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

The Three Approaches to Value

Appraisers estimate value three ways and reconcile them. The exam tests when each approach is most appropriate and how the basic math works.

Sales Comparison Approach

Based on the principle of substitution, this approach compares the subject to recently sold, similar properties (comparables or "comps"). The appraiser adjusts each comp's sale price to make it equivalent to the subject.

The golden rule for adjustments:

• If the comp is superior to the subject, subtract from the comp's price.
• If the comp is inferior to the subject, add to the comp's price.

Never adjust the subject; always adjust the comps. Remember CIA: Comp Inferior, Add. (And the reverse: Comp Superior, Subtract.)

Worked Sales Comparison Example

The subject is a 2,000 sq ft home with a 2-car garage. A comparable sold for $390,000. The comp is 1,900 sq ft (100 sq ft smaller) and has a 1-car garage.

Adjustments (the comp is inferior in both features, so add):

• Size: 100 sq ft x $100/sq ft = +$10,000
• Garage: one extra bay worth +$8,000
• Adjusted comp value = $390,000 + $10,000 + $8,000 = $408,000

The comp, made equivalent to the subject, indicates the subject is worth about $408,000. With several comps the appraiser reconciles a range into one figure.

Cost Approach

Used when sales are scarce or the property is unique (schools, churches, new construction). The formula:

Value = Land Value + (Reproduction or Replacement Cost of Improvements - Accrued Depreciation)

• Reproduction cost = exact replica with same materials.
• Replacement cost = equivalent utility with modern materials (more common).

Depreciation has three types you must distinguish:

1. Physical deterioration — wear and tear (curable or incurable).
2. Functional obsolescence — outdated design (one bathroom, a bedroom only reachable through another).
3. External (economic) obsolescence — caused by factors outside the property (a new freeway, a declining neighborhood); always incurable.

Worked Cost Approach Example

A new specialty building sits on land worth $120,000. Replacement cost of the structure is $400,000. The building has $50,000 of accrued depreciation.

• Replacement cost - depreciation = $400,000 - $50,000 = $350,000
• Add land value = $350,000 + $120,000 = $470,000

The cost approach indicates a value of $470,000. Note that land is never depreciated; only improvements depreciate.

Income Approach and the GRM

For income property, value flows from income. Two methods appear on the exam.

Direct capitalization uses net operating income (NOI):

Value = NOI / Capitalization Rate

Example: a building produces $48,000 NOI and the market cap rate is 8%. Value = $48,000 / 0.08 = $600,000. Note the inverse relationship: a higher cap rate yields a lower value.

Gross Rent Multiplier (GRM) is a quick residential tool using gross monthly rent:

Value = Gross Monthly Rent x GRM

If comparable sales show a GRM of 120 and the subject rents for $2,500/month, value = $2,500 x 120 = $300,000. GRM uses gross rent (no expenses); the cap rate uses NOI (after operating expenses).

Building NOI and the IRV Triangle

NOI is calculated step by step, and the exam often hides the answer in the wording:

1. Start with potential gross income (all rent if fully occupied).
2. Subtract vacancy and collection loss to get effective gross income.
3. Subtract operating expenses (taxes, insurance, maintenance, management).
4. The result is NOI. Do NOT subtract mortgage payments or depreciation; those are not operating expenses.

Use the IRV triangle to solve for any unknown: Income = Rate x Value. Cover the term you want. To find value, V = I / R. To find the rate, R = I / V. To find income, I = R x V.

Reconciling the Three Approaches

After computing each approach, the appraiser reconciles them into a single opinion by weighting reliability, not averaging. A quick reference:

If one approach lacks reliable data (for example, no recent sales), the appraiser gives it little or no weight and explains why in the report.

BPOs and CMAs

A Broker Price Opinion (BPO) is a value opinion prepared by a licensed broker or salesperson, often for a lender handling default or REO property, as a low-cost alternative to a full appraisal. A CMA (Comparative Market Analysis) is prepared by a licensee to help a seller price a listing or a buyer frame an offer.

Critical limits:

• Neither a BPO nor a CMA is a USPAP appraisal.
• A licensee must never represent a BPO or CMA as an "appraised value."
• Many states bar a BPO from being used in place of an appraisal to originate a federally related mortgage.
• A licensee preparing a CMA should use recent, nearby, similar comps and disclose that it is an opinion of likely sale price, not a guarantee.