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Valuation Foundations: Sales Comparison, Income, and Indicator Reconciliation.
Sales Comparison Approach
- Based on the principle of substitution: a buyer will not pay more for a property if a similar property is available at a lower price.
- Involves comparing the subject property to comparable properties recently sold in similar areas.
Steps:
- Identify comparable properties (similar in location, size, design, condition, features).
- Collect detailed data on comparables (sale prices, dates, property characteristics, special sale conditions).
- Make adjustments to comparable sales prices to reflect differences between them and the subject property.
Types of Adjustments:
- Quantitative: Based on measurable data.
- Land area: subtract value of difference if comparable’s land is larger.
- Number of bedrooms/bathrooms: subtract value of difference if comparable has more.
- Property age: adjust for age as newer properties are typically more valuable.
- Qualitative: Based on personal estimates or data difficult to quantify.
- Location: subtract value of difference if comparable has a better location.
- Condition: subtract value of difference if comparable is in better condition.
Formula:
Subject Value = Comparable Sales Price +/- Adjustments
Income Approach
- Based on the principle that a property’s value is directly proportional to the income it can generate.
- Commonly used for investment properties (rental apartments, offices, retail).
Steps:
- Estimate Potential Gross Income (PGI): total income if all units are fully rented.
- Estimate Vacancy Rate and Collection Losses: deduct percentage from PGI.
- Calculate Effective Gross Income (EGI): EGI = PGI - (Vacancy Rate + Collection Losses).
- Estimate Operating Expenses: costs to operate and maintain the property (taxes, insurance, maintenance, management).
- Calculate Net Operating Income (NOI): NOI = EGI - Operating Expenses.
- Determine Capitalization Rate (Cap Rate): rate to convert NOI to value. Cap Rate = NOI / Sales Price (of comparable properties).
- Calculate Value: Value = NOI / Cap Rate.
Gross Rent Multiplier (GRM):
- Used by residential appraisers.
- Divide monthly income from comparable rentals by their sale price to determine GRM. Then multiply the subject property’s gross monthly income by a selected GRM to estimate value.
Reconciliation of Value Indicators
- After applying the sales comparison and income approaches (and cost approach), the appraiser obtains different value indicators. Reconciliation analyzes the appraisal problem, selects the most appropriate method, and gives it the greatest weight in determining the final value estimate.
Factors Influencing Reconciliation:
- Reliability of data.
- Logic and analysis used in each approach.
- Resulting value indicators: compare and assess their convergence or divergence.
- Appraisal use: consider the intended use when weighting each approach (e.g., income-seeking investors prioritize income approach).
Not a Simple Average:
Reconciliation is not simply averaging the value indicators. It relies on the appraiser’s judgment to arrive at the most reliable value estimate.
Chapter Summary
The chapter discusses the scientific basis of real estate valuation, focusing on three main approaches: sales comparison, income, and reconciliation of value indicators.
Sales Comparison Approach:
- Based on the principle of substitution: a buyer will not pay more for a property than for a similar available one.
- Involves finding comparable properties sold recently in the same or similar area.
- Adjustments are made to the sale prices of comparables to reflect differences between them and the subject property.
- Adjustments are based on factors like location, size, number of rooms, condition, and additional features.
- Formula: Property value = Comparable sale price +/- adjustments.
- Most commonly used for residential properties because it relies on actual market data.
Income Approach:
- Based on the principle that a property’s value is directly proportional to its ability to generate income.
- Estimates the net or gross incomeโ expected from the property.
- Uses a suitable multiplier to convert income into value.
- Gross Rent Multiplier (GRM) is commonly used for residential rental properties; calculated by dividing the sale price of a comparable rental property by its gross monthly income.
- A suitable multiplier is selected from a range of multipliers from comparable rental properties and multiplied by the expected gross monthly income of the subject property to estimate its value.
- Example: If the expected monthly rent is $1525 and the suitable multiplier is 135, the estimated property value is $1525 x 135 = $206,000.
- Important for valuing properties purchased for income generation, such as commercial and investment properties.
Reconciliation of Value Indicators:
- Aims to combine valuation results from different approaches (sales comparison, income, and cost approach).
- Analyzes the results from each approach and assesses their reliability.
- Does not simply average the estimated values.
- Gives greater weight to the most relevant and reliable approach for the specific property.
- Considerations include the reliability of the data used, the logic used in the analysis, and the intended use of the valuation.
- Ensures a more accurate and reliable final value estimate by considering all relevant factors.
Conclusions and Implications:
- No single approach is suitable for all properties.
- The appraiser must select the most appropriate approach(es) based on the property’s characteristics and the purpose of the valuation.
- Reconciliation is a crucial step, requiring appraiser expertise and judgment to determine the appropriate weight for each approach.
- Detailed reports are necessary to document the valuation process and provide logical support for the results.
- The appraiser must be aware of the latest market data and economic trends to ensure valuation accuracy.
