Market or Comparative Sales Approach
The market approach is based on comparison of the subject property to
similar properties which have been sold in the same market. Similarities
and differences must be noted in detail such as:
Conditions of the sale
Date of sale
Location of property
For investment properties, potential income should also be documented.
Conditions of the Sale
The conditions of the sale are extremely important when considering
whether a property is comparable to the subject or not. If the parties
are related, or special financing was obtained, or the seller was forced
to sell by some condition of their life (a move, divorce, etc.) then
the sale might have to be eliminated as invalid.
Remember the definition of market value,
"the most probable price, in terms of cash, in a competitive and open
market, assuming a willing and knowledgeable buyer and seller, allowing
sufficient time for the sale, and assuming that the transaction is not
affected by undue pressures."
Some factors like size or shape or location may have to be accommodated
by adjusting the value of the comparable up or down to reflect the
difference between that property and the subject. The comparable is
always adjusted, never the subject property.
The market approach indicates a range of possible values, rather than a
precise figure, especially if few sales are available or many
adjustments have to be made. In Arizona, the market approach is the most
widely used for residential property valuation. It is ideal for types
of property which are regularly sold, and it may be the only valid
approach for valuing properties which are very old, or for which
reliable cost or income data is unavailable.
The income approach is used to value commercial or industrial
properties, or properties which are bought and sold by investors
primarily because of their income producing potential. This approach to
value depends on reliable and detailed information on the income and the
costs of doing business for a particular business or enterprise. This
is referred to as the "income stream" of the property.
The income approach defines value as "the present worth of future
benefits of owning a property." These are composed of the annual income
for an estimated number of years (called the economic life of the
property) plus a capital amount representing land value or land value
plus some remaining worth of the improvements. This approach emphasizes
investment components rather than physical components of a property.
Steps in the Income Approach
The steps in the income approach are:
Estimate potential gross income (PGI).
Deduct vacancy and collection losses.
Add miscellaneous income to derive effective gross income (EGI).
Deduct operating expenses to derive net operating income (NOI).
Select appropriate capitalization rate and method.