Three Approaches to Value

There are three methods of appraising or establishing the of property:

1. : The cost of reproducing or replacing a property plus land value minus accrued depreciation.
2. : The value indicated by recent sales of comparable properties in the market, with adjustments for age, condition, and other characteristics.
3. : The investment value represented by the net earning power of a property based on the capitalization of the income stream.

There are situations where only one or two approaches may be applicable. For instance, an owner-occupied residential property is not likely to produce rental income that could be capitalized into an estimate of value through use of the income approach. Therefore, the sales comparison or cost approaches might be more appropriate. Vacant land has no cost of improvements, so the cost approach would not be an appropriate method for that situation.

Specialized properties such as mortuaries, hospitals, or zoos do not typically change hands enough to generate comparative sales, so the cost or the income approach might be more appropriate in those cases.

Replacement Cost Approach

Basic steps to this approach are:

1. Estimate the Replacement Cost New of the improvements (RCN).
2. Estimate the loss in value from depreciation.
3. Deduct the total amount of depreciation to arrive at the Replacement Cost New Less Depreciation (RCNLD).
4. Estimate the value of the land as if vacant.
5. Add the land value estimate to the depreciated cost value to arrive at the total property value.

Replacement Cost New is defined as the cost and overhead that would be incurred in constructing an improvement having the same utility as the original, without necessarily reproducing exactly the same characteristics of the property, but using today's materials, labor, and building techniques. In other words, replacement cost represents the cost to create an equally desirable substitute property.

In Arizona for cost estimation, the unit-in-place method is used. The unit-in-place method is less detailed than the quantity survey method, but still reasonably accurate and complete. This is the method used in the Construction Cost Manual prescribed by the Arizona Department of Revenue, for many building components. These allow the appraiser to make adjustments for individual components for various types of structures.

This method combines direct and indirect costs into a single cost for a building component (the unit-in-place) which is then multiplied by the area of the portion of the building being valued to arrive at a total cost for that component.

The depreciation rates in Arizona's Department of Revenue Construction Cost Manual reflect only the physical factors affecting the value of structures. These tables were developed from market analysis. The rates assume that normal maintenance has been performed. The rate of physical depreciation is calculated based on the age of the structure and the quality of the construction. When the overall quality of an improvement is low, normal physical deterioration is more rapid than for fair or good construction.

Normal physical deterioration is calculated according to actual age. Other factors are computed as they arise in individual structures. If a structure has a serious physical defect, the appraiser will first estimate the RCN, and then compute the cost to cure the physical defect (if curable) and then deduct that amount from the to arrive at .

In ad valorem appraisal, deferred maintenance is not normally included in a valuation consideration. This would have the effect of punishing property owners who kept a property in good condition and rewarding those who let properties rundown. Special obsolescence factors may be noted and taken into consideration, but the aim is to achieve equity, so that owners of similar properties bear an equal share of the tax burden, regardless of whether they perform regular maintenance.

In situations where modernization has occurred during the life of a structure, the appraiser must estimate the of each type of structure and compute the effective age and/or the weighted age.

The effective age is calculated by taking the percentage of the remodeling or modernization in relation to the whole.

Market/Sales Comparison Approach

The Market Approach is based on comparison of the subject property to similar properties, which have sold in the same market. Similarities and differences must be noted in detail—date of sale, location of property, physical characteristics, and conditions of the sale are a few examples. For investment properties, potential income should also be documented.

The conditions of the sale are extremely important when considering whether a property is comparable to the subject or not. If the parties are related, or special financing was obtained, or the seller was forced to sell by some condition of their life (a move, divorce, etc.) then the sale might have to be eliminated as invalid. Remember the definition of "market value": "the most probable price, in terms of cash, in a competitive and open market, assuming a willing and knowledgeable buyer and seller, allowing sufficient time for the sale, and assuming that the transaction is not affected by undue pressures." Some factors like size or shape or location may have to be accommodated by adjusting the value of the comparable up or down to reflect the difference between that property and the subject. The comparable is always adjusted, never the subject property.

The market approach indicates a range of possible values, rather than a precise figure, especially if few sales are available or many adjustments have to be made. In Arizona, the market approach is the most widely used for residential property valuation. It is ideal for types of property that are regularly sold. Furthermore, it may be the only valid approach for valuing properties that are very old or where reliable cost or income data is unavailable.

Income Approach

The Income Approach is used to value commercial or industrial properties, or properties, which are bought and sold by investors primarily because of their income producing potential. This approach to value depends on reliable and detailed information on the income and the costs of doing business for a particular business or enterprise. This is referred to as the "income stream" of the property. The Income Approach defines value as "the present worth of future benefits of owning a property." These are composed of the annual income for an estimated number of years (called the economic life of the property) plus a capital amount representing land value or land value plus some remaining worth of the improvements. This approach emphasizes investment components rather than physical components of a property.

The steps in the income approach are:

1. Estimate Potential Gross Income (PGI).
2. Deduct vacancy and collection losses.
3. Add miscellaneous income to derive Effective Gross Income (EGI).
4. Deduct operating expenses to derive Net Operating Income (NOI).
5. Select appropriate capitalization rate and method.
6. Develop an estimated value.

For ad valorem purposes, single-property appraisal is not an efficient method due to the large number of many types of properties which must be valued each year. Therefore, the Assessor's office determines values using Mass Appraisal. By utilizing a computer-assisted mass appraisal system (CAMA) to assist us in this process, annual values on many types of properties can be established uniformly and at a relatively low cost.

Mass Appraisal is the process of establishing values on groups of properties as of a given date using standardized procedures and statistical testing. Its purpose is the equitable and efficient appraisal of property for ad valorem purposes. This involves data collection, market analysis, valuation and quality control.

Related Publications

IAAO Standard on Mass Appraisal of Real Property
IAAO Standard on Automated Valuation Models (AVMs)

Data Collection

Geographic Stratification

An important aspect of mass appraisal is the collection of data on economic and neighborhood trends. Of particular interest is the identification of economic areas economic districts and neighborhoods to account for location differences in the market.

Property Characteristics

Data is collected on physical and location characteristics, which can assist in the valuation and identification process. Not all data collected may be used in the valuation process. Most characteristics are obtained by on-site inspections when the property is newly constructed and thereafter at periodic stages of activity. Characteristics may also be collected through use of mail questionnaires, aerial photography, and information from other outside sources.

Sales Data

For residential properties, a typical time period of 36 to 48 months (3 to 4 years) of sales data is collected and analyzed each year in preparation of values. These sales must first be adjusted to the end of the data collection period, generally June of the year proceeding the valuation year. These adjustments for time account for the principle of supply and demand as well as the principle of change.

Market Analysis and Valuation

After the necessary data has been collected and categorized, values are determined using a technique called Multiple Regression Analysis. Multiple regression explores and quantifies the relationship between two or more components of known and available data (sales prices and property characteristics) to predict a preliminary value. This process analyzes the sales and characteristic data to develop appropriate adjustments for amenities found to be meaningful in the marketplace, such as square footage, pools, garages, etc. These adjustments can then be applied to all properties in a fair and consistent manner.

The Assessor does not create the value. People create value by the decisions they make in the marketplace. The Assessor has the legal responsibility to study those transactions and appraise property accordingly: "Determine the of all such property as of January 1 of the next year by using the manuals furnished and procedures prescribed by the department." ()

Market fluctuations are reflected in s which may go up or down. Analyzing data, establishing values, issuing notices to owners, and finalizing values after a review/appeal period takes time. It takes approximately four and a half years from the beginning of the data collection to the mailing of tax bills. The length of the process is dictated by both and the .

Quality Control

To measure quality in a mass appraisal setting, statistical tests are utilized. A sales ratio study is one such test and is the final step in the mass appraisal process. Properties, which have sold, are grouped and the established values are compared to the sale amounts to ensure that they fall within an acceptable range.