ago for $98,500. If the appropriate adjustment for market conditions is 0.30% per month (without compounding), what would be the adjusted price of the comparable property? b. $101,455 Without compounding: $98,500*(1+(0.003x10)) = $98,500*1.03 = $101,455 With compounding: $98,500*(1.003)10 = $98,500*1.030408 = $101,495.21 or $101,495 9. A comparable property sold six moths ago for $150,000. The adjustments for the various elements of comparison have been calculated as follows: Location: -5 percent Market conditions: +8 percent Physical characteristics: +$12,500 Financing terms: -$2,600 Conditions of sale: 0 Legal characteristics: 0 Use: 0 Nonrealty items: -$3,000 (Note that the term “Legal characteristics” should be replaced with the term “property rights conveyed”) Making the adjustments in the order suggested in Exhibit 7-6, what is the comparable’s final adjusted sale price/indication of the subject’s value? a. $160,732 Transaction price Adjustment for financing terms Adjusted price Adjustment for market conditions Adjusted price Adjustment for location Adjusted price Adjustment for physical characteristics Adjusted price Adjustment for nonrealty items Indication of subject value Minus Plus 8% Minus 5% Plus minus $150,000 $2,600 $147,400 $11,792 $159,192 $7,959.60 $151,232.40 $12,500 $163,732.40 $3,000 $160,732 10. A property comparable to the single-family home you are appraising sold 3 months ago for $450,700. You have determined that the adjustments required for differences in the comparable and subject property are as follows: What is the final adjusted price (indication of the subject’s value) for the comparable? e. none of the above Unfortunately, “none of the above” is not one of the choices listed in the book. Note that the correct answer is $455,638. Study Questions 1. What is the theoretical basis for the direct sales comparison approach to the market valuation? Solution: The direct sales comparison approach to the market valuation relies on value judgments made by willing buyers and sellers. Therefore, this method uses market-driven information. The sales comparison approach involves comparing a subject property with recently sold comparable properties. 2. What main difficulty would you foresee in attempting to estimate the value of a 30-year old property by means of the cost approach? Solution: The cost approach assumes that the market value of a new building is similar to that of constructing the building today. Of the two methods available for estimating cost, appraisers normally use the reproduction cost of a building for appraisal purposes. A 30-year old building likely possesses many characteristics that render it obsolete. Therefore, calculating an accurate reproduction cost for an older building is difficult because outdated features, such as room arrangement, decorative features, and materials, are included in the reproduction costs. Estimating these costs can be problematic because reproducing the cost of a 30-year old building requires significant effort and assumptions of accrued deprecation. 3. The cost approach to market valuation does not work well in markets that are overbuilt. Explain. Solution: In an overbuilt market, the market value of an existing property is frequently less than the construction cost of the property. The estimated value calculated using reproduction cost of the property is likely significantly different from the value obtained from the sales comparison approach and the income approach. 4. What is meant by functional obsolescence? Could a new building suffer from functional obsolescence? Solution: Functional obsolescence refers to a building’s loss in value resulting from changes in tastes, technical innovations, or market standards. Typically, functional obsolescence is associated with a building’s decline in utility through the passage of time, but it is possible for a newer building to suffer from functional obsolescence. For example, costumer preferences and demands may change soon after a relatively new building is completed. 5. Why is an estimate of the developer’s fair market profit included in the costs estimate? Solution: In practice, developers and contractors frequently include their profit in the calculated cost amount because a fair and reasonable profit amount is considered a cost of the project. 6. Reproduction cost has been estimated as $350,000 for a property with a 70-year economic life. The current effective age of the property is 15 years. The value of the land is estimated to be $55,000. What is the estimated market value of the property using the cost approach, assuming no external or functional obsolescence? Solution: Reproduction cost Less: Depreciation Depreciable Cost of Building Improvements Add: Estimated Value of Site Indicated Value by the Cost Approach 350,000 (75,000) [$350,000 x 15/70] 275,000 55,000 330,000 7. What is an appraisal report? Solution: An appraisal report is the document prepared by the appraiser. This report contains the appraiser’s final estimate of value, the data forming the foundation of this estimate, and the calculations supporting the estimate. 8. What is the difference between market value and investment value? Solution: Market value is the most probable selling price; investment value is the value to a particular investor. 9. Contrast self-contained appraisal reports, summary appraisal reports, and restricted appraisal reports. Solution: A self-contained appraisal report includes all the detail and information that were used by the appraiser to derive his or her estimate of market value or the other conclusions within the report. A summary appraisal reports simply summarizes the conclusions of the appraisal. The majority of the data and techniques used in the appraisal are kept in the appraiser’s work file. A restricted appraisal reports provides a minimal discussion of the appraisal with many references to the appraiser’s work file/international documentation.. #10 You are appraising a single-family residence located in the Huntington neighborhood at 4632 NW 56th Drive. The property is being acquired by a mortgage applicant and you have been asked to appraise the property by the lender. Seven potential comparable sales were initially identified. However, three of these seven were highly similar to the subject property in their transactional, physical and locational characteristics. You therefore decided to exclude the other four transactions from the comparable set. The elements of comparison you used to compare and adjust the sale prices of the comparable properties are listed in the market data grid below. The property rights being conveyed in the acquisition of the subject property are fee-simple absolute. Conventional mortgage financing will be used by the purchaser and the acquisition appears to be an arm’s length transition. Thus, no adjustments need to be made to the sale prices of the comparable properties for the type of property rights conveyed, financing terms, or conditions of sale. However, the buyer of comparable 2 was aware that she would have to replace one of the air conditioning units immediately after acquiring the property; thus, she was able to negotiate a $3,000 price reduction from the seller. Comparable 1 sold three months ago, while comparables 2 and 3 sold six months ago. Based on your knowledge of recent price appreciation in this market, you have decided that comparable 2 would sell for 2 percent more if sold today and that comparables 2 and 3 would sell for 4 percent more if sold today. The subject property is located in Huntington, as is comparable 1. However, comparables 2 and 3 are located in Kensington and Millhoper, respectively. Although Huntington is a high-end neighborhood, both Kensington and Millhoper are generally considered to be slightly more desirable, In fact, homes in these two neighborhoods generally sell for about a 3 percent price premium relative to similar homes in Huntington. In these neighborhoods, an incremental square foot of lot size or living area is worth about $20 per square foot and $80 per square foot respectively. Each year of effective age reduces the value of properties in this market by about $3,000 per year. You experience suggests that each additional half-bath is worth $500; each additional full bath $1,000. Additional garage spaces, wood decks, and pools in these neighborhoods are worth $8,000, $1,000, and $12,000, respectively. No significant non-realty items were included in the comparable transactions and non-realty items are not part of the acquisition of the subject property. Based on the above discussion of the elements of comparison, complete an adjustment grid for the three comparable properties. What is the final adjusted price (indication of the subject’s value) for comparable 1, 2, and 3? #11 Assume the market value of the subject site is $120,000. You estimate that the cost to replicate the improvements to the subject property would be $428,000 today. In addition, you estimate that accrued depreciation on the subject is $60,000. What is the indicated value of the subject by the cost approach?