Which of the value approaches is used most often when the subject property is an owner occupied home?

Appraisers use three approaches to value in Appraisal Practice when determining the Market Value of a property:

• The Sales Comparison Approach
• The Cost Approach
• The Income Approach

1. The Sales Comparison Approach

The most frequently-used and accepted approach to determining value in real estate appraisal practice is the sales comparison approach. This approach to value bases its opinion of value on what similar properties (otherwise known as “comparables”, or “comps”) in the vicinity have sold for recently. These properties are adjusted for time, acreage, size, amenities, etc. as compared to the property that is being appraised. Understanding which (and to what extent) adjustments are reasonable for a given market area (for a given property) relies on the experience of the appraiser. A property characteristic that is highly valued in one neighborhood may not be valued to the same degree in a different area.

2. The Cost Approach

The second approach to determining the value of a property is the cost approach. This approach seeks to determine how much a property would cost to replace (meaning, rebuild) after subtracting accrued depreciation. Accrued depreciation is the reduction in actual value of property over a period of time as a result of wear and tear or obsolescence. The term reproduction cost is used if an exact replica of the original property is produced. The term replacement cost is used if a property is rebuilt with comparable utility, but using current design and construction methods and materials.

The cost approach is considered to be more reliable when used on newer construction. The methods and results of the cost approach are considered to be less reliable with older construction.

The cost approach appraisal is frequently the only approach that is considered to be reliable when appraising special use properties such as commercial/industrial properties or public properties such as libraries, schools or churches which are not traded on the open market.

3. The Income Approach

The third approach to value is called the income approach. When a property generates income for it’s owner, that income, or potential for income, helps to substantiate, calculate or identify the market value of the property. Apartment buildings and duplexes are examples of income-producing properties. Appraisers use the income derived from the property as part of the assessment the market value of the property.

The income approach, sometimes referred to as the income capitalization approach, is a type of real estate appraisal method that allows investors to estimate the value of a property based on the income the property generates. It’s used by taking the net operating income (NOI) of the rent collected and dividing it by the capitalization rate.

The income approach is typically used for income-producing properties and is one of three popular approaches to appraising real estate. The others are the cost approach and the comparison approach. The income approach for real estate valuations is akin to the discounted cash flow (DCF) for finance. The income approach discounts the future value of rents by the capitalization rate.

When using the income approach for purchasing a rental property, an investor considers the amount of income generated and other factors to determine how much the property may sell for under current market conditions. In addition to determining whether the investor may profit from the rental property, a lender will want to know its potential risk of repayment if it extends a mortgage to the investor.

Of the three methods for appraising real estate, the income approach is considered the most involved and difficult.

When using the income approach for purchasing a rental property, an investor must also consider the condition of the property. Potential large repairs that may be needed can substantially cut into future profits.

In addition, an investor should consider how efficiently the property is operating. For example, the landlord may be giving tenants rent reductions in exchange for completing yard work or other responsibilities. Perhaps specific tenants are facing economic difficulties that should turn around in the next few months, and the landlord does not want to evict them. If rent being collected is not greater than current expenses, the investor will most likely not purchase the property.

With the income approach, the cap rate and estimated value have an inverse relationship—lowering the cap rate increases the estimated value

An investor must also ascertain how many units on average are empty at any given time. Not receiving full rent from every unit will affect the investor’s income from the property. This is especially important if a property is in great need of repairs and many units are vacant—suggesting a low occupancy rate. If the units are not filled on a regular basis, rent collection will be lower than it could be, and purchasing the property may not be in the investor’s best interest.

• The income approach is a real estate valuation method that uses the income the property generates to estimate fair value.
• It's calculated by dividing the net operating income by the capitalization rate.
• A buyer should pay special attention to the condition of the property, operating efficiency, and vacancy when using the income approach. 

With the income approach, an investor uses market sales of comparables for choosing a capitalization rate. For example, when valuing a four-unit apartment building in a specific county, the investor looks at the recent selling prices of similar properties in the same county. After calculating the capitalization rate, the investor can divide the rental property’s NOI by that rate. For example, a property with a net operating income (NOI) of $700,000 and a chosen capitalization rate of 8% is worth $8.75 million.

The term sales comparison approach refers to a real estate appraisal method that compares one property to comparables or other recently sold properties in the area with similar characteristics. Real estate agents and appraisers may use the sales comparison approach when evaluating properties to sell. This method accounts for the effect that individual features have on the overall property value. In other words, the total value of a property is the sum of the values of all of its features.

• A sales comparison approach is a valuation method used in the real estate industry that compares one property to similar ones recently sold in the area.
• The SCA is used as the backbone for the comparative market analysis which considers prices of recently sold properties that are similar and within the same geographic area.
• Some of the common characteristics that make up the SCA include location, recently sold listings, features, age and condition, and average price per square foot.

The sales comparison approach helps real estate professionals and buyers determine if the price of a home is fair and comparable to the current market. Professionals use similar properties that were recently sold within a short distance of the subject property—usually in the same neighborhood—that share similar characteristics as a comparison.

The SCA is used as the backbone for the comparative market analysis (CMA). This is an analysis of the prices of recently sold properties that are similar and within the same geographic area. In other words, the approach often entails looking at local properties to see what they have in common. From there, appraisers can determine a value for a property based on its features.

Although there are many steps that a real estate appraiser can take in evaluating a property's value, the following are some of the most common characteristics used in an SCA:

• Location and neighborhood: Geography may directly impact the value of real estate. It's important to compare homes in the same neighborhood rather than those found in another part of town. Factors considered include proximity to schools, nearby bodies of water, parks, and how close they are to highways and overpasses, as well as pollution levels.
• Recently sold listings: These properties can provide a starting point for the value of homes in the area. Although features and the market factor into the sale price, reviewing property values and recent sales are good baseline numbers.
• Features: A home should be compared with properties with the same number of bedrooms, garages, and bathrooms. The comparison should include homes of about the same square footage on parcels of land that are about the same size.
• Age and condition: It's important to compare homes of similar age as well as soundness. A home's condition significantly influences an appraisal. For example, there may be two similar homes in the same neighborhood. But if one is in need of repair, it can seriously affect its value.
• Average price per square foot: Once similar homes are compiled, take each of their sale prices and divide them by their square footage. The result yields the cost per square foot based on the homes in the sales comparison analysis. Take the average cost per square foot for all comparable homes and multiply that number by the square footage of the home being appraised.

There are many other features that may increase the value of a home. However, a sales comparison analysis is not an exact science since the value of a home is somewhat subjective, meaning one family may find more value in it than another, thereby increasing their offer. As stated earlier, outside factors such as the overall state of the economy, the job market, and the state of the real estate market all play heavily into how much a home is sold for or how long it sits on the market.

Since the sales comparison approach isn't an official appraisal, owners may need to hire an appraiser for unique properties and those that are hard to value.

But remember, the sales comparison approach used in real estate valuation is not an official appraisal. In cases where a unique property is to be valued or one whose value is difficult to determine, a formal appraisal may be required. This means hiring an appraiser—an independent and unbiased professional who determines the property's fair value by using certain facts, figures, and other considerations.