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

Appraisers estimate value through three approaches. The exam tests when each fits and how the arithmetic works.

Sales Comparison Approach (Market Data)

The sales comparison approach values a property by comparing it to recent sales of similar properties and adjusting for the differences. It is the dominant method for single-family homes because it mirrors how real buyers shop, and it rests on the principle of substitution.

The critical rule is the direction of adjustment, and you always adjust the comparable, never the subject:

• If the comparable is superior to the subject, subtract value from the comp.
• If the comparable is inferior to the subject, add value to the comp.
• If they are equal in a feature, make no adjustment.

A handy mnemonic is CIA: Comp Inferior, Add (and by reverse, comp superior, subtract).

Worked Example: Sales Comparison Grid

The subject is 2,000 sq ft with a 2-car garage. A comparable sold for $390,000, has 1,900 sq ft and a 1-car garage. Assume the market supports $100/sq ft and $8,000 per garage bay.

The comp is inferior on both features, so we add to it:

$390,000 + $10,000 + $8,000 = $408,000 adjusted value.

If instead the comp had a pool worth $15,000 that the subject lacked, the comp would be superior on that line and we would subtract $15,000.

Cost Approach

The cost approach assumes a buyer will pay no more than the cost to acquire the land and build an equivalent structure, less any loss in value. The formula is:

Value = Land Value + (Replacement Cost - Depreciation)

Two cost bases matter:

• Reproduction cost - cost to build an exact replica, including outdated features.
• Replacement cost - cost to build a structure of equal utility using modern materials and methods. Replacement is more common in practice.

The three forms of depreciation (accrued loss in value) are:

The cost approach shines for new construction and special-use property (schools, churches) where comparable sales are scarce.

Worked Example: Cost Approach

• Land value: $120,000
• Replacement cost of improvements: $300,000
• Accrued depreciation: $40,000

Value = $120,000 + ($300,000 - $40,000) = $120,000 + $260,000 = $380,000.

Trap: Land is not depreciated, only the improvements are. And depreciation is subtracted; an answer choice that adds depreciation is wrong.

Income Approach

The income approach values a property by the income it produces and is the primary method for investment property. The two core formulas are:

NOI = Effective Gross Income - Operating Expenses (debt service and income tax are excluded)

Value = NOI / Cap Rate

The capitalization rate expresses the return an investor requires. Note the inverse relationship: a higher cap rate (more risk) produces a lower value, and a lower cap rate produces a higher value.

Worked example:

• Gross annual income: $60,000
• Operating expenses: $20,000
• NOI = $60,000 - $20,000 = $40,000
• Cap rate: 8%
• Value = $40,000 / 0.08 = $500,000

For quick estimates, appraisers also use multipliers:

• GRM (Gross Rent Multiplier) = Price / monthly rent
• GIM (Gross Income Multiplier) = Price / annual income

If a fourplex sells for $480,000 with monthly rent of $4,000, the GRM is 120 ($480,000 / $4,000).

CMA, BPO, and Assessed Value

The Broker Price Opinion (BPO) sits between an agent's CMA and a full appraisal. A broker prepares it, often for a lender or asset manager handling a distressed or REO property, at lower cost and faster turnaround than an appraisal. It is not a USPAP appraisal and cannot replace one in a federally related transaction.

Assessed value is set by a tax assessor for property-tax purposes and often lags the market. Property tax = Assessed Value x Tax Rate. If assessed value is $350,000 and the rate is 1.2%, the annual tax is $350,000 x 0.012 = $4,200.

Choosing the Right Approach

• Typical subdivision home with good comps: sales comparison.
• New custom home or church with few comps: cost approach.
• Apartment building or strip center: income approach.

Selecting Comparables and Final Traps

Good comparables are recent, physically similar, and located in the same market area, ideally closed within the past six months. When no exact match exists, appraisers derive adjustment amounts from paired-sales analysis: comparing two otherwise-identical sales that differ in a single feature to isolate that feature's market value.

Watch for these exam traps: applying the income approach to an owner-occupied home that produces no rent; forgetting to subtract depreciation in the cost approach; adjusting the subject instead of the comparable; and treating a CMA or BPO as if it were a USPAP appraisal a lender could rely on for a federally related loan.