Question

Discuss your understanding of determining value for a real estate property using the Sale Comparison Approach, the Cost Approach and the Income Approach from both the residential (personal home) perspective and the commercial investment property perspective.

Answer 1

There are basically three ways for valuation of a real estate property,

· Sale comparison method: The sale comparison method is based on the idea that the price of the property in the location would be similar to the other properties being sold in the locality. When an investor is going to buy a property then he would not be willing to pay more than the sale price of similar properties in the locality. The logic is applicable both for residential property and commercial property. In residential property, people look as to what other people are paying for similar properties in the neighborhood and for commercial properties business look as to what other businesses are paying for similar properties in the neighborhood.

· Cost approach: The cost approach focuses on as to how much it would cost to create a similar property and then account for the fact that current property must have been depreciated in value. In cost approach the value of a property consists of value of land and the net value of the building. The residential consumer focuses on as to how much it will cost for me renovate the building making it suitable according to himself however the business focus on the value as to how much it will cost for him to renovate the building to use that building in business. In both the cases the focus is on the value of land plus the construction cost of new building minus the depreciation on that.

· Income approach: The income approach is similar to the valuation of a financial security as to how much the cash flow the real estate property is going to generate. Like when we are valuing stocks, we take the future dividends of the stock and discount it here we use the same process but here the cash flow is generated in terms of rental income and the rental income is used to calculate the net operating income and to value the property. The valuation approach for a residential property as well as for commercial property are mostly same it just that in commercial property the rental income is large whereas in residential property rental income is comparatively small.