Property Valuation Principles and Approaches
Property Valuation Principles and Approaches
This domain tests value definitions, highest and best use, and the three approaches to value. Questions often ask which approach fits a property type, which data source is primary, and when reconciliation is required.
Core rules
- Market value assumes a willing buyer and seller, both informed, no undue stimulus, and payment in cash or equivalent. Use value and investment value are different standards; do not substitute them without instruction.
- Highest and best use is tested in four steps: legally permissible, physically possible, financially feasible, maximally productive. It must be reasonably probable, not speculative.
- Sales comparison is preferred for owner-occupied residential property. Adjust the comparables to the subject: if the comparable is superior, subtract; if inferior, add.
- Cost approach is most reliable for new or special-purpose property where depreciation is measurable.
- Income approach is preferred for properties bought for their income; value = net operating income ÷ capitalization rate.
- Reconciliation is not averaging. Weight the approaches by relevance and reliability of data.
Worked example
A subject produces effective gross income of $100,000, operating expenses of $28,000, and a market capitalization rate of 9%. NOI = $100,000 − $28,000 = $72,000. Indicated value = $72,000 ÷ 0.09 = $800,000. If the cap rate were 8%, value would be $900,000; the lower cap rate reflects lower risk or higher growth expectations. State the rate source and date.
Traps
Using potential gross income instead of effective gross income; applying a cap rate to before-tax cash flow; double-counting reserves; treating a sale with atypical financing as arm's-length; adjusting the subject instead of the comparable; averaging reconciled values without judgment.