What Are The Best Approaches To Valuation In Real Estate Appraisal?

If you’re new to the real estate industry, the term valuation may not mean much to you yet, but it’s a vital step in the appraisal process. In this article, we’ll dive into what valuation means in real estate, the three best approaches to valuation, and how it pertains to you as an aspiring real estate agent.

What exactly does valuation mean in real estate?

Valuation is the process of determining a property’s value by using three different approaches: sales comparison, cost and income. Evaluating a property is no easy task and is crucial to determine a home’s value. Real estate investment companies and independent investors, especially, need potential investment properties thoroughly evaluated in order to make the best financial decision.

Who conducts valuations?

Real estate evaluations and appraisals are most commonly conducted by real estate valuation analysts, licensed appraisers, property valuers, or land surveyors.

What are the three approaches or methods to valuation?

  1. Sales Approach – Best for residential properties, the sales comparison approach compares the property to nearby properties, or comps, that have recently sold. Comps should be located within a mile of said property and sold less than six months from the current date. Typically appraisers will compare the property to at least three comps that are similar in square footage, year built, location, etc.
  2. Cost Approach – Unlike the sales comparison approach to valuation, the cost approach is best used when evaluating special purpose, new construction, or commercial properties. Instead of comparing the property to similar properties, the cost approach determines how much it would cost to replace or replicate the property.

    In order to find the value of a property using the cost approach, the land, construction, and depreciation costs all need to be determined or estimated as accurately as possible. According to WallStreetMojo, this formula should be used to find the value of a property using the cost approach: Land + Construction Cost – Depreciation = Value.
  3. Income Approach – The income approach is used for income properties that will be available to rent or lease, such as apartments or office buildings. Let’s take a look at the steps to discover the value of a property using the income capitalization approach as outlined on WallStreetMojo:

    Find Annual Gross Income – First, the potential income must be estimated based on current market rates.
    Find Effective Gross Income – Subtract potential losses.
    Find Net Operating Income (NOI) – Calculate the property’s operating expenses.
    Find Rate of Return for Type of Property – To find the rate of return, or capitalization (cap) rate, the NOI of comps must be found and divided by their sales price.
    Find Value – Once the cap rate and NOI of your property is found, divide the NOI by the cap rate to estimate your property’s value.

How can I help my clients more when it comes to valuation and appraisal?

Though this article simply outlined the three approaches to valuation in real estate, there is so much more to this process. As a real estate agent, you must know these different methods so you can help your clients determine the price for selling or buying a property. Your clients will rely on you to advise them on the right listing price for their home or when a sales price is too high or low when looking for a new property.

If you’re interested in real estate, we would love to answer your questions further and help you prepare for your real estate licensing exam. Call us at (574) 551-0316 or visit the contact page to talk with one of our team members today!