Real Property

Sales Comparison

The Sales Comparison approach is the most common approach to valuing residential properties. In this approach, the appraiser compares the property being appraised to similar properties that have recently sold. Similarities and differences must be noted in detail such as: date of sale, location of property, physical characteristics, and conditions of the sale.

Before an appraiser can use home sales as comparables, the sale must be verified. The sales are analyzed to determine if they are "arm’s length" transactions. An arm’s length transaction is defined as “a transaction between unrelated parties under no duress. There are multiple reasons for a home to sell under duress. These reasons include, but are not limited to: foreclosure, short sales, estate sales, job transfer, divorce, etc. Because duress sales typically don’t sell for market value, these sales are removed from the analysis.

The appraiser makes adjustments to the sale prices of the comparable properties for different variables such as location, size, quality, condition, amenities, etc. Appraisers generally use a Paired Sales Analysis to determine market differences for different features.

Below is an example of a Paired Sale

There is a $1,500 difference in sales price. The only difference between the two homes is that Home "B" does not have a fireplace. The $1,500 shows that, all things the same, a buyer is willing to pay $1,500 more for a fireplace.

Income Approach

The Income Approach is the most often used approach in the appraisal of commercial or industrial properties, or properties which are bought and sold by investors primarily because of their income producing potential. This approach to value depends on reliable and detailed information on the income and costs of doing business for a particular business or enterprise.

This is referred to as the "income stream" of the property. The income approach defines value as "the \ present worth of future benefits of owning a property." These are composed of the annual income for an estimated number of years (called the economic life of the property) plus a capital amount representing land value or land value plus some remaining worth of the improvements. This approach emphasizes investment components rather than physical components of a property.

Here is an example of the Income Approach:

Income

• Potential Rental Income (Small Office Condo)
• Add: Misc Income (if any, coin operated vending machine, parking, etc)
• Less: Vacancy/Collection loss

Amount	Description
$19,200.00	$800/month * 12 months * 2 units
$0.00	No Misc Income
$960.00	5% in Vacancy Losses
$18,240.00	Effective Gross Income

Expenses (Based on Effective Gross Income)

• Fixed (does not vary with use)
• Variable (vary with use)
• Others

Amount	Description
$800.00	Insurance
$2,000.00	Taxes
$960.00	Managment Fee (5%)
$220.00	Painting
$100.00	Exterminating
$600.00	Repair/Maintenance
$1,880.00	Total Variable Expenses
$680.00	Other Expenses: Replace Reserves
$5,360.00	Total Expenses

Net Operating Income = Effective Gross Income - Total Operating Expenses
Example: $12, 880 = $18,240 - $5,360

Value

Value = Net Operating Income / Capitalization Rate
Example:$135,579.00 = $12,880 / 9.5 %

In this example the Small Office Condo is worth $135,579.00

Cost Approach

The Cost Approach is based upon the proposition that an informed buyer would not pay more than the cost of producing a substitute property with equal utility as the subject property. The Cost Approach works best for new residences, specialty buildings, large commercial units, and when little market data is available.

The steps in performing the Cost Approach are:

1. Estimate the land value, as if vacant
2. Estimate the replacement cost new of the improvements
3. Estimate cash amount of accrued depreciation due to loss in value, physical deterioration, and obsolescence
4. Deduct the accrued depreciation
• Physical – Deterioration due to weathering, wear, tear, etc.
• Functional – Depreciation resulting from deficiencies or super adequacies in the structure
• Economic (external) – Obsolescence due to outside of the subject property
5. Estimate the present depreciated value of other improvements
6. Add estimate of land value to the depreciated value of improvements to get the value of the subject property.

Sample use of Cost Approach:

1. Land value, as if vacant: $50,000
2. Replacement Cost New (RCN): $180,000
3. Physical deterioration: $35,000
4. Functional obsolescence: $15,000
5. Economic obsolescence: $5,000

The total accrued depreciation is $55,000 ($35,000+$15,000+$5,000)

The depreciated value of improvements is $125,000 ($180,000-$55,000)

Value indicated by the Cost Approach: $175,000 ($125,000+$55,000)

In this example, our house is worth $175,000.