3.3 Valuation Approaches (Sales Comparison, Cost, Income) and BPOs

The three approaches at a glance

The sales comparison approach rests on the principle of substitution: a buyer pays no more than for an equally desirable substitute. It is the most reliable for residential property and the backbone of a CMA.

Sales comparison: adjust the comparable, never the subject

The rule that trips up the most candidates: you adjust the comparables, not the subject. If a comparable is superior to the subject (it has an extra bathroom the subject lacks), you subtract that value from the comp's sale price. If a comparable is inferior (no garage where the subject has one), you add value to the comp.

Memory hook: CIA — Comp Inferior, Add (and the reverse, comp superior, subtract).

Worked example. Subject has a garage and a third bedroom. A comparable sold for $300,000.

• Comp lacks a garage worth $12,000 → comp is inferior → add $12,000.
• Comp has a finished basement the subject lacks, worth $8,000 → comp is superior → subtract $8,000.

Adjusted comp value = 300,000 + 12,000 − 8,000 = $304,000.

Cost approach: replacement vs. reproduction, then depreciation

The formula:

Value = Land value + (Cost new − Accrued depreciation)

• Reproduction cost = exact replica with the same materials.
• Replacement cost = a functional equivalent with modern materials (used more often).

Depreciation comes in three forms—know which are curable:

Worked example. Land $80,000; replacement cost new $260,000; accrued depreciation $45,000. Value = 80,000 + (260,000 − 45,000) = $295,000. External obsolescence is always incurable because the owner cannot control it.

Income approach: IRV and the cap rate

For income property, value derives from net income via the IRV triangle:

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

Use Net Operating Income (NOI) — effective gross income minus operating expenses, before mortgage payments (debt service is not an operating expense).

Worked example. A building generates $60,000 NOI and the market cap rate is 8%.

Value = 60,000 ÷ 0.08 = $750,000.

Inverse relationship trap: as the cap rate rises, value falls for the same income. If buyers demand a 10% return instead, value = 60,000 ÷ 0.10 = $600,000. A higher cap rate signals higher perceived risk, so riskier properties sell for less per dollar of income.

Watch how NOI is built. Start with potential gross income, subtract a vacancy and collection loss to get effective gross income, then subtract operating expenses (taxes, insurance, management, repairs, reserves) to reach NOI. Do not subtract the mortgage payment, depreciation, or income taxes—those are below the NOI line.

For small residential rentals appraisers may instead use a gross rent multiplier: Value = Monthly rent × GRM. If similar buildings sell at 120 times monthly rent and a unit rents for $2,000, indicated value ≈ $240,000. The GRM is faster but cruder because it ignores expenses.

CMAs and BPOs — not appraisals

A CMA is the salesperson's pricing tool: recent comparable sales, active listings, and expired listings to suggest a list price. A BPO is a broker's price opinion, often ordered by lenders for short sales or REO, and is generally cheaper and faster than an appraisal. Neither is an appraisal, and in many states a licensee may not call a BPO an appraisal or charge for one as if it were appraisal work. Use a CMA to set price; rely on a licensed appraiser when a defensible value opinion is legally required.

When you build a CMA, read the comparables the way an appraiser would: prefer sold comparables (what buyers actually paid), use active listings to gauge current competition, and use expired listings as a ceiling—properties that did not sell signal an overpriced range. Keep comps recent (often within three to six months), geographically close, and similar in size, age, and style. The closer the comp, the smaller the adjustments and the more reliable the indicated price.

Net adjustment grids in the sales comparison approach

Real appraisals adjust comparables across several features at once on a grid, then sum the adjustments. The rule never changes: adjust the comp, not the subject — add to an inferior comp, subtract from a superior one.

Worked grid: A comparable sold for $320,000. Versus the subject:

• Comp has an extra half-bath worth $6,000 (comp superior) → −$6,000
• Comp lacks a garage worth $15,000 the subject has (comp inferior) → +$15,000
• Comp has a larger lot worth $4,000 (comp superior) → −$4,000
• Comp sold 9 months ago in a 4%-appreciating market → time adjustment +$320,000 × 0.04 = +$12,800

Net adjustment = −6,000 + 15,000 − 4,000 + 12,800 = +$17,800. Adjusted comp value = 320,000 + 17,800 = $337,800.

Trap: Apply the time (market-conditions) adjustment to the comp's sale price, and make it before or alongside the feature adjustments — forgetting the time adjustment in a rising market understates value.

Depreciation math and effective age

In the cost approach, accrued depreciation is most simply estimated by the age-life (straight-line) method: divide the improvement's effective age by its total economic life to get the percent depreciated.

Worked example: A building has a replacement cost new of $300,000, an effective age of 12 years, and a total economic life of 60 years.

• Depreciation rate: 12 ÷ 60 = 20%
• Accrued depreciation: $300,000 × 0.20 = $60,000
• Depreciated improvement value: $300,000 − $60,000 = $240,000
• Add land (not depreciated) of $90,000 → total value = $330,000

Note effective age (how old the building behaves, given upkeep) can be lower than actual age: a well-maintained 25-year-old home might have an effective age of 12. Land is never depreciated in the cost approach — only the improvements lose value. Confusing actual age with effective age, or depreciating the land, are the two classic cost-approach errors.