Valuation Approaches and Methods
Domain 2: Valuation Approaches and Methods
This domain tests the three approaches and when each is most reliable. You must know adjustment logic in sales comparison, depreciation in the cost approach, and capitalization in the income approach.
Core rules
- Sales comparison: select closed sales, listings, or contracts; verify; adjust for transactional differences first, then property differences. Adjust the comparable's price toward the subject: if the comparable is superior, subtract; if inferior, add.
- Cost approach: land value plus current construction cost, less depreciation. Depreciation is physical deterioration, functional obsolescence, or external obsolescence.
- Income approach: direct capitalization divides stabilized net operating income by a market-derived cap rate. Gross income multiplier uses gross rent.
- Reconcile: explain why one approach is most credible given property type, data quality, and intended use.
Worked example
A comparable sold for $500,000. It has a pool the subject lacks, so subtract $25,000; the subject has a newer roof, so add $10,000. Indicated value = $500,000 - $25,000 + $10,000 = $485,000. A second comp indicates $495,000. Both support a range of $485,000-$495,000; the appraiser weights the first comp more heavily if its adjustments are smaller and better supported.
Traps
- Reversing the direction of an adjustment.
- Double-counting an item in both transactional and property adjustments.
- Deducting depreciation from land as well as improvements.
- Applying a cap rate derived from different income or risk characteristics.
- Reconciling by averaging approaches without judgment.