Which rate is used to determine the value of a property?
When it comes to buying or selling a property for your business, the starting point is to figure out how much the property is worth. This seems simple enough – surely, you see what has previously been sold in your locality and use that as a jumping off point? Sadly, the valuation of property – and especially commercial property – is not quite so straightforward. If it were, there would be no need for professional appraisers in this field. Show
What Is Market Value?Market value is a professional opinion of what a property would sell for at arm's length – meaning to an independent buyer, without any concessions or kickbacks – based on the local real estate market, supply and demand, what other similar properties are selling for in the area, and the specific features and benefits of the property. This is not the same as the market price of a property, which can be more or less than the market value. That's because the price is whatever the seller agrees to sell the property for. This could be the same as the market value, or the seller may accept a lower price for the property because, for example, he needs a quick sale. Three Different Methods of ValuationThere's also a much longer definition of market value, and that depends on the type of valuation method being used. There are three primary methods of valuation in the United States: the sales comparison approach, the cost approach and the income approach. Part of an appraiser's job is to know what method to use for a given property in a given location. Before we look at the three approaches, bear in mind that a good percentage of a property's value is subjective. Deciding how much a property is worth is more art than science, and certain parts of the process can be a little difficult to comprehend. You could ask three different appraisers to value the same property and get three different answers. This is especially true for a commercial property where scarcity might play a role in the property's valuation. The valuations could be tens of thousands of dollars apart in some cases! House Valuation Using the Sales Comparison ApproachThe sales comparison approach is the most frequently used method for determining the value of residential real estate, although it is also suitable for valuing some types of commercial properties. Using this approach, the property's value is based on what similar properties have sold for recently in the same market. These properties are called "comparables" or "comps" – hence the term sales comparison approach. Here's how it works:
Land Appraisal Using the Cost ApproachThe cost approach starts by calculating how much the property would cost to rebuild, either as an exact replica of the current building or for the construction of a similar building with comparable features and amenities but with modern construction materials. The appraiser then deducts an amount for accrued depreciation, which represents the reduction in the value of the property over time as a result of obsolescence or wear and tear. The theory here is that no one would pay more for an existing property than it would cost to build the same property from scratch. The cost approach is favored in newer construction or for valuing special-use properties where there aren't enough similar properties for comparison. If you're valuing a commercial property, industrial property or bare land, then this is may be the most reliable approach. Here's how you do it:
Income Approach for Leased BuildingsIf the subject property is leased and income-producing, you have the option of valuing it using the income approach. This method uses the property's rental income, or potential for income, to substantiate its market value. Apartment buildings and duplexes are examples of properties that you might value using the income approach. This method gets a little complicated, and whole books have been written on how to do it. Here's the abbreviated version:
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