Understanding real estate valuation methods is crucial for evaluating residential and commercial properties. Real estate agents use this knowledge to set selling or rental prices. That way, they ensure successful sales, meeting the seller's goals. Mortgage lenders and investors also find it essential to comprehend these methods. Experts in real estate investment need property valuations for informed decision-making. Selecting the right investment property is crucial for their rate of return.

This article explores popular property valuation methods. It gives insights into their methodology and how to incorporate them into valuation.

What are the three standard methods of valuation in real estate?

A precise property valuation relies on a systematic gathering of information. It gathers and assesses data on the specific property and its surroundings. Real estate valuations use various methods to determine the market value. The most relevant methods are the sales comparison, the cost, and the income approach. The following article will explore each method and explain how to use them.

The sales comparison approach

The sales comparison approach is also known as the market data approach. Experts use it to assess the value of a property and the land's value. They estimate the value of the property by comparing it to similar properties.

To ensure a valid comparison, each comparable property should meet the following criteria:

• Similarity to the subject property: Comparables should ensemble the real estate appraisal.

• Recent sales within the last year: Sales of similar properties in a competitive real estate market over the past year.

• Sold under typical market conditions: The conditions of comparable sales should reflect the standard market scenario.

Adjustments to the price estimate are often necessary based on the following:

• Age and condition of buildings

• Date of sale

• Terms and conditions of sale

• Location

• Physical features

The cost approach

The cost approach is based on the principle that the value of a property is equivalent to the cost of replacing the property with a similar one or rebuilding it identically. The cost approach is ideal for assessing non-income properties like schools, churches, hospitals, and government buildings. This approach estimates building costs. Thus, it looks at comparable prices, construction materials, installation costs, and the value of the land.

In the context of property valuation, the following depreciations are essential:

• Physical Deterioration

• Functional Obsolescence: The value may drop due to design, market preferences, or functionality.

• Economic Obsolescence: External factors like traffic changes or construction noise can lower a property’s value.

The income approach

This method values properties by linking expected return with net income. It's straightforward for properties with predictable and stable future income and expenses.

When employing the income approach, valuers go through the following steps:

1. Calculate the potential annual gross income.

2. Establish adequate gross income accounts for vacancy and rent collection losses.

3. Subtract annual operating expenses to determine the yearly net operating income.

4. Assess the property's value to a real estate investor. Calculate the income-based capitalisation rate or return rate. The capitalisation rate depends on costs and comparable investment options. Additionally, varying risks and durations can have an impact. This evaluation is crucial in volatile markets, where distortions may occur.

5. Use the capitalisation rate to estimate the property value.

   
   

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