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Three Methods of Property Valuation

Originally published in the Comox Valley Business Gazette, June/July 2015

Every day our real estate appraisers are asked a simple question: What’s the current market value of my property?

The basics of real estate appraisal lie in the use of three proven methods of valuation — the Cost Approach, Income Approach and Direct Comparison Approach — each considered within the context of the subject property and applied as necessary.

Cost Approach: Most applicable to newly built or special-use properties, this method is based on the economic principle of substitution and holds that a potential buyer of a property will concurrently consider the cost of acquiring a similar vacant piece of land and constructing a building of similar size and utility. The Cost Approach value is then refined downwards by the application of depreciation factors. To apply this method, the appraiser relies on known vacant land sales and building construction costs.

Income Approach: Commercial real estate is an investment and competes with the full spectrum of investments to attract capital (i.e., stocks, mutual funds, fine art, etc.). In applying the Income Approach, the appraiser calculates the anticipated net income of the property (rents less expenses) and then divides by a market-derived yield rate to determine the current market value of the property. This method is most applicable to investment rental properties.

Direct Comparison Approach: A potential buyer of a property will typically consider other recent sales and listings of similar properties. The approach includes a set of procedures by which a value indication is derived by comparing the subject property to similar properties on an appropriate “unit of comparison basis” (e.g. per square foot). The appraiser applies adjustments to individual elements of comparison to derive a market value estimate; it’s most applicable to owner-occupied properties.

Selection, application and reconciliation of the three approaches require an appraiser’s judgment and interpretation. Real estate markets are local; a quality appraisal report can only be prepared by an appraiser with comprehensive, local market knowledge.

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