Real Estate Appraisal: Three Roads to Value

Price, cost, value, and core principles

Appraisal questions are usually classification or calculation questions, so identify the type of value, the principle involved, and the best approach before touching the numbers. Price is the amount paid or asked in a transaction, cost is the amount required to create an improvement, and value is an opinion of worth under stated conditions on a stated date.

Market value is the most probable price a property should bring in a competitive and open market when buyer and seller are typically motivated, informed, and not under unusual pressure. Market price is the actual amount; market value is an opinion. For value to exist, remember DUST: demand, utility, scarcity, and transferability.

Substitution says a buyer will not normally pay more than the cost of an equally desirable substitute, and it underlies the sales comparison approach. Anticipation says value reflects expected future benefits, and contribution asks what an item adds to value rather than what it cost. Progression and regression describe how neighboring values lift or drag a home. Highest and best use is the legal, physically possible, financially feasible use that produces the greatest value.

• Price is paid or asked; cost is to create; value is a supported opinion
• DUST: demand, utility, scarcity, transferability
• Substitution: do not overpay when an equivalent alternative exists
• Anticipation: value reflects expected future benefits
• Progression and regression: neighboring values influence the subject
• Highest and best use: legal, physical, financial, maximally productive

Sales comparison approach and a worked example

The sales comparison approach estimates the subject property's value by analyzing recent sales of similar properties. It is usually strongest for owner-occupied residential property when enough reliable comparable sales exist.

Adjust the comparable, not the subject. Use CBS: Comparable Better, Subtract; if the comparable is worse than the subject, add. Reconciliation is the appraiser's reasoned weighting of the indications, not a simple average.

A comparable sold for $340,000. Its garage is worth $18,000 more than the subject's, so subtract $18,000. It lacks the subject's renovated kitchen, which the market supports at $12,000, so add $12,000: $340,000 − $18,000 + $12,000 = $334,000. Adjustments reflect market reaction, not the owner's construction receipts.

• Comparable inferior to subject: add to comparable
• Comparable superior to subject: subtract from comparable
• Sale price: $340,000
• Superior garage: −$18,000; inferior kitchen: +$12,000
• Adjusted price: $334,000
• Reconciliation weighs reliability; it does not blindly average

Cost-depreciation approach

The cost-depreciation approach estimates land value, adds the current cost of the improvements, subtracts accrued depreciation, and adds the value of other site improvements. Land is normally valued as though vacant because land itself is not depreciated in this calculation.

Replacement cost is the cost to build a structure with equal utility using modern materials and standards. Reproduction cost is the cost to create a duplicate using the same or very similar design and materials. The cost approach is especially useful for newer or special-purpose properties with few comparable sales.

Depreciation has three broad categories: physical deterioration, functional obsolescence, and external or economic obsolescence. A worn roof is physical. An outdated floor plan is functional. Noise from a newly built highway outside the property is external.

• Value = land + improvement cost - depreciation + site improvements
• Replacement: equal utility with modern materials
• Reproduction: duplicate of the original
• Physical, functional, and external depreciation

Income capitalization approach and worked examples

The income capitalization approach converts a property's expected income into a value indication. It is most relevant when buyers purchase primarily for income, such as apartment buildings, offices, or retail property.

Direct capitalization uses the formula Value = Net Operating Income divided by Capitalization Rate, or V = I ÷ R. Net operating income is income after vacancy and operating expenses but before mortgage payments, depreciation for income-tax purposes, and the owner's personal income taxes.

A gross rent multiplier is a simpler residential-income shortcut: Value = Rent × GRM, using the rent period stated in the problem. With $48,000 of net operating income and an 8% cap rate, value is $48,000 ÷ 0.08 = $600,000. With $2,400 monthly rent and a GRM of 145, value is $348,000. A lower cap rate with the same income produces a higher value.

• V = I ÷ R
• I = V × R; R = I ÷ V
• $48,000 NOI ÷ 0.08 = $600,000
• $2,400 monthly rent × 145 GRM = $348,000
• Same income + lower cap rate = higher value

Appraisal, CMA, and BPO

An appraisal is a formal, supported opinion of value prepared under the rules governing appraisal practice, including USPAP when applicable. Federal lending transactions and other assignments may require a state-licensed or state-certified appraiser.

A comparative market analysis, or CMA, is a broker's analysis of comparable listings and sales, commonly used to help a seller choose a listing price or a buyer evaluate an offer. A broker price opinion, or BPO, is a broker's opinion of probable selling price, often requested for portfolio, loss-mitigation, or similar brokerage purposes.

Florida's broker definition includes certain valuation activity but expressly excludes appraisal services that must be performed only by a state-licensed or state-certified appraiser, or by a registered trainee appraiser. A sales associate performs brokerage activity only under the direction, control, or management of the employing broker. Do not present a CMA or BPO as a licensed appraisal when it is not one.

• Appraisal: formal opinion under appraisal standards and credential rules
• CMA: brokerage analysis commonly used for listing or offering decisions
• BPO: broker opinion of probable selling price
• Sales associate: works under the employing broker

Fast exam traps

Do not confuse price with value or cost. Adjust the comparable, never the subject. Do not depreciate land in the cost approach. Mortgage principal and interest are debt service, not operating expenses used to calculate NOI. Finally, do not simply average three appraisal approaches; reconcile them according to their relevance and data quality.

When the property is a typical owner-occupied house, sales comparison is usually most persuasive. For a newer special-purpose building, cost may be strongest. For an income property purchased for its earnings, income capitalization often deserves the greatest weight.

• Typical house: sales comparison
• New special-purpose building: cost approach
• Income-producing investment: income approach
• Final value: reconciliation, not automatic averaging