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  • Writer's pictureJesse Ledbetter

How to read an appraisal: Part 8

As we near the conclusion of our series on how to read the URAR 1004 Appraisal form that is used for most lender transactions, we will look at the other two approaches to value that must be considered in every appraisal - Cost and Income Approach on page 3.

The Sales Comparison Approach is most commonly referred to by individuals in the appraisal process, referring to "comps" and adjustments. The following two methods are less well known, but often used.

The Cost Approach - this approach to value attempts the following:

  1. To value the land as if it were vacant.

  2. Determine the cost of building the dwelling new, on the day of inspection.

  3. Subtracting any depreciation that might have accrued to the property over its life time.

  4. Subtracting any external or functional problems (ie. property has a power line overhead or the home has two bathrooms, but one is in an odd placement)

  5. Adding these figures together to come to a value of the improved property.

In another blog I will address the strengths and weaknesses of this approach. Suffice it to say, there is a reason why no government agency requires that it be performed except in the case of new construction.

The Income Approach - is most often used on properties that are income producing. The approach is performed by:

  1. Determining the market rent of the subject property. In other words, what is a typical market participant willing to pay in rent to live in the subject home. This is performed by researching recent rentals in the area of similar homes.

  2. Determining the sales price to rental rate ratio for similar homes that have sold in the area. This may include going back in time to determine if the GRM (gross rent multiplier) is increasing or decreasing, to arrive at the most recent estimate.

  3. Multiplying these figures together to come to the value of the property.

Next week, we wrap up the series as we look at how the appraiser, now armed with three approaches to value (Sales, Cost, Income) comes to the final figure in the report.

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