Condition vs Income in Valuations. The Importance of Due Diligence.
Categories: Commercial Appraisals, Finance, Real Estate Appraisal
Adjusting for condition isn’t something that most appraisers love to do as it involves a significant amount of research to make an accurate estimate of the difference in value due to the condition of physical improvements.
The income approach to valuations is a relatively simple method that calculates the value of a property based on the net income it generates in the course of a year. An appraiser will use a multiplier called the capitalization rate to calculate the value. Valuations professionals like using this method whenever possible as the data regarding investor income and risk expectations is readily available by examining income and purchase price trends for a class of properties in a given market.
Often, less detail-oriented appraisers will focus too heavily on the income a property produces without giving adequate attention to the impact the property’s condition has on value, particularly in the long term. Even where a development’s income is relatively strong, savvy investors should consider how the condition of the property will influence ongoing maintenance and operational costs.
Older buildings, and those less well maintained, can suffer from a host of environmental and efficiency issues that potentially hinder the property’s exit value, contribute to liability concerns, lead to excessive energy and water expense, and limit tenant appeal, ultimately leading to losses and diminished returns.
In the case of single family residences, and those properties not intended for income generation, condition is a primary issue that appraisers must consider in the absence of financial data and comparisons. Adjustments for features are typically straight-forward using the paired sales analysis method; however, adjusting for condition requires more insight on how property condition influences appeal, functionality, and short-term/on-going repair expenses.
While a property’s value may be supported by the presence of comparables with very similar features, location, and functional utility, differences in condition can render a drastic disparity in value, especial within the minds of real estate consumers, personal and commercial alike.
The most professional and diligent appraisers and valuation firms place an emphasis on looking at the broader image when considering the property’s value. Equal weight must be given to economic, social, regulatory, and behavioral factors that influence the market value of a property. For those valuation professionals that really get into condition and understanding how the market reacts to property age, best use, and economic/functional obsolescence, they are able to deliver higher quality reports that perform more reliably in serving the sensitive needs of clients and borrowers.
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