The adage heard often in the real estate business is that the "homes value is whatever someone will pay for it." Having said that, there are three generally accepted methods of estimating the value of real property (real estate).
Sales Comparison Approach (Comparable Sales)
Starting with the Cost Approach, which is generally used on newly constructed buildings, is based on the cost of construction (replacement cost) plus the cost of the land. This is mostly used on commcercial real estate appraisals and is virtually never used for residential real estate.
The Income Approach is always used on income producing properties, whether they are residential, industrial or commercial. The income approach uses the Gross Operating Income, Less Operating Expenses and vacancy to determine the net operating income which is divided by the Capitalization Rate (Cap Rate) to determine the property value. This can be useful in determining values on multifamily residential properties, particularly when no comparable property sales exist.
The most commonly used way to appraise property values is currently the Sales Comparison Approach. This is simply finding similar properties and using recent sale prices to estimate the value of another property. Adjustments can be made based on minor differences in the homes being compared such as a variance in the number of bedrooms or bathrooms. Appraisers and Realtors use data from the Multiple Listing Service (MLS) and use the Sales Comparison Approach to establish listing prices, offering prices, negotiate sales and appraise properties.
The above information about the basics of real estate property valuation is limited. Also, sometimes appraisals are performed where multiple approaches are conducted and compared / contrasted to adjust value or add a more complete sense of value.
The most common use of real estate appraisals is by banks to assure that the real estate being loaned upon is worth the price being paid. These appraisals are considered biased in some regards, since they are merely used to justify the price paid. If the genuine 'value' of the home was significantly greater than the sale price, the appraisal would never state the true value, only the sale price. An example commonly used, is if a person purchased a home in St Louis for $200,000, and then won the lottery, and decided to sell the home to a friend for $50,000 despite no change in market conditions. The second appraisal for loan purposes would be somewhere close to $50,000 regardless of what it actually could sell for on the open market.
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