Property Valuation: The Three Approaches
Learn the three standard approaches to property valuation: Market Comparison, Income Capitalization, and Cost Approach. Understand when to use each and how to compute basic valuations.
Market Comparison Approach (Sales Comparison)
“The Market Approach provides an indication of value by comparing the subject property with identical or similar properties for which price information is available. The approach considers the sales of similar or substitute properties and related market data, and establishes a value estimate by processes involving comparison.”
What This Means
The Market Comparison Approach is the most common method for residential properties. It estimates value by comparing the subject property to recent sales of similar properties (called "comparables" or "comps"). Steps: (1) Find 3-5 recent sales of similar properties in the same area, (2) Adjust for differences (size, condition, features, time of sale), (3) Compute the adjusted P/sqm, (4) Apply to the subject property. Adjustments are key. a larger lot commands a lower P/sqm, a corner lot commands a premium, a renovated house is worth more than an unrenovated one.
- Find 3-5 comparable sales in the same area (within 6-12 months)
- Adjustments: size, location, condition, age, features, time of sale
- Larger lots: usually lower P/sqm (inverse relationship)
- Corner lots: 10-20% premium over interior lots
- Result: a market-supported value range (not a single number)
Real-World Scenario
A broker needs to price a 200 sqm residential lot (interior lot, regular shape) in a subdivision. Three recent sales in the same subdivision: Comp A: 180 sqm interior lot sold for P4,500,000 (P25,000/sqm). Comp B: 220 sqm corner lot sold for P6,160,000 (P28,000/sqm). Comp C: 195 sqm interior lot sold for P5,070,000 (P26,000/sqm).
What is the estimated value of the subject lot?
Income Capitalization Approach
“The Income Approach provides an indication of value by converting future cash flows to a single current capital value. This approach considers the income that an asset will generate over its life and indicates value through a capitalization process. The two common methods are direct capitalization and discounted cash flow.”
What This Means
The Income Approach values property based on its income-generating potential. Best for: rental properties, commercial buildings, and investment real estate. The Direct Capitalization formula: Value = Net Operating Income (NOI) ÷ Capitalization Rate (Cap Rate). NOI = Gross Rental Income - Operating Expenses (maintenance, taxes, insurance, management fees, vacancy allowance). Cap Rate = the market rate of return investors expect (typically 5-8% for Philippine commercial properties, 4-6% for residential). Lower cap rate = higher value (investors accept lower return for safer/premium assets).
- Formula: Value = NOI ÷ Cap Rate
- NOI = Gross Income - Operating Expenses (before debt service)
- Cap Rate: 4-6% residential, 5-8% commercial, 8-12% high-risk
- Lower cap rate = higher value = lower risk/premium location
- Also compute Gross Rent Multiplier (GRM) = Price ÷ Annual Gross Rent
Real-World Scenario
An investor is evaluating a commercial building that generates P200,000/month gross rent (100% occupied). Operating expenses are P40,000/month. Similar commercial properties in the area sell at 7% cap rate. The building is also 100% leased for the next 5 years.
What is the property's value using the income approach?
Cost Approach (Replacement/Reproduction Cost)
“The Cost Approach provides an indication of value by calculating the current replacement or reproduction cost of an asset and making deductions for physical deterioration and all other relevant forms of obsolescence. The cost of the land is added to the depreciated cost of the improvements to obtain the total property value.”
What This Means
The Cost Approach answers: "What would it cost to rebuild this property today, minus wear and tear?" Formula: Value = Land Value + (Replacement Cost of Building - Depreciation). Use when: (1) no comparable sales exist (unique/specialized properties), (2) new construction (depreciation is minimal), (3) insurance valuation. Depreciation types: Physical (wear/age), Functional (outdated design), and External/Economic (neighborhood decline). Common construction costs in the Philippines: P20,000-40,000/sqm for standard residential, P40,000-60,000/sqm for mid-range, P80,000+/sqm for high-end.
- Formula: Value = Land Value + (Replacement Cost - Depreciation)
- Replacement cost: what it costs to build the same building TODAY
- Physical depreciation: age/wear (straight-line method: 1-2% per year)
- Functional obsolescence: outdated layout, systems, or design
- Best for: unique buildings, new construction, insurance valuations
Real-World Scenario
A 10-year old, 200 sqm residential house sits on a 300 sqm lot. The lot is worth P20,000/sqm based on market comparison. The house would cost P35,000/sqm to rebuild today. Assume a useful life of 50 years and straight-line depreciation. No functional or external obsolescence.
What is the property value using the cost approach?
Frequently Asked Questions
Which valuation approach should I use for a residential property?
For standard residential properties (houses, condos, lots in subdivisions): use the Market Comparison Approach. it is the most reliable because comparable sales data is usually available. For rental properties: use the Income Approach as a secondary check. The Cost Approach is best for new or unique buildings where no comparables exist. Professional appraisers typically use all three and reconcile the results, giving most weight to the approach most applicable to the property type.
What is a Comparative Market Analysis (CMA) and how is it different from an appraisal?
A CMA is an informal valuation prepared by a real estate broker to help set a listing price or advise a buyer. it uses the market comparison approach but is not a formal appraisal. A formal appraisal is prepared by a licensed real estate appraiser, follows Philippine Valuation Standards, and results in an official appraisal report. Banks require formal appraisals for loan purposes; CMAs are sufficient for listing and negotiation.
How do I find comparable sales data in the Philippines?
Sources for comparables: (1) Your own brokerage's closed transaction records, (2) Registry of Deeds. deed prices are public record (though often understated), (3) BIR zonal values. minimum benchmark per area, (4) Developer price lists for new projects in the area, (5) Online listings (PropertyFinder, Lamudi). these are ASKING prices, not closed prices, so discount by 5-15%, (6) Assessor's Office schedule of market values. The best source is actual closed transactions from trusted broker networks.