Property Valuation and Appraisal
Framing the problem
Market value assumes a willing, informed buyer and seller, no undue pressure, and reasonable market exposure. Market price is what the property actually sold for; the two diverge in distressed or non-arm's-length sales. Highest and best use must be legally permissible, physically possible, financially feasible, and maximally productive.
The three approaches
Sales comparison: adjust the comparables, never the subject, for differences in time, location, size, condition, and features; if the comparable is superior, subtract. Cost approach: land value plus replacement cost new, minus depreciation (physical deterioration, functional obsolescence, external obsolescence). Income approach: value equals net operating income divided by the capitalization rate; the gross rent multiplier is price divided by gross monthly rent and is only a screening tool.
Principles that appear as distractors
Substitution, contribution, conformity, progression and regression, anticipation, competition, change, and increasing or decreasing returns. Reconciliation weights approaches by relevance - sales comparison dominates for owner-occupied homes, the income approach for apartments.
Traps
- Adjusting the subject instead of the comparables.
- Applying a cap rate to gross rent rather than net income.
- Treating an appraisal as a home inspection or a price guarantee.
- Confusing reproduction cost (exact replica) with replacement cost (equal utility).
- A licensee's CMA is not an appraisal and must be labeled as an opinion of price.
Worked example
A duplex produces $30,000 effective gross income and $6,000 of operating expenses, so NOI is $24,000. At an 8% cap rate, value is $24,000 / 0.08 = $300,000. If the cap rate rises to 10%, value falls to $240,000 - more risk, less value.
Rule of thumb
Adjustment direction: subtract from the comparable for a feature it has and the subject lacks; add to the comparable for a feature the subject has and it lacks.