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

Sales comparison approach

The sales comparison approach (also called the market data approach) estimates value by comparing the subject to recently sold, similar properties and adjusting for differences. It is the most reliable approach for single-family homes and rests on substitution.

The golden rule of adjustments: always adjust the comparable, never the subject.

• If a comparable is superior to the subject (extra bathroom, larger lot), subtract value from the comp.
• If a comparable is inferior to the subject (smaller, older), add value to the comp.

Think of it as making each comp "become" the subject. After adjusting, the comps cluster around the subject's indicated value.

Worked adjustment example

A comparable sold for $300,000. Compared to the subject:

Adjusted comp value = $300,000 − $5,000 + $12,000 − $4,000 = $303,000.

Notice we added for the missing garage because the comp is inferior on that feature, and subtracted for the extra bath and larger lot because the comp is superior. Reverse the signs and you get a wrong answer — a frequent exam trap. The appraiser repeats this for several comps and reconciles them.

Cost approach

The cost approach is most useful for new, special-purpose, or unique properties (schools, churches, libraries) where comparable sales are scarce. The formula:

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

• Reproduction cost: cost to build an exact replica with the same materials.
• Replacement cost: cost to build a property of equal utility with modern materials (more common).

Land is added at the end because land does not depreciate. Depreciation applies only to the improvements.

Three causes of depreciation

Accrued depreciation — loss in value from any cause — has three categories. Know which are curable versus incurable and which are off-site.

External obsolescence is the key trap: because the cause is outside the property line, the owner cannot cure it, so it is always incurable.

Worked example. Land = $80,000. Replacement cost of the house = $240,000. Accrued depreciation = $36,000. Value = $80,000 + ($240,000 − $36,000) = $80,000 + $204,000 = $284,000.

Income approach

The income approach is the primary method for income-producing property (apartments, offices, retail). The core relationship is IRV:

Value = Net Operating Income (NOI) ÷ Capitalization Rate

Rearranged: Income = Rate × Value, and Rate = Income ÷ Value. NOI is gross income minus vacancy and operating expenses — but not debt service (mortgage payments) and not depreciation/income taxes.

Worked example. A building has NOI of $60,000 and the market cap rate is 8% (0.08). Value = $60,000 ÷ 0.08 = $750,000.

Key relationship to memorize: a higher cap rate yields a lower value (more perceived risk), and a lower cap rate yields a higher value. If the same $60,000 NOI were capitalized at 6%, value = $60,000 ÷ 0.06 = $1,000,000.

Gross rent multiplier (GRM)

For small residential rentals, appraisers use a quick shortcut, the gross rent multiplier:

GRM = Sales Price ÷ Monthly Gross Rent (or gross income multiplier, GIM, using annual income)

Derive the GRM from comparable rentals, then apply it: Value = Monthly Rent × GRM.

Worked example. Comparable rentals show an average GRM of 120. The subject rents for $2,000/month. Estimated value = $2,000 × 120 = $240,000. The GRM uses gross rent and ignores expenses, which is why it is only a rough screening tool, not a substitute for full income capitalization.

Broker price opinions (BPOs)

A broker price opinion is an estimate of a property's probable selling price prepared by a real estate broker or licensee, usually at a lender's request. BPOs are common in short sales, REO (lender-owned) dispositions, loan-modification reviews, and default servicing, where ordering a full appraisal on every file would be costly.

Key exam points:

• A BPO is not a USPAP appraisal and must not be presented as one.
• Many states regulate when a licensee may charge for a BPO and prohibit BPOs for federally related mortgage origination loans (where an appraisal is required).
• A BPO resembles a CMA in method (comparable sales and listings) but is delivered to a third party such as a lender rather than to a consumer setting a list price.

The takeaway: a licensee can offer a price opinion through a CMA or BPO, but only a qualified appraiser issues a formal appraisal for lending in a federally related transaction. Confusing the two — or charging an appraisal-style fee for a BPO — is a discipline risk.