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The Three Approaches to Value: The Cost, Income, and Comparable Sales Methods

Property valuations- or estimated property fair market values- are used for many purposes ranging from loans to taxation. But how are valuations calculated?

Real estate appraisers and valuation professionals generally calculate property valuations using the three different methods of value: the cost approach; the income approach; and the comparable sales/ market approach. Experts select the best approach based on the property type (i.e. residential or commercial) and specific property characteristics (including age and condition).

The Sales Comparison Approach

When looking to evaluate a residential property, experts are most likely to turn to the sales comparison approach. As the name suggests, this method pays particular attention to comparing recently sold properties with the subject property. The properties that are selected for comparison- often called “comparables”- should always be similar to the subject property in terms of location, tax classification, and fundamental property characteristics. Experts identify comparables by consulting real estate publications, public records, real estate agents, and much more. Experts often adjust comparables based on the level of similarity to the subject property.

The Cost Approach

Valuation experts use the cost approach primarily for commercial properties, including special use properties and new construction properties. The cost approach values property by summing up the overall cost of the value of the land together with any improvements, subtracted by any depreciation or adjustments. Often, the cost approach generates the upper limit of value of a subject property.

The Income Approach

Also known also as the income capitalization approach, appraisers and valuation professionals often use the income method to accurately determine the value of any income-producing properties. The income approach is generally considered the most applicable to these property types due to the large amount of market data that is available. By deducing how much an owner would earn from renting their property, this model-like approach is intended to be used as a direct reflection of expectations and behaviors within the market.

The sales comparison, market, and income approaches to value offer valuation professionals and real estate owners alike the ability to calculate the estimated fair market value of a subject property at any given time. To stay up to date with all property value news and updates, subscribe to our blog.

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