The Three Types of Real Estate Appraisals

A real estate appraisal is an important component of the overall real estate transaction. The value determined is often used for property financing or refinancing as well as for home equity loans and lines of credit. There are three primary types of real estate appraisals that may be used, including the "cost approach," the "sales comparison approach," and the "income capitalization approach."

In the past, some have referred to the "cost approach" as the "summation approach." A real estate appraisal using this method will value the land less any depreciated improvements. The improvements refer to new construction costs of the improvements on the land in today's standards. Most real estate appraisals using this method will start with a replacement cost and then subtract value for any issues relating to the land or the improvements on the land. This type of real estate appraisal is considered to be more effective on newer structures than on older ones.

The "sales comparison" real estate appraisal is often performed or utilized in combination with one or both of the other forms. This approach compares the price per unit area of similar properties in the surrounding area. For example, a potential buyer will be presented with a full listing of properties that are similar in features, sales prices, including a comparison to their own property explaining the overall appraisal value. The price variations are generally averaged to create a fair market value for the property being appraised. This type of real estate appraisal is considered to be the most accurate appraisal as it utilizes recent market values on comparable properties.

The "income capitalization approach" to real estate appraisal is also commonly referred to as the "income approach" and is mostly used for commercial properties, not residential. This type of appraisal uses models to predict the behavior of market participants, in particular with regard to commercial, income-producing properties. Most commercial real estate investors are interested and relying on the income possibilities or past income performance data when deciding to purchase a property. This type of appraisal is more technical and often lengthier than residential appraisals.

When purchasing either a commercial or residential property, a real estate appraisal is a standard procedure, enabling both parties in the real estate transaction to understand the fair market value of the property in question. In commercial real estate, the appraisal is often used as a primary component in the purchase decision. In residential real estate, the appraisal is often used to obtain financing.