Income method: what to consider? Property Valuation: Cost Approach Cost Income Comparative Valuation Approaches

The task of assessing the value of a business at different stages of its development does not lose its relevance. The enterprise is a long-term asset that generates income and has a certain investment attractiveness, so the question of its value is of interest to many, from owners and management to government agencies.

The most commonly used method for estimating the value of a business is income method (income approach), because any investor invests money not just in buildings, equipment and other tangible and intangible assets, but in future income that can not only recoup the invested funds, but also bring profit, thereby increasing the investor's well-being. At the same time, the volume, quality and duration of the expected future income stream play a special role when choosing an investment object. Undoubtedly, the amount of expected return is relative and is subject to a huge influence of probability, depending on the level of risk of a possible investment failure, which must also be taken into account.

Note! The underlying cost factor when using this method is the expected future income of the company, which represents certain economic benefits for the owners of the enterprise. The higher the income of the company, the greater, other things being equal, its market value.

The income method is the best way to take into account the main goal of the enterprise - making a profit. From these positions, it is most preferable for business valuation, as it reflects the prospects for the development of the enterprise, future expectations. In addition, it takes into account the economic obsolescence of objects, and also takes into account the market aspect and inflationary trends through the discount rate.

With all the undeniable advantages, this approach is not without controversial and negative points:

it is quite laborious;
it is characterized by a high level of subjectivity in forecasting income;
the proportion of probabilities and conventions is high, since various assumptions and restrictions are established;
the influence of various risk factors on the predicted income is great;
it is problematic to reliably determine the real income shown by the enterprise in the financial statements, and it is not excluded that losses are deliberately reflected for various purposes, which is associated with the lack of transparency of information of domestic enterprises;
complicated accounting of non-core and surplus assets;
incorrect assessment of unprofitable enterprises.

It is imperative that special attention be paid to the ability to reliably determine the future revenue streams of the enterprise and the development of the company's activities at the expected pace. The accuracy of the forecast is also strongly affected by the stability of the external economic environment, which is relevant for the rather unstable Russian economic situation.

So, it is advisable to use the income approach to evaluate companies when:

they have a positive income;
it is possible to make a reliable forecast of income and expenses.

Calculation of the company's value using the income approach

Estimating the value of a business using an income approach begins with solving the following tasks:

1) forecast of future income of the enterprise;

2) bringing the value of the future income of the enterprise to the current moment.

The correct solution of these problems contributes to obtaining adequate final results of the evaluation work. Of great importance in the course of forecasting is the normalization of income, with the help of which one-time deviations are eliminated, which appear, in particular, as a result of one-time transactions, for example, when selling non-core and excess assets. To normalize income, statistical methods are used to calculate the average, weighted average, or an extrapolation method that represents is a continuation of existing trends.

In addition, it is necessary to take into account the factor of changes in the value of money over time - the same amount of income at the moment has a higher price than in the future. The difficult question of the most acceptable timing for forecasting the company's income and expenses needs to be resolved. It is believed that in order to reflect the inherent cyclicality of industries, a reasonable forecast should cover a period of at least 5 years. When considering this issue through a mathematical and statistical prism, there is a desire to lengthen the forecast period, assuming that a larger number of observations will give a more reasonable value of the company's market value. However, a proportional increase in the forecast period complicates the forecasting of income and expenses, inflation and cash flows. Some appraisers note that the forecast of income for 1-3 years will be the most reliable, especially when there is instability in the economic environment, since with an increase in forecast periods, the conditionality of estimates increases. But this opinion is true only for sustainable enterprises.

Important!In any case, when choosing a forecasting period, it is necessary to cover the period until the company's growth rates stabilize, and in order to achieve the greatest accuracy of the final results, the forecasting period can be divided into smaller intermediate periods of time, for example, six months.

In general terms, the value of an enterprise is determined by summing the income flows from the activities of the enterprise in the forecast period, previously adjusted to the current price level, with the addition of the value of the business in the post-forecast period (terminal value).

The two most common methods for assessing the income approach - income capitalization method And discounted cash flow method. They are based on estimated discount and capitalization rates that are used to determine the present value of future earnings. Of course, within the framework of the income approach, many more varieties of methods are used, but basically all of them are based on discounting cash flows.

The purpose of the assessment itself and the intended use of its results play an important role in the choice of assessment method. Other factors also influence, for example, the type of enterprise being assessed, the stage of its development, the rate of change in income, the availability of information and the degree of its reliability, etc.

Methodcapitalizationincome(Single-Period Capitalization Method, SPCM)

The income capitalization method is based on the assumption that the market value of an enterprise is equal to the present value of future income. It is most appropriate to apply it to those companies that have already accumulated assets, have a stable and predictable current income, and its growth rates are moderate and relatively constant, while the current state gives a known indication of long-term trends in future activities. And vice versa: at the stage of active growth of the company, in the process of restructuring or at other times when there are significant fluctuations in profits or cash flows (which is typical for many enterprises), this method is undesirable for use, since it is likely to get an incorrect result of valuation.

The method of capitalization of income is based on retrospective information, while for the future period, in addition to the amount of net income, other economic indicators are extrapolated, for example, the capital structure, the rate of return, the level of risk of the company.

The valuation of an enterprise using the income capitalization method is carried out as follows:

Current market value = DP (or P net) / Capitalization rate,

where DP - cash flow;

P is clean - net profit.

Note! The reliability of the valuation result depends very much on the capitalization rate, so special attention should be paid to the accuracy of its calculation.

The capitalization rate allows you to convert the values of profit or cash flow for a specific period of time into a measure of value. As a rule, it is derived from the discount factor:

Capitalization rate =D– T r,

Where D- discount rate;

T p - the growth rate of cash flow or net profit.

It is clear that the capitalization ratio is often less than the discount rate for the same company.

As can be seen from the presented formulas, depending on what value is capitalized, the expected growth rate of cash flow or net profit is taken into account. Of course, for different types of income, the capitalization rate will vary. Therefore, the primary task in the implementation of this method is to determine the indicator that will be capitalized. In this case, income can be predicted the year following the valuation date, or the average income calculated using historical data is determined. Since the net cash flow fully takes into account the operating and investment activities of the enterprise, most often it is used as the basis for capitalization.

So, the capitalization rate in its economic essence is close to the discount factor and is strongly interconnected with it. The discount rate is also used to bring future cash flows to the present.

Discounted cash flow method ( Discounted Cash-Flows, DCF )

The discounted cash flow method allows you to take into account the risks associated with obtaining the expected income. The use of this method will be justified when a significant change in future income is predicted, both up and down. In addition, in some situations only this methodis applicable, for example, expansion of the operation of the enterprise, if at the time of the assessment it does not operate at full capacity, but intends to increase it in the near future;planned increase in output; business development in general; merger of enterprises; introduction of new production technologies, etc. InUnder such conditions, annual cash flows in future periods will not be uniform, which, of course, makes it impossible to calculate the company's market value using the income capitalization method.

For new businesses, discounted cash flow is also the only option to use, as the value of their assets at the time of valuation may not match their ability to generate income in the future.

Of course, it is desirable that the company being assessed has favorable development trends and a profitable business history. For companies that suffer systematic losses and have a negative growth rate, the discounted cash flow method is less suitable. Particular care must be taken when evaluating enterprises with a high probability of bankruptcy. In this case, the income approach is not applicable at all, including the income capitalization method.

The discounted cash flow method is more flexible becausecan be used to evaluate any operating enterprise usingitemized forecast of future cash flows. It is of no small importance for the management and owners of the company to understand the impact of various management decisions on its market value, that is, it can be used in the process of cost management based on the obtained detailed business value model and see its susceptibility to the identified internal and external factors. This allows you to comprehend the activities of the enterprise at any stage of the life cycle in the future. And most importantly: this method is the most attractive for investors and meets their interests, since it is based on forecasts of future market development and inflationary processes. Although there is some difficulty in this, sincein an unstable crisis economy With predicting the flow of income for several years ahead is quite difficult.

So, the initial basis for calculating the value of a business by the methoddiscounted cash flowsis a forecast, the source of which is historical information about cash flows. The traditional formula for determining the present value of discounted future income is as follows:

Current market value = Cash flows for the periodt / (1 + D) t.

The discount rate is the interest rate required to bring future earnings to a single value of the present value of the business. For the investor, it is the required rate of return on alternative investment options with a comparable level of risk at the time of assessment.

Depending on the type of cash flow chosen (for equity or for total invested capital) used as the basis for valuation, the method for calculating the discount rate is determined. Cash flow calculation schemes forinvested and equity capital are presented in table. 12.

Table 1. Cash flow calculation for invested capital
Index	Impact on bottom line cash flow (+/-)
Net profit
Accrued depreciation
Decrease in own working capital
Increasing own working capital
Sale of assets
Capital investments
Cash flow for invested capital

Table 2. Cash flow calculation for equity
Index	Impact on bottom line cash flow (+/-)
Net profit
Accrued depreciation
Decrease in own working capital
Increasing own working capital
Sale of assets
Capital investments
Increase in long-term debt
Reducing long-term debt
Cash flow for equity

As you can see, the calculation of cash flow forequity differs only in that the result obtained by the algorithm for calculating the cash flow for invested capital is additionally adjusted for changes in long-term debt. Then the cash flow is discounted in accordance with the expected risks, which are reflected in the discount rate calculated in relation to a particular enterprise.

So, the cash flow discount rate for equity will be equal to the required rate of return on invested capital required by the owner,invested capital- the sum of weighted rates of return on borrowed funds (that is, the bank's interest rate on loans) and on equity, while their shares are determined by the shares of borrowed and equity funds in the capital structure. Cash flow discount ratefor invested capitalcalled weighted average cost of capital, and the corresponding method of its calculation -weighted average cost of capital (WeightyAVerageCost ofCapital, WACC). This method of determining the discount rate is most commonly used.

Besides, to determine the cash flow discount rate for equity may apply the following are the most common ways:

capital asset pricing model ( CAPM);
modified capital asset valuation model ( MCAPM);
cumulative construction method;
excess profit model ( EVO) and etc.

Let's consider these methods in more detail.

Methodweighted average cost of capital ( WACC)

It is used to calculate both own and borrowed capital by constructing the ratio of their shares, it shows not the balance sheet, butmarket value of capital. The discount rate for this model is determined by the formula:

DWACC = C zk × (1 - N prib) × D zk + C pr × D priv + C oa × D about,

where C zk - the cost of borrowed capital;

N prib - income tax rate;

D zk - the share of borrowed capital in the capital structure of the company;

С pr - the cost of raising equity capital (preferred shares);

D priv - the share of preferred shares in the capital structure of the company;

C oa - the cost of raising equity capital (ordinary shares);

D about - the share of ordinary shares in the capital structure of the company.

The more the company attracts cheap borrowed funds instead of expensive equity capital, the smaller the value WACC. However, if you want to use as much cheap borrowed funds as possible, you should also remember about the corresponding decrease in the liquidity of the company's balance sheet, which will certainly lead to an increase in lending interest rates, since this situation is fraught with increased risks for banks, and the value WACC will, of course, grow. Thus, it would be appropriate to use the “golden mean” rule, optimally combining equity and borrowed funds based on their balance in terms of liquidity.

Methodestimatescapitalassets (Capital Asset Pricing Model, CAPM)

Based on the analysis of stock market information on changes in the yield of freely traded shares. In this case, when calculating the discount rate for equity, the following formula is used:

DCAPM = D b / r + β × (D r − D b/r ) + P 1 + P 2 + R,

where D b / r - risk-free rate of return;

β - special coefficient;

D r - total profitability of the market as a whole (average market portfolio of securities);

P 1 - premium for small enterprises;

P 2 - premium for the risk characteristic of an individual company;

R- country risk.

The risk-free rate is taken as a basis for assessing the various types of risk associated with investing in a company. Special beta coefficient ( β ) represents the amount of systematic risk associated with the economic and political processes taking place in the country, which is calculated on the basis of deviations in the total return of the shares of a particular company compared to the total return of the stock market as a whole. The overall market return is the average market return index, which is calculated by analysts based on a long-term study of statistical data.

CAPMquite difficult to apply in the conditions of the underdevelopment of the Russian stock market. This is due to problems in determining the beta coefficients and the market risk premium, especially for closed enterprises, whose shares are not listed on the stock exchange. In foreign practice, the risk-free rate of return, as a rule, is the rate of return on long-term government bonds or bills, since it is believed that they have a high degree of liquidity and a very low risk of insolvency (the probability of state bankruptcy is practically excluded). However, in Russia, after some historical events, government securities are not psychologically perceived as risk-free. Therefore, the average rate on long-term foreign currency deposits of the five largest Russian banks, including Sberbank of Russia, which is formed mainly under the influence of domestic market factors, can be used as a risk-free rate. As for the coefficients β , then abroad most often they use ready-made publications of these indicators in financial directories calculated by specialized firms by analyzing the statistical information of the stock market. Appraisers usually do not need to independently calculate these coefficients.

Modified capital asset valuation model ( MCAPM)

In some cases, it is better to use a modified capital asset valuation model ( MCAPM), which uses such an indicator as a risk premium, which takes into account the non-systematic risks of the enterprise being valued. Unsystematic risks (diversifiable risks)- these are risks that arise randomly in the company, which can be reduced through diversification. In contrast, systematic risk is due to the general movement of the market or its segments and is not associated with a specific security. Therefore, this indicator is more suitable for the Russian conditions for the development of the stock market with its characteristic instability:

DMCAPM = D b/r + β × (D r − D b/r ) + P risk,

where Db/r is the risk-free rate of return on Russian domestic foreign currency loans;

β - coefficient, which is a measure of market (non-diversifiable) risk and reflects the sensitivity of changes in the profitability of investments in companies in a particular industry to fluctuations in the profitability of the stock market as a whole;

D r - profitability of the market as a whole;

P risk is a risk premium that takes into account the non-systematic risks of the company being valued.

Cumulative Method

It takes into account various types of investment risks and involves an expert assessment of both general economic and industry-specific and specific enterprise factors that give rise to the risk of shortfall in planned income. The most important factors are the size of the company, structure finance, production and territorial diversification,quality of management, profitability, predictability of income, etc.The discount rate is determined based on the risk-free rate of return, to which is added an additional premium for the risk of investing in this company, taking into account these factors.

As you can see, the cumulative approach is somewhat similar to CAPM, since they are both based on the rate of return on risk-free securities with the addition of additional income associated with the risk of investing (it is believed that the greater the risk, the greater the return).

Olson model (Edwards - Bell - Ohlson valuation model , EVO ), or the method of excess income (profit)

It combines the components of income and cost approaches, minimizing their shortcomings to some extent. The value of the company is determined by discounting the flow of excess income, that is, deviating from the industry average, and the current value of net assets. The advantage of this model is the ability to use for the calculation of available information on the value of the values available at the time of valuation. A significant share in this model is occupied by real investments, and only residual profit is required to predict, that is, that part of the cash flow that really increases the value of the company. Although this model is not without some difficulties in use, it is very useful in developing an organization's development strategy related to maximizing the value of the business.

Derivation of the final company's market value

After the preliminary value of the business is determined, a number of adjustments must be made to obtain the final market value:

on excess/lack of own working capital;
on non-core assets of the enterprise;
on deferred tax assets and liabilities;
on net debt, if any.

Since the calculation of the discounted cash flow includes the required amount of own working capital associated with the revenue forecast, then if it does not match the actual value, the excess of own working capital must be added, and the disadvantage must be subtracted from the value of the preliminary cost. The same applies to non-performing assets, since only those assets that were used in the formation of cash flow participated in the calculation. This means that if there are non-core assets that have a certain value that is not included in the cash flow, but can be realized (for example, upon sale), it is necessary to increase the preliminary value of the business by the value of the value of such assets, calculated separately. If the value of the enterprise was calculated for the invested capital, then the resulting market value refers to the entire invested capital, that is, it includes, in addition to the cost of equity, the value of the company's long-term liabilities. This means that in order to obtain the cost of equity, it is necessary to reduce the value of the established value by the amount of long-term debt.

After making all the adjustments, the value will be obtained, which is the market value of the company's equity capital.

The business is able to generate income even after the end of the forecast period. Incomes should stabilize and reach a uniform long-term growth rate. To calculate the cost inpost-forecast period, you can use one of the following discount calculation methods:

by salvage value;
by net asset value;
according to the Gordon method.

When using the Gordon model, the terminal value is defined as the ratio of cash flow for the first year of the post-forecast period to the difference between the discount rate and the long-term growth rate of cash flow. The terminal value is then reduced tocurrent cost indicators at the same discount rate that is used to discount the cash flows of the forecast period.

As a result, the total value of the business is determined as the sum of the current values of income streams in the forecast period and the value of the company in the post-forecast period.

Conclusion

In the process of estimating the value of a company using an income approach, a financial model of cash flows is created, which can serve as a basis for making informed management decisions, optimizing costs, analyzing the possibilities of increasing project capacities and diversifying the volume of products. This model will continue to be useful after the evaluation.

To choose one or another method for calculating the market value, first of all, you need to decide on the purpose of the assessment and the planned use of its results. Then you should analyze the expected change in the company's cash flows in the near future, consider the financial condition and development prospects, as well as assess the economic environment, both global and national, including the industry. When the market value of a business needs to be known due to lack of time, or to confirm the results obtained using other approaches, or when in-depth cash flow analysis is not possible or required, the capitalization method can be used to quickly obtain a relatively reliable result. In other cases, especially when the income approach is the only possible to calculate market value, the discounted cash flow method is preferred. Perhaps, in certain situations, both methods will be needed to calculate the value of a company at the same time.

And of course, do not forget that the value obtained using the income approach directly depends on the accuracy of the analyst's long-term macroeconomic and industry forecasts. However, even the use of rough forecasts in the income approach process can be useful in determining a company's estimated value.

The main approaches to the valuation of real estate objects (cost, income, comparative)

In real estate appraisal, there are three generally accepted approaches to determining the value: costly, market and profitable. Each approach has its own established methods, techniques and procedures. The conceptual similarity of approaches to the evaluation of various property objects is revealed. At the same time, the type of the object being valued determines the features of specific methods arising from the specific problems of valuation, which, as a rule, are inherent only to this type of property.

Cost approach

The cost approach to the valuation of real estate is based on comparing the costs of creating a real estate object with the value of the valued or comparable objects. The approach is based on a study of the investor's ability to acquire real estate and proceeds from the principle of substitution, which states that the buyer will not pay for an object more than what it would cost to obtain the relevant building plot and build an object of similar purpose and quality in the foreseeable period without significant delays.

1. Calculation of the cost of acquiring or long-term lease of free and available land in order to optimize its use;
2. Assessment of the replacement cost of the building being assessed. The calculation of the replacement cost is based on the calculation of the costs of recreating the object in question, based on current prices and manufacturing conditions for similar objects on a certain date.
3. Determining the amount of physical, functional and external depreciation of the property;
4. Estimation of the value of entrepreneurial profit (investor's profit);
5. Calculation of the final cost of the appraised object by adjusting the replacement cost for depreciation, followed by an increase in the resulting value by the cost of the land plot.

The cost approach is most appropriate when evaluating properties that have recently been put into operation, it leads to the most convincing results in the case of a reasonably justified cost of the land and little accumulated depreciation of improvements. The cost approach is justified in estimating the value of planned facilities, special purpose facilities and other property, transactions for which are rarely concluded on the market, and can be used in valuation for insurance purposes. This approach, when evaluating objects subject to reconstruction, allows you to determine whether construction costs will be offset by an increase in operating income or proceeds from the sale of property. The use of the cost approach in this case avoids the risk of overinvestment.

Also, the cost approach is used for the purposes of taxing the property of legal entities and individuals, during the arrest of real estate, to analyze the best and most efficient use of a plot of land.

Determining the value of a land plot

In accordance with Art. 35 of the Civil Code of the Russian Federation, upon transfer of ownership of a building, structure, structure located on someone else's land to another person, it acquires the right to use the corresponding part of the land plot occupied by the building, structure, structure and necessary for their use, on the same conditions and to the same extent as the previous owner.

Of all land valuation methods, the method of comparative sales analysis is of decisive importance.

The replacement cost of construction of the property under appraisal is calculated at current prices as new (excluding accumulated depreciation) and related to the appraisal date. The basis for determining the replacement cost is the calculation of the costs associated with the construction of the facility and its delivery to the customer. Depending on the procedure for accounting for these costs, it is customary to allocate direct and indirect costs in the cost of construction.

Direct costs are directly related to construction (the cost of materials, the wages of construction workers, the cost of construction machines and mechanisms, etc.). Indirect costs - costs that are not directly related to construction (fees to design and estimate organizations, the cost of investments in land, marketing, insurance and advertising costs, etc.). The developer's profit reflects the costs of managing and arranging the construction, general supervision and the entrepreneurial risk associated with the development. The profit of the entrepreneur is defined as part of the profit from the sale of the object. Regardless of the amount of interest and the corresponding basis (a component of the value of property), the amount of entrepreneurial profit remains constant.

The main source of comparative data on the cost of real estate objects are construction contracts for the erection of structures, such as the one being assessed. In addition, design appraisers typically maintain their own databases of current prices for completed homes, office buildings, apartments, hotels, shop buildings, and industrial buildings. Currently in Russia there is a system of standards and price levels determined by the corresponding price indices.

Built objects under the influence of various natural and functional factors lose their operational qualities and are destroyed. In addition, the market value of the object is influenced by external economic impact from the immediate environment and changes in the market environment. At the same time, physical depreciation (loss of performance), functional aging (loss of technological compliance and cost due to scientific and technological progress), external or economic depreciation (change in the attractiveness of an object in terms of changes in the external environment and the economic situation in the region) are distinguished. Together, these types of depreciation constitute accumulated depreciation, which will be the difference between the replacement cost of the object and the cost of reproduction (replacement) of the object of assessment.

The most complete and reliable source of information about the technical condition of a building or structure is the materials of a natural survey. The first condition for conducting such surveys should be an accurate definition of the functional purpose of the object of assessment: use for its intended purpose or with a change in technological and functional parameters. In this case, it is necessary to present the limits of changes in loads and impacts on the supporting structures of buildings.

The second condition for conducting research is to obtain complete information about the natural and climatic parameters and specific factors of the impact of the area where the object is located and their changes in the process of technogenic activity.

Market Approach

A prerequisite for the application of market approach methods is the availability of information about transactions with similar real estate objects (that are comparable in purpose, size and location) that took place in comparable conditions (time of the transaction and conditions for financing the transaction).

The comparative approach is based on three main principles of real estate valuation: supply and demand, substitution and contribution. Based on these principles of real estate valuation, the market approach uses a number of quantitative and qualitative methods to highlight the elements of comparison and measure adjustments to market data of comparable properties to model the value of the property being valued.

The main principle in the market approach to real estate valuation is the substitution principle, which states that a potential buyer will not pay a price for property that exceeds the cost of acquiring a similar, from his point of view, property.

The main difficulties in applying the methods of the market approach are associated with the lack of transparency of the Russian real estate market. In most cases, the real prices of real estate transactions are unknown. In this regard, often when assessing, the prices of proposals for objects put up for sale are used.

The sales comparison method determines the market value of a property based on an analysis of recent sales of comparable properties that are similar in size and use to the property being valued. This method of valuation assumes that the market will set the price for the property being valued in the same way as for comparable, competitive properties. In order to apply the sales comparison method, specialists use a number of valuation principles, including the principle of substitution.

The application of the sales comparison method consists in sequentially performing the following steps:

1. detailed market research in order to obtain reliable information about all factors related to objects of comparable utility;
2. identifying suitable units of comparison and conducting a comparative analysis for each unit;
3. comparison of the object being evaluated with the selected objects of comparison in order to adjust their sales prices or exclude them from the list of those being compared;
4. bringing a number of adjusted indicators of the cost of comparable objects to the market value of the object of assessment.

Real estate offices, government sources, own databases, publications, etc. can be used as sources of information about real estate market transactions.

After choosing the unit of comparison, it is necessary to determine the main indicators or elements of comparison, using which it is possible to model the value of the object through the necessary adjustments to the purchase and sale prices of comparable real estate objects.

In valuation practice, when determining the value of real estate, such main elements of comparison are distinguished as the transferred rights to real estate, the conditions for financial settlements when acquiring real estate, the terms of sale (purity of the transaction), the time of sale, the functional purpose of the object, location, convenience of access roads, area of the object, technical condition and level of finishing of premises.

This method is most effective for regularly sold objects.

Quantitative and qualitative methods are used to highlight the elements of adjustment measurement.

Quantitative methods include:

- analysis of paired sales (two different sales are compared to determine the adjustment for one element of comparison);
- statistical analysis (the method is based on the use of the apparatus of mathematical statistics for correlation and regression analysis);
- analysis of the secondary market (this method determines the amount of adjustments based on data that is not directly related to the object of assessment or the object of comparison) and others.

Quality practices include:

- classification (comparative) analysis (the method is similar to the analysis of pair sales, except that the adjustments are expressed not in percentages or monetary amounts, but in fuzzy logic categories);
- distributive analysis (comparative sales are distributed in descending order of adequacy, then the place of the object of assessment in the series of comparative sales is determined).

income approach

Determining the market value of real estate using the income approach is based on the principle of expectation. According to this principle, the typical investor, that is, the buyer of a property, acquires it in anticipation of receiving future income from use. Considering that there is a direct relationship between the size of the investment and the benefits from the commercial use of the investee, the value of real estate is defined as the value of the rights to receive income generated by it, in other words, the value of the property is defined as the present value of future income generated by the subject of appraisal.

The advantage of the income approach compared to the cost and market approaches is that it reflects the investor's view of real estate as a source of income to a greater extent, that is, this quality of real estate is taken into account as the main pricing factor. The main disadvantage of the income approach is that, unlike the other two approaches, it is based on forecast data.

The main stages of the assessment procedure in this approach:

1. Preparing a forecast of future income from the lease of the areas being assessed for the period of ownership and, based on the data obtained, determining the potential gross income (GRP), which is calculated by the formula:

PVD \u003d S * Ca, where

S - area to be leased, sq.m;

Ca - rental rate for 1 sq.m.

2. Determination based on market analysis of losses from underutilization of space and in the collection of rent, calculation of the actual gross income (ARI). As a rule, the owner in the long run does not have the opportunity to permanently lease 100% of the building area. Losses of rent occur due to underemployment of the property and non-payment of rent by unscrupulous tenants. The degree of unemployment of an object of income-producing real estate is characterized by the coefficient of underutilization, determined by the ratio of the value of unleased areas to the value of the total area to be leased.

The calculation of the actual gross income (ARI) is carried out according to the formula:

DVD = PVD * Kz * Ks, where

DVD - actual gross income;

GPV - potential gross income;

Kz - area load factor;

Кс - payment collection coefficient.

It should be noted that other income received from the operation of the facility in excess of rental payments (for example, for the use of additional services - car parking, etc.) must be added to the DIA calculated by the above method.

3. Calculation of the costs of operating the property being valued, which is based on an analysis of the actual costs of its maintenance and / or typical costs in this market. Expenses are conditionally fixed (property tax, insurance premiums, payments for a land plot), conditionally variable (utilities, current repairs, salaries of maintenance personnel, etc.), replacement costs (expenses for the periodic replacement of rapidly wearing structural elements of a building).

Thus, the estimated value of operating costs is subtracted from the DIA, and the final figure is net operating income (NOR).

4. Recalculation of net operating income into the current value of the object.

Direct capitalization method - a method for determining the market value of a profitable object, based on the direct conversion of the most typical income of the first year into value by dividing it by the capitalization ratio obtained on the basis of an analysis of market data on the ratio of net income and the value of assets similar to the object being valued, obtained by the market extraction method. Such a Western classic version of the direct capitalization method, in which the capitalization ratio is extracted from market transactions, is practically impossible to apply in Russian conditions due to the difficulties in collecting information (most often, the conditions and prices of transactions are confidential information). Based on this, in practice it is necessary to use algebraic methods for constructing the capitalization coefficient, which provide for a separate assessment of the rate of return on capital and the rate of its return.

It should be noted that the direct capitalization method is applicable to the valuation of operating assets that do not require, at the date of the valuation, large investments in the duration of repairs or reconstruction.

I could buy it, but at a reasonable price.

You already know how and where to find a good deal and how to negotiate a purchase. Now you will learn how to correctly evaluate the object that you intend to purchase. We'll start by discussing market value, and then we'll talk about other valuations that you can rely on to make the right decision.

Although the market price of an object should never serve as the sole basis for making a decision, it is still one of the basic reference points. To value an apartment building, mansion, or condominium, most landlords, investors, and appraisers use a form similar to the one shown in Figure 1. 14.1.

The two major mortgage lenders in the United States, Freddie Mac And Fannie May approved this form and recommended it for widespread use. Landlords and investors in other countries also follow a similar evaluation process. No matter where exactly the property is located, the principles of market valuation remain unchanged.

We will now go through all the main sections of this evaluation form.

word of caution

A word of caution: Too many landlords, investors, and home buyers take this valuation as the final result. But all estimates of value are no more certain than the facts on which they are based, and no more just than the conclusions that are drawn from these facts. Unfortunately, experience shows that appraisers often make mistakes both in the facts themselves and in their interpretation.

Whether you are doing your own estimating or using the results of an evaluator, critically analyze all incoming data and any inferences and conclusions drawn from that data.

Standard act of real estate valuation

The purpose of this act is to provide the lender / client with accurate and objective information related to the assessment of the market value of the object in question.

Address City State Zip Code

Borrower Registered Owner County

Legal Description

Appraiser No. Tax year Real estate tax, $

District Name Geographical Location Census District

Residents □ Owner □ Tenants □ Vacancy □

Valuation of ownership □ Freehold □ Leasehold □ Other (description)

Transfer type □ Purchase □ Loan refinancing □ Other (description)

Creditor/Client Address

Is this property currently listed for sale, or has it been listed for sale in the 12 months prior to the date of this valuation? □ Yes □ No

Source of data used, offer price, date

I did □ did not □ review the contract for the purchase of the property in question. Describe the results of the analysis or explain why the analysis was not performed.

Contract price $ Contract date Is the seller the registered owner? □ Yes □ No Date (source)

Are there any financial concessions in favor of the borrower (the seller pays interest on loans, includes furniture, household appliances, etc. in the price of the object, pays a down payment, etc.)? □ Yes □ No

If yes, please provide the full dollar amount of the rebates and a full description of the rebates.

Note: The racial composition of the area's population is not the subject of an estimate.

Characteristics of the area			Mansions (trends)			Mansions		Land use at the moment, %
Location □ City □ Suburb □ Countryside			Cost □ Increasing □ Stable □ Falls			price rises		Mansions
Development □ Over 75% □ 25-75% □ Less than 25%			Supply/demand □ Shortage □ Balance □ Excess			$ (thousand) (years)		Houses for 2-4 apartments
Growth □ Rapid □ Stable □ Slow			Sale term □ Up to 3 months □ 3-6 months □ Over 6 months					apartment buildings
District boundaries								commercial real estate

Description of the area

Market conditions (including those supporting the above conclusions)

Dimensions Area Shape General view
Zoning classification Zoning description
Zoning compliance □ Fully legal □ Non-compliant within the law (inheritance from grandfather) □ No zoning per se □ Non-compliant
Is the current use of the object the best way? □ Yes □ No If no, please explain why.

Facilities	Central.	Other (describe)			Center.		Other (describe)		External good- device	Societies.	Parts.
Electricity				Water pipes
				Sewerage
Flood Hazard by Classification FEMA□ Yes □ No Flood zone FEMA Map FEMA No. Map compilation date
Are the interior and exterior amenities typical of the area? □ Yes □ No If no, please explain why.
Are there adverse environmental factors? □ Yes □ No If yes, please describe these factors.




general description	Foundation		External Description Material/ Condition	Description of the interior materials / condition
Objects □ One □ One with additional buildings	□ Concrete slabs □ Space for crawling		foundation walls
number of storeys	□ Complete basement □ Partial basement		External walls
Object type □ free standing □ Joint	Basement sq. feet
□ Existing □ Estimated □ Under construction	Basement finishing %		Gutters and downspouts	Floor in bathrooms
Design(Style)	□ Outdoor inlet/outlet □ Sump pump			Bathroom upholstery
Year of construction	□ Signs □ Invasions □ Dampness		Storm window sashes/insulation	Parking □ No
Actual age (years)	Heating □ Water □ Radiant heater		Shutters/blinds	□ Access road Number of cars
Attic □ No	□ Other	Type of fuel	Facilities □ Wood stoves (number)	Covering the driveway
□ Lean ladder □ Steps	□ Cooling □ Central air conditioner		□ Fireplaces (qty)	Number of cars
	□ Individual □ Other		□ Patio/flat roof □ Veranda	□ Carport Number of cars
□ Finishing □ Heating			□ Pool □ Other	Object type □ freestanding □ Joint
Appliances □ Refrigerator □ Cooker/oven □ Dishwasher □ Microwave □ Washer/dryer □ Other appliances (description)
Finished living space above standard contains: Rooms Bedrooms Bathrooms Size of living space above standard (sq. ft.)

Additional characteristics (special energy-saving devices, etc.)

Describe the general condition of the property (need for repair, etc.)

Are there physical deficiencies that affect the comfort of living, the level of sound insulation, or the structural integration of the property? □ Yes □ No If yes, please describe these shortcomings.

Is this property appropriate for the area in which it is located? □ Yes □ No If no, explain why

Here, similar properties located in the area are offered for sale at prices ranging from ... $ to $ thousand

Here, similar properties located in this area have been offered for sale over the past twelve months at prices ranging from ... $ to $ thousand

Characteristic

Comparative Selling #1

Comparative Selling #2

Comparative Selling #3

Proximity to object

Sale price, $

Sale price / total living space, thousand $ per sq. foot

Data source

Verification source

Charge adjustments

Description

+ (-) $ Amendment

Description

+ (-) $ Amendment

Description

+ (-) $ Amendment

Sale or financing

Date of sale

Location-
position

Leasehold / unlimited ownership

Land plot

General form

Design (style)

Construction quality

Actual age

Physical state

Above standard

Number of rooms

Living space, sq. feet

Basement and finished rooms above standard
functional utility
Heating/air conditioning
Energy saving elements
Garage / carport
Veranda/terrace/patio



Net Adjustment(Total)	□ + □ -		□ + □ -	□ + □ -
specified cost, Pure amend. %
Tot. amend. %
I researched / did not research the history of sales and transfers of the object in question and the objects of comparison. If not, please explain why.

My research found/did not find any sale or transfer of the property in question during the three years prior to the date of the appraisal.
Data source.
My research found/did not find any sale or transfer of the properties being compared during the three years prior to the date of the valuation.
Data source.
Report on previous sales and transfers
		Compare- Sales No. 1	Compare- Sales No. 2		Compare- Sales No. 3
Date of previous sale/transfer
Previous sale/transfer price
Data source.
Date of receipt of data
Analysis of previous sales/transfers

The result of the valuation by the method of comparative sales

The cost of the object, calculated by the method of comparative sales, $

Cost: Comparative sales method, $ Comparative cost method (if applicable), $ Comparative income method (if applicable), $

This assessment was carried out on a □ “as is” basis, □ assuming that all necessary corrections and improvements have already been made, □ assuming the property is in perfect condition, requiring no repairs.

After conducting a complete visual inspection of the property and completing the full survey, I have estimated the value of the property at the amount of $ at the time of the valuation (date).

Standard act of real estate valuation







COMPARATIVE COST METHOD (Fannie May
Provides the borrower/client with objective information about the cost of the object. All the calculations below can be reproduced by the client independently.
Serves to check the estimates obtained by the method of comparative sales by other methods.


Valuation Reconstruction Rebuild	The cost of the land ........................................................................................ $
Cost Data Source	Living quarters sq. ft/$.................................................................. $
	sqft/$.................................................................. $
Comments (estimated area, degree of wear, etc.)	Garage/carport sq. ft/$.................................................................... $
	Full cost of new construction .............................................................. $
	Minus Physical	Functional
			.................. $
	The cost of the building, taking into account depreciation .................................................................. $ The cost of the plot in the "as is" condition................................................... $
Possible period of further commercial use (only for the Ministry of Housing and Urban Development), Years	The final cost of the object ................................................................... $
*COMPARATIVE INCOME METHOD (Fannie* May does not require evaluation by this method)**
Average Market Monthly Rent $ × Total Rent Multiplier = $ Comparative Income Cost
Conclusion on the evaluation

PROJECT INFORMATION ON THE PLANNED DEVELOPMENT (PZ)

Is the developer/builder under the control of a homeowners association? □ Yes □ No Property type □ Freestanding □ Shared

The following information applies ONLY to PZ properties provided that the developer/constructor operates under the control of a homeowners association and the property is part of a community-based housing unit.

Legal name of the project

Total number of phases Total number of residential units Total number of residential units sold

Total number of housing units for rent Total number of housing units offered for sale Source of data

Does this project involve the conversion of existing buildings into the RoW? □ Yes □ No If yes, please indicate date of conversion

Does this project consist of multiple residential units? □ Yes □ No Data source

Has the construction of residential units, public facilities and recreational facilities been completed? □ Yes □ No If no, indicate the stage of construction.

Are the common areas rented by the homeowners association or rented out by the association? □ Yes □ No If yes, describe the terms of the lease.

Describe public and recreational facilities.

Standard act of real estate valuation

This form is intended for the evaluation of mansions or mansions with ancillary buildings, including objects included in the planned development (PD). This form is not intended for valuation of prefabricated homes or apartments that are part of condominiums or co-ops.

This act of real estate appraisal assumes: a specific scope of work performed by the appraiser, the purpose of the act, the user of the act, determining the market value of the object, a statement of assumptions and limitations, certification of the appraiser. It is forbidden to make any additions or corrections to all of the above points. The appraiser may expand the scope of the work performed by conducting additional studies. The evaluator certification also does not allow any additions or corrections. However, additional certifications required by law or relating to the appraiser's membership in a real estate appraisal organization are permitted.

Scope of work. The scope of the appraiser's work is determined by the complexity of the appraisal statement and the requirements of this form. This includes determining the market value of an object, a statement of assumptions and limitations, certification of the appraiser. The appraiser is obliged, as a minimum: 1) to carry out a complete visual examination of the appraised object, both inside and outside; 2) conduct an inspection of the area; 3) conduct an inspection of each of the compared objects, at least by examining them from the street; 4) research, verify and analyze all data obtained from reliable public and private sources; 5) present the results of your analysis in this report, as well as express your opinion.

purpose of the act. This act is intended for the lender/customer in order to determine the value of the object, on the security of which the loan will be issued.

Act user. The user of this act is the lender/customer.

Determination of market value. This is the most likely price at which the property could be sold on a free and open market, subject to a fair sale and prudence on the part of both the seller and the buyer. This definition implies a specific date of sale and transfer of title from seller to buyer under the following conditions; 1) the seller and the buyer are sufficiently motivated to complete the transaction; 2) both parties are well informed and each party acts in its own interests; 3) there is sufficient time to put the object up for sale on the open market; 4) payment is made in cash US dollars or according to the relevant financial agreement; 5) the price of the object does not imply any financial or other concessions.

Statement of Assumptions and Limitations. Appraiser certification in this act is subject to the following assumptions and limitations:

1. The appraiser is not responsible for all legal issues related to both the property being appraised and its title, with the exception of information obtained by him during the appraisal process. The appraiser assumes the title is absolutely legal and does not express his opinion about the title.

2. In this report, the appraiser gives a general description of the object, indicating its size and characteristic features. The description should help the reader to get a visual idea of the object itself and its dimensions.

3. The assessor examines the flood maps provided FEMA, and indicates whether the object is in the danger zone. Because the appraiser is not a topographer, his conclusions cannot serve as a guarantee, express or implied.

4. The appraiser is not subject to legal liability for any doubtful points related to the legal status of the object, if such liability has not been agreed in advance.

5. In this report, the appraiser indicates all the shortcomings associated with the technical condition of the object (elements requiring repair, worn parts, hazardous elements, sources of toxic substances, etc.) that were identified during the inspection. Unless otherwise stated, the appraiser is unaware of possible hidden defects that could reduce the value of the item. The Appraiser makes no warranties, express or implied, in this regard. Since the appraiser is not a specialist in the field of environmental protection, this act cannot be considered as an environmental assessment of the object.

6. The appraiser bases this act on the assumption that the object is in a normal technical condition, or on the assumption that all necessary repairs will be carried out in a professional manner.

Market value analysis

We will not be able to analyze in all detail each item of the given evaluation form. Nevertheless, we will discuss each of the sections of the valuation act and highlight the main sources of errors and dubious conclusions.

Object in question

The first section provides basic information about the object under consideration. For the most part, this is accurate and objective information, but it is still worth checking its accuracy. Pay special attention to ownership.

The appraisal of the value of a property must include consideration of title, i.e. ownership. What problems can be associated with the transfer of the title? Remember that you are not only acquiring a building along with a land plot - you are acquiring legal rights that govern the use of real estate, its transfer, reconstruction, etc. Professional valuation acts are often assume in advance that ownership issues will be settled without any problems. Do not rely on such a priori assumptions. Consult with a law firm or an attorney who specializes in property law.

Contract

Most lenders issue mortgages based on the contract purchase price or the market value of the property, whichever is lower. Let's assume that you have found a good option. You have agreed on a price of $160,000 for a $200,000 property. You calculated that with an ADR of 80%, the bank will give you a loan that fully covers the purchase price (80% × 200 thousand - 160 thousand dollars). The idea is not bad, but the fact is that the bank will proceed not from the market value, but from the contract price, and you will receive a loan in the amount of 128 thousand dollars (80% × 160 thousand - 128 thousand dollars). That's why banks always require you to show the amount of the contract.

Never lie to a creditor

To get around this hurdle, some dishonest buyers enter into a "shadow contract" with the seller, listing a price of $200,000, and then present a "fake" contract for a loan. This action is qualified by the legislation as fraud in the banking sector. Never resort to such tricks.

Never lie to a lender about the actual amount of the contract or about other facts related to obtaining a loan. (Notorious lobbyist Jack Abramoff was recently sentenced to six years in prison for credit fraud.)

Concessions from the seller

Sometimes the buyer agrees to pay a price that exceeds the market value of the property. In exchange for this, the seller may offer to pay a down payment, pay a security deposit or additional costs associated with the conclusion of the transaction. It is possible that furniture or household equipment will be included in the sale price. In such cases, when the seller makes concessions, the bank wants to know the market value of the property, and not just the amount of the contract. OKS in this case will be charged based on the market value of the property.

Object location

First of all, you need to remember that federal law prohibits appraisers from taking into account the racial composition of the population in the area of the property in any form. Therefore, any professional act of assessment does not even mention the racial and demographic characteristics of the area.

Demand, supply and scale of prices in the area where the object is located

Conversely, the valuation report contains a brief description of the types of real estate characteristic of the area and the types of its use.

The act also indicates the scale of real estate prices and upward or downward trends in the number of properties sold or leased.

As an investor, pay close attention to these trends. Market value estimates are made based on the current situation, but you must be able to look into the future.

Economic base and other features of the area

Based predominantly on the present, the assessments not only overlook the development trends of the area, but also do not provide a detailed analysis of the economic base, employment levels and prospects for growth or decline. And again, as an investor, it is your responsibility to research all these questions deeply and thoroughly.

It is important to assess how the number of jobs in the area is changing, how transport arteries are developing, and how the overall growth of the metropolis affects the fate of this area. Even in areas that are in decline, some areas may well thrive. Conversely, in prosperous areas, non-developing areas may exist. Market value estimates rarely take into account the area's future prospects.

Land plot

In many urban areas, the cost of land is between 30 and 60% (sometimes even more) of the total market value of the property. Carefully study this important component. First of all, mark the area and go around its boundaries. Take all measurements. You must know the exact dimensions of your site and represent it visually.

Zoning and land use rules

As you learned in Chapter 8, there are dozens of zoning and land use regulations that govern the use of real estate. Knowing all the legal subtleties will open up many promising opportunities for you. Or vice versa, these laws can become an invincible barrier to your grandiose plans. Study these laws in detail, not just a broad classification of zoning (residential, commercial, industrial, agricultural, etc.).

The assessment of the market value may or may not take into account how the given object complies with zoning rules and building codes. But no act says anything about how to take advantage of these laws (including rezoning) in order to give real estate additional value.

Communal amenities

Contrary to the ideas of urban residents, not all real estate objects are equipped with the necessary communal amenities. A friend of mine who has no experience in investing bought a house without even suspecting that the house had no sewerage. Ceteris paribus, the lack of utilities significantly reduces the value of real estate.

Don't repeat the same mistake. Check the gas and water supply, sewerage, electrics, security systems, the availability of the Internet. Although valuation reports rarely mention utility costs, they can have a significant impact on the overall value of a property. Therefore, in addition to the availability of utilities, you should check the level of utility costs. To do this, you should contact the utility companies serving this facility.

residential amenities

Residential amenities include not only communal amenities, but also walkways, landscaping, swimming pools, tennis courts, fences, basements, utility rooms, appliances, terraces, patios, verandas, driveways, garages, and more. For real estate appraisal, it is necessary to evaluate the quality of all additional amenities both inside and outside the building.

You should also pay attention to the footage, the number of rooms, the presence of built-in wardrobes, the architectural plan and design, energy efficiency, sound and thermal insulation, window quality, age and physical condition of the property. Each of these details can significantly affect the value of a property. In addition, any additional convenience should be considered in any of the three main methods of estimating the cost.

Cost estimation methods

In order to most objectively assess the market value of real estate, three parallel methods of assessment can be applied:

1. Comparative sales method. In this case, the characteristic features and cost of similar objects are compared (see Figure 14.2).

Rice. 14.2. Comparative sales method

2. Comparative cost method. You should calculate what it would cost you to build a similar building at today's price level (plus the cost of the land), and then subtract the amount of accumulated depreciation (depreciation) from the resulting figure (see Fig. 14.3).

3. Comparative income method. This valuation method capitalizes net rental income and translates it into a market value estimate (see Figure 14.4).

Rice. 14.3. Comparative cost method

Note: As mentioned earlier, the comparative cost method can also help determine the trend of future real estate prices. (See below the application of this approach to the valuation of commercial real estate).

Once you have determined the market value using each of these methods, you will know the price limits and can get an objective estimate of the value of your property (see Figure 14.5). The comparative sales method is appropriate for valuing detached houses, co-op houses, and condominiums, while the comparative income method is best used for valuing apartment buildings, office buildings, and shopping malls. The comparative cost method is most often used to test figures obtained by other methods.

Rice. 14.4. Capitalized income method

Remember, if a property sells for substantially more than the cost of building a new building, developers will start building in droves. Unfortunately, this way of making high profits often fails when the supply of new properties temporarily outstrips the demand for them.

Rice. 14.5. Three Approaches to Estimating Market Value

To get rid of unsold (or unrented) properties, developers are drastically cutting prices and rent levels, offering buyers (tenants) numerous concessions (reduced interest financing, two-month rent waiver, $99 to move house, etc.). Conversely, if a property sells for substantially less than the cost of building a new building (economic downturn or oversupply), developers leave the market. But sooner or later, the growth of the economy leads to the creation of new jobs and higher incomes. The excess supply is eliminated. New buyers and tenants are competing for vacant properties that are rapidly shrinking. Prices and rents start to rise.

Therefore, reasonable investors always monitor the cost of erecting new buildings, the income of builders, benefits when buying (renting) real estate and other market trends. And again, I emphasize: while evaluating the past and present, do not forget to look to the future.

Comparative sales method

Let's return now to fig. 14.1 for the information used to make the assessment.

Comparative selling works best when you carefully research and note all the salient features of the property in question and those with which you are comparing. That is why I advise you to carefully look at all the objects offered for sale in the area of interest to you. Make a detailed description of all the characteristic features of these objects. Take photographs. Write down your remarks and comments. As a result, you will have a large list of objects for comparison.

In addition, by tracking real estate sales in your area, you will learn which features of housing are most attractive to tenants and buyers, what sells the fastest and what has the highest price. With a deep knowledge of the market, you will always be able to spot a property that is selling below its market price. If you lack such knowledge, you can easily miss a profitable option.

Knowing the facts will help you make informed offers to buy (sell) real estate. A factual argument is much more convincing than a simple statement: “Here is my proposal. You can either accept it or reject it."

Now let's look at the method of comparative sales in more detail. As you can see for yourself, the proposed assessment form (see Figure 14.1) leaves no room for detailed explanations and critical comparison. This is one of the reasons why professional valuers often make erroneous conclusions. Figuratively speaking, they paint a picture with a rough brush, missing details that are of great importance.

Moreover, you will be surprised, but it is true: evaluators are almost never inside the objects with which they are comparing. At best, they receive second-hand information from sales agents who conducted transactions with these objects. But most of the time (and I've seen this over and over again) evaluators simply ignore all the differences between the object in question and the objects with which they are compared. They don't even know there are any differences.

For these and other reasons, neither I nor Donald Trump ever rely on the opinion of official assessors. We watch, listen, analyze and draw our own conclusions. You must do exactly the same.

Mutual arrangement of compared objects

As a rule, the closer the compared objects are, the more accurate the comparison will be. (Ideally, similar objects should match in all respects.) But often it turns out that appraisers compare houses that are too far apart.

What does "too far" mean? This is any distance that refers objects to different zones of attraction. It could even be the other side of the street, a different school district, or a different distance from the subway or public transportation. Always check the selection of the evaluator. Are the locations of objects really comparable? Does everything match in the vicinity of the compared objects?

Selling price and price per square foot

Generally, investors and secured lenders prefer that the objects in question be valued 10-20% lower than the upper limit of the cost of similar objects in the area. Property whose price lies below the average "fork" of prices has greater liquidity.

Also, if you have not been able to find a complete match for your property (which is very likely), choose homes that are clearly superior to yours, as well as homes that are clearly not up to yours. In this way, you can set the "fork" of prices. If your house stands out from all the other houses in the area for better or worse, it will be quite difficult to determine the upper and lower limits of its value.

Let's assume that higher quality homes were selling recently for $450,000 to $475,000. Houses worse than yours sold between $400,000 and $420,000. By defining a "fork", you can say that your house costs between $425,000 and $445,000.

As we have emphasized earlier, a good practical way to determine the cost is the price per square foot. To calculate the price per square foot (cf), simply divide the selling price (minus rebates, if any) by the building's total living area. (Do not include garages, basements, attics, utility rooms, etc.). Let's say a home sells for $380,000 and contains 1,843 square feet of living space:

c.c.f. = $380 thousand/1,843 c.c.f. = $206.

The price per square foot gives an approximate starting point, but as you have already understood, never have the last word until you have studied and appreciated all the salient features of the object.

Data sources and how to verify them

Only in very rare cases, appraisers independently inspect the objects that they have chosen for comparison. Most often, they study archived data, information from multiple listing services, or use data from real estate agents. Although no estimator can work without the use of secondary data, always independently verify this information. Secondary data can serve as a source of erroneous conclusions.

Introduction of amendments

The evaluation form shown in fig. 14.1 contains a list of the characteristic features of the object. Since it is impossible to find two completely similar objects, the valuation requires the introduction of "corrections" to the cost of compared objects, depending on what characteristic features they have.

In other words, the process of introducing amendments answers the question: "At what price would this object be sold if its characteristics completely coincided with those of our object?". To answer this question, you must match and compare all the features of the two objects, point by point. If there is a complete match of the characteristics, no adjustments are necessary.

If at some point the foreign object outperforms yours, the estimated value of that characteristic should subtract from the sale price of this object. Conversely, if your home outperforms the comparison object in some feature, the appraised value of that feature should add up to the selling price of the property. By doing so, you will get a much more objective estimate of the value of the compared objects.

In table. In Figure 14.1, we illustrate the amendment process with a simple example.

In the first option, the seller assumes 90% of the OKS at 6.5% per annum. At the same time, investment financing usually requires 75% AQC at 7.5% per annum. Without this financial concession, the first seller would have bid $11,250 below the actual price. Therefore, this amount must be deducted from the sale price.

Table 14.1. Amendment process (selected characteristics)

	Option 1	Option 2	Option 3
Sale price, thousand $
Characteristics
Seller's concessions, thousand $	Analogy		Analogy
Financial concessions, thousand $		Analogy	Analogy
Date of sale, thousand $	Analogy		Analogy
Location, thousand $	Analogy	Analogy
Architectural plan (design), thousand $	Analogy		Analogy
Garage, thousand $		Analogy
Swimming pool, patio, terrace, thousand $			Analogy
Adjusted price, thousand $

Below we provide an explanation of the other amendments.

Option 1. Garage (+$8,250). Our property includes a spacious two car garage, while option 1 offers a small one car garage. If property #1 had the same garage as our property, its value would increase by $8,250.

Option 1: Pool, patio and deck (-$6,750) Option 1 outperforms our facility in these parameters, since we do not have a terrace and patio. Without these features, item #1 would have cost $6,750 less.

Option 2. Date of sale (+7 500 dollars ). The market price implies a comparison at the moment. Since property #2 was sold six months ago in a rising market, it would be worth $7,500 more today.

Option 2. Seller's concessions (-7,500 dollars ). The sale price of $213,440 includes the cost of hand draping, washer, dryer, and utility storage. Since these items are not normally included in the price of a home, the cost of these items should be deducted from the sale price.

Option 2. Architectural plan (design) (+3 750 dollars ). Unlike our house, this option does not have a convenient passage from the garage to the kitchen. The garage is located under the house, so you have to go up to the kitchen using the outside stairs. If this house had more convenient communication between the kitchen and the garage, its price would increase by $3,750.

Option 3: Location (-15,000 dollars ). This house is located at the end of the street, and the land borders with a forest area. As for our house, it stands in the middle of a noisy street and borders on its neighbor's plot. If facility No. 3 had not been so well located, it would have cost $15,000 less.

After making adjustments for each of the characteristics, you must add up all the numbers in the columns. The result will give you an answer to the question: "How much would this object cost if it were an exact copy of our object?". You may be asking, "How can I value each of the adjustments in dollar terms?". This is a complex question and there is no simple answer to it. The skill here comes with experience, after you analyze a lot of different trades. This can take months or even years. You can also take advice from experienced agents and appraisers.

But even in the absence of experience, you should be critical of all assessments made by professionals. Ask questions. Explore their findings. Check all the facts. As you look at different properties, learn to recognize their characteristic features. Remember that your task is not only an assessment of the market value of the object. You have to think about how to give this object additional value.

Sales history (transfers)

In the late 1980s, some real estate markets crashed. This led to the bankruptcy of many banks and savings and loan associations. Later it turned out that these markets were thoroughly infected with the virus of fraud and speculation. As a result, financial institutions oblige appraisers to examine the entire sales history of the properties for which a loan is issued, as well as the sales history of the homes with which these properties are compared.

If real estate is being sold frequently and at an ever-increasing price, this indicates that this market is approaching a recession. When regulators detect these signs, they are forcing lenders to tighten their lending standards and urge valuation of collateral more cautiously.

You should also keep a close eye on such trends. But if you still decide to play this risky game, remember that time is the decisive factor here. Your sense of timing will be the key to success. (Here I am addressing mainly those who have decided to play on the imminent resale and are not going to make improvements to the property they are purchasing.)

Comparative selling price

Once you have compared all assignments, sale dates, features and transfer histories, you can competent judgment about the market value of your property. While many people claim to know real estate prices perfectly, only careful methodology and accurate data can give you the confidence to act quickly (if necessary) and without undue risk.

Comparative cost method

Although cost and income methods are not always used for valuation, as an investor, you must be able to use different approaches to real estate valuation.

Calculate the cost of building a new home

To understand the methodology of the cost approach, let's go back to the bottom of Fig. 14.1. First, you must calculate the cost of building a new building based on the cost of building one square foot of housing in your area.

Construction costs are determined by the size and quality of the house. Make sure you include all extras and luxuries (e.g. crystal chandeliers, high quality carpeting, home appliances). Subzero, plumbing Kohler, sauna, etc.) and included their cost in the total cost of the house.

Subtract depreciation (depreciation)

Once you have calculated the cost of erecting a new building at today's building prices, you must consider three types of depreciation: 1) physical, 2) functional, and 3) economic (external). Old buildings are usually cheaper than new ones, because during their operation they have undergone physical wear. They were affected by the weather and other factors, including possible misuse. Frayed carpets, faded paint, cracked panels, corroded pipes, and leaking roofs all reduce a building's value. How much? Here, an appropriate evaluation method is needed. To specify a specific figure, evaluate the degree of wear as a percentage. In some cases, the degree of wear can reach 70%. There is another method: estimate how much the repair work will cost to bring the house into proper condition.

After assessing physical wear, it is necessary to evaluate functional depreciation. Unlike depreciation due to long-term use, functional depreciation implies a decrease in value due to obsolescence of wall coverings, architectural plan, electrical wiring systems, color schemes, design, etc. Physically, a house may be in excellent condition, but its obsolescence is already beginning to turn away potential tenants and buyers.

The Bonwit Teller building has outlived itself. It is completely outdated functionally. The land occupied by this building could have been used much more efficiently.

External depreciation is due to the fact that today's way of using this object is no longer the most profitable. Let's say you find a well-preserved residential building in an area that has become predominantly commercial. The zoning of the area has changed. It is more than likely that the main part of the value of the object is now the cost of the land. If someone buys a "building", he will immediately demolish it and build a new shopping or office center on this site. The same principle applies in cases where the area becomes more and more prestigious and good houses with three bedrooms and two bathrooms of 2 thousand square meters. feet are being demolished, and in their place houses of 6 thousand square meters are being built. feet worth $2 million or more.

Economically obsolete property referred to as "demolition" property. But remember that the term "for demolition" can mean both a dilapidated building and a well-preserved building. When you buy a demolished property, you pay only for the land plot, minus the cost of demolishing the building and removing construction debris.

The cost of the land

To estimate the value of a land plot, find an empty, similar lot that has recently been sold, or a similar lot bought along with a demolition building. When evaluating similar lots, compare their salient features such as size, boundaries, general appearance, topography, laws pertaining to the use of those lots, subdivision rules, and other features that buyers usually look for.

Market value estimated using comparative cost method

As can be seen from the evaluation form shown in Fig. 14.1, the market value calculation consists of three steps. The first step is to estimate the cost of building a new building similar to the existing one. The second step is to determine depreciation in monetary terms and subtract this figure from the amount of costs. The third step - the cost of the land plot is added to the result obtained. Since all three required figures can only be estimated approximately, this approach does not give a definite answer to the question of the actual value of the object. But this technique helps to identify market trends and also provides a benchmark figure that can be compared with the figures obtained by the comparative sales method and the comparative income method.

Comparative income method (CIR)

Immediately below the Comparative Cost Method section of the valuation form (Figure 14.1) is the Comparative Income Method section. This approach is based on an evaluation technique called the multiplier of the total rent(MSR).

To calculate the market value using the MRA, you must know the total monthly rent and the selling price of similar buildings. Let's say that you have collected information about three buildings for rent. The first building is located at 214 Jackson with a gross monthly rent of $1,250 and a sale price of $220,000. The second building is located at 312 Lincoln with a gross monthly rent of $1,350 and a sale price of $247,000. The third building is located at 107 Adams with a gross monthly rent of $1,175 and a sale price of $210,000. Now you can calculate the MSR for each of these objects:

MSR = Sale Price / Monthly Rent

If the house you are appraising has a monthly rent of $1,125, calculate the fork of its value as follows:

"Fork" of the value of the house you are evaluating

	Monthly rent, $	Cost, thousand $

Thus, the value of your property is in the range of $215,600 to $224,175.

Since the MSR method does not directly take into account all kinds of concessions, the characteristics of objects, their location, the level of operating costs, it is just a technique for rough assessment of the market value. But many investors use this technique to get a base figure that can be used as a starting point for further analysis. Like the comparative selling method, the MSR method works best in cases where closely spaced similar objects are compared.

The MCP figures given in this example are not necessary match the MCP values for your city. Even in the same city these figures can vary greatly from area to area. In San Diego, the RSM value for mansions in the La Jolla area exceeds 400, in Claremont it ranges from 250 to 400, in National City the MSR value does not exceed 200. Even within the same area, the MSR for mansions is higher than for condominiums. As with any other valuation method, use the data for the area in which the property being valued is located.

Property in a prestigious area can be very expensive. Cheap real estate in a remote area is also not the best way to invest money. But you should always know the true value of what you are buying. Never pay more for an item than its true value.

Reconciliation of grades

After evaluating an object with all three methods, you should analyze the results depending on how you intend to use this object. As we have already noted, the method of comparative sales is best suited for valuing single-family mansions. But for real estate that you intend to use to generate income, the methods of comparative sales and comparative income are somewhat different from those described earlier (although the basic principles remain the same).

Valuation of profitable (commercial) real estate

To briefly illustrate the income property valuation methodology, let's take the Royal Terrace multi-apartment complex as an example. The complex includes 38 apartments with an area of 550 sq. feet each. The building is located in Middleton, Iowa, a relatively inexpensive Midwest area with a stable economy and a persistent lack of jobs, income, and population.

After studying all the features and location of the Royal Terrace, you have found two similar properties in the area that have been sold within the past six months. Here is a brief description of these objects.

2735 Maple (Comparison #1)

The 25-year-old building contains 33 apartments. Inside the building looks more shabby than the Royal Terrace, but in general condition and construction, these objects are quite similar. However, there is one significant drawback: Maple is located next to the new high school. Currently, apartments are rented for $285 per month. The area of each apartment is 525 sq. ft. According to information received from the building manager, the percentage of vacant apartments is stable at around 4%, and operating costs are 52% of the rent. From archival documents and conversations, you learned that the building was sold with a down payment of 20% and a secured loan for 25 years at 7% per annum. The sale price was $506,700.

1460 Elm (Comparison #2)

The building is 16 years old. 40 apartments. The design is more advanced than that of the Royal Terrace, and the building itself is two blocks from the park, which has tennis courts, a swimming pool and a nine-hole golf course. Today, apartments are rented for $315 a month, and each apartment is 550 square meters. ft. An average of 4% of apartments are empty, and operating costs amount to 49% of the rent. Archival data indicates that the purchase of the building was financed with an ADR of 80% for 30 years at 6.75% per annum. The sale price was $772,400.

In addition to collecting this data, you consulted Marshall and Swift and learned that the construction of such a building would cost $72 per square meter today. foot.

You received information from the accountant at Royal Terrace about income and expenses for the calendar year up to December 31st of the previous year.

MSR

The MSR technique is used to value income properties in much the same way as it is used to value rental houses and condominium apartments. By choosing objects for comparison, you determine the multiplier of the total income. Then multiply this figure by the amount of potential income you expect to receive from your property. The difference is that for rental houses and condominiums you calculate the multiplier based on monthly rent, and for apartment buildings you calculate it based on annual income. Notice that in our example, the objects we selected for comparison have an MSR of 4.49 (506,700/112,860) and 5.10 (772,400/15120). If you choose to set the Royal Terrace to an MCP of 4.75, your property will cost:

4.75 x $134,520 = $638,970.

The MCP technique is widely used in some areas to evaluate some types of multi-apartment buildings. But in general, buyers do not attach the same importance to this technique as to the method of direct capitalization of income. Unless the objects being compared are completely similar, the MCP technique does not give a sufficiently reliable evaluation result. In addition, buyers rarely use MVR to value office buildings, shopping malls, and other types of income-producing properties. Due to the wide range of lease conditions and the characteristics of various objects, the MCP method does not take into account many important factors. However, the SRM is one assessment tool that works well in some specific circumstances.

Capitalization of income

Another way to value multi-family (and not only) buildings is the method of direct capitalization of income. Remember the formula we already gave:

where C is the cost of the property, NOR is the net operating income, and H is the capitalization rate that owners of similar profitable real estate usually require.

Thus, if the net operating income that Royal Terrace should generate is $63,174 at a capitalization rate of 0.096, the value of the property can be calculated using the formula:

C = 63,174/0.096, C = $658,062.

Of course, we left unanswered the question: “What are the considerations for calculating net operating income and capitalization rate?”. Now let's look at this issue in more detail.

CHOD

Investors calculate the NPV as the annual expected rental income minus losses on vacant apartments, operating costs, property taxes and insurance payments.

However, as with the Royal Terrace example, many non-professional investors (as well as many accountants) do not know how to calculate NOR for income capitalization purposes.

In addition, many sophisticated income property owners overestimate their rental income and underestimate losses due to vacant apartments and operating costs. Using distorted income and expense figures, they are trying to convince buyers that their property is worth more than it is. In fact.

Thus, whether buying property from a professional or from an amateur, be equally on the alert. Never take on faith the numbers that are offered to you. Instead, calculate the NOR yourself, based on your own research and market knowledge.

Now we will try to reconstruct the statement of income and expenses presented by the owner of the Royal Terrace (tables 14.2 and 14.3). Such a reconstruction should more accurately determine the net operating income that can be expected from this object in the coming year, subject to competent management.

income reconstruction. First of all, notice that we used the average market rent and the average market vacancy rate (vacant apartments) to calculate gross income. These figures may not match the actual figures for each specific facility. To find the best rates for rental income and vacancies, look at the corresponding rates for similar properties located in your area of interest. Analyze the current state of the market. After recalculating the estimated income, do an analysis of expenses.

Management and advertising. The report submitted by the owner does not include management and advertising costs. The owner manages his own building, and since rents are relatively low, reports of available apartments are mostly word of mouth. However, the new owner should consider the cost of both professional management and advertising.

Table 14.2. Statement of income and expenses submitted by the owner of the Royal Terrace

Actual amount of rent, thousand $

Insurance (three-year policy), thousand $
Real estate tax (paid on 8/2/86 for 1985), thousand $
Caretaker's salary, thousand $
Gas and electricity, thousand $
Water and sewerage, thousand $
Garbage removal, thousand $

Mortgage interest, thousand $
Depreciation, thousand $
Net income, thousand $

Insurance payments and property taxes. The owner exaggerated his insurance costs because he stated the amount of payments for three years at once in the annual report. Therefore, this amount should be reduced three times - from 19,200 to 6,400 dollars. We also had to revise the tax amount. Firstly, the new selling price of the property will certainly increase, and this will entail an increase in tax payments.

Table 14.3. Reconstructed income statement

Gross potential income (38 × 12 × $295), thousand $
Losses on empty apartments / 4%, thousand $
Actual gross income (123,120), thousand $

Management (0), thousand $

Insurance (19,200), thousand $
Real estate tax (3,682), thousand $
Caretaker salary (12,000), thousand $
Gas and electricity (16,590), thousand $
Water and sewerage (3,200), thousand $
Garbage removal (1,847), thousand $

Other expenses, thousand $
Total expenses, thousand $
Net operating income, thousand $

In this city, appraisers usually rely on data from previous appraisals, but if the deal needs to be registered in the county, a reassessment is made. In addition, the county council raised the tax rate significantly, so a higher tax would have to be paid next year even without a reassessment.

Utilities, cleaning, etc. Regarding utilities and garbage collection, you should contact the companies that provide these services. But based on their data, you will be able to calculate your expenses for the next year. The caretaker's salary has been cut due to the fact that some of his duties will fall on the firm that will manage the building.

At one time, the owner of the building independently carried out some repairs. Since the new buyer is acquiring the Royal Terrace as an investment and not as a personal employment item, this expense should be increased significantly.

Repair and maintenance. Property owners usually underestimate the costs associated with maintaining a building and replacing worn items (carpets, roof, appliances, etc.). Therefore, we have increased this item of expenditure to a more objective level.

Other expenses. Note that in the last paragraph, we added $2,000 for miscellaneous expenses. This item includes costs for legal fees, cleaning of premises, purchase of finishing materials (paint, wallpaper), etc. But we did not include mortgage interest and depreciation in the list of expenses. While these costs are unavoidable, they are not included in the calculation of net operating income.

CHOD. After reconstructing all income and expenses, it can be seen that the net operating income from Royal Terrace for the next year is expected to be $63,174.

Determining the capitalization rate

Typically, investors and appraisers determine capitalization rates based on the average market level. For example, to determine the capitalization rate for the Royal Terrace, you can calculate this rate for the objects Maple and Elm (table 14.4). For Maple, which is in slightly worse shape (five years older, more worn and next to a motorway), the buyer set a capitalization rate of 9.8%. The Elm facility (better location, younger age and funding at 6.75% per annum) received a rate of 9.2%. Given these facts, what capitalization rate should be set for Royal Terrace?

First, we see that this value is likely to be between 0.092 and 0.098. The reason is that investors, other things being equal, prefer newer buildings. They believe that the new building is subject to fewer risks than the old one. Investors also believe that the new building will generate revenue longer and present more room for rent increases. Since King's Terrace sits between Maple and Elm in terms of parameters, its capitalization rate should also be somewhere in between.

Now, continuing our analysis, we must determine which is closer to the Royal Terrace - to Elm or Maple?

After weighing and considering all the similarities and differences, what capitalization rate will we choose? We need a specific number.

How about 0.096? Like any decision related to valuation, the choice of capitalization rate is determined not only by facts, but also by the conclusions that we make based on these facts. Remember that no two properties are the same, no two buyers are the same, and no individual has complete market information. Here we assumed that the Royal Terrace is still closer to Maple. In addition, financing of our transaction will most likely be carried out at 7%, and not at 6.75% per annum. Therefore, we end up choosing 0.096.

Direct capitalization method

The final step of this valuation method is to convert the NPV to capital. In our example, we perform this step by dividing $63,174 by 0.096. As a result, the market value of the object, estimated using the income capitalization method, will be:

C = $63,174/0.096, C = $658,062.

Comparative sales method

When buying residential complexes, office buildings or shopping centers, many investors rely entirely on the income capitalization method. However, they should use other methods of comparative valuation, if only to support the figure obtained by the income capitalization method. You can, for example, use the comparative cost of one apartment or one square foot of living space, as shown in table. 14.5.

Table 14.5. Comparative cost of one apartment

Peculiarities	2735 Maple	1460 Elm	Royal Terrace
Physical state	A little bit worse	A little better
Age, years
Location	Busy street traffic	Near the park
Financing	80% OKS 7% 25 years	80% OKS 6.75% 30 years
Sale price, thousand $
Number of apartments
Number of rooms
Total living area, sq. feet
The cost of one apartment, thousand $
The cost of one sq. feet, thousand $

Based on the data in Table 14.5, we can estimate the market value of the Royal Terrace:

38 × $16,800 = $638,400

20,900 × $31.50 = $658,350.

As you can see, the valuation using the comparative sales method reinforces the valuation obtained by the direct capitalization method. Of course, no method of evaluation gives an absolutely accurate answer. Investors rely on different facts and draw different conclusions based on them. But careful analysis using various evaluation methods will help you make the right decision.

Comparative cost method

As shown in Table 14.6, the comparative cost method gives an estimate of the value of the property at $922,252.

Table 14.6. Comparative Cost Method: Royal Terrace

New building construction costs (20,900 sq. ft × $72), thousand $
Depreciation
Physical, thousand $
Functional, thousand $
Economic, thousand $
Cost minus depreciation, thousand $
The cost of the land, thousand $
Market value, thousand $

This approach shows a significantly higher market value. Why? Because Middleton lacks a vibrant economy. Construction costs (which are determined by national building materials prices) are rising faster than real estate values in Middleton.

Therefore, an investor who purchases the Royal Terrace need not fear excessive competition from new developments. Rents in new homes will be much higher (and the same goes for the cost of new homes).

Thus, the market risk here is relatively low. In addition, the investor has the opportunity to improve their property and give it additional value. Because investors don't expect property prices to skyrocket in Middleton, they can buy properties with a higher capitalization rate, thus increasing their cash flow per dollar of investment.

In any case, bought at a price of 650 thousand dollars or less, the Royal Terrace will be a pretty good investment. But before making an offer to buy, an investor should calculate the Cash Investment Ratio (CRR) and Total Return on Investment (ROI) – taking into account depreciation and possible growth in real estate prices.

Return on cash investment

For the purpose of illustration, let's say you purchased the King's Terrace for $650,000. To make the purchase, you paid $120,000 in cash (20% down payment) and took out a loan of $520,000 (80% ACC) for 30 years at 7% per annum. To calculate your first year's pre-tax income (EBIT), you subtract the annual mortgage payment from your first year's expected net operating income:

Annual mortgage payment

($520,000 / 7%, 30 years) $41,905,

IT \u003d DDVN / the amount of cash investments,

THEM = $21,269/$130,000,

So, if you were right in your initial assumptions, your cash ROI looks pretty good. Thanks to the use of credit, you raised the payback ratio from 9.6% to 16.3%. In today's market conditions, most investors would find a cash return of 16.3% very attractive.

Overall ROI

The ROI calculated above does not take into account the additional benefits that you could get from depreciation and higher property prices. To calculate your total return on investment, you must project your annual PVH over the entire expected life of the property (say, five years) and calculate the cash income you will receive after that time if the property is sold.

To illustrate, let's assume that due to Middleton's weak economic performance, your PVH will grow at a rate of only 2% per year, and so will real estate prices. In five years, your mortgage balance will be $488,343.

Now we will look at tables 14.7 and 14.8. First, we see that a 2% increase gives you $193,427 in cash on sale after five years. Table 14.7 also shows your income without a price increase (pessimistic case) and with a 5% price increase (optimistic case).

Using the software excel(or similar), you can calculate the total return on your investment, as shown in table. 14.8.

At different rates of real estate price growth, your expected total return on investment (TRO) would be between 17.78% and 31.67%.

Of course, Tab. 14.8 is only a simplified version of the calculations. You can change the parameters of rent, operating expenses, mortgage interest, loan terms, down payment and other parameters. In addition, you can calculate how much the value of your property will increase after its improvement and modernization.

Table 14.7. Net income from sales at different rates of growth in real estate prices

Growth in real estate prices, %
Sale price, thousand $
Minus 5% costs for the sale, thousand $
Less mortgage balance, thousand $
Net income from sales (before taxes), thousand $

Table 14.8. Calculation of ROI under the condition of a 2% increase in DDVN with various types of growth in real estate prices

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
DDVN, thousand $
No price increase, thousand $

DDVN, thousand $
2% price increase, thousand $

DDVN, thousand $
5% price increase, thousand $

After trying several scenarios of analysis, you can calculate all the options - from the most unfavorable to the most successful. Since none of us can predict the future with absolute accuracy, knowing your limits will not only help you make the best decisions, but will also enable you to face the times when circumstances turn against you.

1 FEMA(short for Federal Emergency Management Agency) - Federal Agency for Emergency Circumstances. — Note. per.

2 The value of properties being compared may be subject to financial and other concessions, so appropriate adjustments should be made here. Amendments are not needed if such concessions are traditional for the area or are easily identifiable, as they are typical for any transactions. Special adjustments can be made by comparing financial terms offered by a third party not involved in the transaction. Any adjustment should not be a mechanical recalculation of the dollar equivalent of the concession, but should be based on the anticipated market reaction to the granting of such a concession.

3 ACS (loan/value ratio) is the percentage of the loan amount to the assessed value of the property pledged under this loan. — Note. per.

4 With almost 100% occupancy of apartments.

5 Owner's details are in parentheses. Market value does not include mortgage interest and depreciation.

6 Based on average market values for similar properties.

Business valuation is carried out using three approaches: income, comparative and cost. Each approach allows you to emphasize the special characteristics of the object.

At income approach income is put at the forefront as the main factor determining the value of the object. The greater the income brought by the object of evaluation, the greater the value of its market value, all other things being equal. What matters here is the duration of the period for obtaining a possible income, the degree and type of risks accompanying this process. The income approach is a calculation of the present value of future income that will arise from the use of property and its possible further sale. In this case, the waiting principle applies.

This approach is considered the most acceptable for investment reasons, since any investor who invests money in an operating enterprise, in the end, does not buy a set of assets consisting of a set of tangible and intangible assets, but a stream of future income that allows him to make a profit, recoup the invested capital and increase his well-being.

The income approach is usually the most appropriate procedure for business valuation, but it is also advisable to use the comparative and cost approaches. In some cases, the cost and comparative approaches may be more accurate or more efficient. In many cases, each of the three approaches can be used to test cost estimates obtained from other approaches.

Comparative approach particularly effective when there is an active market for comparable properties. The accuracy of the valuation depends on the quality of the collected data, since, using this approach, the valuator must collect reliable information about recent sales of comparable properties. This data includes: economic characteristics, time of sale, location, terms of sale and terms of financing. The effectiveness of this approach is reduced if: there were few transactions; the moment of their commission and the moment of evaluation are separated by a long period of time; the market is in an anomalous state because rapid changes in the market lead to distortion of the indicators. The comparative approach is based on the principle of substitution. For comparison, objects competing with the valued business are selected. Usually there are differences between them, so it is necessary to adjust the data accordingly. The amendments are based on the principle of contribution.

Cost approach is most suitable for assessing enterprises with heterogeneous assets, including financial ones, and also when the business does not generate a steady income. It is advisable to use the cost approach methods when evaluating special types of business (hotels, motels, etc.), insurance. The information collected includes data on the assets being valued (land prices, building specifications, etc.), data on the level of wages, cost of materials, equipment costs, profits and overheads of builders in the local market, etc. The cost approach is difficult to apply when evaluating unique objects of historical value, aesthetic characteristics, or obsolete objects.

The cost approach is based on the principles of substitution, best and most efficient use, balance, economic value, economic division.

The advantages and disadvantages of the three approaches are presented in Table. 17.2.

Table 17.2. Advantages and disadvantages of the main approaches to business valuation

An approach	Advantages	Flaws
Profitable	Takes into account the future expectations of the investor. Allows to take into account the economic obsolescence of the enterprise. It makes it possible to take into account the profitability of investments in a business, taking into account the volume of proceeds from the sale of products and costs, as well as the market aspect, since the required rate of return is based on market data	It does not allow to accurately determine the discount rate for the future income of the enterprise due to the lack of market data and the instability of the economy. Limited by the lack of sufficient information on the current and future net income of the enterprise
Comparative	Reflects the actual results of the production and economic activities of the enterprise. Really shows the demand and supply for this investment object, since the price of the actually completed transaction most integrally takes into account the situation on the market	Ignores the prospects for the development of the enterprise, since the basis for the calculation is the financial results achieved in the past. It is of value only in the presence of comprehensive financial information not only for the enterprise being assessed, but also for a large number of similar analogue firms. The complexity of calculations and adjustments and their justification. Low reliability of the information received
costly	It is most attractive when typical sellers and buyers seriously focus on construction costs in their decisions. However, if the cost approach shows that construction costs may be significantly less than the cost of acquiring an object, determined by the income approach, then this fact may force the investor to opt for the construction option.	Static and inability to take into account the prospects for the development of the enterprise. Does not take into account the location of the property complex being assessed. Difficulty in accurately assessing all forms of wear

The three approaches are linked. Each of them involves the use of different types of information obtained in the market. For example, the base for the cost approach is data on current market prices for materials, labor, etc.; for the income approach - discount rates and capitalization ratios, which are also calculated from market data.

In a perfect market, all approaches should result in the same value. However, most markets are imperfect, supply and demand are not in balance. Potential users may be misinformed, production may be inefficient. For these and other reasons, different cost indicators can be obtained with these approaches.

The system of cost indicators for evaluation purposes is shown in fig. 17.1.

There are several known real estate valuation methods used for various objects. The choice of evaluation method depends on a number of factors, such as the nature of the object, the purpose of its evaluation. It is recommended to choose the largest number of methods for evaluating a particular object in order to obtain the most accurate cost.

All methods are grouped into three approaches to real estate valuation:

market (comparative);

costly;

profitable.

Market (comparative) approach to valuation- this is a set of methods for estimating the value based on a comparison of the object of assessment with its analogues, in respect of which there is information on the prices of transactions with them.

Conditions for applying the comparative approach:

· The object must not be unique;

· The information must be exhaustive, including the terms of transactions;

· Factors influencing the value of comparable analogues of the property being valued must be comparable.

This approach is based on the substitution principle, i.e. assumes that a rational investor or buyer would not pay more for a particular object than it would cost to acquire another similar object with the same utility.

When comparing sales, the appraiser considers comparable items, then makes adjustments between the compared item and the comparable item. The adjusted price allows the appraiser to draw a conclusion about the possible value of the property being valued on the market.

Stages of evaluation by the sales comparison method:

Stage 1. Market research - an analysis of the state and trends in the development of the real estate market, and especially the segment to which the property being assessed belongs; real estate objects are identified that are most comparable to the property being assessed, sold relatively recently.

Stage 2. Collection and verification of the reliability of information about the proposed for sale or recently sold analogues of the appraised object, comparison of analogue objects with the appraised object.

Stage 3. Adjustment of sales prices of selected analogues in accordance with the differences in the object of assessment.

Stage 4. Establishing the value of the appraisal object by agreeing on the adjusted prices of analogue objects.

The objects to be compared must belong to the same segment and transactions with them must be carried out on conditions typical for this segment in terms of the exposition period and the independence of the subjects of the transaction.

The exposition period is the time that the object is on the market.

The independence of the subjects of the transaction means that transactions are not concluded at a market price if the seller and buyer:

are in a relationship;

are representatives of the same organization;

have a different interdependence and mutual interest;

transactions are carried out with objects burdened with a pledge or other obligations;

· are engaged in the sale of real estate of deceased persons, etc.

Adjustments should be made for all major features and amenities that would be worthwhile from the prospective buyer's point of view. Adjustments are made:

1) at the time of sale - allows you to bring the price of an analogue object on the date of sale to today's price;

2) ownership of real estate - based on the assumption that when the object is sold to the buyer, all ownership rights to this property are transferred. If the rights are "bad", then the adjustment is made with a "-" sign and vice versa;

3) on the terms of financing transactions;

4) on the terms of sale;

5) on the state of the market - is done in order to take into account changes in supply and demand, which are caused by changes in legislation and the tax base;

6) location;

7) for use - objects that have retained their usage profile should be considered as compared.

Adjustments can be made both in value terms and as a percentage.

Percentage Adjustments are made by multiplying the selling price of the analogue object by a coefficient reflecting the degree of differences in the characteristics of the analogue object and the object being valued. If the object being valued is better than a comparable analogue, then an increasing coefficient is added to the price of the latter, if it is worse - a decreasing one.

Cost adjustments change the price by a certain amount, which evaluates the differences in the characteristics of the object-analogue and the object being evaluated.

Advantages of the comparative approach:

1. The final cost reflects the opinion of typical sellers and buyers.

2. Sales prices reflect changes in financial conditions and inflation.

3. Adjustments are made for differences in the compared objects.

4. Relatively easy to use and gives reliable results.

Disadvantages of the comparative approach:

1. Sales differences.

2. Difficulty in collecting information on sales prices.

3. Difficulty in collecting information about the specific conditions of transactions.

4. Dependence on market activity.

5. Difficulty in reconciling data on substantially different transactions.

Cost Approach to Real Estate Valuation- this is a set of valuation methods based on determining the costs necessary to restore or replace the object of assessment, taking into account accumulated depreciation. In this case, the land plot is assessed on the basis of the current market price situation separately from buildings (structures). The result of the assessment is the sum of the construction costs and the cost of the land.

The approach is based on the assumption that the buyer will not pay more for a finished object than for the creation of a new object of similar utility.

When evaluating new objects, the cost approach is the most reliable.

This approach is appropriate or the only possible one in the following cases:

· technical and economic analysis of the cost of new construction;

justification of the need to update the existing facility;

valuation of buildings for special purposes;

· when evaluating objects in the "passive" sectors of the market;

· analysis of land use efficiency;

solving the problems of object insurance;

solving problems of taxation;

· when agreeing on the value of the property obtained by other methods.

Disadvantages of the cost approach:

1. Costs are not always equivalent to market value;

2. Attempts to achieve a more accurate assessment result are accompanied by a rapid increase in labor costs;

3. Inconsistency between the costs of acquiring the property being valued and the costs of new construction of exactly the same property, since accumulated depreciation is deducted from the cost of construction in the process of valuation;

4. Problematic calculation of the cost of reproduction of old buildings;

5. Difficulty in determining the amount of accumulated wear and tear of old buildings and structures;

6. Separate assessment of the land plot from buildings.

Assessment stages in accordance with the methods of the cost approach:

1. Calculation of the cost of a land plot, taking into account the most efficient use;

2. Calculation of the replacement cost or replacement cost of the object;

3. Calculation of accumulated wear:

· physical deterioration- wear associated with a decrease in the performance of an object as a result of natural physical aging and the influence of external adverse factors;

· functional wear- wear and tear due to non-compliance with modern requirements for such objects;

· external wear– depreciation as a result of changes in external economic factors.

4. Calculation of the value of the object, taking into account the accumulated depreciation;

5. determination of the final cost of the object (cost including depreciation + cost of the land plot).

When using the cost approach to real estate appraisal, it is important for the appraiser to understand the difference between replacement cost and replacement cost.

replacement cost of the object is determined by the costs in current prices for the construction of an exact copy of the object being evaluated with the implementation of the same architectural and planning solutions, building structures and materials. In this case, the same functional depreciation of the object and the same shortcomings in the architectural solution that the evaluated object has are reproduced.

replacement cost is determined by the costs in current prices for the construction of an object that has an equivalent cost and utility with the estimated one, but built in a new architectural style using progressive materials and equipment.

Thus, the replacement cost expresses the costs of reproducing an exact copy of an object, and the replacement cost expresses the costs of creating a modern analogue object.

For most valuation purposes, full replacement value is preferable because the replacement creates a property that is different from the property being valued.

In addition, it is difficult to measure the difference in utility between an existing building and a proposed new one that would have modern characteristics.

From a theoretical point of view, replacement cost is more preferable, because it is unlikely that anyone would want to reproduce a building of a certain age with all its functional deficiencies.

If it is necessary to start construction again, then priority is given to a building with the same utility, but created according to modern standards and design.

Replacement cost structure

The replacement cost includes:

direct costs;

indirect costs;

Entrepreneur's profit.

Direct costs - those costs that are directly related to this property and include the cost of raw materials and materials, the cost of equipment, labor costs for construction, the cost of temporary structures, the contractor's profit.

Indirect costs are costs that arise during construction, but cannot be identified directly in the structure itself. These include insurance and promotional fees during construction, architect fees, legal fees, feasibility study costs, property change costs, marketing costs for the sale of the property, etc.

The entrepreneur's profit is the premium for the use of his capital in this particular area.

At the stage of preliminary calculations, indirect costs are calculated as a percentage of the direct costs.

The amount of direct costs is determined based on the following methods:

· Quantitative survey method. It provides for the decomposition of the building into separate elements and the multiplication of the costs for each element by their total number. When carrying out this method, it is necessary to count the total number of, for example, all nails of all types of sizes, all paint of all brands, etc. For most evaluation purposes, this method is too laborious to apply.

· Breakdown method. Involves finding the cost of various components on a unit basis, such as foundations, walls, roofs, etc. With reference information on unit prices, this method allows you to reproduce the full cost of reproduction of the object.

· Comparative unit method. It is based on a comparison of a unit area of the evaluated object with the cost of a typical object, with adjustments for the features of the object being evaluated.

After calculating the replacement cost, it should be brought to today's prices in accordance with the change in the cost of construction.

Wear assessment

After the assessment of the full cost of reproduction is completed, depreciation should be deducted from the amount received.

The term depreciation, which is used in the valuation of real estate, should be distinguished from depreciation in accounting.

In accounting, depreciation is charged in accordance with legally established norms, regardless of market conditions.

In appraisal activity, depreciation is the loss of value of property due to various reasons.

The following methods can be used to estimate the amount of wear:

· Sales comparison method. The trick is to subtract the value of the property, derived from the sales comparison or income capitalization method, from the replacement value of the building and the value of the land. The resulting difference is the total accumulated depreciation.

· Breakdown method. The bottom line is that the depreciation of each component of the property being valued is estimated and, by summing up, the amount of depreciation is obtained. The method is very labor intensive.

The method of economic age. Estimates depreciation according to the relationship between the economic age of the building and its overall economic life and comparing it with the cost of new construction.

Economic age (EA) shows the usefulness and condition of an object. It can be more or less than chronological, depending on the degree of load the building was operated with.

Economic life (TE) is the period of time during which, in the opinion of the appraiser, improvements to the property contribute to its value.

· Modified method of economic age. Allows you to calculate depreciation most accurately: first, the cost of correctable physical and functional depreciation is deducted from the total cost, then the economic age method is applied to the remaining cost, and the depreciation is summed up.