The Three Approaches to Value
There are three approaches to the determination of property value: the cost approach, the market sales comparison approach, and the income approach. These approaches are based on three aspects of value:
- The value indicated by recent sales of comparable properties in the market, with adjustments for age, condition, and other characteristics
- The cost of reproducing or replacing a property minus accrued depreciation
- The investment value as represented by the net earning power of a property based on the capitalization of the income stream.
The generally accepted procedure is to utilize as many of the three industry-accepted approaches as possible in an appraisal. Choose the most appropriate as the principle method for the specific appraisal situation, and apply the other valuation approaches to support the final value estimate.
There are situations where only one or two approaches may be used. For instance, an owner-occupied residential property is not likely to produce rental income that could be capitalized into an estimate of value through use of the income approach. So, the sales comparison or cost approaches might be more appropriate. Vacant land has no cost of improvements, so the cost approach would not be an appropriate method for that situation.
Specialized properties such as mortuaries, hospitals or zoos do not typically change hands enough to generate comparative sales, so the cost or the income approach might be more appropriate in those cases.