Real Estate Basics – Three Approaches to Value

Posted by admin on May 29, 2010 under Real Estate License Basics | Be the First to Comment

This installment of the Real Estate Basics series will review what you need to understand about property valuation to earn your real estate license. The real estate courses that you complete to prepare you for your real estate license exam will teach you how to calculate these values, however for the purposes of our explanation we will concentrate on defining each of the three approaches.

The first approach is the Sales Comparison Approach or the Market Data Approach. This approach to value takes the subject property and compares it to other sales of similar properties in the same area. When the subject property has more features than a property it is being compared to, than the value of these features is added to the comparable property. For example, an appraiser is given a three bedroom, two bathroom subject property to appraise and wants to you a three bedroom comparable property with only one bathroom. The value of the bathroom will be added to the comparable property. If the comparable property has features the subject does not, then the value should be subtracted from the comparable property. In a Sales Comparison Approach, the value should always be added or subtracted from the comparable property, never from the subject property.

Next there is the Cost Approach, also referred to as the Summation Approach. This approach to value is used mainly on properties that are difficult to find comparables for due to a lack of market data. With the Cost Approach the value is based upon what it would cost to replace it. The cost to reproduce a building with all original materials that is as close as possible to the original form and function is the reproduction cost. The cost to rebuild something with available materials using current methods replacement cost.

Finally there is the Income Capitalization Approach to value. This approach is based upon the property’s ability to generate income. The current value of the property and the projected income that it can bring in are considered when calculating the value. This approach takes the projected annual income of a property and making the appropriate deductions for expenses and depreciation to come up with the annual net operating income. In order to calculate the property value, the income is divided by the Capitalization Rate, or the estimated rate of return that an investor would expect to see.

A great deal of the real estate training that you will receive in any real estate school will have several sections concentrating on the essentials of assessing a property value. In order to be successful with your real estate license you must completely understand the concept of how to accurately value a property.