Series: How do I read an appraisal? Part 9

cost income.PNG

We’ll come back to the bottom of page two of the URAR 1004 (found here: next week, but first we need to address the other two approaches to value. In the prior weeks we’ve looked at the top of page two which addresses the Sales Comparison Approach. Today we tackle the Cost Approach and Income Approach.

Cost Approach

A common error in the sales comparison approach is “A house is worth whatever someone is willing to pay.” A similar error might be, “A house is worth whatever it costs to build.” So many more factors affect value than this. Right now (Winter 2019) builder costs are quickly outpacing the market value of homes in our coverage area. Market values, over time, are affected by the cost of construction, but the cost of construction is far more volatile than market values.

For this approach, cost manuals are consulted to determine cost to construct new, and then depreciation (physical, functional and external) are subtracted, arriving at a estimated replacement cost of the home. Among newer homes the cost approach can be very helpful, however, Town and Country has regularly seen that the older the home, the less effective this tool becomes. It is interesting that some many lenders do not require this approach to be developed at all.

However, the cost approach, even when not as reliable of a market value indicator, can assist in determining other adjustments used elsewhere in the appraisal analysis.

Income Approach

This tends to only be developed with the subject property is an income producing property or is in an area where it highest and best use would be that of an income producing property.

This area is very small on the form, however it is deceptive. The analysis and work file required to perform this analysis properly does not fit in such a small space, and usually requires 2-3 more pages to be added to the report. However, in brief, the following is performed:

  1. The estimated rent that the property could produce is developed from numerous comparable rentals.

  2. The Gross Rent Multiplier (GRM) is calculated from comparable rental sales by dividing the sale price by the monthly gross rent. Example: a property that is similar to the subject sold for $50,000, and its monthly rent was $1,000 per month. The GRM would be 50. This is performed with multiple properties.

  3. Multiply the estimate rent for the subject by the GRM to arrive at the income approach indication of value..

This is very simplified, but a basic overview to understand the methodology behind the numbers in this section.