As you know, we’re dedicated to clarifying the appraisal process because we are firm believers in transparency as well as education. In fact, that’s exactly what our blog is for: to bring you the latest in appraisal news, regulations, and insight. Today we’re tackling property appraisal methods. You might not realize that the property appraisal process consists of three specific methods for determining value. While each method is used to help an appraiser form an opinion of property value, there are different reasons an appraiser might select a specific method. The approach might depend on property type, appraisal use, and available data. As Rob has stated before, “While the regional and local discussion is nice, it is the analysis of the data, focused on the appraisal problem, that creates the quality report.” Here, we dive into this analysis to clarify each property appraisal method and showcase why an appraiser might choose a specific method.
What is the cost approach appraisal method?
A cost approach appraisal method uses the market price for a property, which is calculated with this formula:
market price = (cost of the land + cost of construction) – property’s depreciation
Essentially, the price a buyer should pay for a piece of property should be equal to the cost to construct that building’s equivalent. This method might be chosen for several reasons, especially when conducting a commercial property appraisal. For one, the cost approach appraisal method is commonly used for properties that are constructed but not frequently sold (like churches, schools, or government buildings). It is also commonly used for valuing new properties.
What is the sales comparison appraisal method?
Often referred to as the most popular appraisal method, the sales comparison approach is commonly used for residential appraisals, and specifically single family homes. Here, valuation is determined by comparing properties with similar characteristics using recent sales or current market prices. The appraiser will use a variety of data points to decide commonalities between properties. Elements like location, physical characteristics, zoning use, and conditions of sale are all factored into the decision. Through comparing properties, an appraiser will ultimately arrive at a value.
What is the income capital appraisal method?
For the income capital appraisal method, value is measured by looking at the present value as well as the future value of a property. According to the Appraisal Institute, “There are two methods of income capitalization: direct capitalization and yield capitalization. Indirect capitalization, the relationship between one year’s income and value is reflected in either a capitalization rate or an income multiplier. In yield capitalization, the relationship between several years’ stabilized income and a reversionary value at the end of a designated period is reflected in a yield rate.” As you might have surmised, an income capital appraisal is typically used for investment properties. Apartment buildings, commercial real estate, condos, and multi-family homes are all good examples of properties that would receive an income capital appraisal.
Deciphering appraisals can be daunting, but it doesn’t have to be. We’re here to help. As you work through each of these methods, don’t hesitate to reach out if you have any questions.