The Three Approaches to Value
Appraisers use three approaches to value in Appraisal Practice when determining the Market Value of a property:
- The Sales Comparison Approach
- The Cost Approach
- The Income Approach
1. The Sales Comparison Approach
The most frequently-used and accepted approach to determining value in real estate appraisal practice is the sales comparison approach. This approach to value bases its opinion of value on what similar properties (otherwise known as “comparables”, or “comps”) in the vicinity have sold for recently. These properties are adjusted for time, acreage, size, amenities, etc. as compared to the property that is being appraised. Understanding which (and to what extent) adjustments are reasonable for a given market area (for a given property) relies on the experience of the appraiser. A property characteristic that is highly valued in one neighborhood may not be valued to the same degree in a different area.
2. The Cost Approach
The second approach to determining the value of a property is the cost approach. This approach seeks to determine how much a property would cost to replace (meaning, rebuild) after subtracting accrued depreciation. Accrued depreciation is the reduction in actual value of property over a period of time as a result of wear and tear or obsolescence. The term reproduction cost is used if an exact replica of the original property is produced. The term replacement cost is used if a property is rebuilt with comparable utility, but using current design and construction methods and materials.
The cost approach is considered to be more reliable when used on newer construction. The methods and results of the cost approach are considered to be less reliable with older construction.
The cost approach appraisal is frequently the only approach that is considered to be reliable when appraising special use properties such as commercial/industrial properties or public properties such as libraries, schools or churches which are not traded on the open market.
3. The Income Approach
The third approach to value is called the income approach. When a property generates income for it’s owner, that income, or potential for income, helps to substantiate, calculate or identify the market value of the property. Apartment buildings and duplexes are examples of income-producing properties. Appraisers use the income derived from the property as part of the assessment the market value of the property.