Differences in Approaches

 Real Estate Appraisal Approaches In the field of real estate appraisal, there are three generally accepted valuation approaches:

1. Income capitalization approach. A set of procedures through which an appraiser derives a value indication for an income-producing property by converting its anticipated benefits (cash flows and re- version) into property value. This conversion can be accomplished in two ways. One year's income expectancy can be capitalized at a market-derived capitalization rate or at a capitalization rate that reflects a specified income pattern, return on investment, and change in the value of the investment. Alternatively, the annual cash flows for the holding period and the reversion can be dis- counted at a specified yield rate.

2. Sales comparison approach. A set of procedures in which a value in- dication is derived by comparing the property being appraised to similar properties that have been sold recently, applying appropri- ate units of comparison and making adjustments to the sale prices of the comparables based on the elements of comparison. The sales comparison approach may be used to value improved properties, vacant land, or land being considered as though vacant; it is the most common and preferred method of land valuation when com- parable sales data are available.

3. Cost approach. A set of procedures through which a value indica- tion is derived for the fee simple interest in a property by estimat- ing the current cost to construct a reproduction of, or replacement for, the existing structure; deducting accrued depreciation from the reproduction or replacement cost; and adding the estimated land value plus and entrepreneurial profit. Adjustments may then be made to the indicated fee simple value of the subject property to reflect the value of the property interest being appraised.

 business valuation / Business Appraisal Approaches In the field of business valuation / Business Appraisal, there are also three generally accepted valuation approaches:

1. Income approach. A general way of determining a value indication of a business, business ownership interest, or security using one or more methods wherein a value is determined by converting antici- pated benefits.

2. Market approach. A general way of determining a value indication of a business, business ownership interest, or security using one o more methods that compare the subject to similar businesses, busi- ness ownership interests, or securities that have been sold."

3. Asset-based approach. A general way of determining a value indi- cation of a business's assets and/or equity interest using one or more methods based directly on the value of the assets of the busi- ness less liabilities.

Within the income capitalization approach, the real estate appraisal profession recognizes certain analyses that are generally analogous to the income approach used in business valuation / Business Appraisal. For example, the method that real estate appraisers call "direct capitalization" is concep- tually similar to the income approach method of capitalizing normalized earnings in business valuation. Within the category of direct capitalization, the real estate profession includes gross income multipliers, recognizing—as do business appraisers—that the concept underlying their validity is that a given level of gross income generated by a certain type of property or business should be able to generate a certain level of net income. Also, the method that real estate appraisers call "yield capitalization" is conceptually similar to the income approach method of discounted cash flow analysis in business valuation / Business Appraisal.

Income capitalization approach methods are conceptually similar in business valuation / Business Appraisal and in real estate appraisal. However, in most cases, estimating an economic income stream for an operating business is much more difficult than estimating an economic income stream for an apartment complex, office building, or some similar income-producing real estate. Furthermore, the risks of an operating business are typically more complex to assess and quantify than are the risks of operating real estate. Therefore, the selection of the appropriate discount rate and/or capitalization rates is often more difficult within the context of business valuation / Business Appraisal.

 To cope with these challenges adequately, the business appraiser needs a broad understanding of relevant economic and industry factors, capital market conditions, business management, and accounting. As for the sales comparison approach, the real estate appraiser will seek and analyze market-derived data on the sales of comparable properties. Likewise, the business appraiser will seek and analyze market- derived data on transactions involving comparable, or guideline, businesses. The business appraiser will interpret the transactional data for guidance in determining applicable valuation parameters such as cap- italization rates for earnings or cash flow, and gross revenue multipliers and multiples of the entity's market value to asset value measures, such as book value or adjusted net tangible asset value.

 One tool the business appraiser has that is not available to the real estate appraiser is an actual public market in the fractional interest securities of many kinds of companies. The business appraiser's asset-based approach methods have some general similarities to the real estate appraiser's cost approach meth- ods. The asset-based business valuation approach really provides an in- dication of the value of the business enterprise by developing a fair market value balance sheet. All of the business's assets are identified and their fair market value in use is estimated, and the current value of all of the business liabilities as of the valuation date is estimated.

The difference between the fair market value of the assets and the cur- rent value of the liabilities is an indication of the business enterprise equity value under this approach. Similarly, in the various cost approach methods, the real estate ap- praiser will identify and quantify all of the hard costs, the soft costs, th developer's profit, and the entrepreneurial incentive associated with de- veloping the subject real estate. In a fee simple real estate appraisal, mortgage liabilities are not subtracted by the real estate appraiser.