Three Approaches to Value
Your county Assessor and their appraisers use one or more of the three approaches to value to produce appraisals that are used by the Assessor to estimate fair market value for property tax purposes. The Cost Approach estimates value based on the typical cost of materials and labor necessary to build a structure of similar size and quality in that location while accounting for depreciation due to age and condition. The Sales Comparison Approach estimates value based upon the price, in the local market, necessary to acquire a property of similar location, quality, size, age, and condition. The Income Approach estimates value based upon typical market income of a similar property.
Cost Approach to Value
In the cost approach to value, the cost to acquire the land plus the cost of the improvements minus any accrued depreciation equals value. Depreciation is a loss in value from any cause, and can take the form of physical deterioration, functional obsolescence, or economic obsolescence. The underlying premise of the cost approach is that ‘a potential user of real estate won't, or shouldn't, pay more for a property than it would cost to build an equivalent.’ (PRINCIPLE OF SUBSTITUTION)
Sales Comparison Approach to Value
The sales comparison approach is directly rooted in the real estate market. The value of the subject property is equal to the sales prices of comparable properties plus or minus any adjustments. The sales comparison approach compares a piece of property to other properties with similar characteristics that have been sold recently. The sales comparison approach takes into account the affect that individual features have on the overall property value, meaning that the total value of the property is a sum of the values of all of its features.
Income Approach to Value
The income approach quantifies the present worth of future benefits associated with ownership of the real estate asset. The income approach comes in two different forms: net income approach and gross income approach. Net income is what is left over after vacancy and collection loss and allowable expenses have been subtracted from the potential gross income. The net income is divided by a capitalization rate (the investor’s desired rate of return) for an estimate of value. In the gross income approach, the income is multiplied by a factor in order to arrive at the value. The net income approach is typically seen on larger commercial occupancies like office buildings, retail, apartments and hotels / motels. The gross income approach is typically seen on income producing residential properties.