
When calculating the value of real estate, the commonly asked question "How much is my house worth?" is answered through real estate appraisal reports.
What methods are used in the preparation of appraisal reports?
There are three main methods used to determine the value of real estate: sales comparison approach, cost approach, and income capitalization approach.
The sales comparison approach is the most useful method when similar properties to the subject real estate have recently sold or are on the market. The appraiser uses this method to compare the subject property with similar properties and create an indicator of value.
The cost approach relies on market participants accepting that value is related to cost. This method estimates the current value of the property based on the cost to build an equivalent property.
In the income capitalization approach, the present value of the future benefits of owning the property is measured. This method requires estimating the income, expenses, and capitalization rate of the property in the future. Additionally, the impact of changes in these factors on the value of the property needs to be determined.
These three methods can be applied to various appraisal problems.
For example, the sales comparison approach can be used for residential properties that typically do not generate income and small commercial properties that are owner-occupied.
The cost approach is particularly meaningful when land value is well-supported and structures are new or have minimal depreciation, suggesting the most effective and efficient use as if vacant.
It can also be applied to older properties where there is a sufficient amount of data available to calculate depreciation.
If the value of properties is determined solely based on the income they generate (such as rental properties or commercial buildings), the income capitalization approach is used to determine the value.
Ideally, all three methods should be applied as long as the data is appropriate. The methods used depend on the type of property, the purpose of the appraisal, the defined scope of work, and the quality and quantity of data obtained for analysis.