Explanation of Valuation Methods
The Cost Approach is a method by which a structure is valued based on the cost of replacement, less depreciation. It begins when a copy of a building permit is received at the Assessor’s Office. A Deputy Assessor inspects and measures the structures at the building site for the purpose of data collection. The information listed includes the building use, quality of construction, exterior measurements, story height and other assessable amenities.
Once all data is collected, the cost of the structure is calculated. The land value is based on the size, use and location of the site; the value is derived from the market place. The land and building values are added to arrive at a total assessed value.
The Sales Comparison or Market Approach utilizes actual sales that take place in the jurisdiction. The local Assessor is informed of each sale by receiving copies of Real Estate Transfer Declarations which are filled out at a closing. This document states the sale price, sale date, seller, buyer and legal description of the property. In the Sales Comparison Approach the subject property, the property in review, is compared to similar properties that have recently sold. The comparison indicates an estimate of the subject’s value.
The Income Approach is used to value commercial income-producing properties such as apartment and office buildings, warehouse and retail space, etc. This approach estimates the income stream that would be produced at the highest and best use of a property under typical management. The income is then capitalized into an estimate of value.
The Income Approach studies: Potential Gross Income – the rent that would be collected if the property were fully occupied at market rent. Vacancy and Collection Allowance – the loss expected from vacancy and bad debts, which is subtracted from Potential Gross Income. Miscellaneous Income – receipts from concessions, laundry rooms, parking or storage rentals. This is added into the calculation to arrive at the Effective Gross Income of a property. Operating Expenses – expenses for administration, repairs, maintenance, utilities, insurance, and reserves for replacements are deducted from the Effective Gross Income. Net Operating Income – is the income produced by subtracting the Operating Expenses from the Effective Gross Income.
Once the Net Operating Income is known, a capitalization rate is used to convert the income into value. The capitalization rate has three components:
1. The Discount Rate – rate of return on the investment.
2. The Recapture Rate – rate of return of the investment.
3. The Effective Tax Rate – takes into account property tax.
The Net Operating Income is divided by this Overall Capitalization Rate to arrive at the property’s value.