How are Property Values Determined?
If you are in a situation where you need to know the value of your home, then you might have to get a professional appraisal. However, before you go out and find a real estate appraiser, it is useful to know what methods they use to appraise property values. If you understand their methods, you can get a better idea of the factors that determine the value of any property. Let's take a look at the methods that are currently in use.
Direct Comparison Approach
This method looks at a property and determines its value based on what an informed buyer would pay for a similar or comparable property, a property that is just as desirable and just as useful as your property is.
Steps Required in Direct Comparison Approach:
- Selecting good comparable sales and listings.
The comparables need to be within the local market area, at or near the date of appraisal and truly comparable in that it will appeal to the same type of buyer who would consider buying the property being appraised, e.g., if the appraisal is for a detached house, then a semi-detached house would not be a good comparable. The comparable sales also need to be a bona fide arm's length transaction.
- Collecting information on each comparable. The best way would be inspection of comparables if possible.
- Analyze all relevant data, e.g., time of sale and features.
- Comparing each property with the subject property and making the necessary adjustments.
- Reconciliation and arriving at a reasonable value estimate.
The cost approach is a method that is often used to appraise new improvements that represent the highest and best use of the land or a property with unique features where there are no comparable sales data. Here the appraiser determines how much it would cost to replace this property with one that would be equally as useful and desirable.
Steps in applying the cost approach:
- Estimate the value of the site. Determining how much is the site worth, based on a study of comparable sales.
- The cost to replace the property on the effective date of appraisal or in selected circumstances the reproduction cost, the cost of constructing a similar house, determining how much would it cost to replace the building with one that is equally useful, using current building materials.
- Estimate what factors are causing this property to depreciate. These can include wear and tear or the inability of the building to live up to the function that it was meant to handle when it was first constructed. Other external economic factors that would depreciate the value of the property are also considered, such as changes in transportation or advances in current building methods.
- Subtract the accrued depreciation (Step 3) form the cost to replace the property or reproduction cost of the improvements (Step 2).
- The value from step 4 is added to the land value determined in the step 1 and the appraiser then has the current market value of the property.
If you have a property than can generate income from rent or other economic activity, then the Income approach can be used by the appraisers. The idea here is that the value of a property is directly related to the anticipated benefits from the property ownership.
There are 6 steps:
- Find out how much income can be realized from your property. This can be determined by analyzing income for similar properties in the area.
- Calculate the effective income by deducting estimated losses due to vacancy and bad debt from the potential income in step 1.
- Add other possible incomes to the effective income to arrive at the gross operating income.
- Calculate net operating income by deducting the operating expenses from gross operating income.
- Select appropriate capitalization rate.
- Capitalize net operating income into a value estimate. This is a mathematical process called capitalization which uses the selected capitalization rate to convert the net operating income into a value estimate.
These are the basic methods that are used in determining property values and if you decide to have your home or property professionally appraised, most likely one of these methods will be used.
Key Criteria in Property Values
It is important to be mindful of the hierarchy of central factors that will determine the value of a home. In the majority of cases, LOCATION and SIZE will most account for value. The home's condition, quality and amenities contribute less.
Principles of Property Valuation
The following, known as Principles of Home Evaluation, are some important terms to distinguish in the listing of your home.
- COST - The amount paid for a home.
- PRICE - The amount asked for a home.
- VALUE - The worth to someone in particular.
- MARKET VALUE - The appeal to MANY home buyers, causing a sale within a short period of time.
Regression & Progression of Property Values
Regression occurs when the value of a larger home is brought down due to the influence of numerous smaller homes in the area. Alternately, Progression refers to cases in which a smaller home's value is increased due to its proximity to larger homes.