3.3 Valuation Approaches and BPOs

3.3 Valuation Approaches and BPOs

Three approaches estimate value, each rooted in the principle of substitution. The exam tests the mechanics of each.

Sales comparison approach

The appraiser finds recently sold comparables (comps) similar to the subject, then adjusts each comp's sale price for differences. The golden rule:

Adjust the comparable, never the subject. If the comp is inferior to the subject, add value to the comp. If the comp is superior, subtract. Memory hook: CIA — Comp Inferior, Add.

Worked example: The subject has 3 bedrooms and a 2-car garage. A comp sold for $300,000 but has only 2 bedrooms (a bedroom is worth $15,000) and a 3-car garage (the extra bay is worth $8,000).

• Comp lacks a bedroom → comp is inferior → add $15,000
• Comp has an extra garage bay → comp is superior → subtract $8,000

Adjusted comp value = $300,000 + $15,000 − $8,000 = $307,000.

The comp with the fewest and smallest adjustments is generally the most reliable indicator. This approach is best for single-family homes where ample sales exist.

Cost approach

The cost approach is best for new construction and special-purpose properties (schools, libraries, churches) that rarely sell and produce no income. The formula:

Value = Reproduction or Replacement Cost − Accrued Depreciation + Land Value

• Reproduction cost — exact duplicate using the same materials.
• Replacement cost — equivalent utility using modern materials. Usually the more practical figure.

Land is added separately because land does not depreciate.

The three types of depreciation

Worked example: A new building costs $400,000 to replace, has accrued depreciation of $50,000, and sits on land worth $120,000.

Value = $400,000 − $50,000 + $120,000 = $470,000.

Trap: External obsolescence is caused by factors outside the property line and the owner cannot fix it — it is always incurable. Students wrongly label it curable because "the airport could move."

Income approach

Used for income-producing property (apartments, office, retail). The core relationship is IRV:

Income = Rate × Value, so Value = Income ÷ Rate

Here Income is Net Operating Income (NOI) — gross income minus vacancy and operating expenses, before debt service. Rate is the capitalization (cap) rate.

Worked example: A building generates $90,000 NOI. Investors expect a 9% cap rate.

Value = $90,000 ÷ 0.09 = $1,000,000.

Notice the inverse relationship: if buyers demand a higher cap rate (more risk), value falls. At a 10% cap rate the same $90,000 NOI is worth only $900,000.

For small residential rentals, appraisers may use a Gross Rent Multiplier (GRM): Value = Monthly Gross Rent × GRM. A home renting for $2,000/month in a market with a GRM of 150 indicates a value of $300,000. GRM uses gross rent (no expense deduction); cap rate uses net income — do not confuse the two.

BPOs versus appraisals

A Broker Price Opinion (BPO) is a licensed broker's estimate of likely sale price, used by lenders for non-lending decisions such as short sales, REO pricing, or portfolio review. Key limits:

• A BPO is not an appraisal and the broker is not acting as an appraiser.
• A BPO cannot substitute for an appraisal in a federally related transaction requiring one.
• Many states cap or regulate BPO fees and prohibit calling a BPO an appraisal.

A CMA is similar but is prepared by an agent for a seller or buyer to set a listing or offer price. Both the CMA and the BPO rely on comparable sales — the same logic as the sales comparison approach — but they are pricing tools, not supported value opinions, and neither follows USPAP.

Choosing the right approach

The exam often asks which approach best fits a property. Match the property to its data source:

When comparable sales are plentiful, sales comparison wins. When a property is held for cash flow, income wins. When a property is unique and rarely trades, the cost approach is the fallback because it does not depend on a market of similar sales.

Cap Rate Sensitivity: A Worked Investor Decision

The inverse relationship between cap rate and value is heavily tested, so practice it numerically. A 12-unit building produces $108,000 NOI. At an 8% cap rate the indicated value is $108,000 / 0.08 = $1,350,000. If rising interest rates push buyers to demand a 9% cap rate, the same NOI now supports only $108,000 / 0.09 = $1,200,000 — a $150,000 drop with no change in the building's income.

Conversely, if the owner raises rents and lifts NOI to $120,000 while the market holds at 8%, value climbs to $1,500,000. Two levers move income-property value: the NOI (numerator) and the cap rate (denominator), and the exam will move one while holding the other to test whether you can predict direction.

GRM vs. Cap Rate Side by Side

Worked GRM check: a fourplex rents for $8,000/month gross in a market with a GRM of 96. Value = $8,000 x 96 = $768,000. Note GRM uses the gross figure, so it never reflects how efficiently the property is operated — which is exactly why serious investors prefer the cap-rate (NOI) method.

Trap: "Reproduction" and "replacement" cost are not synonyms. Reproduction duplicates the building exactly (including obsolete features); replacement builds equivalent utility with modern materials. Appraisers usually use replacement cost, and a distractor that swaps the two is a frequent miss.