"Whichever approach or combination of approaches is used, the value of a property should never be higher than that calculated under the cost method."
Appraisers can choose from three approaches to determine what a buyer would pay for a commercial property. But which approach is the most appropriate method of valuation?
The cost approach assumes that buyers will pay no more for a property than it would cost them to build an equal substitute. The appraiser calculates the cost to build the property and subtracts physical, economic, and functional depreciation.
Appraisers prefer this approach for newer properties that lack an operating history. The cost approach is also preferred for unique or specialty properties because no comparable properties may exist.
The income approach assumes that buyers will pay no more for the commercial real estate being assessed than it would cost to purchase an equally-desirable, substitute investment. The appraiser calculates the net income from the property over a given number of years, and discounts the result to its present value.
Appraisers prefer the income approach for income-producing properties that are typically bought and sold by investors. However, this approach requires accuracy in setting the interest rate and predicting future expenses.
The sales approach assumes that buyers will pay no more for the property than it would cost them to purchase an equal substitute. The appraiser locates sales of comparable properties and adjusts the prices to reflect the subject property. Although this approach may be the most accurate in that it provides a price in a particular market, finding a truly comparable property can sometimes be difficult.
Whichever approach or combination of approaches is used, the value of a property should never be higher than that calculated under the cost method. A buyer would not pay more for a property than it would cost to build, unless something else was included in the value. Anything above the value given by the cost approach must be business value, which is excluded from value calculations for property tax purposes.