The Appraisal process
Once the site has been inspected, an appraiser uses two or three approaches to determining the value of real property: a cost approach, a sales comparison and, in the case of a rental property, an income approach.
Cost ApproachThe Cost Approach is comprised of four primary elements. First, the site (land) is valued via the Sales Comparison Approach. The second step is to estimate cost new of the improvements (building and site improvements). From this cost new figure is deducted accrued depreciation (if any), which represents loss in value to the improvements from all sources. Accrued depreciation is estimated by analyzing the disadvantages or deficiencies of the existing building and improvements as compared to a new building without any disadvantages or deficiencies.
Sales Comparison ApproachThe value indication is estimated in the Sales Comparison Approach by analyzing prices of the most similar properties to the subject that have recently sold, are under agreement of sale or available for sale. Sale prices of sold properties are analyzed because prices and resultant units of comparison for those properties are known while the value of the subject is unknown.
Income ApproachThe Income Approach is predicated on the assumption that a definite relationship exists between the amount of income a property can earn and its value. In other words, value is created by the expectation of benefits to be derived in the future. In this approach, the anticipated annual net income of the subject property is processed to produce an indication of value. Net income can be converted into a value indication, either by capitalization or a discounted cash flow analysis. Both processes require the selection of an appropriate capitalization or discount rate which considers factors such as risk, time, interest on the capital investment and recapture of the depreciating asset. The appropriateness of this rate is critical and it may be developed in various ways, such as a built-up method or mortgage-equity method, comparison to competing investments or by extraction from market data.
ReconciliationCombining information from all approaches, the appraiser is then ready to stipulate an estimated market value for the subject property. It is important to note that while this amount is probably the best indication of what a property is worth, it may not be the final sales price. There are always mitigating factors such as seller motivation, urgency or ''bidding wars'' that may adjust the final price up or down. But the appraised value is often used as a guideline for lenders who don't want to loan a buyer more money than the property is actually worth. The bottom line is: an appraiser will help you get the most accurate property value, so you can make the most informed real estate decisions.