Real Estate Exam Property Valuation & Appraisal Guide 2026
Property valuation accounts for approximately 12-14% of the real estate licensing exam — that's roughly 15-20 questions on a 100-question national section. Many candidates underestimate this section because it involves both conceptual knowledge AND math calculations.
This guide covers every valuation concept you'll see on the 2026 exam, from the three appraisal approaches to depreciation types to the principles of value.
free real estate exam practice questionsFree exam prep with practice questions & AI tutor
The Foundation: What Creates Value?
Before understanding how to value property, you need to know what creates value in the first place.
The DUST Acronym
All four of these characteristics must be present for a property to have market value:
| Letter | Characteristic | Meaning |
|---|---|---|
| D | Demand | Desire for the property backed by purchasing power |
| U | Utility | The property's usefulness to satisfy a want or need |
| S | Scarcity | Limited supply of similar properties |
| T | Transferability | The ability to transfer ownership from one person to another |
Exam Tip: If even one DUST element is missing, the property lacks market value. For example, a beautiful mansion (utility) that can never be legally sold (no transferability) has no market value.
Market Value vs. Market Price vs. Cost
This distinction appears on virtually every exam:
| Term | Definition | Key Point |
|---|---|---|
| Market Value | The most probable price in a fair, open market | What the property SHOULD sell for |
| Market Price | What the property actually sold for | What the property DID sell for |
| Cost | The amount spent to build or acquire the property | What was PAID to create it |
These three numbers are often different. A distressed seller might accept a market price far below market value. A renovation might cost $50,000 but only add $20,000 in market value.
The 3 Appraisal Approaches
1. Sales Comparison Approach (Market Data Approach)
When to use: Residential properties — this is the most common and most tested approach.
How it works:
- Find 3-5 recently sold properties similar to the subject (called "comparables" or "comps")
- Adjust each comp's sale price for differences with the subject
- Reconcile the adjusted values to determine the subject's market value
The Adjustment Rules (Critical for Exam)
The golden rule: Always adjust the COMPARABLE, never the subject.
| Situation | Action | Memory Aid |
|---|---|---|
| Comp has a feature the subject lacks | Subtract from comp | Comp Better = Subtract |
| Subject has a feature the comp lacks | Add to comp | Comp Less = Add |
Example:
- Subject property: 3 bed, 2 bath, with pool, no garage
- Comp sold for $400,000: 3 bed, 2 bath, no pool, 2-car garage
- Pool value: $20,000 | Garage value: $30,000
Adjustments:
- Comp has no pool (subject does) → Add $20,000 to comp
- Comp has garage (subject doesn't) → Subtract $30,000 from comp
- Adjusted comp value: $400,000 + $20,000 - $30,000 = $390,000
2. Cost Approach (Replacement/Reproduction)
When to use: New construction, unique properties (churches, schools), or when few comparable sales exist.
Formula:
Land Value + Replacement Cost - Depreciation = Property Value
How it works:
- Estimate the land value separately (using sales comparison of vacant land)
- Calculate the cost to replace the building at current prices
- Subtract all applicable depreciation
- Add land value to the depreciated building cost
Key distinction:
- Replacement cost = cost to build with modern materials and design (more commonly used)
- Reproduction cost = cost to build an exact replica (same materials, design)
3. Income Approach (Capitalization)
When to use: Investment and commercial properties (apartments, offices, retail).
The Cap Rate Formula:
This is one of the most important formulas on the exam. You must be able to solve for any variable:
| Find | Formula |
|---|---|
| Cap Rate | NOI ÷ Value |
| Value | NOI ÷ Cap Rate |
| NOI | Value × Cap Rate |
Step-by-step process:
- Calculate Potential Gross Income (PGI) — total income if fully occupied
- Subtract Vacancy and Collection Loss → Effective Gross Income (EGI)
- Subtract Operating Expenses → Net Operating Income (NOI)
- Divide NOI by Cap Rate → Property Value
Example:
- PGI: $120,000/year (10 units × $1,000/month)
- Vacancy loss: 5% → -$6,000
- EGI: $114,000
- Operating expenses: $44,000
- NOI: $70,000
- Cap Rate: 7%
- Value: $70,000 ÷ 0.07 = $1,000,000
Important: Operating expenses do NOT include mortgage payments or income tax. These are excluded from NOI calculations.
Gross Rent Multiplier (GRM) — The Quick Valuation Tool
GRM is a simpler income-based tool used for quick estimates:
| Formula | Use |
|---|---|
| GRM = Sale Price ÷ Gross Monthly Rent | Finding the multiplier |
| Value = Gross Monthly Rent × GRM | Estimating property value |
Example: Similar properties sell for 150× their monthly rent (GRM = 150). A property renting for $2,000/month would be valued at $2,000 × 150 = $300,000.
GRM vs. Cap Rate: GRM uses gross rent (before expenses) and is simpler. Cap Rate uses NOI (after expenses) and is more accurate. The exam tests both.
Principles of Value
These principles explain WHY properties are valued the way they are. High-frequency exam topics:
Principle of Substitution
A buyer won't pay more for a property than the cost of acquiring an equally desirable substitute. This is the foundation of the Sales Comparison Approach.
Principle of Contribution
The value of an improvement is measured by what it contributes to the property's total value — not by its cost. A $40,000 pool that adds only $15,000 in value has a contribution of $15,000.
Principle of Anticipation
Value is based on the expectation of future benefits. This is the foundation of the Income Approach — investors pay for expected future income.
Principle of Conformity
Maximum value is achieved when properties in a neighborhood are similar in size, style, and quality. Related sub-principles:
- Progression: A smaller/less valuable property benefits from being near larger/more valuable properties
- Regression: A larger/more valuable property loses value when surrounded by smaller/less valuable properties
Principle of Highest and Best Use
The most profitable, legally permitted, physically possible, and financially feasible use of a property. Appraisers must consider highest and best use when valuing property.
Principle of Supply and Demand
When demand exceeds supply, prices rise. When supply exceeds demand, prices fall. Basic economics applied to real estate.
Depreciation — The Three Types
Depreciation reduces value from the replacement cost. Know these three types cold:
1. Physical Depreciation
Cause: Normal wear and tear, age, weather damage Examples: Worn roof, peeling paint, cracked foundation, aging HVAC Curable or Incurable: Can be either
- Curable: Cost to fix is less than the value added (e.g., replacing worn carpet)
- Incurable: Cost to fix exceeds the value added (e.g., replacing an entire foundation)
2. Functional Obsolescence
Cause: Outdated design, layout, or features within the property Examples: Single bathroom in a 4-bedroom house, no closets, outdated kitchen, 8-foot ceilings in luxury market Curable or Incurable: Can be either
- Curable: Adding a bathroom where plumbing allows
- Incurable: Redesigning the entire floor plan
3. External (Economic) Obsolescence
Cause: Factors OUTSIDE the property that the owner cannot control Examples: New highway nearby, factory emissions, rising crime, declining neighborhood, airport noise Curable or Incurable: Always incurable — the owner cannot control external factors
Exam Tip: External depreciation is ALWAYS incurable. This is the most tested distinction. If the question mentions something outside the property reducing value, it's external/economic obsolescence.
CMA vs. Appraisal — Know the Difference
| Comparative Market Analysis (CMA) | Appraisal | |
|---|---|---|
| Who prepares it | Real estate agent/broker | Licensed appraiser |
| Purpose | Help set listing price or offer price | Determine market value for lending |
| Required by | Not legally required | Required by lenders |
| Legal standard | Not a formal appraisal | Must follow USPAP standards |
| Cost | Usually free (part of agent services) | $300-$600+ |
BPO (Broker Price Opinion): A less formal valuation prepared by a broker, often for lenders during foreclosures or short sales. Less detailed than an appraisal, more formal than a CMA.
Appraisal Licensing Levels
| Level | What They Can Appraise |
|---|---|
| Trainee | Under direct supervision of a licensed appraiser |
| Licensed Residential | Non-complex residential up to $1,000,000 |
| Certified Residential | Any residential property regardless of value |
| Certified General | Any property type (commercial, industrial, residential) |
Common Exam Mistakes on Valuation
- Adjusting the subject instead of the comparable. Always adjust the comp.
- Forgetting that external depreciation is always incurable. If it's outside the property, the owner can't fix it.
- Including mortgage payments in NOI calculations. Operating expenses do NOT include debt service or income tax.
- Confusing replacement cost with reproduction cost. Replacement = modern equivalent. Reproduction = exact replica.
- Mixing up GRM and Cap Rate formulas. GRM uses gross rent. Cap Rate uses NOI.
Start Practicing Valuation Questions Now
Property valuation is one of the highest-impact sections on the exam — and one of the most predictable. The same formulas and concepts appear repeatedly.
Our AI tutor can walk you through any valuation calculation step by step. Just click "Ask AI" whenever you get stuck.
Related Real Estate Exam Guides
- Contracts & Agency Guide — Master the other highest-weighted section
- Financing & Mortgage Guide — LTV, loan types, and lending regulations
- Fair Housing Laws Guide — Protected classes, violations, and exemptions
- Real Estate Exam Cheat Sheet — Quick reference for all key topics