THE REAL ESTATE EVALUATIONS OPERATIONAL HANDBOOK

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1 United Nations Economic Commission for Europe WORKING PARTY ON LAND ADMINISTRATION THE REAL ESTATE EVALUATIONS OPERATIONAL HANDBOOK Speaker: Mauro Iacobini Agenzia del Territorio Largo Leopardi, 5 Roma 06/ 05 / 2011

2 THE REAL ESTATE EVALUATIONS OPERATIONAL HANDBOOK Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 02

3 Therefore, it is increasing the gap beetwen: Traditional appraisal methodology GAP The wide variety of statistical and econometric techniques Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 03

4 The methods used by the Italian appraisers are based on: simple theoretical hypotheses; experience; subjective judgments. Result: Conflicting assessments Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 04

5 1. Valuation is a science that yields precise answers Reality 1: Valuations are always biased Truth 1.1: All valuations are biased. The only questions are how much and in which direction. Truth 1.2: The direction and magnitude of the bias in your valuation is directly proportional to who pays you and how much you are paid. Reality 2: Equity valuations are always imprecise but they are most valuable when they are most imprecise. Truth 2.1: There are no precise valuations Truth 2.2: The payoff to valuation is greatest when valuation is least precise. Reality 3: Complex valuations do not yield better estimates of value. Truth 3.1: One s understanding of a valuation model is inversely proportional to the number of inputs required for the model. Truth 3.2: Simpler valuation models do much better than complex ones. (Aswath Damodaran) Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 05

6 Agenzia del Territorio supports: ISVAP (public institute) in the supervision of insurance companies; Local authorities in the urban planning services; Public authorities in the activities of enhancement and disposal of their real estate assets; and it also provides: assessments related to feasibility studies for most important projects. Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 06

7 Necessary conditions for a right appraisal are: (1) Knowledge of the real estate market (specific economic information) (2) Knowledge of the real estate property and its location in the national area (characteristics of assets) Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 07

8 In particular, the economic information necessary for the real estate appraisal (knowledge of the real estate or housing market ) is represented by: Buying-selling prices, in order to use the Sales Comparison Approach; Construction costs, in order to use the Cost Approach; Rents, yields and costs in order to use the Income or Financial Approach. Agenzia del Territorio Largo Leopardi, 5 - Roma 06/05/2011 pag. 08

9 Initiatives undertaken by Agenzia del Territorio Implementation and improvement of statistical analysis on the real estate market; Drafting of an operational handbook for real estate appraisals; Training program addressed to the Agency's technical staff; Creation of a real estate estimates database in order to monitor and develop the best practice in the real estate field. Agenzia del Territorio Largo Leopardi, 5 - Roma 06/05/2011 pag. 9

10 Real Estate Market Observatory Detection of collection of basic market data; Explanation of the sources; Elaboration of criteria for determining the quotations; Quotations referred to the whole country (direct collection in ~ 1300/8100 municipalities). Agenzia del Territorio L.go Leopardi, 85 - Roma 06/05/2011 Pag 10

11 Activities for the future are: To improve data quality; To gather additional economic information (e.g. the unit construction costs related to different regional markets). Agenzia del Territorio Largo Leopardi, 5 - Roma 06/05/2011 pag. 11

12 THE REAL ESTATE EVALUATIONS OPERATIONAL HANDBOOK (the Italian acronym is MOSI) Main aim To standardize the behavior of the technicians working in the different Provincial Offices when enforcing various estimation procedures. Agenzia del Territorio Largo Leopardi, 5 - Roma 06/05/2011 pag. 12

13 THE REAL ESTATE EVALUATIONS OPERATIONAL HANDBOOK (MOSI) It is not a text of economic valuation; It defines: - the operating procedures to perform real estate appraisals also when (sufficient) economic information are missing; - the methodology to improve the knowledge of local housing market. Agenzia del Territorio Largo Leopardi, 5 - Roma 06/05/2011 pag. 13

14 Valuation approaches The variety of (direct and indirect) estimation methods necessarily requires a procedure choice to steer the Agency technicians. According to Agenzia del Territorio, it is better to use in turn simplified procedures or more complex methods depending on the specific case. Agenzia del Territorio Largo Leopardi, 5 - Roma 06/05/2011 pag. 14

15 Valuation Approaches Valuation approaches include: Market Approach; Cost Approach; Income Approach. Agenzia del Territorio Largo Leopardi, 5 - Roma 06/05/2011 pag. 15

16 Sales Comparison Approach The Sales Comparison approach is the most frequently used approach for estimating the market value of residential properties (including single and multifamily ones). Agenzia del Territorio makes use of a semi-empirical procedure, in order to assess real estate properties in markets having low-dynamic and low-transparency, and when it is not possible to use other approaches. Agenzia del Territorio Largo Leopardi, 5 - Roma 06/05/2011 pag. 16

17 Sales Comparison Approach The adjustment price of each real estate property characteristic is market-derived on the basis of activities carried out by the Agency Provincial offices. In the future, the market-derived adjustments could be identified through scientific methods, such as the Multiple Regression Analysis (MRA) and the Analytic Hierarchic Process (AHP). Agenzia del Territorio Largo Leopardi, 5 - Roma 06/05/2011 pag. 17

18 THE COST APPROACH assesses the market value of a real property by adding the prices of the different factors used in the production process. modern (new or recent) real estates, built with current technologies and distributive criterions, fittings endowments, comfort and safety levels consistent with standards in force cost for the asset duplicating COST VALUE REPRODUCTION COST ancient or historical real estates, built with outdated technologies and distributive criterions, fittings endowments, comfort and safety levels not consistent with standards in force cost of building a similar asset, using updated construction methods and materials SUBSTITUTION VALUE REPLACEMENT COST DECREASED ACCORDING TO DEPRECIATION Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 18

19 REPRODUCTION COST It deals with assuming normal real estate development activity appropriate to guarantee the reproduction of the property to be assessed, whether such reproduction is regarded as duplication or as replacement. V M Market value of the property FORMULA V M = C L + C B + B F + P D Market Value V M appraised through the procedure of the reproduction cost C L C B B F P D Cost of Land Construction Cost Financial burdens Entreprener Profit CL direct and indirect Costs of Land C B direct and indirect Construction Cost B F Financial burdens Ctc Technical Construction Cost Cic indirect Cost of Building P D Profit of the developer C BL B BL C FL C CS C ES B PSU B CC R P C LP E G E C B FL B FC P DL P DC Cost for buying land Burdens for buying land costs to make land suitable for building Construction Cost of Covered Surfaces Cost of arrangement of outdoor areas Burdens of Primary and Secondary Urbanization Contributions related to the cost of construction Professional fees Costs for connecting to public services General Expenses Marketing Expenses Financial burdens on the debt rate related to direct and indirect costs of the Land Financial burdens on the debt rate related to direct and indirect construction costs Profit of the developer on direct and indirect costs of the Land Profit of the developer on direct and indirect construction costs Ou Burdens of Urbanization Cg Management Costs of the real estate development Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 19

20 PARAMETRIC EVALUATION sources information unity of measure adjustments Specialized publications with index parametric costs typologies costs inpact times volume gross surface floor typical numbers location area works category C tc technical construction cost sources Local Specialized publications that collect the single costs of construction materials, working hours and other factors ANALYTICAL EVALUATION quantity costs metric calculation unitary prices amounts Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 20

21 PARAMETRIC EVALUATION sources information Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 21

22 ANALYTICAL EVALUATION sources metric calculation of the costs C TC pag. 22

23 INCOME APPROACH Direct Capitalization Yield Capitalization Discounted Cash Flow Analysis Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 23

24 Aswath Damodaran Valuation Inferno: Dante meets DCF Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 24

25 Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 25

26 Economic information necessary for the implementation of the DCFA in real estate appraisal (i.e. items likely to generate strong cash flows and the variables that affect its performance) are approximately the following: 1. gross annual income; 2. Inflation performance; 3. using period under the lease; 4. vacancy; 5. cost of purchasing the property (stamp duty, notary charges, etc.); 6. cost of debt; 7. operating costs of leased properties (local property tax, administration, insurance, maintenance etc.); when it is appropriate to assume a conversion of the property, the following must be added: 8. highest & Best Use; 9. any investment required for conversion (restructuring etc.); 10. any time for conversion (of the property) and to rent it out, compared to existing urban settlements and their constraints; 11. potential gross income of the converted property and for the last year flow (terminal value); 12. revaluation; 13. future market rents. Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 26

27 THANKS FOR YOUR ATTENTION! Agenzia del Territorio Largo Leopardi, 5 Roma 06/05/2011 pag. 27

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