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2/9/2011
1
the
adjustment
process
under direct
comparison
Direct Comparison Approach
Market value is developed by comparing the
subject to recently sold, similar properties
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APPRAISAL PRINCIPLES
Relationship to Economic Principles
Principle of supply and demand
Shifts in supply and demand factors may cause
shifts in prices of properties in a market area
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Relationship to Economic Principles
Principle of substitution
The price paid for a property will be equal to the
cost of acquiring an equally desirable substitute
under the same market conditions
It sets the upper limit to the direct comparison
approach
Relationship to Economic Principles
Principle of balance
The relationship between a property and its
environment must be in balance to achieve
optimum market value
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Relationship to Economic Principles
Principle of externalities
Market value will be influenced by external
factors within the propertys market area
APPLICABILITY AND
LIMITATIONS
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Applicability and Limitations of DCA
Advantages
Best reflects the actions of buyers and sellers
Easily understood, explainable and defensible
Disadvantages
Must have adequate sales data
Can be difficult comparing between properties
and locations
Data has a shelf-life
Three Easy Steps!
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Research
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Begin the Hunt
Search for market transactions
Sales of recent, similar arms length
transactions
The more compsthe better!
Dont give up quality just to get
quantity
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Similar Building Characteristics
Design
Size, floor plan, additives
Construction and Maintenance
Quality of construction
Level of maintenance
Equipment/Fixtures
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Similar Building Characteristics
Age
Effect can be altered through
renovations
Can be affected by location
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Similar Lot Characteristics
Natural Features
Topography, shape, view, etc.
Proximity to Amenities
Shopping, schools, employment, CBD,
transportation routes, etc.
Services, tax levels
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Similar Lot Characteristics
Lot Size
Will determine what kind of building
can be erected
Shape can also affect value
Area vs Depth vs Frontage
Whats important?
6300
sq ft6500
sq ft
Which Lot Is Worth More?
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Site Adjustments
Irregular Shape
Based on the loss of utility of the lot
MAKE ADJUSTMENTS
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Make Adjustments
Identify differences between the
subject and comparables
Adjust the comps to be equivalent
to the subject
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Elements of Comparison
Each difference between the subject and
comps that could affect market value is
identified as an
ELEMENT OF COMPARISON
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Pro
pe
rtyP
rop
erty
Elements of Comparison
1. Real property rights conveyed
2. Financing terms
3. Conditions of sale (motivation)
4. Money spent after purchase
5. Market conditions (time)
6. Location
7. Physical characteristics
8. Economic characteristics
9. Use/Zoning
10. Non-realty components
Order of
these
first five is
mandatory!
Tran
sactio
na
l
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Real Property Rights Conveyed
Easements, leases, restrictive covenants
Refers to bundle of rights being the
same as the subject
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Financing Terms
Price may be affected by a mortgage at
higher- or lower-than-current market
rates
Comps with unusual financing are
typically omitted
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Conditions of Sale (Motivation)
Price may be affected by:
Seller being forced to sell quickly
Buyer being forced to buy quickly
Non arms-length transactions should be
avoided
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Money Spent After Purchase
Price may be lowered to account for
expenditures that the buyer has to make
immediately after the purchase
Note: This only applies to sales where the
buyer knew about this cost in advance
and reduced the offer accordingly
This is not about latent defects
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Market Conditions (Time)
To account for market shifts between sale
dates and the valuation date
Important to know when the contract
was signed, not when the deal closed
Long closing dates can distort the
effect of market conditions on sale
price
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Location
Different neighbourhoods,
corner lots, etc.
Reference to
positive/negative locational
influences
Excessive locational
differences may exclude a
property from comparison
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Physical Characteristics
Site
Size, shape, view, topography, etc.
Improvements
Size, quality, condition, age, amenities,
etc.
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Economic Characteristics
For income-producing properties
Operating expenses
Quality of management
Lease terms
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Use/Zoning
Highest and best use of comps and
subject should be the same
Zoning is especially important in valuing
vacant land
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Non-Realty Components
Chattels, fixtures, equipment, etc.
When non-realty components are
included in sale price of comps
Comp price will be inflated
This adjustment can include tangible and
intangible items
Which Doughnut Shop Will You Buy?
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TYPES OF ADJUSTMENTS
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Two Types of Adjustments
Quantitative adjustments
Dollar or percentage amounts
Use if sufficient information is available
Qualitative adjustments
Non-numerical
Use if sufficient information is not available
Requires considerable appraisal judgment
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QUANTITATIVE ADJUSTMENTS
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Methods
Dollar adjustments
A dollar amount is attached to the
difference between the subject and
the comp
Best suited to physical, motivation,
financial adjustments
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Methods
Percentage adjustments
A percentage amount is attached to
the difference between the subject
and the comp
Best suited to market (time) and
location adjustments
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Dollar Adjustment Method
Example
Houses are valued at $40 per square foot
Subject has 1,000 sq ft
Comp has 1,100 sq ft
Diff = 100 sq ft (1,100 1,000 = 100)
100 sq ft x $40 per sq ft = $4,000
Adjust the comp downward by $4,000
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Percentage Adjustment Method
Example
Bedrooms impact market value by 10% each
Subject has 3 Bedrooms
Comp has 2 Bedrooms
Comp Sale Price = $90,000
1 Bedroom Diff = $9,000 (10% $90,000)
Adjust the comp upward by $9,000
Value = $99,000 ($90,000 + $9,000)
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Assumptions
1. The valuation function is linear
Dollar adjustments have a constant
value
regardless of the magnitude of the
characteristic
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Valuation Function is Linear
1,000 sq ft2,000 sq ft
5,000 sq ft
$40/sq ft
$40/sq ft
$40/sq ft
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Assumptions
1. The valuation function is linear
Percentage adjustments are constant
in percentage terms
but, therefore, not in dollar terms
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Valuation Function is Linear
Bedrooms impact market value by 10% each
$300,000 house
with 3 bedrooms
1 Bedroom = $30,000
$250,000 house
with 3 bedrooms
1 Bedroom = $25,000
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Assumptions
2. All influences on value are
independent of one another
This means that we assume
strongly correlated factors act
independently of each other, and
can be adjusted for separately
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QUALITATIVE ADJUSTMENTS
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Qualitative Methods
Relative comparison analysis
Ranking analysis
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Example of Using Qualitative Adjustments
After all possible QT adjustments have
been made
There is no data available (no similar
comps) to assist in defining location
Subject Comp #1 Comp #2
Adj Sale Price - $185,000 $192,000
Location - Inferior Superior
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Example of Using Quantitative Adjustments
The only conclusion may be
$185,000 $192,000Subject<
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Data Before Discretion
QT analysis should always be used as the
primary adjustment technique
If certain elements of a property can be
defined no further than inferior or
superior . . . .
(No comps are similar to the subject in
a particular element)
Then QL techniques will help define the
top or bottom of a value range
Making Adjustments
Comparable Property Adjustment
When a feature of the
comparable is INFERIOR
to the subject property
ADD to the sale price
of the comparable
When a feature of the
comparable is SUPERIOR
to the subject property
SUBTRACT from the sale price
of the comparable
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DATA ANALYSIS TECHNIQUES
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Data Analysis Techniques
Paired Sales
Statistical Analysis
Cost Analysis
Capitalization of Rent Loss
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Paired Sales
When two properties are equivalent in all
respects but one, the difference in price is
the value of the single difference
between the two properties
Process of determining an adjustment by
analyzing sales isolated with and without
an element affecting value
Paired Sales Example
Sale House Size Sale Date Location Condition Sale Price
1 1,969 September Good Average $222,250
2 2,055 September Poor Good $231,000
3 2,055 July Poor Good $233,000
4 1,969 March Poor Average $223,500
5 1,969 March Good Average $226,900
6 2,055 July Poor Average $230,000
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Paired Sales Example
Sale House Size Sale Date Location Condition Sale Price
1 1,969 September Good Average $222,250
5 1,969 March Good Average $226,900
5
1
$226,900
September$222,250
March
$4,650
$4,650 / $226,900 = 2.05%
2.05% / 6 mths = 0.34% decrease per mth
6 mths
Sale House Size Sale Date Location Condition Sale Price
2 2,055 September Poor Good $231,000
3 2,055 July Poor Good $233,000
Paired Sales Example
3
2
$233,000
September$231,000
July
$2,000
$2,000 / $233,000 = 0.86%
0.86% / 2 mths = 0.43% decrease per mth
2 mths
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Paired Sales Example
Sales 1 and 5 show a 0.34% decrease per
month
Sales 2 and 3 show a 0.43% decrease per
month
A reasonable estimate of a time
adjustment for the market area
would be 0.39% decrease per
month
Paired Sales Example
Sale House Size Sale Date Location Condition Sale Price
4 1,969 March Poor Average $223,500
5 1,969 March Good Average $226,900
5
4
$226,900
Poor$223,500
Good
$3,400
$3,400 / $223,500 = 1.52%
A good location is 1.52% better than a
poor location
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Subject is a 12-unit
apartment building
located downwind
of a new asphalt
batching plant
Sale A is a vacant
lot adjacent to the
subject, zoned for a
12-unit apartment
building, which sold
for $36,000
Sale B is a vacant
lot on the other side
of town, zoned for a
12-unit apartment
building, which sold
for $48,000
Sale C is a 9-unit
apartment building
in the subjects
neighbourhood,
which sold for
$459,000
Sale D is a 10-unit
apartment building
on the other side of
town, which sold for
$540,000
Paired Sales Example
Prop Type Zoning Neg Infl SP
Subject Apt 12 unit Yes
Sale A VL 12 unit Yes $36,000
Sale B VL 12 unit No $48,000
Sale C Apt 9 unit Yes $459,000
Sale D Apt 10 unit No $540,000
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Sale D (unaffected) $540,000 /10 = $ 54,000 per unit
Sale C $459,000 / 9 = $ 51,000 per unit
Difference $ 3,000 per unit
12 units = $36,000
Sale B (unaffected) $48,000 /12 = $ 4,000 per unit
Sale A $36,000 /12 = $ 3,000 per unit
Difference $ 1,000 per unit
12 units = $12,000
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Property Adjustment $3,000 12 units = $36,000
Less Land Adjustment $1,000 12 units = $12,000
Building Adjustment $2,000 12 units = $24,000
The negative influence affecting the:
subject building = $24,000
subject land = $12,000
Total Location Adjustment = $36,000
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Statistical Analysis
Appraisers should recognize the differences
between statistical processes in the collection of
data and should be able to distinguish between
descriptive and inferential statistics. Without an
understanding of these issues, any use of
statistical calculations is dangerous or ill-
advised.The Appraisal of Real Estate,
Third Canadian Edition,
Appraisal Institute of Canada
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Cost Analysis
Adjustments based on cost indicators
such as cost to cure or depreciated
building costs
Caution cost and market value are often
not synonymous
Only used if the appraiser can show that
cost equals value, or if no market data is
available
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Cost to Cure
Cost to tear out or remove existing
component
+ Cost of correct-replacement component
+ Any costs above and beyond total cost if
included in initial construction
Salvage value (if any)
Cost to cure
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Capitalization of Rent Loss
Analysis of loss in rental income due to
specific elements
Process
1. Calculate lost rent
2. Capitalizelost rent
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Capitalize Lost Rent
Taken from Income Approach
Converts a propertys capacity to generate Future Benefits into an indication of Present Value
V = Value
I = Income
R = Capitalization Rate
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Capitalization of Rent Loss Example
Consider a 4,000 sq. ft. retail establishment in an oversupplied market
In a normal market, net operating income would be $8/sq. ft.
However, since the oversupply began, net operating income has fallen to $6.25/sq. ft.
The overall capitalization rate as indicated by the market is 10%
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Capitalization of Rent Loss Example
Mkt Cap Rate = 10%
Subject Size = 4,000 sq ft
Market Rent = $8.00/sq ft
Actual Rent = $6.25/sq ft
Rent Loss = $1.75/sq ft ($8.00 $6.25)
Total Rent Loss = $7,000 ($1.75 4,000 sq ft)
Locational
Influence = $70,000 ($7,000 10%)
RECONCILIATION
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Rationale
Reconcile the adjusted sale prices into a FINAL ESTIMATE OF VALUE
Your reconciliation should include a
discussion of the strengths & weaknesses
of each comparable and the reliability of
adjustments made
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3 Principal Considerations of Adjustments
in Reconciliation
Total NUMBER of adjustments
Total NET adjustment
Total GROSS adjustment
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Net and Gross
Net Adjustment
Difference between sale price and
adjusted sale price
Gross Adjustment
Total adjustments (ignoring negative
signs)
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Net v. Gross
Example A:
Sale Price $ 200,000
Time + 10,000
Location 5,000
Size 6,000
Adj S/P $199,000
Net Adj = -1,000
Gross Adj= 21,000
Example B:
Sale Price $ 200,000
Time + 2,500
Location 1,000
Size + 1,500
Adj S/P $203,000
Net Adj = 3,000
Gross Adj = 5,000
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20% Rule for Adjustments
Net adjustments to comps should be
LESS THAN 20% of the original sale price
Net adjustments greater than 20%
indicate the comp is too different from
the subject to be useful
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Reliability of Adjustments
Must also determine which adjustments
are most reliable
Remember not to equate cost to value
when using the direct comparison
approach
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Mark LeavensReal Property Administration Program
(416) 4915050, Ext. 6390
Mark.Leavens@senecac.on.ca
Kent PeelSchool of Public and Legal
Administration
(416) 4915050, Ext. 2198
Kent.Peel@senecac.on.ca
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