Broker
Chapter 7
Sales Comparison, Cost Depreciation and Income Approaches
Copyright Gold Coast Schools
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Learning Objectives
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Describe the assumptions underlying the sales
comparison approach
Calculate the various adjustments necessary
under the sales comparison approach
Distinguish between fixtures and trade fixtures
Construct a sales comparison adjustment grid
using the proper sequence of adjustments
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Learning Objectives
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Distinguish among normal sale price, market
conditions-adjusted normal sale price, and
final adjusted sale price
List the steps in the cost-depreciation
approach
Distinguish between reproduction cost and
replacement cost
Describe the 3 methods for estimating cost
Distinguish among the types of accrued
depreciation
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Learning Objectives
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Calculate an accrued depreciation
adjustment using the lump-sum age-life
method
Define effective age and economic life
Perform a GRM analysis
Distinguish among potential gross income,
effective gross income, and net operating
income
Distinguish among the 3 types of operating
expenses
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Learning Objectives
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Develop a reconstructed operating statement
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Calculate a market-derived capitalization rate
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Calculate value using the income approach
formula
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Sales Comparison Approach
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Basic premise
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Underlying assumptions
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Market value can be inferred from the sales of
comparable properties
Market price is valid evidence of market value
Principal of substitution
Methods of adjustment
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Comparable inferior add (CIA)
Comparable better subtract (CBS)
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Sales Comparison Approach
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Elements of comparison
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Financing terms
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Mortgage assumption
Seller financing
Contract for deed
Wraparound loan
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Sales Comparison Approach
1.
Conditions of sale
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All secondary sources of data must be confirmed
thru a primary source
Examples (undue stimuli)
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Pending foreclosure
Loss of job
Bankruptcy
Non arm’s-length transaction
Adjustments are difficult, possibly impossible to
make—comp should not be used
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Sales Comparison Approach
2. Market conditions
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Time
Successive sales analysis (formula)
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Resale price
Minus initial sale price
Equals difference in price
Divided by initial sale price
Equals percentage change
Divided by # of months between sales
Equals monthly rate of change
Personal Property
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Sales Comparison Approach
3. Location
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Most important factor in buying decision
Considerations outside the property
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External economies
External diseconomies
Physical characteristics
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Size (square footage)
Improvement’s condition
Construction quality
Architectural style
Age and amenities
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Methods of Adjustment
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Normal sale price
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Market conditions normal sale price
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The price the comp would have sold for if the
transaction would have been consistent with
the market
The price the comp would have sold for in
today’s market
Final adjusted sale price
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The price the comp would have sold for it were
exactly like the subject property
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Cost-Depreciation Approach
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Four Steps
1)
2)
3)
4)
Estimate the Current Reproduction (or
Replacement) Cost
Estimate the Depreciation and Deduct it from the
Cost
Estimate Value of Site and Nonstructural Site
Improvements
Add the Value of the Site, Nonstructural Site
Improvements to the Depreciated Cost
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Cost-Depreciation Approach
Step One – Estimate the Cost
 Three methods
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Quantity Survey - detailed inventory of everything
required to reproduce a building
Unit-In-Place - cost is calculated for each individual
component
Comparative Square-foot (Unit Comparison)
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Cost per square or cubic foot
Benchmark properties - basis for comparison
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Cost-Depreciation Approach
Step Two – Estimate the Depreciation
and Subtract from the Cost
 Depreciation - The loss of value due to
any cause
 Accrued Depreciation - The total loss in
value from all types
 Land does not depreciate
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Cost-Depreciation Approach
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Three types of depreciation
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Physical Deterioration - wear and tear
Functional Obsolescence - does not meet
current standards or an overimprovement
External (Economic) Obsolescence influence outside property boundaries
Ways to accrue depreciation
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Breakdown method
Market extraction method
Lump-sum age-life method
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Cost-Depreciation Approach
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Depreciation can be
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Curable – The cost to correct is
less than the added value
Incurable – The cost to correct
is greater than the added value
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Cost-Depreciation Approach
Straight Line Depreciation
 Economic Life - Estimated time in
years that an improvement can be
profitably useful
 Effective age - as it appears to be
 Cost new ÷ economic life = yearly
depreciation
 Yearly depreciation X years = total
depreciation
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Accrued Depreciation
Effective Age
÷
Economic Life
X
Reproduction (or replacement) cost new
=
Accrued Depreciation
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Cost-Depreciation Approach
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Step Three - Estimate the Value of
the Site and Site Improvements
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Value of the land
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Determined by Comparable Sales approach
Land does not depreciate
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Cost-Depreciation Approach
Step Four
Depreciated Cost
(Step 2)
+
Value of the Site and Site Improvements
(Step 3)
=
Value of Property
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Income Capitalization Approach
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Value - Present worth of Future
income of the subject property
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Gross Income Multiplier (GIM) or
Gross Rent Multiplier (GRM)
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Gross Rent Multiplier (GRM) Estimates value from monthly rental
income only
Gross Income Multiplier (GIM) Estimates value from all sources
including rental income plus any other
source
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GIM/GRM
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Step 1 : Estimate Gross Rent (or Income)
for Subject Property
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Step 2 : Calculate Average Multiplier (GRM
or GIM) using several comps
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Sale price divided by gross rent (or income) of
comparable properties and then average
Step 3 : Estimate Value of Subject Property
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Average multiplier times gross rent (or income)
from subject property
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Income
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Three types
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Potential Gross Income (PGI) - Annual
income the property would produce if fully
rented and there are no collection losses
Effective Gross Income (EGI) - Income after
vacancy and collection losses are subtracted
and other income is added
Net Operating Income (NOI) - Income
remaining after subtracting all operating
expenses
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Operating Expenses
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Three categories
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Fixed Expenses (FE) - e.g. taxes and
insurance
Variable Expenses (VE) - e.g. utilities,
maintenance
Reserve for Replacements (R) - e.g. roof
covering, air-conditioning
Operating expenses do not include
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Mortgage Payments (Debt Service)
Income Taxes
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Income Capitalization Approach
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Overall Capitalization Rate
(OAR) - average rate of return
received on similar properties
Net Operating Income (NOI) ÷ Rate
= Value (Sale Price)
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Income Capitalization Approach
Math Concept
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Net Operating Income (the "I" in IRV)
Potential Gross Income
PGI
Vacancy and Collection loss allowance
Other Income
Effective Gross Income
(or GI)
- V&C (% or $)
+ OI
EGI
{ Fixed Expense}
Operating
Expenses
{ Variable Expense}
- OE
(or
EXP)
{ Reserves }
Net Operating Income
NOI
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Income Capitalization Approach
Estimating Value
“IRV FORMULA"
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I
R V
Net Income divided by Rate = Value
NOI  R = V
Net Income divided by Value = Rate
Rate times Value = Net Income
NOI  V = R
R x V = NOI
Note: When the rate goes up, the value goes
down (and vice-versa) (see math supplement)
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Income-Capitalization Approach
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Reconstructed operating statement
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Appropriate items
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Vacancy and collection losses
Reserves for replacement
Management fee
Inappropriate items
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Depreciation
Personal expenses
Federal income taxes
Debt service
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