Methods for evaluating real estate properties

The three most commonly used methods for evaluating real estate properties are: the cost approach, the market comparison approach, and the income approach.
The experience and competence of the appraiser are crucial in order to obtain the most accurate assessment of the fair market value of the building.

Cost Approach

When evaluating real estate using this method, the average costs of constructing a similar building are calculated, using modern construction materials and following contemporary trends in functionality and interior design.After calculating the necessary costs for building the structure, the accumulated depreciation is calculated. Depreciation is divided into three main components: physical wear and tear, functional obsolescence, and external factors.One of the most popular methods for calculating depreciation is the so-called Age-Life Method, which encompasses the influence of all three components of depreciation. In this method, depreciation is calculated as a percentage of the calculated costs for constructing a similar building.

After calculating the depreciated value of the building, the market value of the land on which it is built should be added. For this purpose, a comparison is made with the price of land per square meter in the area of the building, taking into account the parameters of other similar transactions.

An appraisal of the property using the cost approach is formed by adding the depreciated value of the building to the calculated market value of the land. The cost approach is mainly applied when evaluating relatively new buildings or properties with special purposes. The approach is not suitable for evaluating very old buildings or when it is difficult to calculate depreciation.

Market comparison method

This method is based on the principle of substitution (i.e. the assessed property is worth as much as a property with the same quality of construction, amenities, functionality, location, access, etc.). The availability of market information for transactions involving similar properties is crucial in order to apply this method correctly.

Assuming that the appraiser has sufficient information about transactions involving properties similar to the one being assessed, the price per square meter or per room (in the case of hotel assessment, for example) is calculated. To reach this price, the appraiser needs to compare it with transactions involving already sold properties (taking into account their specific characteristics and paying attention to current market trends).

Income Approach

When calculating the value of a property using this approach, two techniques can be applied – Direct Capitalization and Discounted Cash Flow – depending on whether the property is used by the owner or rented out.

The main factor needed to calculate the value of a property using the income approach is the capitalization rate. This is a value determined by the market and is an indicator of the level of development and liquidity of the market, as well as the risk involved in investing in the respective type of property.

Direct Capitalization is applied when evaluating a property that is used entirely or predominantly by its owner. In such cases, the potential rent for a building with similar characteristics, location, access, and representation is calculated. This is how the potential annual income is estimated if the property is rented out.

After deducting the operating expenses for the maintenance and servicing of a similar building, the potential operating profit from the property is obtained. This profit is capitalized using the capitalization rate for similar types and classes of properties.

Discounted cash flows are used as a valuation technique in cases where the subject of the valuation is a building that offers rental space. Typically, 10-year forecasts are made for future operating profit and cash flows from the property.
After discounting with an appropriate capitalization rate, the value of the building is obtained using the income approach.

Fair market value

After evaluating the property using the three approaches, the appraiser needs to calculate the fair market value of the property. This can be done by selecting the value obtained from one of the approaches or by making a weighted average of the values obtained from the used methods.

In conclusion, the preparation of an accurate market assessment depends on having up-to-date information about the real estate market, as well as the experience and competence of the appraiser. This would guarantee clients a very high quality of service and an accurate representation of the value of their assets.

Author: Stanimir Stankov / VIP Client Manager, New Home 1 / tel .: 0894 555 690

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