Property valuation (or appraisal)of your real estate assets is a keyaspect of property investment.It’s important in the purchaseand resale of a property, but alsofor insurance and financing purposes for the timeyou own the property. Understanding the valuationprocess allows you to assess and place anappropriate value on your property.
Cost Approach:This is based on the concept of objective value(also known as “the cost to create”). Costapproach is particularly useful when the subjectproperty has been extensively renovated ornewly constructed. The main stages of the costapproach to value are:
• Estimation of the value of the site and itsreproduction cost, sometimes mistakenlycalled “replacement value”. In some cases,replacement value is the only accurate figureyou can use, along with an estimate of theaccrued depreciation associated withstructures on the property.
• Adjustment of the property’s value isdetermined by subtractingthe estimate of accrueddepreciation from theestimate of thereproduction cost(or replacement value, when applicable).
• Market value estimate is calculated by takingthe adjustment figurefrom the step above andadding the estimate ofthe value of the site.
Sales Comparison Approach:The sales comparison approach isperhaps the most commonmethod of determining the value ofreal property. The estimation of theproperty value is based on recentsales data for direct comparables sold in the area inthe past six to 12 months. Real estate agents often usethis approach in larger markets where there are anumber of similar properties, as this valuation methodaccurately represents the market value of theproperty.
Income Approach:This is commonly used to determine the value ofan income-producing property where there is arelationship between theincome a property is capableof producing and the valueof the property. The main stepsin calculating the value of aproperty using the incomeapproach are:
Estimation of potential annual gross income.Using a motel as an example,the potential annual grossincome is the dollar value thatcould be realized if every roomwas fully rented at the highestrate every night for the entire year. A vacancyand bad-debt allowance, based on currentmarket conditions, is subtracted from this figure,which becomes the effective gross income.
• Estimation of annual operating expenses. This isa figure that is often determined by calculatingthe operating expenses applicable to the majorityof similar property types in the samemarketplace. Thisincludes industry-standard expenses,such as telephone,Internet and cableservices, as well as fees forregular utility and seasonalmaintenance. The annualoperating expenses are deducted from theeffective gross income to provide an estimate ofnet operating income.
• Capitalization rates are determined when thevaluator converts the income of a propertyinto an estimation of the future cash flowcompared to the return on the initialinvestment. These ratios are usually expressedas a percentage of the expected return onyour initial investment.