Having a real estate appraisal done can be frightening. I mean it is basically a professional opinion of what the real estate is worth. However, you need not worry. Appraisals are not based on what a professional thinks he would pay for your real estate. The process is actually very systematic and standards have been developed to ensure that real estate appraisals are based on numbers and are as accurate as possible.
With every piece of real estate there are a few different values that can be determined. The most accurately used value is the fair market value. However, there are three different approaches to coming up with this figure. Cost, sales, and income are the three different approaches that may be used based on the real estate situation.
The cost approach may seem like the most logical and it is when you are appraising newer real estate. For this approach you are simply taking the value of the land, adding the cost to construct the building, and subtracting the depreciation.
This is sort of like taking a broken pair of sunglasses and saying that the price to replace them is $20 bucks. However, this example does not take into consideration land value and depreciation. Now, if the pair of sunglasses are from the 1800's it is harder to make an exact determination of what the replacement costs are. In this situation it would be easier to find a group of similar sunglasses and average the selling prices. This is in fact how you would calculate the sales approach to real estate appraisals. You simply look at the market for similar real estate.
Now, instead of sunglasses, let's imagine that we are a seamstress and we have broken our sewing machine. We are not just missing the amount of the sewing machine but the amount of money the sewing machine generated. This is the same with some real estate such as office buildings that are used for income purposes. Instead of just coming up with amount of the real estate, in this case you would use the income approach to estimate how much income is generated in a certain period. This is just an illustration, because figuring this income approach takes many calculations including cash flow analysis and other equations.
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