There are normally three accepted approaches to value, the Cost, Sales Comparison, and Income Approaches.
The Cost Approach uses the following steps:
- The land is valued separately by means of the Sales Comparison Approach
- The current replacement cost new of the improvements less any estimated depreciation is added to the lot value.
The Sales Comparison Approach is generally pertinent in the valuation of all real estate since it interprets the actual behavior of buyers and sellers in the marketplace. A comparative analysis is used to apply quantitative and/or qualitative techniques to comparable sales to estimate the value of a property. In this approach the following steps are used:
- Transfers of similar properties are analyzed on the basis of an element or unit of comparison, i.e. price per unit of comparison (per square foot of land, building, per room, per lot, per acre).
- Each unit or element of comparison is analyzed to determine if an adjustment is required.
- Adjustments are separated into transactional adjustments and physical adjustments. The impact of different forms of ownership (fee simple, leasehold estate) and for conditions of sale and market conditions are transactional adjustments.
- The sales are then adjusted for dissimilarities in physical characteristics, which include, age, location and other factors that affect value, to assign a value to each unit.
- The adjusted values are reconciled and a unit value is concluded for the subject.
The Income Approach typically applies to income producing properties. The typical purchaser is an investor who would base their purchase decision on the income producing capability of the property. Direct Capitalization, Yield Capitalization Methods and Subdivision Development Analysis Method are valuation techniques.
- Direct Capitalization: This method converts a single year's net income estimate into a value estimate by either dividing the net operating income by an appropriate capitalization rate or multiplying it by an appropriate factor. It is most applicable when a property is operating on a stabilized basis and capitalization rates can be extracted from the sale of similar properties. This method is typically less useful for properties that have not obtained stabilized occupancy or when income and expenses are projected to change in an irregular pattern.
- Yield Capitalization: This method converts future benefits (cash flows and reversion) into an indication of value by applying an appropriate yield rate. Yield rates are selected by analyzing the yields anticipated by typical investors in the market and/or by sales data.
- Subdivision Development Analysis Method: This method is typically applicable when subdivision is the highest and best use and the property has significant entitlements. The direct and indirect costs are deducted from estimated gross sale proceeds from finished lots over a projected absorption period. The net revenue is discounted at a rate to estimate the land value.
The value indications from the appropriate approaches are reconciled in order to estimate the value.