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

The Sales Comparison Approach

The sales comparison approach estimates value by comparing the subject to recently sold, similar properties (comparables or "comps") and adjusting for differences. It is the primary approach for single-family homes because it directly reflects buyer behavior under the principle of substitution.

The golden rule of adjustment is: always adjust the comparable, never the subject. Use the memory aid CBS — "Comp Better, Subtract." If the comparable is superior to the subject in some feature, subtract value from the comp; if the comparable is inferior, add value to the comp.

Good comps share location, size, age, and condition with the subject and sold recently (typically within the past 3-6 months) in an arm's length sale.

Worked Sales Comparison Example

The subject has 3 bedrooms and no pool. A comparable sold for $300,000 but has 4 bedrooms (worth +$12,000) and a pool (worth +$8,000) the subject lacks.

Because the comp is better, we subtract those features to make it equal to the subject:

If the comp had been inferior — say it lacked a garage the subject has, worth $10,000 — you would add $10,000 to the comp instead. Net adjustments should generally stay modest relative to sale price.

The Cost Approach

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

Reproduction or replacement cost new − accrued depreciation + land value = property value.

Two cost terms differ:

• Reproduction cost — cost to build an exact replica using the same materials.
• Replacement cost — cost to build a structure of equal utility with modern materials and methods (usually lower, and more commonly used).

The cost approach is most reliable for new construction (little depreciation to estimate) and special-purpose properties (schools, churches, fire stations) that rarely sell and produce no income, so comps and rents are scarce.

Worked Cost Approach Example

A two-year-old building has a replacement cost new of $340,000. It has accrued $25,000 in physical depreciation. The land is valued separately at $90,000.

• Replacement cost new: $340,000
• Less accrued depreciation: −$25,000
• Depreciated improvement value: $315,000
• Plus land value: +$90,000
• Indicated value: $405,000

Remember that land does not depreciate — only the improvements do. That is why the appraiser estimates land value separately (step 5 of the process) and adds it back after subtracting depreciation from the building cost.

The Income Approach

The income approach values property by the income it produces — the primary method for commercial and investment property. The core formula uses a capitalization rate (cap rate):

Value = Net Operating Income (NOI) / Cap Rate.

Net Operating Income (NOI) is gross potential income, minus vacancy and collection losses, minus operating expenses. Critically, NOI does not subtract debt service (mortgage principal and interest) or depreciation — those are not operating expenses.

The relationship is inverse: a higher cap rate produces a lower value (more risk, more return demanded), and a lower cap rate produces a higher value. This inverse relationship is heavily tested.

Income Approach Math and the GRM

Worked example: A building generates $250,000 gross income, loses $20,000 to vacancy, and has $80,000 in operating expenses. NOI = 250,000 − 20,000 − 80,000 = $150,000. At an 8% cap rate, value = 150,000 / 0.08 = $1,875,000. At a 10% cap rate, value drops to $1,500,000 — confirming the inverse relationship.

For small residential rentals, appraisers use the simpler Gross Rent Multiplier (GRM):

• GRM = Sale Price / Monthly Gross Rent (or annual = GIM).
• Value = GRM × subject's monthly rent.

If comparable rentals sell at a GRM of 120 and the subject rents for $2,000/month, the indicated value is 120 × $2,000 = $240,000. The GRM ignores expenses, so it is only a rough screen.

Broker Price Opinions and CMAs

Licensees regularly produce two informal value estimates that are not appraisals:

• A CMA (Comparative Market Analysis) helps a seller price a listing or a buyer frame an offer.
• A BPO (Broker Price Opinion) is a broker's value estimate, frequently ordered by lenders for short sales, foreclosures, or portfolio review.

Both rely on comparable sales and active listings. The hard rules: a licensee must disclose that the document is not an appraisal, must not call it one, and (in most states) may not perform a BPO for a federally related transaction that legally requires a licensed appraiser. Misrepresenting a BPO as an appraisal is unlicensed appraisal activity and a disciplinary violation.

Choosing the Right Approach and Reconciling

The exam routinely asks which approach an appraiser would weight most for a given property. Match the property type to its dominant approach:

Reconciliation, not averaging. If the three approaches indicate $312,000 (sales), $328,000 (cost), and $295,000 (income) for a house, the appraiser leans on the most data-supported approach — sales comparison — and might conclude $312,000, not the $311,667 average.

Trap: a higher cap rate produces a lower value. Cap rate measures risk and required return, so riskier income property is worth less per dollar of income, not more. Candidates who treat "bigger rate" as "bigger value" lose this point.