Resource Center by Dan L. Swango, PhD, MAI, SRA

Exploring Residential Dynamics: Commentary on Residential Property Appraisal

About This Column Appraisers who value residential complete assignments in dynamic markets. This edition of Resource Center looks at Residential Property Appraisal, a resource that offers appraisers information and guidance on application of concepts in both typical and atypical residential assignments.

he newly published Residential Property Residential Property Appraisal is an essential text for the res- Appraisal by Mark R. Tidential appraiser, whether seasoned or Ratterman, MAI, SRA novice. This is the most recent in the Appraisal (Chicago: Appraisal Institute, Institute’s books of particular interest to residen- 2020). 500 pages, Illus. tial appraisers.1 Its sixteen chapters cover the Price: $85 softcover or PDF basics—addressing timeless topics with current AI Price: $75 applications. In addition, it covers subtopics such Print and PDF bundles available as specialty residential property types, green and at http://bit.ly/AI_Online_Store high-performance houses, and specialty residen- tial markets. The reader will find helpful supple- mentary information in a section on financial calculator basics and a bibliography for those AI-RRS, contribute chapters on residential spe- interested in digging deeper. cialty segments as described below. The author, Mark R. Ratterman, MAI, SRA, Residential Property Appraisal is intended for is an outstanding communicator. He offers clear both instruction and reference. Its complete, explanations of basics that even experienced functional index is an essential aid for looking up appraisers can use for a refresher and that nov- topics or terms of interest. Of course, the PDF ices need for in-depth understanding and clarity. version of the book inherently carries the ability The writing is clear and to the point, with ample for the user to search for any word or group of examples, illustrations, and resource citations. words. The appendix at the end of this column In addition, Sandra K. Adomatis, SRA, LEED lists key concepts that are defined in Residential Green Associate, and Maureen Sweeney, SRA, Property Appraisal.

1. Other books include, but are not limited to, The Valuation of Condominiums, Cooperatives, and PUDs; Residential Green Valuation Tools; Appraising the Tough Ones: Creative Ways to Value Complex Residential Properties; Valuation by Comparison: Residential Analysis and Logic, 2nd ed.; Identifying Residential Architectural Styles; Using Residential Appraisal Report Forms: URAR, Form 2055, and the Market Conditions Form, 2nd ed.; and An Introduction to Green Homes. Of course, residential appraisers also rely on the Appraisal Institute’s texts The Appraisal of and The Dictionary of .

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Chapter 1, “Real Property Ownership and look at the sources of mortgage money, the sec- Appraisals,” introduces foundational concepts ondary mortgage market, and influences on the in real estate including the following: mortgage market. This discussion covers the fed- • Forms of ownership eral reserve system, credit regulation, and the US • Distinction between real property Department of the Treasury. The chapter is and real estate rounded out with a discussion of the particulars • Personal property of loan risk, points, financial trends, financing • Tangible and intangible property fraud, and financing plans and trends. • Fixtures and trade fixtures • Types of estates Chapter 3, “The Valuation Process, Begin- • ning the Appraisal, and Data Collection,” • Powers of government offers a good in-depth overview of the approaches • Leasehold and leased fee interests to value, which are more specifically addressed in • Identification of property rights later chapters. The text here starts with an effec- • Condominiums and cooperatives tive discussion of the valuation process and a dia- • Planned unit developments (PUDs) gram of the steps involved. The author presents a thorough treatment of the important topics of The chapter also has excellent to-the-point dis- scope of work, data collection, property descrip- cussions about contracts, , types of , tion, site value, and data analysis. The text pro- and options. vides a practical look at elements of data analysis The second part of the chapter provides an in the appraisal process—including market and overview of appraisal and appraisers. It explains neighborhood analysis and what an appraisal is, why appraisals are needed, analysis—with illustrative examples. the valuation process and related services, and Chapter 3 concludes with a brief discussion of residential appraiser qualifications, including reconciliation and reporting the defined value, licensing, certification, designations, credentials, with more thorough examples left for later in the and competency. book. The real-world topics of scheduling and planning, collection of data on the subject prop- Chapter 2, “Principles of Value, Real Estate erty, property inspection, and collection of data Economics, and Finance,” takes a look at the on comparable properties also are discussed. concept of value and types of value; gross and net pricing; insurable value; and assessed value. Chapter 4, “Neighborhood and Market Area Principles of are clearly Analysis and Highest and Best Use,” provides explained. Real estate markets are examined by information about analysis of location. The dis- property type, including their key characteristics, tinction is made between a market study and a and the differences between neighborhoods, dis- marketability study, and an explanation is given as tricts, and market areas are explained. The clas- to the questions each answers, the items included, sic “four forces that influence value” are presented and the use of each. The distinctions between along with the significance of changes, trends, neighborhood and market area are explained, and and cycles in real estate markets. critical market area influences and trends are The second portion of the chapter gets into the presented. The discussion addresses the following financing side of residential real estate, with a topics related to these concepts:

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• Social influences, including population • public and private limitations on trends and characteristics, community ownership rights of the site (, and neighborhood organizations, and the covenants and use restrictions, need for understanding the quality of ser- party-wall agreements); vices, establishments, and neighborhood • understanding physical characteristics associations. of the site (immediate location • Economic influences, including demo- character­istics, physical and economic graphics about income and purchasing linkages, environmental influences); power, financing availability, real estate • tax and assessment information; prices, rent levels, new construction, gov- • real estate tax status (especially ernment services and tax influences, public compared to similar properties); and private restrictions, schools, and owner- • special assessments; occupancy rates. • government and private services • Environmental influences (physical and and costs; geographic), including siting factors, flood • explanations of the types of legal zones, location as it relates to the overall descriptions; and community, transportation systems and • data sources for site information. linkages, recreation, amenities, soils, views, characteristics and conditions of resi- The chapter has a thorough discussion of each dences, and adequacy of utilities. There is item, with illustrations, exhibits, and examples. also discussion of the importance of consis- tency in markets and reporting neighbor- Chapter 6, “Improvements Description,” hood conclusions. addresses the description of building improve- ments, from site placement and utility to con- Highest and best use is the next main section of struction materials and building systems features. the chapter. Several commonly used highest and The chapter discussion covers Fannie Mae qual- best use definitions are presented and discussed. ity of construction ratings and property condi- This chapter offers a well-explained section on tion ratings. Residential architecture and trends, highest and best use of a site as though vacant types of houses, house living zones and condition and highest and best use of a property as improved. are all in this chapter. The concept of consistent use is addressed and analyzed. There is also a useful discussion of spe- Chapter 7, “Land and Site Valuation,” delves cial situations in highest and best use analysis; it into the difference between land and site. The tackles the concepts of interim uses, legally non- text explores the notion of valuation of property conforming uses, excess and surplus land, and rights to or in the physically described real estate; neighborhoods in transition. Examples are the principles of progression and regression; included throughout the discussion to augment and the market forces that influence land value. definitions and concepts. The chapter allocates significant discussion to the valuation of land and site in the residen- Chapter 5, “Site Description,” addresses what tial context. The major land and site valuation is needed for understanding of a site before its techniques are thoroughly discussed with clear valuation. Topics covered here include explanations and examples of each. Emphasis • legal and other descriptions; is on the sales comparison method, with seven- • property rights involved; teen pages describing the technique and thor-

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ough examples of research, comparison, and Chapter 9, “Estimating Depreciation,” intro- adjustments (both qualitative and quantitative), duces the three types of depreciation—the mar- and applied conclusion. ket extraction method, age-life method, and Other land or site valuation techniques dis- breakdown method. There is a thorough expla- cussed include the allocation technique, extraction nation of each depreciation type, with helpful technique, income capitalization techniques diagrams illustrating the relationship and major (land residual and ground rent capitalization), items in each method. The examples help and subdivision development analysis. When to improve the reader’s understanding and are use each of these land or site valuation methods is valuable for both the student and experienced covered and examples are provided. appraiser as a reference.

In Chapter 8, “The Cost Approach,” the appli- Chapter 10, “The Sales Comparison cation of this approach and its pros and cons are Approach,” gets into the basic steps of this examined. The author breaks the cost approach approach and includes an example of a sales com- into the following useful steps: parison adjustment grid. The discussion addresses 1. Develop an opinion of the market value real-world topics such as errors in data searches, of the site as though vacant. strengths and limitations of the approach, and 2. Estimate direct and indirect construction the research and selection of comparable sales. costs of the improvements. The latter section discusses how to identify com- 3. Estimate the entrepreneurial incentive parable properties, the importance of field required to bring the improvements inspection (particularly when database informa- into production. tion is insufficient), the importance of highest 4. Add direct costs, indirect costs, and and best use, and verification of data—with key entrepreneurial incentives. items to cover in the verification process. A brief 5. Estimate improvements’ applicable section on “thinking of comparables as competi- depreciation from any cause. tive properties” contains some particularly valu- 6. Deduct the depreciation from all causes able practical points. from the improvement cost estimate. The process of making comparison adjustments 7. Estimate the contributory (net) value is a significant part of this chapter. It addresses of the site improvements. units of comparison, dollar versus percentage 8. Add the site value to the depreciated cost adjustments, sequence of adjustments, and of all improvements. paired-data analysis and its limitations. Qualita- tive analysis is also covered, including ranking. Other sections of interest examine the relation- The chapter concludes with considerations in ship of the cost approach to appraisal principles, the final reconciliation of data, findings, and the challenges of overimprovement and under- analysis in the sales comparison approach. improvement, and the applicability of the cost approach. Cost-estimating methods are intro- Chapter 11, “Adjusting Comparable Sales,” duced with examples. The comparative unit continues the discussion of the sales comparison method, unit-in-place method, and quantity sur- approach and process. There is an overview of the vey method are also covered. Finally, this chapter concept of comparison adjustments and elements offers a good introduction to depreciation, with of comparison followed by a discussion of each of details left to the next chapter. the following examples of elements of comparison:

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• Real property rights conveyed whether location is in the site value or a separate • Financing terms, concessions adjustment for the total property sales compari- • Conditions of sale son process. Ample examples are provided in this • Expenditures immediately after purchase section and throughout the chapter. • Market conditions, date of sale Comparisons of improvement condition brings • Location up some practical points useful to the practi- • Property interests tioner, as does the discussion of above-grade and • Site size below-grade footage. As with other topics, the • View amenity examples make the discussion practical and use- • Improvement age ful for understanding and reference. • Improvement condition • Above-grade room count Chapter 12, “The Income Capitalization • Above-grade gross living area Approach,” provides a good overview of the • Basement, finished area below grade income capitalization approach for the residen- • Heating, cooling, energy-efficient items tial appraiser, its research and data requirements, • Garage, car storage and applicability. This section includes the use of • Porches, patios, decks multipliers and the direct capitalization process • Intangible property, economic characteristics as relates to the single-family residential prop- • Zoning erty. This chapter has excellent discussions, and • Personal property, nonrealty components many examples, involving: • the data collection and rent survey process, Of course, there may be subitems and other • analysis of provisions, points for consideration depending on the com- • derivation of multipliers from the market parable and appraised property characteristics. (including the adjusting of comparable sales), For example, in the section on rights conveyed, • reconciliation of the multiplier indications, long-term leased land is addressed as well as dif- • estimating monthly rent (including ferences in rights such as mineral rights, life adjusting market data), estates, and negative easements. Under the sec- • reconstructed operating statements, tion on financing terms and concessions, non- • estimating operating expenses, and standard or creative financing is discussed along • direct capitalization of a single year’s net with the possible impact on price of the compa- income. rable and need for comparison adjustments. Other financing arrangements, such as seller This chapter is a significant aid to understanding financing, non-cash considerations in a compa- the income approach for single-unit residential rable transaction, and below-market rate financ- property because of its clear writing, practicality, ing, are covered with valuable examples. and helpful examples. The condition of sale element of comparison has good coverage in the chapter along with an Chapter 13, “Final Reconciliation and the example. The consideration of expenditures Appraisal Report,” covers a topic of importance made immediately after purchase and market for appraisal reports. The discussion in this chap- conditions/date of sale elements of comparison ter will help appraisers—even experienced practi- are discussed effectively. The location adjust- tioners—understand reconciliation and improve ment is well covered and addresses key practical the appraisal process and their writing of the points. For example, the discussion looks at reconciliation part of their appraisal reports. Part

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of reconciliation includes a self-review of the residential property. Awareness of the following work done in the appraisal process through the basics will help keep the appraiser’s thinking and approaches; to enhance this step the text includes analysis process on track in these assignments: a good self-review checklist. (Page 407) • Buyers and sellers buy and sell real property The importance of addressing the appraisal (i.e., rights), not real estate. question and any special situations is part of the • The address of a property is merely direc- self-review and reconciliation process. For exam- tions to the mail carrier—it does not ple, the client may need a defined value for the describe the bundle of rights involved. property “as is” or “as if repaired,” or may want a • Condominium is a generic term used to list of needed repairs and estimated cost to com- describe a property that is or is not attached plete, or may have stipulated specific require- to another unit and normally has a level of ments for the report’s content. maintenance performed by a homeowners The chapter has a good discussion about the association (HOA). importance of reviewing for adequacy of data • Condominium is also a legal term, specifi- and analysis, consistency, math, and other such cally defined by the state jurisdiction in items. The author notes that discussion in the which it is located. reconciliation section of the appraisal report • PUDs are properties with ownership nor- should address the applicable approaches, qual- mally like most other types of real estate, ity and quantity of data available and used, the with interests spatially defined by the legal value indications, and the supported final value description. PUDs normally have HOAs indication. As the author says, “Reconciliation (community associations), and individual is a process that is required in all appraisals. Rec- ownership carries both individual and joint onciliation is necessary because value opinions property rights. (Pages 423–424) are often based on imperfect data” and multiple value indications as well as special conditions or The chapter has a thorough five-page overview assumptions. (Page 422) of condominiums, condominium ownership, Examples of various commonly used form common elements, limited common elements reports are included in the text, but the reader (LCEs), site condominiums, and condo-hotels. must remember that these change from time to Cooperatives, their characteristics, valuation time, so it is important to check current require- considerations, and a comparison of condomini- ments of the client, regulators, and the secondary ums and cooperatives make up the next section. mortgage market. It addresses cooperative ownership and propri- etary leases. The balance of the first part of the Chapter 14, “Specialty Residential Property chapter is a discussion of PUDs, leasehold estates Types,” drills down into concerns regarding cer- and ground (land) leases. Examples are included tain types of residential properties. This section, to increase the reader’s understanding. contributed by Maureen Sweeney, SRA, AI-RRS, The last ten pages of the chapter address the addresses the specific situations and considerations valuation of “small income-producing proper- for specialty property types, including condomini- ties.” These include duplexes, triplexes, quads, ums, site condominiums, condo-hotels, coopera- two-flats, and three-flats. The author notes the tives, planned unit developments (PUDs), and importance of understanding the bundle of rights, small income-producing residential properties. and characteristics of the lease(s) in place for The author points out several important details such properties. Also important is an understand- to keep in mind in valuing these special types of ing of the market norm for occupancy period; rent

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amount; payment of utilities, insurance, and maintenance section examines the importance taxes; parking; concessions; termination terms; of the truly green building ideally costing less to and tenant restrictions. The and tenant operate than a non-green building. obligations are among the points for appraisers to The chapter goes on to explain the “Residen- investigate—for the subject and comparable rent- tial Green and Energy Efficient Addendum” als alike.2 The distinction between market rent report form, and green verification programs, and contract rent is explained as well. including As the text explains, the capitalization tech- • Energy Star, nique most often used in the appraisal of small • LEED, income-producing properties is direct capitaliza- • Living Building Challenge, tion. This topic is well covered and explained • National Green Building Standard, with good examples.3 • Pearl Certification, and • Passive House. Chapter 15, “Green and High-Performance Homes,” was contributed by Sandra K. Adoma- Several green residential studies are shown for tis, SRA, LEED Green Associate. The meaning additional resources of information for apprais- of “green” and “high-performance” are discussed ers. (Pages 459–460) so the reader has an immediate basic understand- ing of the terms. The six elements of green build- Chapter 16, “Specialty Residential Markets,” ing are listed and discussed individually: also contributed by Maureen Sweeney, SRA, • Site AI-RRS, covers a number of useful topics: • Water efficiency • Senior housing • Energy efficiency • Investor markets • Indoor air quality • Bulk sales, which may involve a few • Materials residences or a portfolio of residences • Operations and maintenance • Multiple sales of similar units, such as developed residential lots, houses, and The energy efficiency section of this chapter condominiums explains energy ratings and rating systems and • properties, including solar photovoltaics. The indoor air quality sec- a financial institution’s real estate tion addresses indoor pollutants. The materials owned properties section discusses quality and quantity of materi- • Homes in poor condition als and the effect on the construction budget and • Relocation appraisals4 building performance. Finally, the operations and • Rural markets

2. It is important for the appraiser to understand state landlord-tenant laws for residential property, especially for reported month-to-month rentals. 3. analysis is also explained, with examples. 4. The Employee Relocation Real Estate Advisory Council uses the term anticipated sales price; its definition and components are explained in the text. The client for relocation appraisals has particular needs, one of which is a prospective opinion of value considering the client’s specified marketing period. Forecasting is in the definition of anticipated sales price, and thus involved in the appraisal process and appraisal report.

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The discussion on specialty markets is signifi- Appraisal Forms” points the residential appraiser cant. In these assignments, the appraiser needs to to good online resources, including some resources consider items, and even valuation techniques, for appraising green properties. The text con- that may differ considerably from the typical res- cludes with a twelve-page Index to help the idential property appraisal. The author alerts reader find specific topics and terms. appraisers to the special items calling for particu- lar attention in each specialty category. Exam- Recommendation. Valuers will find the Appraisal ples further enhance readers’ understanding. Institute’s new Residential Property Appraisal a The book’s regular chapters are supplemented helpful reference and guide. The text covers the by a five-page special section on Financial Calcu- basics and more. Written by residential experts, it lator Basics, with emphasis on the classic work- provides a thorough overview of all aspects of res- horse, HP-12C calculator. This part of the book idential appraisal as well as the issues that may be addresses the calculator’s mortgage and other encountered. The general discussion leads the financial functions and offers helpful hands-on reader through the various steps in a valuation of examples. Also included are citations for addi- residential property. This is supplemented by tional resources. chapters on the specific considerations in valua- Another helpful supplement follows: the Bibli- tion of green residential properties and specialty ography, which includes citations for a number residential property types, such as condominiums. of books on residential appraisal, including many The clear writing and exhibits throughout aid in with advice on completing residential forms and the reader’s understanding. Residential Property on valuing specialty residential property types Appraisal is an essential text for residential apprais- and markets. The section “Publications about ers, no matter what the level of experience.

About the Author Dan L. Swango, PhD, MAI, SRA, is president of Swango Real Estate Counseling and Valuation Inter­national in Tucson, Arizona. He is experienced in valuation and consulting involving equity investment, debt security, risk reduction, profit optimization, estate planning and settlement, buy/sell opportunities, and eminent domain. Swango is an instructor and commu­nicator with domestic and international experience. He is namesake of The Appraisal Journal’s Swango Award, past Editorial Board chair and editor-in-chief of The Appraisal Journal, and a current member of the Journal’s Review Panel. Contact: [email protected]

If you know of additional resources of interest to real estate analysts and valuers—or would like to suggest topics for this column—please contact the author.

SEE NEXT PAGE FOR APPENDIX >

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Appendix Terms and Concepts Defined in Residential Property Appraisal

Actual age Earnest money Highest and best use Ad valorem tax Easement Homeowners association Anticipated sales price Economic base Anticipation Economic base analysis Improvements Appraisal Economic life Income capitalization approach Approaches to value Effective age Indirect costs Assessed value Effective date Inspection Assignment condition multiplier Installment contract Assumption of mortgage Effective purchasing power Insurable value Automated valuation model Elements of comparison Intended use Eminent domain Intended user Balloon payment Entrepreneurial incentive Interim use Bargain and sale Entrepreneurial profit Basic industries Equity Jurisdictional exception Bundle of rights theory Escheat Buydown Estate Land Excess land Lease Capitalize, capitalization External obsolescence Leased fee interest Cash equivalency analysis Leasehold interest Common elements Fair housing laws Legal permissibility Community associations Fannie Mae Legally nonconforming use Competition Federal discount rate Limited common elements Conditional sales contract Fee simple estate Linkage Condo hotel Final reconciliation Littoral rights Condominium Financial feasibility Location Condominium ownership First mortgage Consistent use Fixture Market area Contract Forecasting Market rent Contract for deed Form report Market study Cooperative ownership Fraud Market value Cost approach Freddie Mac Marketability Creative financing Fully amortizing mortgage Master plan Functional obsolescence Maximum productivity Date of opinion of value Mortgage Decline General data Mortgage-backed securities Deed General warranty deed Mortgagee Deed of trust Multiple listing Deed restriction Ginnie Mae Direct capitalization Green, high performance Neighborhood Direct costs Gross rent multiplier Neighborhood life cycle Disintermediation Growth District CONTINUED >

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Appendix (continued)

Operating expense ratio Sales comparison approach Option Scope of work Overimprovement Second mortgage Secondary mortgage market Paired sales analysis Seller financing Partial interest Sequence of adjustments Personal property Service industry Physical deterioration Site Physical possibility Siting factor Planned unit development Special assessment Points Specific data Police power Stability Potential gross income Subordinate lien Potential gross income multiplier Substitution Principal, interest, taxes, and Superadequacy insurance Surplus land Pro rata share Progression Tangible property Proprietary lease Taxation Prospective opinion of value Title Purchase-money mortgage Trade fixtures Purchasing power Transition

Quitclaim deed Underimprovement Unit Real estate Useful life Real property Utility Recession Reconciliation Valuation process Regression Value Relocation Value in use Relocation company Verification Remaining economic life Remaining useful life Zoning Replacement cost Report Reproduction cost Reserve requirement Restrictive covenant Revitalization Riparian rights Risk

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