Appraisal Approach

Definition of "Appraisal Approach"

Written by

Michael Severin

RE/MAX Results

The appraisal approach is used to estimate the value of an asset, based on various factors to reach the closest educated guess of the asset. While an appraisal approach does consider the asset’s cost, any income it may generate as well as the asset’s fair market value, it is, as mentioned above, an estimated guess intended to forecast the potential revenue the asset could have in a free market if it were to be sold. Selling is also the most common reason why appraisals are performed, but insurances and taxes also require appraisals to determine the coverage value and tax requirements.

What is the Appraisal Approach used for?

While above we mentioned a few reasons why appraisals are required, appraisals are always used to determine the worth of assets, typically of high-value assets. Real estate properties are the most common assets to be appraised, but objects of art can also be appraised, jewelry, vehicles, and financial interests. Because these assets don’t change hands often, they are difficult to quantify. A home isn’t sold once a week and from the time it was bought to the time it was sold, the market prices change drastically. That is why these types of assets need to be appraised by qualified professionals known as appraisers.

How is the Appraisal Approach Applied?

In order for an appraisal to be considered legitimate by insurance companies or taxing authorities, it must be executed by a disinterested party who has the license and certification granted by the state regulatory board. Important to note, however, that when a real estate property is appraised for an insurance policy, for example, and inside the house, there is an original Van Gogh, the real estate appraisal can not appraise the work of art and add it to the price. An additional appraiser with expert knowledge in art must be summoned so that the Van Gogh can be appraised by a specialty appraiser. If the homeowner doesn’t agree with the appraisal report they can argue against it, but it is important to know when to dispute a home appraisal as the cost of the appraisal, also known as an appraisal fee, is covered by them.

Appraisal Approaches in Real Estate

There are several reasons for appraisals in real estate. The most often encountered situations when an appraisal is necessary, include property insurance, taxation, financing, sales listing, and investment analysis. Real estate appraisals determine a property’s value based on the property’s age, condition, location as well as other relevant characteristics. Appraisals are used by banks to limit the amount of money loaned to borrowers to the property’s worth.

Real estate appraisers follow the next three appraisal approaches in order to determine the property’s value:

Sales Comparison

The most common appraisal approach used by real estate appraisers, through the sales comparison appraisers determine the property’s value by comparing it to at least three comparable properties in the same neighborhood.

Cost Approach

Through the cost approach, appraisers look at the cost of building a new building identical to the one being appraised, including construction costs, material expenses, and land cost in the area, without depreciation.

Income Approach

Also known as an “income capitalization approach”, the income approach estimates the property’s value by looking at the income it generates. To calculate the income approach the appraiser takes the net operating income and divides it by the capitalization rate.