How to choose the appropriate real estate valuation methodology
For the valuation of a property the valuer has at his disposal 5 basic methodologies which are then selected according to the conditions, purpose and needs of the valuation. The five main categories of methodologies are:
- The comparative method is the oldest and most widely used property valuation method due to its direct link to the real estate market. However, this method finds its optimum application mainly in residential real estate properties. This method essentially compares the appraised property with other similar properties that are on the market or have already been sold (called comparables) and subsequently adjustments are made to adjust the attributes of the comparables to the appraised property to calculate its final value.
- The income capitalization method, this group of methods is mainly used for commercial real estate which generates revenue, the method is divided into the Direct Capitalization method and the Discount Cash Flow (DCF) method.
- In the direct capitalization method, the present value of the appraised property is derived from the income that a property will generate in combination with the capitalization rate to be applied. The method is based on combining and calculating the market value of the property and the income it will generate. This method, in contrast to the cash flow discount (DCF) method, is best applied to smaller sized commercial real estate properties.
- The cash flow discount (DCF) method is used to calculate the net present value of an investment taking into account the income and expense of the investment each year adjusted to the present value of money. The cash flow discount (DCF) method is based on combining and calculating the market value of the property and the net income it will generate. As mentioned above this method finds effective application mainly in large commercial real estate properties such as a hotel, a shopping center etc.
- Depreciated Replacement Cost (DRC) method, in this method the value of a property is estimated by calculating the cost of the land using the available comparative data and then adding the replacement cost of the building built on this land. This method is mainly used in large commercial and industrial properties that are isolated and comparables are not easy to be found, its difference with the discounted cash flow (DCF) method is that this method estimates the value of the property through the value of the land on which it will be built or already constructed and the cost of its construction, while the cash flow discount method ( DCF) manages the valuation through the profits the property will make.