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

Sales Comparison Approach

The sales comparison (market data) approach estimates value by comparing the subject to recently sold, similar properties (comparables or comps). It rests on the principle of substitution and is the most reliable approach for owner-occupied residential property.

The golden rule of adjustment: adjust the comparables, never the subject. Then apply the CBS / CIA memory aid:

• Comp Better → Subtract from the comp.
• Comp Inferior → Add to the comp.

If a comp has a third garage bay the subject lacks (comp is better), you subtract that value from the comp's sale price so it matches the subject.

Worked Adjustment Example

Subject has 3 bedrooms, 2 baths, no pool. A comp sold for $300,000 and has 3 bedrooms, 3 baths, and a pool.

Both features make the comp superior, so both are subtracted. The adjusted price of $282,000 is the comp's indication of the subject's value. With several comps, the appraiser reconciles the adjusted figures, weighting the closest matches most heavily — not simply averaging them.

Cost Approach

The cost approach is based on the idea that a buyer will pay no more than the cost to build an equivalent property. The formula:

Value = (Reproduction or Replacement Cost of improvements − Depreciation) + Land Value

• Reproduction cost — an exact duplicate using the same materials.
• Replacement cost — a functional equivalent using modern materials and methods (more common).

The cost approach is most appropriate for new construction and special-purpose properties (schools, churches, libraries) that rarely sell and produce no income, so comps and rents are scarce.

The Three Types of Depreciation

Depreciation is loss in value from any cause and falls into three categories:

• Physical deterioration — wear and tear (worn roof, peeling paint). Often curable.
• Functional obsolescence — outdated design or features (a one-car garage, a bedroom only reachable through another bedroom). May be curable or incurable.
• External (economic) obsolescence — caused by negative factors outside the property line (a new highway, a nearby landfill, a declining job market). Always incurable because the owner cannot fix it.

Worked example: A new building costs $500,000 to replace, has $60,000 of accrued depreciation, on land worth $120,000. Value = ($500,000 − $60,000) + $120,000 = $560,000.

Income Approach and the GRM

The income approach values property by the income it produces. For commercial / investment property the formula is IRV:

Value = Net Operating Income (NOI) ÷ Capitalization Rate

NOI is gross income minus vacancy and operating expenses — but not mortgage payments (debt service) or depreciation. Example: NOI of $48,000 at a 8% cap rate → Value = $48,000 ÷ 0.08 = $600,000. Note the inverse relationship: as the cap rate rises, value falls.

For small residential rentals (1–4 units) appraisers use the Gross Rent Multiplier (GRM):

GRM = Sale Price ÷ Monthly Gross Rent, then Value = GRM × subject's monthly rent.

If comps sell at a GRM of 120 and the subject rents for $2,000/month, value ≈ 120 × $2,000 = $240,000.

CMAs and Broker Price Opinions

A Comparative Market Analysis (CMA) is the salesperson's pricing tool: a study of recently sold, currently listed, and expired comparable properties used to recommend a list price. A Broker Price Opinion (BPO) is a similar value estimate, often ordered by lenders or for short sales and REO (bank-owned) properties.

Critical exam point: a CMA or BPO is NOT an appraisal. It is prepared by a licensee, not a certified appraiser, and may not be used in place of an appraisal for a federally related loan. Licensees should never represent a CMA as an appraisal or use the word "appraised value."

Choosing the Right Approach and Avoiding Math Traps

The exam often hands you a property type and asks which approach an appraiser would weight most. Memorize the pairings:

Cap-Rate and GRM Worked Problems

IRV problem: A strip center has potential gross income of $120,000, a 5% vacancy allowance, and operating expenses of $34,000. NOI = $120,000 - $6,000 - $34,000 = $80,000. At a 10% cap rate, Value = $80,000 / 0.10 = $800,000. Remember NOI excludes mortgage debt service and depreciation; including them is the most common error.

Inverse-relationship trap: Hold NOI at $80,000 but raise the cap rate to 12.5%; value falls to $80,000 / 0.125 = $640,000. Higher perceived risk (higher cap rate) means a lower price, a relationship the exam tests directly.

GRM problem: Three comparable duplexes sold at GRMs of 118, 122, and 120, so the appraiser uses about 120. If the subject rents for $2,400 per month, indicated value = 120 x $2,400 = $288,000.

Cost-approach reminder: Value = (Replacement cost - Accrued depreciation) + Land. Land is added back after subtracting depreciation, and land itself is never depreciated.