Real Estate Valuations

Introduction

Estimating the value of a real estate is a key element to real estate financing, listing for sale, property insurance, investment analysis, and taxation. For most instances, figuring the asking price of a property is the typical application of a real estate valuation. However, the methods and basic concepts remain the same for any application.

Value

Value is defined as the present worth of future benefits from owning the real estate property. Most goods are consumed quickly, but the benefit of owning real estate is realized over many years. Therefore, a valuation takes into consideration the social and economic trends, environmental conditions, and government regulations.

Utility – the capability to satisfy a future owner’s needs and desires

Demand – the need or desire for ownership supported by access to finances that satisfy the need

Transferability – the ease by which the ownership can be transferred

Value

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The four elements that determine value are:

Scarcity – the finite supply of similar properties4

Appraisal Methods

Cost Approach

Income Capitalization Approach

Gross Income Multipliers

Appraisal Method Approaches

Appraisal Methods1) Cost Approach

The cost approach estimates the value of a real estate that has been improved by additional buildings. This method separates the value of the land and the buildings, taking into account the depreciation. The estimates are combined to determine the value of the entire property. The cost appAroach assumes that a reasonable buyer would not spend more for an improved piece of real estate than it would cost to buy a bare lot and build a comparable building. This method works well when the property is a type that does not come to the market frequently, such as a church, school, government building, or hospital.

Appraisal Methods2) Income Capitalization Approach

The income approach represents another common method of real estate appraisal. This considers the relationship between the net income of a property and the rate of return that an investor seeks. Generally, the income capitalization approach is used to put a value on income producing properties including office buildings, apartment complexes, and shopping centers. This type of appraisal is straightforward when the property has consistent and predictable revenues and expenses.

Appraisal Methods3) Gross Income Multipliers

The gross income multiplier method is used to value a real estate that could become a rental property, such as single-family homes or duplexes. The GIM method relates the expected rental income to the sales price of the real estate. For residential properties, the gross monthly income is considered. For industrial and commercial properties, the gross annual income is considered.

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