Three Valuation Approaches
Professional appraisals use three approaches: comparable sales approach, cost approach, and income approach. Comparable sales analyze recent sales of similar properties, adjusting for differences to estimate subject property value. This approach works well for homogeneous properties with active markets. Cost approach calculates land value plus construction costs minus depreciation, useful for new construction. Income approach capitalizes net operating income at market cap rates, the primary method for investment analysis.
Investment property valuation emphasizes income approach dividing expected NOI by market cap rates. Properties generating higher NOI command higher valuations, while properties with lower cash flow generate lower valuations. This approach directly links investment returns to valuations.
Identifying Valuation Disparities
Market prices sometimes diverge from intrinsic values estimated through fundamental analysis. Properties trading below their fundamental values represent potential bargains. Conversely, overpriced properties require exceptional appreciation expectations to justify cost. Comparing market prices to valuations derived from fundamental analysis identifies mispricings offering opportunities.
Market cycles create valuation disparities with properties undervalued during downturns and overvalued during peaks. Disciplined investors accumulate properties during undervaluation periods and reduce positions during overvaluation periods, capitalizing on cyclical mispricings.