By Jennifer Choi
Many people who do not work in the property market are interested in real estate. I get a lot of questions that can be filtered into one simple query, “Why is property A worth more than property B when they look pretty much the same?”
For those who think no buildings can be identical, let me give you a more realistic example. Imagine two office buildings that are located in the same market and features similar qualities in terms of its structure. Building A is fully occupied with strong tenants, but for some unknown reason, building B is only half occupied and the tenant size is relatively small. Now, how would you feel about paying same price for these two properties?
Just like the saying, “Do not judge the book by its cover,” the market values of a property cannot be determined just by the way it looks, but by various factors. There are three different approaches to value a property and introduction to these approaches will shed light on your questions. The appraisers derive a value using one or more of the three approaches which appears most appropriate for each property.
In cost approach, the value of a property is derived by adding the estimated land value to the current construction cost for the improvements, permanent structures on properties, and then subtracting any anticipated depreciation.
This approach is particularly useful in valuing relatively new improvements or for the properties that are not frequently traded in the market and have few comparable properties.
An appraiser can also develop a value indication by utilizing the sales comparison approach, which compares the subject property with sales of comparable properties. One premise of the sales comparison approach is that the market will establish a price for the subject property in the same manner that the prices of comparable, competitive properties are established.
The appraiser estimates whether there are properties comparable to the subject and make adjustments by considering various elements including but not limited to conditions of sale, location, physical characteristics, economic characteristics, market conditions, and zoning.
The income capitalization approach is another method to derive to the value of a property, which is very useful when appraising an income producing property. This method takes into account for the income generated by the property which is capitalized by applying appropriate rate or factor and converts it into present value.
A lot of commercial investors may put the most weight on the value derived from the income capitalization approach as their primary goal would be to gain most return from their investments.
It is based on each appraiser’s experience and opinion to decide which approach is most appropriate for a property. From casual conversations with the local appraisers, it is my impression that cost approach has been the most popular one in Korea. However, this trend is slowly changing as the Korea’s real estate market matures and the investors get more sophisticated.
Investors now put their money into a property to get return on their investments and look for properties that can produce a certain level of income. Due to this reason, I believe the income capitalization approach is an important tool to look at when deriving to a value of a property.
In addition, sales comparison approach can also point you to a right direction by analyzing comparable properties. Looking at the sale comparables closely, you will be able to read a trend defined by their transacted prices. After all, valuation in most cases is to derive a “market value,” which is defined by what willing buyer and willing seller may agree for a specific property.
Jennifer Choi is manager of valuation at Cushman & Wakefield Korea.