There are three methods real estate investors or analysts use to arrive at their opinion of value. One or more of these methods can be used in any given assessment. Typically, the primary method used will rely almost entirely on the type of property being assessed or appraised. Other determining factors may include the goal of the appraisal, the scope of work involved, and the data available for the analysis.
The cost approach to assessment and appraisal is established by understanding the construction methodologies and property attributes related to cost. The cost approach is estimated by adding the cost of land to the current cost of construction related to all improvement on land, and subtracting depreciation in all improvements on the land. The construction costs of buildings would include a reproduction cost or a replacement cost of the same or similar like materials or systems. This approach works best when it used for the assessment of new or newer properties that are not frequently transacted. The actual costs are usually derived from cost estimator software, cost manuals, builders, and contractors. Note: The land would remain a separate value when using the cost approach.
Direct Comparison Approach
The direct comparison method to assessment of real estate is most useful when there is a large number of similar properties that have recently transacted on the market or are currently listed on the market. Using this method, the assessment would come from identifying the subject with similar properties, called comparables (or comps). The sale prices that most identify with the subject would have a heavier weight on the value, oppose to one that is further from the subject characteristics. Most of the time the comparables would create a range of value, upon which; opinion must be used to find an exact value. Several elements or factors are used to qualify the degree of similarity between comparables and the subject. This would include: real property rights, financial terms, property conditions of the sale, post sale expenditures, location, market factors, physical characteristics, economic characteristics, use/zoning, non-real estate components of sale (chattels, fixtures). After the best comparables are set, a dollar figure or percentage is applied to the sale price of each property to estimate the hypothetical value of the subject. For instance comparable A has 1 more bathroom than the subject; therefore subtract $9000 from the comparable to hypothetically get the sale to reflect the same characteristic as the subject.
The income method to the assessment of real estate would be from an analysis of present value of the future benefits of property ownership. A property’s income and resale worth upon return may be capitalized into a current, lump-sum amount. There are two methods of the income approach; one is direct capitalization and the other yield capitalization. Direct capitalization is the relation between one year’s income and worth indicated by either a capitalization rate or an income multiplier. Yield capitalization is the relationship between several years of stabilized income and worth at the end of a specified period reflected in a yield rate. The most commonly used yield capitalization method would be the discounted cash flow analysis.
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