6.2 Sales Comparison & Cost Approaches to Value

6.2 Sales Comparison & Cost Approaches to Value

California real estate appraisers and brokers utilize three primary approaches to estimate market value: the Sales Comparison Approach, the Cost Approach, and the Income Capitalization Approach. This section examines the mechanics, formulas, and applications of the Sales Comparison and Cost approaches, along with the detailed analysis of accrued depreciation.

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1. The Sales Comparison Approach (Market Data Approach)

The Sales Comparison Approach (historically called the Market Data Approach) estimates property value by comparing the subject property with recent sales of similar properties (comparables or "comps") in the same or competing market areas.

Applicability

• Best Suited For: Single-family residential homes, residential condominiums, townhomes, and vacant/unimproved land.
• Rationale: Relies heavily on the Principle of Substitution—buyers will not pay more for the subject property than the price paid for comparable substitute homes recently sold nearby.

Mechanics of Comparable Adjustments

Because no two properties are identical, appraisers make financial adjustments to the sale prices of the comparable properties to make them equivalent to the subject property.

CRITICAL RULE: NEVER ADJUST THE SUBJECT PROPERTY! Always adjust the price of the comparable property ($Comp$) to match the features of the subject property ($Subject$).

Appraisers follow two mandatory acronyms to execute adjustments accurately:

• CBS — Comp Better, SUBTRACT: If the comparable property has a feature superior to the subject property (e.g., the comp has a 3-car garage while the subject has a 2-car garage), subtract the market value of that feature from the comparable's sale price.
• CIA — Comp Inferior, ADD: If the comparable property is missing a feature that the subject property possesses (e.g., the comp lacks air conditioning while the subject has central AC), add the market value of that feature to the comparable's sale price.

Standard Appraisal Guidelines for Comparables

• Quantity & Timeliness: A minimum of 3 comparable sales sold within the preceding 6 months (preferably within 90 days in rapidly shifting markets).
• Proximity: Located within the subject property's immediate neighborhood or market area (typically within a 1-mile radius in suburban California).
• Arm's-Length Status: Must be open-market sales without foreclosure distress, probate urgency, or related-party transactions.

Case Scenario: Sales Comparison Adjustment

• Subject Property: 2,000 sq. ft., 4 Bedrooms, 2 Baths, Fireplace, No Swimming Pool.
• Comparable Sale A: Sold for $820,000. 2,000 sq. ft., 4 Bedrooms, 2 Baths, No Fireplace (Inferior by $5,000), Has Swimming Pool (Superior by $25,000).

$\text{Adjusted Comp A Price} = \$820,000 + \$5,000 \text{ (CIA for Fireplace)} - \$25,000 \text{ (CBS for Pool)} = \$800,000$

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2. The Cost Approach (Cost Depreciation Approach)

The Cost Approach is based on the premise that an investor will pay no more for a property than the cost to acquire the land and construct an equally desirable new building.

Applicability

• Best Suited For: Special-purpose public and institutional properties (churches, schools, municipal buildings, libraries, post offices, fire stations) and brand-new construction.
• Rationale: Used when comparable sales are non-existent and the property generates no rental income.

The Cost Approach Formula

To calculate property value under the Cost Approach, appraisers follow a mandatory three-step formula:

$\text{Land Value} + (\text{Reproduction/Replacement Cost New} - \text{Accrued Depreciation}) = \text{Indicated Property Value}$

Exam Note: Land is never depreciated. Land value is calculated separately using the Sales Comparison Approach as if the land were vacant and available for its highest and best use.

Reproduction Cost vs. Replacement Cost

1. Reproduction Cost: The current cost to construct an exact duplicate replica of the subject building using the exact same materials, architectural design, craftsmanship, and structural flaws as the original.
   • Usage: Historical landmark buildings and vintage architectural restorations.
2. Replacement Cost: The current cost to construct a building of equivalent utility and function using modern building materials, contemporary engineering standards, and current building codes.
   • Usage: Standard commercial and residential appraisals.

Cost Estimating Methods

• Square-Foot (Comparative Unit) Method: Cost per square foot of floor area based on regional building cost manuals.
• Unit-in-Place Method: Estimates installed costs of major components (roofing per square foot, foundation per linear foot, framing per stud).
• Quantity Survey Method: Most detailed and accurate method; itemizes every single construction cost (raw materials, labor hours, permits, overhead, profit).

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3. Accrued Depreciation Analysis

Accrued Depreciation is the total loss in value from all causes between the building's cost new and its current market value. Appraisers categorize accrued depreciation into three distinct types: