Valuation Methods and BPO

Appraisers estimate value using three primary approaches. The exam tests when each approach is most appropriate and how the calculations work.

Sales Comparison Approach (Market Data)

The sales comparison approach compares a subject property to recent comparable sales. It is the most common method for residential properties.

Key steps:

1. Select comparable properties.
2. Adjust for differences (size, condition, features, location).
3. Reconcile adjusted prices to estimate value.

Principle of substitution supports this approach: buyers choose the best substitute available.

Adjustment Direction

• If a comp is better, subtract value to make it similar.
• If a comp is worse, add value to make it similar.

Cost Approach

The cost approach is based on the cost to replace the building minus depreciation, plus land value.

Formula:

Value = Land Value + (Replacement Cost - Depreciation)

Reproduction vs. Replacement

• Reproduction cost - Cost to build an exact replica.
• Replacement cost - Cost to build a similar structure with modern materials.

Depreciation Types

• Physical deterioration - Wear and tear (curable or incurable).
• Functional obsolescence - Outdated design or layout.
• External obsolescence - Negative influences outside the property.

The cost approach is useful for new construction and special-use properties where comparables are limited.

Income Approach

The income approach estimates value based on the income a property generates. It is most common for investment properties.

Key formulas:

• Net Operating Income (NOI) = Gross Income - Operating Expenses
• Value = NOI / Cap Rate

Gross Rent and Gross Income Multipliers

• GRM (Gross Rent Multiplier) - Price divided by monthly rent.
• GIM (Gross Income Multiplier) - Price divided by annual income.

These shortcuts are common on the exam for simple calculations.

CMA vs. BPO vs. Appraisal

Table: CMA vs. BPO vs. Appraisal

A Broker Price Opinion (BPO) is an opinion of value prepared by a broker, often for lenders handling distressed properties. It is not a formal appraisal.

Acronym Reference

Table: Valuation Acronyms

Assessed Value and Tax Implications

Assessed value is the value assigned for property tax purposes. Local governments use assessment ratios and mill rates to calculate taxes.

Basic formula:

Property Tax = Assessed Value x Tax Rate

Assessed value often lags market value because assessments may be updated on a cycle.

Applied Scenario: Which Approach Fits Best?

• A new custom home with few comparable sales: use the cost approach.
• A small apartment building: use the income approach.
• A typical single-family home in a subdivision: use the sales comparison approach.

Exam Traps

• Using the income approach for owner-occupied homes without rental income.
• Forgetting to subtract depreciation in the cost approach.
• Treating a CMA or BPO as a formal appraisal.

Summary

Sales comparison reflects market behavior, cost approach reflects replacement cost, and income approach reflects earning power. Know when each method applies, and recognize the limits of CMA and BPO.

Sales Comparison Adjustment Example

Suppose a subject property is 2,000 square feet with a 2-car garage. A comparable sale is 1,900 square feet and has a 1-car garage, and it sold for $390,000.

If square footage is valued at $100 per square foot and a garage bay is worth $8,000, the adjustments would be:

• Add $10,000 for 100 extra square feet
• Add $8,000 for the extra garage bay

Adjusted comp value = $390,000 + $10,000 + $8,000 = $408,000

This adjustment process is central to the sales comparison approach.

Cost and Income Examples

Cost Approach Example

Land value: $120,000 Replacement cost: $300,000 Depreciation: $40,000

Value = $120,000 + ($300,000 - $40,000) = $380,000

Income Approach Example

Gross annual income: $60,000 Operating expenses: $20,000 NOI = $40,000 Cap rate: 8 percent

Value = $40,000 / 0.08 = $500,000

Assessed Value Example

If assessed value is $350,000 and the tax rate is 1.2 percent, the annual property tax is: $350,000 x 0.012 = $4,200

These quick calculations appear frequently on the exam.

Selecting Comparables and Making Adjustments

Comparable sales should be recent, similar in size and condition, and located in the same market area. When exact matches do not exist, appraisers use adjustments based on paired sales or market-derived data.

Common adjustment categories include:

• Location and neighborhood
• Living area and lot size
• Bedrooms and bathrooms
• Condition and upgrades
• Parking and amenities

Remember the adjustment rule: adjust the comparable, not the subject.

Capitalization Rate Basics

The cap rate reflects the return an investor expects. A higher cap rate means higher risk and lower value, while a lower cap rate means lower risk and higher value. When interest rates rise, cap rates often rise, which can reduce values for income properties.

Exam Application Check

If the question asks which approach is least reliable for a unique property with no income and no comps, the best answer is usually the cost approach because it relies on replacement cost and depreciation.