What are the approaches to value?

There are three general groups of methodologies for determining value. These are usually referred to as the “three approaches to value” which are independent of each other:

Cost Approach
This approach is based upon the principle that the value of the property is significantly related to its physical characteristics, and that no one would pay more for a facility than it would cost to build a like facility in today’s market on a comparable site.

Income Approach
The Income Approach is based on the premise that properties similar to the subject are income producing, and that investors purchase these properties based upon their income-producing ability. In the Income Approach, market rents for the subject property are estimated, the applicable operating expenses are deducted, and the resulting net income is capitalized into a value estimate. This method is known as Direct Capitalization.

Another method of the Income Approach is the Discounted Cash Flow Analysis. This approach follows the same methodology as the direct capitalization but projects cash flows over a typical investor holding period. This approach is particularly meaningful for properties which have multiple tenants with varying lease terms. This approach is also useful in analyzing properties which are not stabilized, or have contract rents which differ substantially from market rent.

Sales Comparison Approach
This approach is based on the principle of substitution. This principle states that no one would pay more for the subject property than the value of similar property in the market. This approach analyzes sales of comparable properties with regard to the nature and condition of each sale. Comparisons are made for varying physical characteristics.