Valuation is the process through which a person (generally, an appraiser) identifies how much a real estate property is worth on the market.
Valuations are essential for establishing the right price for a sale or the value of a building when taking out a loan. Since the worth of property is tightly bound to its location and wider market conditions, there are a host of factors to keep in mind when considering the value of a building:
– Health of the local (and sometimes, global) economy;
– Social trends (from population growth, to a new generations entering the workforce, etc.);
– Government and municipal regulations (from property taxation, to zoning restrictions, to rules regarding building height);
– Environmental considerations (properties equipped with energy-saving and environmentally-friendly systems are becoming increasingly valuable).
When conducting a property valuation (appraisal), there are three main approaches to consider, as detailed below.
This approach compares the sale prices of other recently sold properties that are similar in size, location, age, condition and amenities.
Cost approach makes estimates for each building on the property, taking depreciation into account. Depreciation refers to anything that could negatively impact the value of a building. This may include things like physical deteriorations sustained by the building(s), functional obsolescence (features or design elements that become outdated and are no longer deemed desirable) or economic obsolescence (unfavorable outside conditions, like a downturn in the local economy, vicinity to a rundown neighborhood, lack of appropriate infrastructure, etc.).
Income capitalization approach is used to gauge income producing properties’ value. By deducting any losses that might be incurred from vacancy, rent collection or operating costs from the income produced by the property, investors can measure the rate of return they can expect from the building(s).
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