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Real Property Valuation 
Three Approaches to Value
Cost Approach The cost approach involves making an
estimate of the depreciated cost of reproducing or replacing the building and site
improvements. Reproduction cost refers to the cost at a given point in time of
reproducing a replica property; whereas replacement cost refers to the cost of
reproducing improvements of equal utility. From this cost new is deducted any depreciation
for loss in value caused by physical deterioration and functional or economic
obsolescence. To this depreciated cost is added the estimated land value, resulting in an
indication of value derived by the cost approach. The cost approach is significant because
it is the one approach that can be applied on all types of construction. It is a starting
point for appraisers and, therefore, a very effective yardstick in any equalization
program for ad valorem taxes. The widest application of the cost approach is in the
appraisal of property where the lack of adequate market and income data preclude the
reasonable application of the other traditional approaches.
Income Approach The income approach is the most often used
approach in the appraisal of commercial or industrial property. The strength of the income
approach is its ability to measure a property's value based on the property's ability to
generate and maintain a stream of income for the owner. To be effective, this method
requires the appraiser to have the ability to gather basic information, to analyze the
income yields in terms of their relative quality and durability, and to relate all of the
information gathered and analyzed to the changing economic environment of the area being
studied. This approach lends itself best to the appraisal of commercial or industrial
property because the prospective buyers of commercial property are primarily interested in
the potential net return and tax shelter the property will provide them. The price at
which they will be justified in paying for a property is a measure of the prospects of the
net return from their investment in the property.
This approach has its basic application in the appraisals of properties
universally bought and sold for their ability to generate and maintain a stream of income
for their owners. The effectiveness of the income approach lies in the appraiser's ability
to relate to the changing economic environment and to analyze income yields in terms of
their relative quality and durability.
The residential appraiser must analyze the selling prices of comparable
properties and consider the same factors the buyer considers: location, size, quality,
design, age, condition, desirability, and usefulness. When using the market data approach,
the appraiser compiles sales figures and compares a property with similar properties that
have recently sold. The appraiser must take a large number of sales and select only those
which are truly comparable with the property being appraised. Using a specially designed
program, the appraiser can set parameters for comparison. The computer can search the
sales file, seeking only those sales that truly match up with the subject property. This
ability to select comparable sales from the sales file is significant because it produces
estimates of value that directly reflect the attitude of the market.
Approaches to Property Classes
The prime objective of mass appraisals for tax purposes is to equalize
property values regardless of property class. For instance, the value of one residential
property must be equalized with each residential property, as well as with each
agricultural, commercial, and industrial property within the political jurisdiction. The
property classes or types are residential, agricultural, commercial, and industrial.
The common basis for equalization is market value: the price which an
informed and intelligent person, fully aware of the existence of competing properties and
not being compelled to act, is justified in paying for a particular property. Therefore,
the appraiser's job is to estimate a reasonable price for the property. To make this
estimation, the appraiser must coordinate the valuation approaches of the various property
classes to reflect the prospective buyer's motives for each property type. In other words,
the motives that influence prospective buyers tend to differ depending upon the type of
property involved, and the appraiser's approach to value must differ accordingly.
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