Property Valuation and Financial Analysis
The three approaches
Sales comparison is the primary approach for residential property: adjust comparables to the subject (never the reverse). Cost approach suits new or special-purpose property: reproduction or replacement cost minus depreciation, plus land value. Income approach capitalizes net operating income and dominates for investment property.
Key formulas
Gross rent multiplier = price ÷ gross rent; value = gross rent × multiplier. A lower GRM implies a higher yield. Capitalization: value = net operating income ÷ cap rate, and cap rate = NOI ÷ value. Higher cap rate means lower value for the same income - a frequent trap.
Depreciation
Depreciation is physical deterioration, functional obsolescence (curable or incurable, such as a poor floor plan), or external obsolescence (economic or locational, always incurable). Land is never depreciated. Highest and best use must be legally permissible, physically possible, financially feasible, and maximally productive.
Traps
Do not mix gross rent with NOI in cap-rate problems. Do not adjust the subject. Remember reconciliation: the appraiser weights the approaches rather than averaging them. A broker's comparative market analysis is not an appraisal and must be labeled as such.
Rule of thumb
Cap rate moves opposite to value; adjust comparables toward the subject.
Worked example
A duplex produces $72,000 gross income; vacancy and operating expenses total $22,000, so NOI is $50,000. At a market cap rate of 8%, value = $50,000 ÷ 0.08 = $625,000. Checking the inverse: $50,000 ÷ $625,000 = 8%.