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

3.3 Valuation Approaches and BPOs

Appraisers develop up to three independent approaches, then reconcile them. Each rests on the principle of substitution.

1. Sales comparison approach (market approach)

The appraiser finds recently sold comparables similar to the subject, then adjusts each comp's sale price for differences. The cardinal rule: adjust the comparable, never the subject.

• If the comp is SUPERIOR to the subject (extra garage, better lot), SUBTRACT value from the comp.
• If the comp is INFERIOR (older roof, no deck), ADD value to the comp.

Mnemonic: CBS — Comp Better, Subtract.

Worked example: A comp sold for $400,000. It has a $15,000 finished basement the subject lacks (comp superior → subtract $15,000) but the subject has a $10,000 deck the comp lacks (comp inferior → add $10,000).

Adjusted comp = $400,000 − $15,000 + $10,000 = $395,000 indicated value for the subject.

2. Cost approach

Useful for new construction and special-purpose properties (schools, libraries) with few comparables. The formula:

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

• Reproduction cost = building an exact replica (same materials/design).
• Replacement cost = building one of equal utility with modern materials (more common).

Accrued depreciation has three forms — examiners test which are curable:

External obsolescence is incurable because the owner cannot fix something off the property.

Worked example: Land $90,000; replacement cost of improvements $300,000; accrued depreciation $60,000. Value = $90,000 + ($300,000 − $60,000) = $330,000.

3. Income approach

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

Value = Net Operating Income (NOI) ÷ Capitalization Rate

NOI = effective gross income − operating expenses (NOT mortgage payments or depreciation). Remember the inverse relationship: a lower cap rate produces a HIGHER value, because investors accept lower returns for safer properties.

Worked example: A building produces NOI of $120,000 and investors require a 8% cap rate. Value = $120,000 ÷ 0.08 = $1,500,000.

If the required cap rate falls to 6%: $120,000 ÷ 0.06 = $2,000,000 — same income, higher value.

Gross Rent Multiplier (GRM) is a quick shortcut for small residential rentals using monthly rent: GRM = Sale Price ÷ Monthly Gross Rent. The Gross Income Multiplier (GIM) uses annual income, typical for commercial. Example: a comp sold for $300,000 with monthly rent of $2,000 → GRM = 150. Apply to a subject renting for $2,200/month: $2,200 × 150 = $330,000.

A cap rate can also be derived from comps the same way: if a sold building had NOI of $80,000 and sold for $1,000,000, the implied cap rate is $80,000 ÷ $1,000,000 = 8%, which you then apply to the subject's NOI. Always confirm whether the multiplier in a question uses monthly rent (GRM) or annual income (GIM) — mixing them produces an answer ten or twelve times off, which is exactly the wrong choice the exam plants.

CMAs and BPOs versus appraisals

Real estate licensees routinely estimate value, but their work products are not appraisals:

• A CMA (comparative market analysis) uses recent comparable sales to help a seller set a list price or a buyer frame an offer. It is a pricing tool, not a certified value opinion.
• A BPO (broker price opinion) is a licensee's written value opinion, frequently ordered by lenders for short sales, REO, or portfolio monitoring where a full appraisal is not required.

Neither a CMA nor a BPO may substitute for a certified appraisal in a federally related transaction above the de minimis threshold. A licensee preparing a CMA/BPO must not imply they are performing an appraisal or hold themselves out as an appraiser. Many states also bar charging a separate appraisal-style fee for a BPO. On the exam, if the scenario involves federally related mortgage lending and value, the answer is almost always the certified/licensed appraiser, not the agent's CMA.

Reconciling the three approaches

After developing each applicable approach, the appraiser reconciles them — weighing the reliability of each given the property type and data quality, then forming a single opinion. Reconciliation is not averaging. For a typical owner-occupied home, sales comparison carries the most weight; for an investment property, the income approach leads; for a unique special-purpose building, the cost approach leads. The appraiser also considers the quantity and quality of data behind each indication — three strong, recent, nearby comps outweigh a thin cost estimate.

Worked reconciliation: a duplex shows sales comparison $360,000, cost $375,000, and income $352,000. Because a two-unit rental attracts investor buyers, the appraiser gives the income approach the greatest weight and reports a value near $354,000 — close to the income indication, not the $362,333 mathematical average.

Putting the numbers together

The three formulas you must recall instantly: sales comparison adjusts comps (CBS — Comp Better, Subtract); cost approach is Land + (Cost − Depreciation); income approach is NOI ÷ Cap Rate. Each is an application of substitution — no buyer pays more than the cost of an equally desirable alternative. Master the adjustment direction, the three depreciation types (only external is always incurable), and the inverse cap-rate relationship, and the bulk of valuation math points become straightforward arithmetic.