Valuation, Appraisal, and Market Analysis
Valuation questions distinguish appraisal from comparative market analysis, test the three approaches, and require simple income capitalization. The broker should know when an appraisal license is required and what a CMA can and cannot say.
Core rules
- The sales-comparison approach adjusts recent comparable sales for differences. The cost approach estimates replacement cost less depreciation plus land value. The income approach capitalizes net operating income.
- Gross rent multiplier equals price divided by gross rent. Capitalization rate equals net operating income divided by value; value equals net operating income divided by cap rate.
- Depreciation includes physical deterioration, functional obsolescence, and external obsolescence.
- Highest and best use is the reasonably probable, legally permissible, physically possible, financially feasible use that produces the highest value.
- A CMA or broker price opinion is not an appraisal and must not be presented as one. Appraisals for federally related transactions require a licensed or certified appraiser.
Worked example
A duplex produces net operating income of $60,000. The market cap rate is 8 percent. Value equals $60,000 divided by 0.08, or $750,000. If the cap rate rises to 10 percent, value falls to $600,000. The reasoning: cap rate and value move inversely; a higher required return lowers the indicated price.
Traps
Do not call a CMA an appraisal. Do not confuse gross rent multiplier with capitalization rate. Do not ignore adjustments when using price per square foot. Do not apply the cost approach without depreciation.