Approaches to Value

Definition

Approaches to value are the methods or procedures by which valuation of a property is ascertained. For different property, different approach to value is used. There are three types of approaches to value and they are sales comparison approach, cost approach and income capitalization approach.

Sales comparison approach

The sales comparison approach is the most commonly used approach in real estate appraisal practice for determining the value. In this approach to value, the property which is being appraised is compared to recently sold properties which are of similar types. This is done for deriving a value indication. For that, the property being appraised is compared to comparables that are adjusted for size, acreage, amenities, time, etc. The appraiser’s experience is important when it comes to understanding the adjustments which are reasonable for a particular market area. The value of one property in a certain area may be high but it may not be of that value in a different area.

This approach to value is usually used for valuation of vacant land, improved properties or lands considered to be vacant. This approach is preferable when there is sufficient availability of comparable sales.

Cost approach

The cost approach to value estimates the value of a property by determining the cost that will be required for constructing a replacement or reproduction of the same property after deduction of accrued depreciation. Accrued depreciation means decline in the property’s actual value over the period of time due obsolescence or wear and tear.

Income capitalization approach

This approach to value is used to derive a value indication for a property that generates income. This is done by finding property value by converting the anticipated benefits. This conversion can be done in two ways. The income expectancy of one year can be capitalized at market-derived rate of capitalization or rate of capitalization that shows a specified return on investment, income pattern and change in the investment’s value. Again, at specified yield rate, the yearly cash flows for holding period and reversion can be discounted. In this approach, the future benefits of a property’s present value are estimated.