Which of the following approaches for calculating the market value of a property

One of the foremost things to consider when you want to purchase a property is its accurate market value.

The process of estimating or calculating the actual property market value, which is known as carrying out an appraisal, can either be done by hiring the service of a professional or understanding how to carry it out and doing it yourself.

Whether you are purchasing the property for personal use or investment purposes, you will need to understand how to get the property's accurate value.

This can, however, be difficult to estimate because it is not a short-term trade and no two properties have identical features.

Unlike trading stocks, it is seemingly impossible to have a general property exchange. Even though you get two properties with identical features, they will most likely be in different locations. As a result, you will have to determine the value of real estate on an individual basis.

Taking the time to estimate the value of a property accurately is critical since it is not a short-term trade. In this article, we shall be guiding you on the various ways to calculate the value of any property correctly and accurately like a professional.

Essential Elements of Market Value

• Demand

Do customers want or need this item (good or service), and do they have the financial ability to satisfy this want or need?

• Scarcity

This is how much of an item (good or service) is available at any given time. In this instance, the land is finite, meaning all the land is already existing. In fact, as a result of different factors, the land is limited.

• Transferability/Purchasing Power

Can the item (good or service) be sold, or can the ownership rights to the item be transferred?

• Utility

This is the measure of the satisfaction a customer can get from an item.

Note that environmental conditions, government regulations, and socio-economic trends affect these value elements. You must consider them significantly when determining the market value of a property.

The Idea of Market Value, Cost, and Market Price

These are terms you should not use interchangeably.  In this scenario, the item to consider is a real estate property.

Cost is the amount spent to build the property. The materials used to construct the property and the labor required are essential costs.

The market price is the amount of money for which the property can be bought or sold in the market. It is also known as the current price of the property.

While market value, on the other hand, is how much a property is worth in the open market according to different market participants. The value is sometimes higher than the market price or lower, depending on any given factor.

For instance, if it took $300 to build a property and it sold at $700,  the cost is $300, and the market price is $700.

Factors that Affect Property Value

Threats of foreclosure and finding flaws in the property's structural integrity are some factors that reduce the value of a property.

On the other hand, kitchen and bathroom remodel, high-demand finishes, well-maintained landscape, increased square footage, smart technology, and aesthetics are some ways to increase the property's value.

Other factors include:

• Property size
• Property improvements
• Property's condition
• Property's age
• Property's location
• Market conditions

How to Accurately Calculate the Market Value of a Property

Also known as carrying out an appraisal of the property, this process involves forming an opinion of the property value (determining the market value) by the methodological collection of data.

As stated earlier, you must carry out property valuation on an individual basis. Value differs from one property to the next, and one's reason for buying the property also differs.

For instance, a buyer seeking a property investment will value the property differently from a buyer who needs a home to reside.

In lieu of this, appraisers use three different approaches to determine the market value of a property. To get a very accurate valuation, you must collect the data, and these approaches must be individually applied where necessary and sometimes together.

These approaches include the following.

The Cost Approach

This approach, also known as the summation approach, comes when the properties appraised may not generate income. They include government buildings and schools. It operates on the theory that people will not buy a property if they will pay more than the cost of building an identical property.

An appraiser estimates the property’s accurate value using this approach by finding the sum of the value of different real estate components. These components are:

• Replacement/Reproduction Cost

This is the estimated cost of constructing the property. Replacement costs, however, use the cost of updated building materials, while reproduction costs use the exact materials as a comparable structure.

• Depreciation

This is the loss in the value of a building. This loss could be physical (wear and tear), functional (change in customer tastes), or economic (recession, noisy airport).

• Market Value of Land:

This is the price of the land on which the property will be built.

After getting the estimated costs of all these components, the appraiser will sum them together to get the property value.

Property value will be the reproduction/replacement costs minus the depreciation costs plus the market value of the land.

I.e.: Property Value = Reproduction/Replacement Costs – Depreciation + Land Value

The Sales Comparison Approach

It is a method that is equally known as the market data approach. This approach comes when trying to determine the value of single properties bought to own a home.

Buyers of these properties usually compare prices of similar-looking homes beforehand to avoid paying more than the regular price of the house.

In this approach of value estimation, appraisers will compare recently sold properties with identical features. They are called comparables (comps); the identical features include location, property size, characteristics, and condition.

An important factor to consider in comparing identical properties is the date of the sale. However, there might have been economic, political, or environmental changes to the property’s location between the time of the last sale and the appraisal time.

Income Capitalization Approach

This approach is also known as the income approach. Appraisal for commercial properties like shopping malls, apartment complexes, and rental properties, whose sole purpose is to generate income or investment, follow this approach.

This approach is more complicated than the sales comparison approach and the cost approach.

It is the current value of the expected benefits investors will make from a real estate investment.

Types of Income Approach

The value obtained by dividing the Net Operating Income (NOI) by the appropriate capitalization rate (cap rate) is known as Direct Capitalization.

Net Operating Income is used to determine the potential success of an investment property and is obtained after determining how much the property will generate after covering all the operations and maintenance expenses and accounting for unrented periods.

To calculate the net operating income, you have to calculate the gross operating income, which is the vacancy and credit losses subtracted from the gross potential income, and then deduct the operating expenses.

The Capitalization Rate, also known as the cap rate, is a way to determine the rate of return generated on a commercial real estate property. This metric is based on the net operating income.

There are three ways to calculate the cap rate:

• The build-up method, which is the interest rate plus non-liquidity rate plus recapture premium plus the rate of risk.
• The market-extraction method, which assumes there is available data about the NOI and sales price on comparable investment properties. The cap rate of each comparable is the NOI divided by the sales price. The average cap rates of each comparable determine the overall cap rate.
• The band of investment method is obtained from individual interest rates for properties that use both debt and equity financing.

The challenge in assessing the accurate estimates for the components of the capitalization rate cannot be overstated.

Dividing the NOI by the cap rate gives you the market value of the property.

Gross income multiplier (GIM) is the ratio of the property's current value to the gross annual income earned and used to appraise rental properties.

It is pertinent to note that the current value of the property is the market price of the property, while the gross annual income is either the average annual rent of the apartments or the annual turnover of the products.

GIM is obtained by dividing the sales price by the rental income. You can use either gross monthly income or gross annual income, depending on the rental agreement. It uses sales and rental data from comparables to establish an accurate gross income multiplier.

In addition, the GIM is simple to use, making it an easy way to compare properties; however, since it doesn’t consider operating expenses, it cannot give a completely accurate value.

Take-Home

Determining the correct valuation of a property is essential for different reasons, especially for potential investment success. And while skilled appraisers mostly do this, anyone involved in a real estate transaction can benefit from understanding the methods and measures of property valuation, as we have vividly discussed in this article.

How market value of a property is calculated?

Which of the following approaches for calculating the market value of a property involves the projection of the property's future expected cash flows?

Which of the following is one of the three approaches to value?

What is the market value quizlet?