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Appraisals are art, not science. While appraisers are well trained professionals, their opinions are really just that, “opinions.” As I’ve said before, the buyer decides the value, no one else. Many a person has been duped by unscrupulous sellers using doctored appraisals to support inflated values. Beware of this and make sure that you do some independent research.

However, since someone has to put a finger on value for lenders, we have to look to the appraiser’s opinion for an idea of what the value is. There are three main types of appraisal methods: cost approach, sales approach, and income approach (my favorite).

The cost approach is a simple approach that estimates the total cost to build the structure and site improvements on the same lot. In the case of a house, the appraiser takes the price to build the house just like it is and adds the cost of the lot and site improvements. From that, the appraiser will deduct the depreciation of the existing house because it is older. This will give the appraiser a cost approach value.

Another method is the sales approach. The appraiser will attempt to find similar properties that have sold as recently and as close to the subject property as possible. If there are differences in the comparables, such as one less bathroom, the appraiser will deduct this from the value of the subject property. Or, if the lot is smaller or larger, he will make an adjustment in the value. Eventually, after making his best guess on value adjustments, he will reach a sales approach value.

The other method, which I prefer s the income approach. This approach is less open to subjectivity than any other method. It is derived strictly from the amount of rent that can be achieved. Based upon this income and using some common valuation methods, the appraiser will reach a value based on the income approach.

While all three methods have their advantages, I prefer the income approach and cost approach, since they are less open to subjectivity and “irrational exuberance” in the market place. Sometimes, buyers become emotional or greedy in hopes of quick profits. These sales can push delicate market values to the brink when a person promotes the sales approach. Many beach condo owners along the Gulf of Mexico fell prey to this appraisal method in 2006 and 2007. Prices sky rocketed as condos were traded like hot stocks in hopes that another sucker would come along. For a while, it worked, as appraisals were completed showing values increasing faster and faster. However, the bottom finally dropped out as the pricing outstripped the income and cost approaches. Had investors been more cognizant of these other two valuation methods, many would have not jumped into the market and lost so much money.

Brian Patton, CCIM, owner of Capital Realty Advisors, LLC, of Atlanta, Georgia, is an author, columnist, and speaker on commercial real estate issues.

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