Real Estate 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.
Residential Property
A prospective buyer for a residential property is primarily interested in the property's capacity as a place to live. The property's location, size, quality, design, age, condition, desirability, and usefulness are the primary factors to be considered in making the buyer's selection. The buyer will rely heavily upon observation and his own intelligence, knowing what he can afford and comparing what is available. One property will eventually stand out as more appealing than another.

The residential appraiser must rely upon the market data approach. The residential appraiser must analyze the selling prices of comparable properties and consider the same features the buyer considers: location, size, quality, design, age, condition, desirability, and usefulness. Likewise, when appraising a property for tax purposes, the appraiser must evaluate the relative degree of appeal of one property to another.
Agricultural Property
The prospective purchase of agricultural property will be motivated in a different way. Primarily, the buyer will be interested in the productive capabilities of the land. It is reasonable to assume that the buyer will be familiar, at least in a general way, with the productive capacity of the farm he proposes to buy. When the appraiser appraises agricultural property for local tax equalization purposes, he must rely heavily upon prices being paid for comparable farmland in the community and use the market data approach. When determining the land's productive capabilities, the land must be divided into various classes according to specific types and uses: tillable, pasture, woodland, and wasteland. The appraiser may then compute the acreage and value for each class individually or compute an aggregate price per acre that includes the amount and type of each class. The appraiser must consider soil types and each soil type's fertility and make an effort to use soil and land maps that are available through agriculture extension services and state universities.

The appraiser must also take into account the buildings on an agricultural property. Since the main purpose for a rural dwelling (like an urban dwelling) is to provide a family with a home, the appraiser should value a rural dwelling in the same way he values any other residence, with the market data approach. The appraiser's approach to other farm buildings, however, must be somewhat different. When appraising farm buildings, the appraiser's primary objective is to arrive at the value the building's presence adds to the land's productivity, and the building's degree of utility or usefulness.

The appraiser must equally consider all other factors that affect property value, such as the property's location relative to the marketplace, the property's relative accessibility, the topography of the land, the shape and size of the fields, the existence and condition of the fences, drainage, water supply etc.
Commercial Property
The prospective commercial property buyer is primarily interested in the potential net return and tax shelter the property will provide. The price the buyer is justified in paying for the property is a measure of his prospects for a net return from his investment. Real estate as an investment must not only compete with other real estate, but also with stocks, bonds, annuities, and other similar investment areas.

The commercial appraiser must explore the rental market and compare the income-producing capabilities of one property to another. Thus, the commercial appraiser must rely heavily on the income approach to value to determine the net economic rent the property is capable of yielding and the amount of investment that is required to affect the net return at a rate investors would expect. The commercial appraiser must complete a comprehensive study of the income-producing capabilities of comparable properties and an analysis of present day investment practices. Because commercial property is not bought and sold as frequently as residential property, the commercial appraiser cannot establish the sales market as readily as for residential property.
Industrial Property
The prospective industrial property buyer is interested in the overall utility value of the property. When evaluating the industrial property's overall utility, the appraiser must give individual consideration to the land and to each improvement on the property.

Industrial buildings are generally designed for a special purpose or operation and usually cannot be used for other purposes. The building will maintain its value as long as the building's purpose is still a vital operation. If the operation becomes obsolete, the building will also become obsolete.

The upper limit of the industrial building's value is the building's replacement cost new. The building's present day value is a measure of the building's present day usefulness in relation to the purpose for which the building was originally designed.

The industrial appraiser must rely heavily on the cost approach to value: determining the upper limit or replacement cost new of each improvement and the subsequent loss of value resulting overall from physical, functional, and economic factors.

The industrial appraiser cannot rely on the market data approach because there is a very limited number of sales, with each sale generally reflecting different circumstances and conditions, and he cannot rely on the income approach because of the lack of comparable investments and the inability to accurately determine each unit of production's contribution to the overall income produced.