Real Estate - Methods Employed In Valuation
( Originally Published 1911 )
What finally determines in land value.—The value of land is not what the owner can sell it for, or what he must take for it, if he wants to get rid of it, but the actual value of land in its last analysis is based on the income, actual or potential, which is to be derived from the ownership of the property when it is adequately or appropriately improved. Experts agree that an inadequate or inappropriate improvement does not actually figure in the selling price of property, but only those improvements which can be made to bring in income in competition with neighboring structures figure in real estate values.
In America we have a rather more difficult problem in determining land values than in a settled country like England. In England a piece of property is worth so many years' purchase of the net income. Because of the continual growth, the shifting and changing of population and the constantly differing methods of utilization of specific land, it is more a speculative article in America. As the value of land is determined very much by its income-bearing capacity, it is highest in those places where the most lucrative business can be trans-acted, and grades down from that to the places where the greatest space is required without a commensurate ability to earn large return.
(a) In great cities and great money centers the most expensive land is the land which is used for the housing of the financial centers. In the city of New York, Wall street and the streets adjoining it, which are used for the office buildings of the financial centers of the country, are the most expensive land.
(b) After the financial center, the next in income-bearing value, and therefor in absolute value, is land used for high class retail business; and in places where there is no financial center that is the highest priced land.
(c) The third in value is high class residential property, property used for the mansions of people who can afford to pay high prices for fine and exclusive surroundings. They will pay almost as much for land which they desire to occupy as the owners of retail shops.
(d) The next in value is land used for hotels or high class residential apartments, and office buildings not in the financial center.
(e) Next in value is land which is in wholesale business districts. Often the highest priced land which is used for wholesale business is that which is nearest the retail shopping district.
(f) The next in value is land which is useful for ordinary tenement purposes, which takes in anything from the six-story apartment house in a reasonably good neighborhood to the flat or tenement of any character which can be constructed ; and land which can be used for small residences, the latter being a little lower than land which may be used for apartments and tenements.
(g) Next in value is land which can be used for sub-urban or detached residences.
(h) Land which can be used for factory purposes.
(i) Farming lands.
(j) Lumber lands.
(k) Wild and unimproved tracts.
General rules for determining land values.—No absolute rule can be given for determining the land value of any specific piece. All that can be done is to give arbitrary rules to aid in determining the value, after the first important steps have been taken.
In valuing improved property, the land value should always be separated from the value of the land with the improvement on it and the land value as thus separated should be considered first. In so doing the first step is to determine the value of a typical lot, say 25 x 100, of the character under consideration. To determine this value the appraiser must have information of sales, in the neighborhood, of lots similarly situated and similarly used. He must take into consideration not only the present use of the lot, but its potential use. Often he must leave the present use out of consideration altogether.
With respect to the use or possible use of the property, the appraiser must consider its relation to transit facilities; even if it is right in the middle of the city, the transit facilities add to the land value, the value tapering off as the property leaves the lines of transit. He must consider the land with respect to nuisances and detriments to the neighborhood ; especially is it necessary to look out for nuisances or undesirable occupations in a neighborhood where land is being valued for use for residential purposes. A school is not a nuisance in itself, but land immediately adjoining or opposite a school is not as valuable for living purposes as if the school were not there. If there are factories in the immediate neighborhood which employ large numbers of workmen who pass back and forth, that will detract from the value of the property, although the factory may be run in such manner as not to be a nuisance.
When a property is off the line of transit or out of the centers of population, the capacity of being reached by transit lines at some time in the future will affect its present value. For the same reason the appraiser must look at the permanence of desirable features of the neighborhood. He must consider the trend of population and of changes in business. It may be that a lot which is good for residential purposes may be more valuable after a while because the present residential purpose will be supplanted by an important business purpose, which may be tending toward the neighborhood, and that tendency will cast its influence before it.
The price actually paid for property is not necessarily a true criterion of its value, and in making valuations even though the appraiser knows prices in the neighbor-hood, he must bear that in mind. The true value is not what A paid for it or what B had to sell it for, but the nearest thing to the true value which may be called the ruling price, is what B would sell it for if he were willing to sell it but did not have to, and what A would give for it, if he were willing to buy it and did not have to. The true value may be very much higher than the ruling price, because A may have some knowledge of a special use to which the property may be put; and the value of land is not the use to which it can ordinarily be put, but the greatest use to which it can be put.
Auction prices.—Prices at foreclosure sales are entirely misleading. Unless it happens to be a particularly choice parcel and very attractive terms are offered, there is not usually public bidding at fore-closure sales. To begin with, the property is usually offered all cash. If a second mortgage is being fore-closed, and the property is offered subject to a prior mortgage, it is usually one which is due or about to be come due, and no definite terms of credit are offered. It is understood that the person to be foreclosed is not able to pay his debts, and there is not likely to be any-body there who will bid more than the plaintiff. Prices at partition sales may be nearer value, but they are not absolute, either. Auction prices at a big sale are misleading, as people may be carried away by enthusiasm and men who need pieces of property in order to help out other lots may pay extravagant prices.
Valuing short lots.—Computations in real estate are based on a typical lot; for example, a lot twenty-five feet wide in front and rear by one hundred feet in depth, the side lines being at right angles to the street. If the appraiser knows the typical lot value, it is easy enough to say that a similar lot in the same neighbor-hood is worth the same money. But if the lot were only eighty feet deep, it would be a different proposition. Looking at it superficially, it might appear if the lot 25 x 100 were worth $10,000, a lot eighty feet deep would be worth four-fifths of that, or a $8,000; but an owner could not get $8,000 for an eighty-foot lot in a $10,000 neighborhood. The most important part of any lot is the frontage to the street, and the rear is the least valuable part; and in order to determine the value of the lot the appraiser must know what relation those two parts of the lot bear to each other. There is no absolute modern formula by which this can be ascertained, but it does not need an expert to see that a lot eighty feet deep cannot be put to many uses for which a hundred-foot lot can be used, nor that a hundred-foot lot can be used for purposes for which an eighty-foot lot would be absolutely useless. If it were a neighborhood of shops and loft buildings, it would not make so much difference if the lot were short, as if it were a neighborhood where you had to have every foot of depth you could get in order to come within some arbitrary rule of the tenement house law. All this must be taken into consideration.
The Hoffman rule.—In attempting to determine the relation of the parts of a lot to each other and to the total value, people have, by a system of inductive reasoning established certain rules. The rule most frequently referred to in New York is known as the "Hoffman rule," compiled by Murray Hoffman, a corporation counsel for the city of New York, who acted for a time as commissioner in condemnation proceedings. He divides a typical lot into strips five feet wide across the lot, and then arbitrarily assigns values to each of those strips, premising that each part of those five-foot strips would be of equal value throughout.
The Rule of William E. Davies.—Recently William E. Davies, a New York real estate broker of experience in New York city, worked out and published a rule agreeing in many particulars with the Hoffman rule, and better in some respects, because it ascribes a value to each foot in the lot, instead of assuming that every foot of each five-foot slice is of the same value. He has also made allowance for a modern condition which did not exist when Mr. Hoffman's table was made; that is the added worth of the land back of a line one hundred feet from the street, which has arisen by reason of modern conditions. Mr. Davies has allowed for the fact that a lot may now be two hundred feet deep, and the land all the way back may be worth money.
TABLE, BASED ON THE FOLLOWING FORMULA, FOR ESTIMATING THE VALUE OF STRIPS OF LOT 25 x 200.
Y = V 1.45 (X + .0352) - .226
NOTE.-This equation of the parabola is not arbitrary, but deduced from the mean of thousands of actual sales.
Depth Ratio Depth Ratio Depth Ratio Depth Ratio
EXAMPLE.-To find the value of lot 110 feet deep, if standard lot worth $75,000, multiply 75,000 by 1.06 =$79,500.
For depths with parts of foot or more than 200 feet, or where greater accuracy is desired than three places of decimals, use the formula in which Y = the proportion of value of lot in question to value of standard lot, and X = the proportion of depth of lot in question to depth of standard lot.
Valuing lots more or less than a typical lot width.--We come now to another problem. All lots are not twenty-five feet wide, and all improvements are not capable of being put upon a twenty-five-foot lot. The lot under consideration may be more or less than twenty-five feet wide. If an owner is offering less than a typical lot in the neighborhood, he will find that he will not get quite the same proportion for it as the width bears to twenty-five feet. If it is a private house street and if he offers so much for sale as is useful for a private house of the character which the neighborhood will bear, he will get nearly the proper proportion of the lot value; but if he offer less than that, he will be told that it is too small to do anything with unless the next lot is bought. Rentable space is always rentable, but if a lot is too small for the purpose of improvement, the owner cannot get as much for it proportionally as for a lot that is a little too large. There is no absolute rule for figuring the ratio of a lot to the typical lot with regard to width; that must be governed by the judgment of the parties concerned, and the advice of their appraisers. If a lot be irregular, that is another problem. It is usual to take the average of the two lines, and say that that is the depth of the lot. But if the irregularity of shape make the property difficult to improve, that would not be reasonable. Very large allowances would have to be made for difficulty of construction, and lack of income after the improvements have been made.
Plottage.—Where more than one lot can be adequately and economically improved to better advantage proportionately than can a single lot treated alone, it is self-evident that the putting together of the two lots into a plot adds immediately to the value of each of the lots concerned. It has added to each lot an element known as "plottage." In sparsely settled neighbor-hoods, and where vacant lots are plentiful and cheap, and it is an easy matter for builders to obtain ad joining plots, plottage is not as valuable as in a neighbor-hood where vacant lots or lots with old buildings are scarce. In the former case the additional value, by reason of plottage, may be 10 per cent, whereas, in the latter case, it may amount to 25 per cent or even more. If a person has two lots which were each, when separate, worth $1,000, and he put them together, as soon as he has done so he has more than $2,000 worth: if plottage be figured at 10 per cent, he now has $2,200 worth.
Illustration of method of appraising property.--The lot illustrated in the diagram is an irregular plot containing fifteen thousand square feet. It is obvious that it would be absurd to value this as though it were a regular plot. Assume that the plot is situated on a more or less important thoroughfare, and is suitable for improvement with a building having stores on the ground floor, and good apartments above, and assume that an ordinary, inside lot in the vicinity is worth $25,000.
For the purpose of valuation the plot is divided into lots each twenty-five feet front, varying in depth from fifty to one hundred feet. Lot A, being a corner, would be worth 50 per cent more than the inside lots, or $25,000 plus $12,500 $37,500. Unless there be some good reason to the contrary, it is usual to value corner lots at 50 per cent more than inside lots. This lot has an aver-age depth of ninety-six and one-half feet, and is a double corner; it is the corner of L avenue and C street, and also of M avenue and C street. On the first count, applying the Hoffman rule, it is worth 98 per cent of a full lot, or $36,750. On the second count something must be added for the extra corner. Extra frontage is considered as adding 25 per cent to the value of the lot. In this case it is fair to add 33-1-3 per cent—$12,250, which gives a value of $49,000 for that corner lot.
Lot B has an average depth of ninety feet. Again using the Hoffman rule, 96 per cent of $25,000, is $24,000, plus 25 per cent for the extra frontage or $6,000, makes B worth 830,000. The same theory holds good right through the line. Then to the whole plot it is safe to add 10 per cent for plottage, which works out a valuation of $270,000. This is at the rate of $18.00 a square foot for the entire plot, as against a lot basis value of $10.00 a square foot.
Valuation of improved property.—In making a valuation of improved property the appraiser should always separate the land value from the value of the land with the improvement, but should not try to separate the value of the improvement from the value of the land because there may be a very expensive building on a very poor lot, and the expensive building would not be worth the cost of construction and, in such a case, if the cost of construction and the land value be figured separately the appraiser's estimate will be too high on that building. He must figure the lot and the improvement according to the income which can be obtained out of the lot and the improvement as it stands, allowing for the lot value, what the lot will bring when adequately improved, allowing for the building what it would cost to reconstruct it—if it is an adequate and permanent improvement upon the land.
An adequate improvement put upon a lot is worth the cost of construction so long as the lot value has not risen beyond the place where the improvement is appropriate and adequate, and the best thing that can be done with the lot. The rule is that the land value in-creases by reason of the better use which can be made of the land; and therefore old buildings are incapable of competing with those which will bring greater income in the neighborhood. For that reason a time may come when the land value rises so high that the value of the construction disappears entirely, and there are lots in old and superannuated neighborhoods where the land value has gone up so that the buildings, for the neighborhood, will not bring adequate rentals, and will not sell for more than vacant lots.
Cost of buildings.—The usual method of ascertaining the cost of a building is by taking the cubic contents of the building, and then figuring the cost per cubic foot of a typical building of similar character. That cost will of necessity rise or fall, with the rise or fall in the cost of building material, and of labor. In New York city appraisers in figuring cost, after allowing for depreciation or superannuation, say a non-fireproof loft building, which is really a shell of walls with-out interior decoration, costs about 10 cents a cubic foot. They figure tenement houses, put up in the manner that a speculative builder puts them up, at about 12 or 15 cents, frame dwellings at about 15 cents, steam-heated apartments (walk-up, without elevators), at 16 to 20 cents, elevator apartments non-fire-proof at about 20 to 25 cents, elevator apartments of the speculative order about 30 to 35 cents, hotel buildings about 35 to 50 cents, fire-proof loft buildings about 25 to 30 cents, office buildings about 45 to 50 cents as high as $1.00 a cubic foot.
The object of the ownership of land is to derive in-come, so that the way to check a valuation is to compare it with the actual income from the property. If the property be properly and adequately improved, it will bring in a proper return on the investment; and appraisers after having tried other methods will check back their appraisals by comparing the rentals with their estimate of the value.
Property taken in condemnation proceedings.—As already explained there has always been attached to the ownership of land the incident that whenever it was required for a public purpose it could be taken for that purpose under the right of eminent domain. It might be that under the public power of eminent domain property could be claimed by the public and applied to the public use, but under a free government we have given one another constitutional guarantee that when real property is required for a public purpose, it may be taken, but it must be upon due process of law, and upon the giving of just compensation. Due process of law involves not only notice but a just trial, and that such a trial shall result in the giving of just compensation for the right of property of which the owner has been deprived.
When we say that property may be taken for a public purpose, we use the word "public" in its very widest acceptation. We mean not only for the uses of the United States government, but for the uses of a state or a county, city or village upon which has been conferred the right to take property by eminent domain for public purposes. The words "public purpose" are wider yet. It is a public purpose if the needs of the public be served in a matter which individual effort could not accomplish without the aid of governmental intervention. If it is necessary that the public shall be able to travel by road or railroad, or to communicate with one another by telegraph or telephone, the rights which are necessary to be exercised over real property for construction of such a road or railroad, or telegraph or telephone lines are a public purpose, and may be obtained under the right of eminent domain. So, wherever a public purpose is to be served, the public confers its right of eminent domain upon its public service corporations, and the use of property for those purposes is a public use.
When corporations take property under the right of eminent domain, they may take so much as is necessary for their public purpose, and no more. They cannot say they Avant a house, without showing why they need it. The power to take property under eminent domain or by condemnation is a legal proceeding in which two issues are tried, first, the issue of the necessity for taking the property; and, second, if that be decided in favor of the corporation or authority desiring to take, the issue as to what compensation shall be given.
As to the necessity for taking, it may be declared by legislature, and if so there is no absolute issue to try. The people may delegate that authority to their agencies of government, municipal corporations, counties, cities, villages, towns. They cannot delegate that authority to private corporations, even though those corporations be clothed with the right of eminent domain. A corporation other than a direct governmental agency seeking to take property must show, if the issue be raised, the necessity for taking. If that necessity be decided in favor of the corporation, then it must proceed to try the issue of what the property is worth. Values of real property are never absolute, and it often becomes a battle of experts. The public authority will offer through its expert evidence as to the value of the property to be taken, and the owner of the property will offer the evidence of his expert. ' They may differ very widely. The proceeding may be before a court, or it may be referred by the court to a commission appointed for the purpose of determining the issue.
Expert appraising.—The business of experts who make it their work to make appraisals and defend them upon examination and cross-examination in condemnation proceedings is the highest paid, and in many respects the most difficult branch of the real estate business. It is difficult to lay down any rules as to how to testify as an expert in a condemnation proceeding. The following suggestions have been given by a successful New York real estate expert appraiser.
Specialization in appraising.—First, and most important, the expert must know his subject. He must be able to appraise the real estate taken in the proceeding in which he is employed, and he must be able to prove the values. It is a very difficult thing for a lay-man to go on the stand and by simply answering the questions which are put to him convey the information and knowledge which he has.
The best witnesses are those who confine themselves to one particular section of a city or one character of real estate. If a man, in his mind's eye, can see the surroundings of a piece of property, not only the very block, but the district for a mile in every direction, and can call to mind almost automatically the character of the buildings, recent changes, contemplated improvements, recent sales, leases and mortgages, and their true consideration, the inside history of the transactions, his testimony carries a great deal more weight and conviction than the answers of a witness who makes mistakes of fact.
Methods of proving values before commissioner. —The simplest and most effective way to prove the value of a conventional piece of property is by quoting sales of similar pieces in the immediate vicinity or similar locations. This is not always possible for various reasons. First, there may not have been any recent sales analogous to the plot in question; or, second, the sales may have been at a figure below or above actual value, by reason of special conditions. Lack of sales in some neighborhoods does not necessarily mean that there is no demand for property there, but may mean merely that there is no property in the market for sale.
In some cases, where figures do not represent actual values, the expert must fall back on his general knowledge, and if in his qualification he has shown that he is thoroughly familiar with the neighborhood, his general knowledge will carry weight. A good deal of the value of the testimony of an expert is in the effect that it has on the commission, more than from what actually appears on the record.
Frequently a witness is asked in cross-examination if he knows of such and such a sale at possibly a wide diversity in price from that which he quoted as his basis of value. Then again his familiarity with the section stands him in good stead. He must know the why's and wherefore's of the sale; if improved, what kind of buildings are erected thereon. It may be that it is a superior improvement, or it may be inferior, or it may be that while the building is a good one, it is not a proper improvement for the land. If the property is vacant there may be a host of reasons why the price is above or below the one he has quoted. There may be rock or bad bottom or vice versa as compared to the plot in question, or it may be a small lot between two substantial buildings, the owners of neither of which care to buy, and which lot by itself is too small for an adequate and proper improvement.
Valuing irregular and short lots.—One of the most important things with which an expert should be familiar is the valuing of small lots less than one hundred feet in depth, and those of irregular shape. Many real estate men differ as to the values of irregular lots, easements, plottage and added value for improvement. No fixed rule as to the handling of these subjects should be made, but it is advisable to work out a theory and stick to it. The use of the Hoffman and Davies rules must be intelligently applied, or they will prove to be valueless. A rule may work smoothly in one case, and work against a person in another, where it is not applicable. A double frontage may add very little to a certain class of private dwelling but may be of immense advantage to a certain kind of office building or high-class apartment house. It is safe to limit a general rule to specific cases, as a theory that at the time the testimony is given seemed to be true for all cases, may react against a person in some widely diverse case, where it is not applicable.
Suggestions for the expert on the stand.—As a general rule, it is well to avoid on the stand the valuing of property off hand on a different theory from the one adopted. Depend on notes, especially for figures, as far as possible, thus keeping the mind clear and wits sharp to parry apparently innocent questions. Frequently a question must be answered by "yes" or "no," and qualification or explanation of the answer may not be allowed. If possible, get the explanation in first, before the "yes" or "no ;" then, even if it is struck from the records, its effect will remain.
The larger general knowledge of real estate an expert has, the more valuable witness he is, all other things being equal. Everyone whose property is taken for a public purpose is entitled to receive a fair and equitable compensation, and its fair market value. It is distinctly part of the duty of the expert to value the real estate thus condemned under its most favorable circumstances, i.e., he must know what are its most valuable uses, its most advantageous methods of subdivision and all its favorable aspects ; and be able to bring these out in the answers to direct questions. This method can only be successful after long experience, with good judgment, and knowledge of the methods of cross-examination. A good working knowledge of the rules of evidence is a very valuable adjunct to the witness.
The simpler and more direct a witness can make his direct testimony, the less likely it is to be shaken on cross-examination. Most condemnation lawyers under-stand this, and ask only the most necessary questions in the examination.
In appraising vacant ground care must be taken to examine the physical aspects very carefully and compare with the damage map. The expert should study; the grade, the abutting property, the condition of surrounding streets, and the status of the assessment. If there is rock on the property and the bottom is bad, he must find out the cost of putting the property in shape for building. It is convenient to value land as at grade, and then make such additions or deductions as may be necessary by reason of existing conditions. In considering all these conditions the appraiser should be able to explain their effect on the final estimate of value. Nothing he has left unsaid is taken for granted, and if some feature beneficial to his side of the case is not brought out by the questions while under cross-examination, it is his duty to try to bring it out. The expert witness should call things by their right names. He must know the difference between a street laid out on a map, one that is graded and regulated, and one that is paved and sewered. A common error is confounding open streets with those that are not only opened, but regulated and sewered. A street is legally open whenever title for the same is vested in the city, and is not necessarily one over which access is possible, as in the case of a graded and regulated street.
Knowledge useful to the expert.—If an expert has some knowledge of the building business, so much the better, but lack of such technical knowledge does not prevent his being able to value simple buildings in connection with land. Every real estate man knows the cost of the standard type of building most commonly erected, and can tell, after inspection of such a building, very close to what it can be built for, although he may not know the price of lime, brick, etc. An expert must also have some knowledge of the existing building laws, and keep himself in touch with the amendments to these laws.
Valuing parts of property, easements, etc.—Where the entire fee is taken in a proceeding, and nothing remains, the case is simpler than one in which only a part is taken, or none of the land or improvements, but only some inherent right, as light, or air, or access in whole or in part. In these cases there usually enters an element of consequential damage.
If an easement over land be taken, as a right of way for a railroad or a right to tunnel under land or to put telephone or telegraph poles in front of a house, it is difficult to find a rule, but one rule that must always be observed is that there shall be at least compensation for that which is taken away. If a man own two lots, one of which is taken in a condemnation proceeding, the benefit which accrues to one lot cannot be offset against the damage to the other. It is a rule of law that benefits may not be offset against damages for condemnation.
It is also true that, in addition to the absolute value of that which is taken, the owner is entitled also to consequential damage. Consequential damage is dam-age to the remainder of a plot, part of which is taken, in addition to the actual value of the land taken. In some instances, where only a part of the land is taken, the remainder may be of so little substantial value, that the damage may be considered as total, but .where a part of a plot is taken, and the remainder has intrinsic value, the approved method of appraising is to value the whole piece in its entirety, then value the part that remains, and the difference between these two will represent the damage. Damage to a piece of property by taking away an easement, such as light, air or access, may be computed in the same way. The element of consequential damage may be very important, as the erection of a structure in front of a property may change the character of a neighborhood, and the plot which may have been suited for a high-class apartment or hotel, may become fit only for a stable or a factory.