Real estate explainer
Three Roads to Value
An appraiser reaches market value three ways. Sales comparison: what did similar homes sell for, adjusted to be like this one? Cost: what would it cost to build new, less the wear of age, plus the land? Income: what is the rent it earns worth to a buyer? Then the appraiser reconciles the three, trusting most the road that fits the property best.
- sales comparison (band: adjusted comps)
- cost approach
- income approach (ring: rent multiplier)
- reconciled value
Reconciliation
Give each approach a weight. They need not add to 100; the page divides by their total.
In a spreadsheet
The property
Cost approach
Income approach
Operating expenses never include the mortgage payment or tax depreciation.
Sales comparison approach
Adjust each comparable to look like the subject. If the comp is worse than the subject in a feature, add its value to the comp’s price; if the comp is better, subtract. The market change is applied first, to the sale price.
| Feature | Value of one | Subject | Comp 1 | Comp 2 | Comp 3 |
|---|
What to notice
Comp worse, add; comp better, subtract. You are asking what the comp would have sold for if it were just like the subject. The comp with the smallest gross adjustment is the most similar and deserves the most weight.
Each road fits some property best. Sales comparison rules for homes, where buyers compare. The cost approach suits new or unusual buildings (a church, a school). The income approach rules for apartments and offices, which buyers purchase for their rent.
Why it works
Cost: value = land + cost new − depreciation + site improvements, with age-life depreciation effective age ÷ economic life × cost new. Land is never depreciated.
Income: NOI = rent − vacancy + other income − operating expenses, and value = NOI ÷ cap rate. A higher cap rate on the same income means a lower value. A gross rent multiplier is quicker: value = GRM × monthly rent.
“A good name is rather to be chosen than great riches.” Proverbs 22:1
Try it
- Family home: check Comp 3 by hand. Why is the garage adjustment added?
- Family home: give the three comps equal weight. How far does the sales value move, and why is equal weighting weaker judgment?
- Change the effective age from 10 to 20 years. How much value does the cost approach lose?
- Apartments: raise the cap rate from 7.5% to 8%. What happens to the income value?
- Apartments: move the reconciliation weights to 60% sales, 10% cost, 30% income. Is that a better fit for this property? Why not?
Adjustment values, costs, rents and rates here are “in this example” numbers taken from or built around the course’s worked problems; a real appraisal draws them from the local market. Adjustments are rounded to the dollar. No outside code, images or trackers.