Methods of valuing property

Establishing the value of a piece of real estate can be a tricky job. Fortunately, there are a number of accepted methods of establishing value estimates. I will review each of these appraisal techniques and show you how to use them.

The three commonly accepted appraisal methods used by professional appraisers are:

1. Comparative market analysis

2. Reproduction cost

3. Capitalization of income

“Comparative market analysis” means nothing more than doing some comparison shopping before you buy any real estate. Just as you would compare and shop prices before buying new furniture or a car, so, too, you need to compare and shop prices for similarly situated properties before making a purchase. The  difference in this instance is that you are comparing a building that is for sale with ones that have already been sold.

What do you need to compare? The major considerations are:

•  Number of units

•  Square footage of the improvements (structure)

•  Square footage of the lot (the dirt)

•  Condition of the surrounding neighborhood

•  Age and condition of the building

•  Income-producing capability (current rents versus market
• rents)

•  Parking (garages, pads, carports, or none)

•  Amenities (view, fireplaces, multiple baths, pool, patios or
  decks, etc.)

Reproduction cost

Another way to estimate the actual value of a property is to use what is known as the “reproduction cost method”.  That is, what would it cost to build that same building today? Here you pretend to buy a lot at today’s value and then build a “used” building that matches the existing building. For this reason alone, this is not an easy method. It requires a good knowledge of the market for raw land as well as an understanding of the costs of construction and depreciation.
Consequently, this method is often used solely by professional real estate appraisers.

If you want to attempt it, the first thing to consider is the cost of the lot. Contact brokers and builders in your area. Find out what similar lots cost.

Step two is to figure out what it would cost to build your building. Analyze the square footage and construction method of the property you want to buy.

Step three is determining the depreciation of this building (in most cases age).

Capitalization of income

The last method of appraising real estate value is called the “capitalization of income” approach. This method determines a building’s value based on its profitability. In the real world of appraising, different methods of valuing property are used for different types of buildings. With single-family homes, the comparative method is used most often. The reproduction cost method is usually employed for specialized properties (like a church) and for new construction. But for investment property of multiple units, the capitalization of income method is best.
This is probably the most difficult of the three methods to use properly when valuing income property, but actually it is the preferred
method.

To determine the capitalization rate on a building, divide the net income by its price. Net income is determined by subtracting the operating expenses from the gross income. The equation looks like this:
Gross income – Operating expenses ÷ Price = Capitalization rate

I recommend using all three methods by averaging the results.

For example:

Comparative Analysis Value $276,667
Reproduction Cost Value $284,930
Capitalization Value $288,000
Averaged Value $283,199