How Appraiser’s Derive a Property’s Value

Appraisals are a crucial part of the real estate transaction process, providing an unbiased estimate of a property’s market value. This value is often needed for mortgage approvals, tax assessments, or other financial decisions. But how exactly is an appraisal conducted? Here’s a breakdown of the main methods appraisers use to determine property value.

1. Sales Comparison Approach
What It Is: The sales comparison approach is one of the most common methods, especially for residential properties. It involves comparing the subject property (the one being appraised) to similar properties, or “comparables,” that have recently sold in the same area.
How It Works: Appraisers look at factors like location, size, age, condition, and recent sale prices of comparable homes. Adjustments are made based on differences between the properties, such as additional square footage, an extra bathroom or age. By analyzing recent sales, the appraiser arrives at a value that reflects what the property would likely sell for in the current market.

2. Cost Approach
What It Is: The cost approach is frequently used for new construction or unique properties without comparable sales. It estimates value based on what it would cost to rebuild the property from scratch, factoring in land, materials, and labor.
How It Works: The appraiser calculates the cost of replacing the structure as if it were new, minus any depreciation due to wear and tear, age, or obsolescence. Then, they add the estimated land value to the replacement cost to arrive at a total property value. This approach is especially useful for insurance appraisals or unusual properties.

3. Income Approach
What It Is: Commonly applied to rental and commercial properties, the income approach evaluates a property’s value based on the income it can generate.
How It Works: The appraiser calculates the expected income the property can produce, such as rent, and adjusts for expenses to determine the net operating income (NOI). Using a capitalization rate, or “cap rate,” the appraiser divides the NOI by this rate to arrive at the property’s value. This method is popular among investors because it emphasizes cash flow potential and return on investment.

Each of these methods provides a different perspective on a property’s value, and the appraiser’s job is to reconcile these values based on the property type and purpose of the appraisal. For residential homes, the sales comparison approach is often prioritized, while income-producing properties may focus more on the income approach. New construction homes may place additional emphasis on the cost approach.