The 3 Methods used to Calculate the Value of Real Estate.
Value in real estate is not straight forward. There are three methods of valuation, which are property and situationally unique, and knowing which methods to use and in what proportions are critical to understanding a parcel’s value. These valuation methods are used within the industry with the intent of ensuring an accurate value is placed on a property — this ensures fair market prices are maintained, enabling buyers and sellers to make sound investment decisions.
The three valuation methods for real estate valuation are: the comparable method, the income capitalization method, and the cost method.
The Comparable Method — also commonly referred to as the market method — is based on the premise that the value of a property is equal to that of comparable properties in the local area. This method is accurately applied when a wide range of sales data is available. The comparison of too few similar properties can lead to inaccurate valuations. When applying the comparable method, the value of the property is evaluated on the market factors that affect its value: location, size, quality, condition, and amenities.
The second method, Income Capitalization, is often used to value commercial and rental properties. It is based on the premise that the value of a property is determined by its ability to generate an income. The primary information used in this method are the estimated future income of the property and the rate of return expectations based on the local market. This method works by multiplying the estimated future income of the property by the capitalization rate, which is determined by the local market. By using this method, one can determine the value of a property based on its income-generating ability.
The last valuation method is the Cost Method — is based on the principle that the market value of a property is equal to the cost to reproduce or replace it. This method is useful for valuing properties that have been around for a long time and for obtaining opinions about the worth of an improvement to an existing building. When applying the Cost Method to a property, the valuer assess the cost of labor and materials necessary to build a similar type of property in the area. The method takes into consideration the age of the structure, current building costs, and comparable local market conditions.
Overall, the three most commonly-used methods for valuing properties in the real estate market are the Comparable Method, Income Capitalization, and Cost Methods. Each method has specific uses, and the method used for a particular property will depend on the individual characteristics of the property and the local market conditions. Understanding how and which method to use, and in what proportions are the critical ingredients needed to create success in valuing real estate.
To see how Team Sobiko’s Realtors® may assist you, please visit our underwriting, commercial or residential service pages.
This publication was created with the help of artificial intelligence software, which was then reviewed and edited for accuracy by a Team Sobiko staff member.
