How To Approach Valuation of Buildings

There are three distinct approaches in evaluating and appraising property and land. These approaches can and many times overlap.

Sales Approach is the most common and the one approach that people think of if they have owned a house. It is basically using comparable property to ascertain the value. It is more difficult with commercial buildings because they don't turn as often and so it is harder to find comparable buildings.

An appraiser should take into consideration 6 factors:

• Financing - do they have advantageous financing
• Sales Conditions - overly restrictive
• Timing - with the comparative properties, when were they sold
• Location - 
• Physical - landscaping, roof (special conditions)
• Market Conditions - balance between supply and demand. Ability to easily replace or substitute the property

The second is the Cost Approach. An appraiser typically uses this approach on newer buildings and uses the costs to replace. Many times using a quantity survey from the detailed building costs to use for replacement value.
Estimate land value then estimate the replacement cost of structure. In the Cost Approach, evaluate the indirect and direct costs. The assessor methods can be either:

• comparative unit - cost per square foot
• quantity survey - contractors line item bid
• unit in place - cost of improvement, unit cost of all building labor and materials, then multiplying the sum used on the building.

Cost approach is used most often when the sales comparison approach can not be used because of lack of data on comparable sales or rentals. The building is a special purpose property with few comparable sales or none or the property is proposed construction. The limitation with the Cost Approach is that it doesn't reflect supply and demand.


The third and final is the Income Approach. In this approach, an appraiser could either use the Direct Capitalization Method which is the process of converting a one-year stabilized NOI or the Discounted Cash Flow Model.(DCF)
Direct Capitalization Method is constructing a Cap Rate.
V=Market Value, I=NOI, R=Cap Rate
V=I/R

The DCF model determines property value by discounting the following values to a present value:

• NOI for all years through the end of the projected holding period for the property
• Sale proceeds for the property at the end of the projected holding period

Effectiveness of DCF model attempts to pattern the thinking of an investor. Stabilized or smaller properties are usually best analyzed by capitalization and properties with uneven cash flows or those acquired by smart investors should be analyzed by a discounted cash flow.