The Three Approaches to Valuation


There are three ways to determine the value of anything, and each plays a part in property appraisal.



1. Sales Comparison Approach

The most widely-used and accepted in residential practice is the sales comparison approach. This approach bases its opinion of value on what similar properties in the vicinity have sold for recently, with appropriate adjustments for time on market, amount of living area, amenities, lot size and so on.  It is these adjustments where the expertise of the professional appraiser becomes necessary -- no computer can tell you how much or little to mark up for an amenity without knowing the neighborhood and how important that amenity is in that particular location.

Appraisers get to know the communities in which they appraise. We innately understand the value of particular features to the people of that area.  Then, the appraiser researches recent sales in the area and finds properties which are "comparable" to the subject being appraised.  By assigning a dollar value to certain items such as upgraded appliances, additional bathrooms, an additional living area, quality of construction, lot size, etc., we adjust the comparable properties so that they are more accurately in line with the features of subject property. The dollar amount of these "adjustments" is determined by the market, not the appraiser.

  • Say, for example, the comparable property has a fireplace and the subject doesn't. The appraiser may deduct the value of a fireplace from the sales price of the comparable home.
  • However, in the case where the subject has something such as an extra half bath that a comparable doesn't have, the appraiser might add the value of that bath to the comparable property.

A valid estimate of what the subject could sell for can only be determined once all differences between the comps and the subject have been evaluated. The sales comparison approach to value is typically given the most importance when an appraisal is for a home purchase.

2.  Cost Approach

Another approach is the cost approach.  How much would a property cost to replace (rebuild), minus "accrued depreciation (depreciation that has occurred since the property actually was built)?"  The cost approach includes concepts like "economic life" and "effective age" that are mostly of use in determining the value of special use properties, special purpose properties or properties where subsequent structural improvements greatly impact value.

Here, we pull information on local building costs, labor rates and other elements to figure out how much it would cost to construct a property similar to the one being appraised. This estimate usually sets the upper limit on what a property would sell for.  The cost approach is also the least used method.


3.  Income Approach

The third approach to value is called the income approach.   Some properties generate income for their owners -- the most obvious examples being rental properties such as apartment buildings, non-owner-occupied houses, duplexes and the like. The rental income an owner might reasonably expect from a property is part of its value. 
This approach is sometimes applied when an area has a reasonable number of rental properties.  The amount of revenue the real estate yields is taken into consideration along with other rents in the area for comparable properties to give an indicator of the current value.

Coming Up With the Final Value

Combining information from all applicable approaches, the appraiser is then ready to state an estimated market value for the subject property. It is important to note that while the appraised value is probably the most accurate indication of what a house would sell for in an open market, it probably will not be the price at which the property closes.  Prices can always be driven up or down by extenuating circumstances like the motivation or urgency of a seller or "bidding wars."  Regardless, the appraised value is typically employed as a guideline for lenders who don't want to loan a buyer more money than the property would likely sell for in an open marketplace.  The bottom line is: an appraiser from Bobkat Appraisal Services will help you discover the most accurate property value, so you can make profitable real estate decisions.