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Flashcards in Unit 16 - part 2 Deck (14):

Three Approaches To Value

1. Sales Comparison Approach
2. Cost Approach
3. Income approach


Sales Comparison Approach

(also known as the market data approach)

In the sales comparison approach, value is obtained by comparing the property being appraised (the subject property) with recently sold comparable properties (properties similar to the subject) in location and features.

The sales comparison approach is usually considered the most reliable of the three approaches in appraising single-family homes.


Cost Approach

The cost approach to value also is based on the principle of substitution.

The cost approach consists of five steps:

1. Estimate the value of the land as though it were vacant and available to be put to its highest and best use.

2. Estimate the current cost of constructing buildings and improvements.

3. Estimate the amount of accrued depreciation (loss in value) resulting from the property's physical deterioration, external depreciation, and functional obsolescence.

4. Deduct the accrued depreciation estimated in Step 3 from the construction cost estimated in Step 2.

5. Add the estimated land value from Step 1 to the depreciated cost of the building and site improvements derived in Step 4 to arrive at the total property value.



Depreciation is a loss in value for any reason.

It is the result of a negative condition that affects real property.

Land is not considered a depreciating asset.


Depreciation is divided into three classes, according to cause:

1. Physical deterioration
2. Functional obsolescence
3. External obsolescence


Physical deterioration

A curable item is one in need of repair, such as
painting, that would result in an increase in value equal to or exceeding its cost.

An item is incurable if it is a defect caused by physical wear and tear and its correction would not be economically feasible or contribute a comparable value to the building, such as an extensive crack in the foundation.


Functional obsolescence (zastarelost)

Obsolescence means a loss in value from the market's response to the item.

Outmoded or unacceptable physical or design features that are no longer considered desirable by purchasers are considered curable if they can be replaced or redesigned at a cost that would be offset by the anticipated increase in ultimate value.

Currently undesirable physical or design features that cannot be easily remedied because the cost of the cure would be greater than its resulting increase in value are considered incurable. (ex. a four-bedroom home with only one bathroom)


External obsolescence

If depreciation is caused by negative factors not on
the subject property, such as environmental, social, or economic forces, it is always incurable.

The loss in value cannot be reversed by spending money on the property.

(ex. close proximity to a polluting factory)


Income approach

It's based on the present value of the right to future income that property will produce.

It assumes that the income generated by a property will determine the property's value.

The income approach is used for valuation of income-producing properties such as apartment buildings, office buildings, retail stores, and shopping centers.


Steps in estimating value using the income approach

I. Estimate the property's annual potential gross income.

2. Deduct an appropriate allowance for vacancy and rent loss, and arrive at the effective gross income.

3. Deduct the annual operating expenses from the effective gross income to arrive at the annual net operating income (NOi).

4. Estimate the price a typical investor would pay for the income produced by this particular type and class of property. This is done by estimating the rate of return (or yield) that an investor will demand for the investment of capital in this type of building. This rate of return is called the capitalization rate (or "cap" rate) and is determined by comparing the relationship of net operating income with the sales prices of similar properties that have sold in the current market.

5. Apply the capitalization rate to the property's annual net operating income to arrive at the estimate of the property's value.


Capitalization rate (cap rate)

Yield investor requires for investment of capital.

net income divided by sales price = cap rate


value, rate & income formula

Income + rate = value

Income + value =rate

Value x rate = income


Gross Rent or Gross Income Multipliers

Gross Rent Multipliers (1-4 units):
sale price divided by MONTHLY gross rent = gross rent multiplier (GRM)

Gross Income Multipliers (5 and more units & commercial):
sales price divided by ANNUAL gross income = gross income multiplier (GIM)



When the three approaches to value are applied to the same property, they normally produce three separate indications of value.

Reconciliation is the act of analyzing and effectively weighing the findings from the three approaches.

The process of reconciliation is not simply taking the average of the three estimates of value.

For example, in appraising a home, the income approach is rarely valid, and the cost approach is of limited value unless the home is relatively new. Therefore, the sales comparison approach is usually given greatest weight in valuing single- family residences.

In the appraisal of income or investment property, the income approach normally is given the greatest weight.

In the appraisal of churches, libraries, museums, schools, and other special-use properties, where little or no income or sales revenue is generated, the cost approach usually is assigned the greatest weight.

From this analysis, or reconciliation, a single opinion of market value is produced.