1025 Income Approach & the Opinion of Value

[ZZGAMAZZ]

The point has been made on a current Thread that the Income Approach in a Small Residential Income Property Appraisal Report #1025 pertains to the borrower's ability to repay the pending loan--like a SFR 1007 Report-- but that the result of the Income Approach should not and cannot be the basis of the appraiser's opinion of market value.

The argument has been proffered by a very esteemed colleague who's Forum advice is always dead on, but this is totally outside the box of any protocol of which I am aware.

Comments please...

 

[Lee Lansford]

The point has been made on a current Thread that the Income Approach in a Small Residential Income Property Appraisal Report #1025 pertains to the borrower's ability to repay the pending loan--like a SFR 1007 Report-- but that the result of the Income Approach should not and cannot be the basis of the appraiser's opinion of market value.

The argument has been proffered by a very esteemed colleague who's Forum advice is always dead on, but this is totally outside the box of any protocol of which I am aware.

Comments please...

In an opinion of market value, is not the Sales Comparison Approach the BEST indicator of MV (with the IA in support)?

As to the IA being "the borrower's ability to repay the pending loan", that may be how the client use's the IA, but, as an appraiser, I don't care very much about that aspect of the transaction.

 

[PropertyEconomics]

The point has been made on a current Thread that the Income Approach in a Small Residential Income Property Appraisal Report #1025 pertains to the borrower's ability to repay the pending loan--like a SFR 1007 Report-- but that the result of the Income Approach should not and cannot be the basis of the appraiser's opinion of market value.

The argument has been proffered by a very esteemed colleague who's Forum advice is always dead on, but this is totally outside the box of any protocol of which I am aware.

Comments please...

Gama please point to the thread where this was stated.

 

[Randolph Kinney]

Fannie Mae Single Family
2007 Selling Guide
Part XI: Property and Appraisal Guidelines
XI, Chapter 4: Reviewing the Appraisal Report (11/01/05)
XI, 408: Income Approach to Value (11/01/05)

XI, 408: Income Approach to Value (11/01/05)
The income approach to value is based on the assumption that market value is related to the market rent or income that a property can be expected to earn. Its use generally is appropriate in neighborhoods that consist of one-unit properties when there is a substantial rental market, and it can be an important approach in the valuation of two-unit to four-unit properties. However, it generally is not appropriate in areas that consist mostly of owner-occupied properties since adequate rental data generally does not exist for those areas. We will not accept an appraisal if the appraiser relies solely on the income approach to value as an indicator of market value.

To arrive at the indicated value by the income approach to value, the appraiser multiplies the total gross estimated monthly market rent for the subject property by a reconciled gross monthly rent multiplier. (Because of the way the appraiser’s opinion of value is derived under this approach, the income approach to value provides a reliable indication of value only when the comparable sales are truly comparable.)

•Estimated market rent is based on an analysis of comparable rentals in the neighborhood. After appropriate adjustments are made to the comparable properties, their adjusted (or indicated) values are reconciled to develop an estimated monthly market rent for the subject property.

•The gross rent multiplier is determined by dividing the sales prices of comparable properties that were rented at the time of sale by their monthly market rent, which is then reconciled to create a single gross rent multiplier (or a range of multipliers) for the subject property.

The appraiser must use his or her best judgment regarding the applicability of the income approach to value. An instance in which the income approach may not be an appropriate indicator of value involves the appraisal of a two-unit rental property in a neighborhood that is dominated by two-unit properties that are owner-occupied. In such cases, the appraiser does not need to develop a gross monthly rent multiplier, but must report the estimated market rent for the subject property. In such cases, the appraiser should provide an appropriate explanation of why he or she chose to report in this manner.

When the property being appraised is a one-unit property that will be used as an investment property, the appraiser must prepare a Single-Family Comparable Rent Schedule (Form 1007) in addition to the appropriate appraisal report form. [This form is not required for a two-unit to four-unit property because the Small Residential Income Property Appraisal Report (Form 1025) provides substantially the same information, nor is it required for a Community Living group home mortgage.] When the appraiser is relying on the income approach to value, he or she should include the supporting comparable rental and sales data, and the calculations used to determine the gross rent multiplier in the appraisal report.

 

[ZZGAMAZZ]

Good morning, Prop. The thread entitled "Multi-Unit Residential Course" is in the California Forum and the issue was first made beginning with Post #17.

My assignment is a 3-plex in a city with only 1 multi-unit sale within the 8 months prior to the effective date, in a stable market where the absence of market activity is based upon limited inventory rather than the current issues that typically affect markets--lack of demand, falling prices, borrower's inability to obtain a loan, etc. Market reaction to properties in the City is extemely favorable even relative to high end, near-by Pasadena, and the gross/net adjustments in the SCA in my opinion diminished the credibility of the SCA.

Admittedly, I was unaware of the reference posted above to XI, 408.

Those guidelines notwithstanding, IMO an investor would be prudent to rely upon market rent rather than comparable sales as the basis or his or her decision to purchase a multi in this neighborhood...

 

[ZZGAMAZZ]

RK:

What took you so long to respond--at least 2 minutes! You musta been sitting at the computer for the past 48 hours waiting for me to take this issue to the general Forum. I would hate to face you in a public debate!!!!

 

[PropertyEconomics]

Fannie Mae Single Family
2007 Selling Guide
Part XI: Property and Appraisal Guidelines
XI, Chapter 4: Reviewing the Appraisal Report (11/01/05)
XI, 408: Income Approach to Value (11/01/05)

XI, 408: Income Approach to Value (11/01/05)
The income approach to value is based on the assumption that market value is related to the market rent or income that a property can be expected to earn. Its use generally is appropriate in neighborhoods that consist of one-unit properties when there is a substantial rental market, and it can be an important approach in the valuation of two-unit to four-unit properties. However, it generally is not appropriate in areas that consist mostly of owner-occupied properties since adequate rental data generally does not exist for those areas. We will not accept an appraisal if the appraiser relies solely on the income approach to value as an indicator of market value.

To arrive at the indicated value by the income approach to value, the appraiser multiplies the total gross estimated monthly market rent for the subject property by a reconciled gross monthly rent multiplier. (Because of the way the appraiser’s opinion of value is derived under this approach, the income approach to value provides a reliable indication of value only when the comparable sales are truly comparable.)

•Estimated market rent is based on an analysis of comparable rentals in the neighborhood. After appropriate adjustments are made to the comparable properties, their adjusted (or indicated) values are reconciled to develop an estimated monthly market rent for the subject property.

•The gross rent multiplier is determined by dividing the sales prices of comparable properties that were rented at the time of sale by their monthly market rent, which is then reconciled to create a single gross rent multiplier (or a range of multipliers) for the subject property.

The appraiser must use his or her best judgment regarding the applicability of the income approach to value. An instance in which the income approach may not be an appropriate indicator of value involves the appraisal of a two-unit rental property in a neighborhood that is dominated by two-unit properties that are owner-occupied. In such cases, the appraiser does not need to develop a gross monthly rent multiplier, but must report the estimated market rent for the subject property. In such cases, the appraiser should provide an appropriate explanation of why he or she chose to report in this manner.

When the property being appraised is a one-unit property that will be used as an investment property, the appraiser must prepare a Single-Family Comparable Rent Schedule (Form 1007) in addition to the appropriate appraisal report form. [This form is not required for a two-unit to four-unit property because the Small Residential Income Property Appraisal Report (Form 1025) provides substantially the same information, nor is it required for a Community Living group home mortgage.] When the appraiser is relying on the income approach to value, he or she should include the supporting comparable rental and sales data, and the calculations used to determine the gross rent multiplier in the appraisal report.

Randolph ... that is all fine and good, however, it is merely a sope of work requirement of THIS lender (ie Fannie).
Not all loans are purchased by Fannie and I would caution everyone that because they say so does not necessarily mean it is appropriate appraisal practice. Their example is well founded, however, a two unit in an area which is predominately owner occupied may in fact render the income approach as an inappropriate method of valuation any way. However, a two unit in an area where the predominate units are rented would suggest the income approach appropriate.
This appears to be a double edged sword and appraisers should use caution and know the requirements of their client prior to accepting the assignment.
It is also interesting to note that while it says an appraisal wont be accepted where the income approach was relied upon solely (which is doubtful in most instances) they also say if you rely on the income approach the comparables and grm should be well documented. A contradiction?

The hair raises on the back of my neck when someone tells an appraiser that a method cannot be relied upon as an indicator of value when they have not 1) Examined the property, 2) Examined the market and 3) Dont know the nature of the investor / owner criteria within any given market.

Caution is the word here ......

 

[Ken B]

Good morning, Prop. The thread entitled "Multi-Unit Residential Course" is in the California Forum and the issue was first made beginning with Post #17.

My assignment is a 3-plex in a city with only 1 multi-unit sale within the 8 months prior to the effective date, in a stable market where the absence of market activity is based upon limited inventory rather than the current issues that typically affect markets--lack of demand, falling prices, borrower's inability to obtain a loan, etc. Market reaction to properties in the City is extemely favorable even relative to high end, near-by Pasadena, and the gross/net adjustments in the SCA in my opinion diminished the credibility of the SCA.

Admittedly, I was unaware of the reference posted above to XI, 408.

Those guidelines notwithstanding, IMO an investor would be prudent to rely upon market rent rather than comparable sales as the basis or his or her decision to purchase a multi in this neighborhood...

Investors have many motivations including tax deductions from periodic net losses and/or gain on the reversion (resale) rather than on the periodic income. These motivations are best reflected in the SCA.

 

[Mztk1]

It is my opinion, Gama, that the accuracy of both the cost approach and the GRM income approach in a residential appraisal (1 to 4 family) are contingent upon the quality of the sales comparison approach.

The one possible exception of this would be if you have new construction, great land sales, but less reliable data on improved lots. But still the cost approach would not reliably enlighten us because measuring depreciation (especially over and under improvements in the case of new construction) requires good sales data.

Even in the 2 family market where it is mostly rentors, you need reliable market sales that are very, very similar to the subject to develop a meaningful GRM and apply it. The methods are circular at best. I suppose there is a situation where it can help.

Just like some around here find the cost approach to be bogus, I think the GRM IA is just as questionable, if not more so. In my opinion, the best either can do (unless there is some very strange situation I have not come across) is support the SCA in a residential assignment. I don't care what Fannie tells us, I have not weighted a GRM IA or a cost approach in a residential report and will probably never do so, though I do say they are "supportive of the sales comparison approach" when their data is solid.

As for the income approach being used for mortgage qualification, I believe that is why the operating income statement is used. That is not, however, my department.

 

[Randolph Kinney]

RK:

What took you so long to respond--at least 2 minutes! You musta been sitting at the computer for the past 48 hours waiting for me to take this issue to the general Forum. I would hate to face you in a public debate!!!!

Gama,

Actually, I am just cleaning up on an appraisal from yesterday.

I am only showing what the Fannie guideline is, not what the pool of underwriting will accept, especially if the appraisal is not destined for Fannie.

For 1025 type properties, where all 3 approaches are used for guaging market value (whether the assumptions are true or not), it is an interesting thought process that reveals the reconciliation and weighting of the approaches. For example:

Fannie Mae Single Family
2007 Selling Guide
Part XI: Property and Appraisal Guidelines
XI, Chapter 4: Reviewing the Appraisal Report (11/01/05)
XI, 409: Valuation Analysis and Final Reconciliation (06/30/02)

XI, 409: Valuation Analysis and Final Reconciliation (06/30/02)
The valuation sections of our appraisal report forms enable an appraiser to develop and report in concise format an adequately supported opinion of market value—based on the cost, sales comparison, and income approaches to value (as applicable), and, in the case of small residential income properties, on comparable rental data. If the appraiser believes that additional information needs to be provided because of the uniqueness of the property or some other condition, he or she should provide additional supporting data in an addendum to the appraisal report form.

The reconciliation process that leads to the appraiser’s opinion of market value is an ongoing process throughout the appraiser’s analysis. In the final reconciliation, the appraiser must reconcile the reasonableness and reliability of each applicable approach to value and the reasonableness and validity of the indicated values and the available data, and then must select and report the approach or approaches that were given the most weight. The final reconciliation must never be an averaging technique.

If the appraiser has provided a comprehensive and logical analysis of the neighborhood and the property, the lender’s underwriter should be able to reach a sound conclusion on the adequacy of the property as security for the mortgage.