3.3 Valuation Approaches (Sales Comparison, Cost, Income) and BPOs
Key Takeaways
- The sales comparison approach adjusts comparable sales to the subject; adjust the comp, never the subject.
- The cost approach is reproduction/replacement cost minus depreciation plus land value, best for new or special-use property.
- The income approach uses Value = Net Operating Income / Capitalization Rate (IRV) and suits income-producing property.
- A BPO is a licensee's opinion of price for lender/REO uses; it is not an appraisal and is limited by state law.
The 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 rests on the principle of substitution and is the primary approach for residential property.
The golden rule: adjust the comparable, never the subject.
- If the comp is superior (has a feature the subject lacks, e.g., a garage), subtract from the comp's price.
- If the comp is inferior (lacks a feature the subject has), add to the comp's price.
Mnemonic: CBS / CIA — Comp Better, Subtract; Comp Inferior, Add.
Worked numeric: sales comparison adjustments
Subject has a 2-car garage and an extra bathroom. Comparable sold for $300,000.
| Difference | Comp vs. subject | Adjustment to comp |
|---|---|---|
| Comp has only a 1-car garage (inferior) | Comp lacks a garage bay worth $8,000 | +$8,000 |
| Comp has one more bathroom than subject (superior) | Bathroom worth $6,000 | −$6,000 |
| Comp has a finished basement subject lacks (superior) | Worth $10,000 | −$10,000 |
Adjusted comp value = $300,000 + $8,000 − $6,000 − $10,000 = $292,000.
The adjusted figure ($292,000) is an indication of the subject's value, not the final answer; the appraiser reconciles several comps.
The cost approach
The cost approach estimates value as the cost to build the improvements new, minus depreciation, plus the land value:
Value = (Reproduction or Replacement Cost − Accrued Depreciation) + Land Value
- Reproduction cost = an exact duplicate using the same materials.
- Replacement cost = a functional equivalent using modern materials.
The cost approach is most reliable for new construction and special-purpose properties (schools, churches, libraries) that rarely sell and produce no income.
Three types of depreciation
Depreciation in the cost approach is loss in value from any cause, in three categories:
| Type | Cause | Curable? |
|---|---|---|
| Physical deterioration | Wear and tear, age, deferred maintenance | Often curable (repaint, new roof) |
| Functional obsolescence | Outdated design or features (one bathroom, no closets) | Sometimes curable |
| External (economic) obsolescence | Forces outside the property (nearby factory, highway noise) | Incurable — owner cannot fix off-site causes |
External obsolescence is always incurable because the cause lies beyond the property line. The exam tests this distinction directly.
Worked numeric: Replacement cost $250,000; physical depreciation $30,000; functional $10,000; external $15,000; land $80,000. Value = ($250,000 − $55,000) + $80,000 = $275,000.
The income approach
The income approach values income-producing property (apartments, offices, retail) by converting expected income into value. The core formula is IRV:
Value = Net Operating Income (NOI) ÷ Capitalization Rate
Rearranged: I = R × V, and R = I ÷ V.
NOI is computed as:
- Potential Gross Income
- − Vacancy and collection loss
-
- Other income
- = Effective Gross Income
- − Operating expenses (NOT mortgage payments, NOT depreciation)
- = Net Operating Income
A common trap: debt service (the mortgage) is excluded from operating expenses when computing NOI.
Worked numeric: income approach
An apartment building has potential gross income of $120,000, vacancy of 5%, and operating expenses of $40,000. The market cap rate is 8%.
- Vacancy loss = $120,000 × 0.05 = $6,000
- Effective gross income = $120,000 − $6,000 = $114,000
- NOI = $114,000 − $40,000 = $74,000
- Value = NOI ÷ cap rate = $74,000 ÷ 0.08 = $925,000
Note the inverse relationship: if the cap rate rises to 10%, value falls to $740,000. Higher cap rate, lower value — investors demanding more return pay less.
Broker price opinions (BPOs) and CMAs
A broker price opinion (BPO) is an opinion of likely sale price prepared by a licensed broker or salesperson, typically for lenders, asset managers, or REO (bank-owned) decisions where a full appraisal is not required.
Key distinctions:
- A BPO and a CMA are licensee products; an appraisal is an appraiser product governed by USPAP.
- A licensee may charge a fee for a BPO only where state law and the brokerage permit it, and may not call it an appraisal.
- A BPO cannot be used in place of an appraisal for a federally related transaction that requires one.
- The licensee must still avoid misrepresentation and stay within the scope state law allows.
If a lender needs a value for a federally related mortgage above the de minimis threshold, a BPO will not satisfy the requirement; an appraisal by a licensed/certified appraiser is required.
Gross Rent and Gross Income Multipliers
For smaller income properties, appraisers and investors often use a quick multiplier instead of a full income capitalization.
- Gross Rent Multiplier (GRM) uses monthly gross rent: GRM = Sale Price / Monthly Gross Rent.
- Gross Income Multiplier (GIM) uses annual gross income: GIM = Sale Price / Annual Gross Income.
These multipliers use gross figures and ignore expenses, which is why they are screening tools rather than precise valuations.
Worked example (GRM): Three comparable rentals sold at GRMs of 110, 112, and 114, so the market GRM is about 112. The subject rents for $1,600/month. Estimated value = 112 x $1,600 = $179,200.
Worked example (GIM): A comparable sold for $720,000 with annual gross income of $90,000, giving a GIM of 8. The subject produces $96,000 annual gross income. Estimated value = 8 x $96,000 = $768,000.
Contrast with the income (cap-rate) approach, which uses net operating income and is more accurate for larger properties. The exam tests whether you keep the figures consistent: a GRM is always derived from and applied to monthly rent, while a GIM uses annual income. Mixing monthly and annual figures is the most common multiplier error.
Gross Rent and Gross Income Multipliers
For smaller income properties, appraisers and investors often use a quick multiplier instead of a full income capitalization.
- Gross Rent Multiplier (GRM) uses monthly gross rent: GRM = Sale Price / Monthly Gross Rent.
- Gross Income Multiplier (GIM) uses annual gross income: GIM = Sale Price / Annual Gross Income.
These multipliers use gross figures and ignore expenses, which is why they are screening tools rather than precise valuations.
Worked example (GRM): Three comparable rentals sold at GRMs of 110, 112, and 114, so the market GRM is about 112. The subject rents for $1,600/month. Estimated value = 112 x $1,600 = $179,200.
Worked example (GIM): A comparable sold for $720,000 with annual gross income of $90,000, giving a GIM of 8. The subject produces $96,000 annual gross income. Estimated value = 8 x $96,000 = $768,000.
Contrast with the income (cap-rate) approach, which uses net operating income and is more accurate for larger properties. The exam tests whether you keep the figures consistent: a GRM is always derived from and applied to monthly rent, while a GIM uses annual income. Mixing monthly and annual figures is the most common multiplier error.
A comparable property has a swimming pool that the subject property lacks. When adjusting in the sales comparison approach, the appraiser should:
An office building produces NOI of $90,000 and the market capitalization rate is 9%. Using the income approach, the indicated value is: