Illinois real estate valuation
Sales comparison, cost and income: the three appraisal approaches
A house can sell for less than it cost to build. An apartment building can command a price based on its income. A nearby sale can be a poor comparable. The three approaches organize different evidence, and the strongest evidence depends on the property and assignment.
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The short answer
Sales comparison analyzes competitive sales and adjusts comparable prices for relevant differences. Cost adds separately supported site value to the current cost of improvements less accrued depreciation. Income converts anticipated property benefits into value, using a method such as direct capitalization, a gross rent multiplier or discounted cash flow. Select and reconcile approaches according to their relevance and evidence. Do not automatically choose the highest result or average three numbers.
Reviewed for October 2026. The PSI outline places these approaches at national III.B.2-4, Estimating Value, within the eight scored national Valuation questions. They do not each have a separate published quota. General appraisal concepts and the identified Fannie Mae mortgage-program requirements are distinguished below. These are original teaching examples, not property appraisals or official PSI questions.
Four questions before choosing an approach
- What is being valued? Identify the property rights, effective date, intended use and assignment requirements. A fee-simple interest and a leased interest need not have the same value.
- What evidence represents this market? Competitive sales support comparison, current cost and depreciation evidence support cost, and credible rent, expense and return data support income analysis. Property type is a clue, not a substitute for those facts.
- Are the inputs consistent? Adjust comparable prices toward the subject. Avoid double-counting site improvements. Match income definitions, capitalization rates and rent periods before calculating.
- Which indications deserve the most weight? Explain relevance and reliability. Follow applicable program rules, including required approaches and reconciliation limits; do not turn a mnemonic or an arithmetic average into an appraisal.
| Approach | Main question | Basic setup | Evidence to inspect |
|---|---|---|---|
| Sales comparison | What do competitive substitutes sell for? | Comparable sale price +/- supported adjustments | Rights, transaction terms, date, location, physical features and verification |
| Cost | What does an equivalent substitute cost today? | Site value + improvement cost new - accrued depreciation | Current costs, separate site value and all relevant depreciation |
| Income | What are the anticipated benefits worth? | Direct cap: annual NOI / matching cap rate; GRM: rent x matching multiplier | Market rent, vacancy, expenses, income definition, rate and period |
The distinctions that matter
| Distinction | How it works | What to notice |
|---|---|---|
| Sale price, cost and value | A transaction price and construction expenditure are evidence, not interchangeable definitions of market value. | A high building bill does not guarantee buyers will pay that amount. Sales need analysis before they become indications for another property. |
| The comparable and the subject | Adjust the comparable sale toward the subject for a supported difference. | Superior comparable: subtract. Inferior comparable: add. Use market contribution, not an automatic dollar-for-dollar construction-cost adjustment. |
| Replacement and reproduction | Replacement uses a modern substitute with equivalent utility; reproduction duplicates the existing improvement's design and materials. | Same usefulness and a replica are different cost bases. Neither is simply the owner's historical invoice. |
| Three sources of depreciation | Physical deterioration concerns wear or damage; functional obsolescence concerns utility, design or features; external obsolescence comes from outside influences. | Physical and functional losses can be curable or incurable economically. External obsolescence is generally treated as incurable by the owner; temporary does not mean owner-curable. |
| Land value and improvement depreciation | The cost approach values the site separately, and applies improvement depreciation to improvements. | Land can lose market value. Account for an adverse site influence in site value rather than depreciating it as a building or subtracting the same loss twice. |
| NOI and financed cash flow | NOI precedes debt service. Expense and reserve definitions still need checking against the rate being used. | Do not insert mortgage payments, accounting depreciation or the owner's income tax into the supplied property-level NOI. Reserve conventions can differ between sources. |
| A cap rate and a gross multiplier | A cap rate relates consistently defined income to value; a gross multiplier relates price to a specified gross income period. | Annual NOI / decimal cap rate is different from monthly rent x monthly GRM. A mortgage interest rate is not a substitute for a property cap rate. |
| Reconciliation and automatic averaging | Reconciliation explains the evidence and weighting. It is not a rule that every mathematical weighted average is forbidden. | Fannie Mae B4-1.3-11 permits a properly explained weighted-average technique and requires the final value within the range of the approaches used. Its UAD 3.6 supplement retains these points. |
Work through the facts
Adjust a superior comparable
A comparable sold for $440,000 and has one additional garage bay. The stipulated market contribution of that bay is $18,000. All other relevant differences are already accounted for.
- The comparable is superior for this feature.
- Adjust its price down: $440,000 - $18,000 = $422,000.
- The supplied figure is a market contribution, not a builder's quote.
Answer: This comparable indicates $422,000 after the stated adjustment. One adjusted sale is not a complete appraisal.
Build the cost indication without a duplicate
Site value is $90,000. Building replacement cost new is $360,000, with $70,000 accrued depreciation. Separate site improvements contribute $15,000 and are expressly excluded from the other figures.
- Depreciated building: $360,000 - $70,000 = $290,000.
- Total: $90,000 + $290,000 + $15,000 = $395,000.
- If the site-improvement amount had already been included, adding it again would duplicate value.
Answer: The supplied cost-approach indication is $395,000.
Capitalize a defined annual income
Stabilized annual NOI is $72,000. A market-supported overall cap rate of 8% uses that same NOI definition.
- Convert 8% to 0.08.
- $72,000 / 0.08 = $900,000.
- Reverse: $900,000 x 0.08 = $72,000. Financing cash flow is a different measure.
Answer: The direct-capitalization indication is $900,000. The rate is supplied, not a current market recommendation.
Keep a gross multiplier on its own time basis
Monthly gross rent is $2,400. Comparable evidence supplies a monthly GRM of 145.
- Use monthly rent with the monthly multiplier: $2,400 x 145 = $348,000.
- Do not substitute annual rent into a monthly multiplier.
- This gross shortcut does not deduct operating expenses and is less informative where expense patterns differ materially.
Answer: The supplied GRM indication is $348,000, not $4,176,000.
Choose cost for the evidence, not a label
A recently completed special-purpose building has few competitive sales and no meaningful private rental evidence. Reliable site, current construction and depreciation information is available.
- Sales and income evidence are comparatively weak.
- Cost can be useful because its inputs are better supported.
- Do not assume new means zero depreciation, or extend this general example into permission to submit a cost-only Fannie Mae mortgage appraisal.
Answer: Cost may deserve substantial weight on these facts. The assignment still determines what work is necessary.
Reconcile an apartment valuation
The approaches indicate $4.9 million by sales, $5.0 million by income and $5.8 million by cost. Sales and rental evidence are strong; the cost depreciation estimate is weak.
- Investigate the discrepancy rather than select the highest figure.
- Give supported income and sales evidence more weight; do not mechanically give the weak cost result one-third influence.
- These facts do not supply precise weights or a unique final value.
Answer: Reconciliation should explain the evidence. No exact final answer follows from these three indications alone.
Use weights only when supported
A separate exercise expressly supplies justified reconciliation weights: 40% to a $490,000 sales indication, 50% to a $500,000 income indication and 10% to a $580,000 cost indication. Calculate the weighted result.
- Weights total 100%. Contributions are $196,000, $250,000 and $58,000.
- The sum is $504,000, within the $490,000-$580,000 range.
- The arithmetic does not establish that these particular weights are justified in a real assignment.
Answer: The stipulated weighted result is $504,000. Fannie Mae requires a proper explanation when this technique is used.
Use the actual Fannie Mae scope
A qualifying Fannie Mae valuation concerns a two-unit property, and the appraiser says a sales analysis alone is enough because most nearby homes are owner-occupied.
- B4-1.3-10 requires the income approach for two- to four-unit properties.
- A broad observation about the neighborhood does not erase that property-specific program requirement.
- For UAD 3.6, use the applicable supplement; its income section specifies at least three rental comparables for each subject unit, with appropriate reuse of comparable units allowed.
Answer: Apply the actual program rule rather than treating all approaches as optional in every assignment.
Mistakes to avoid
- Use whichever approach gives the highest value. Investigate differences and reconcile supported indications.
- The cost of a feature is its sales adjustment. Use the market reaction, which can differ from cost.
- Land cannot lose value. Separate site value from building depreciation; adverse site conditions still matter.
- No weighted average is ever allowed. An explained weighted technique is permitted under the identified Fannie Mae rule; unsupported automatic averaging is different.
Check your understanding
These are original teaching questions, not recalled or predicted PSI questions. Answer first, then explain why the other choices fail.
1. Recent verified sales compete for the same buyers as an owner-occupied subject home. Which approach most directly uses that evidence?
- Historical book value
- Sales comparison
- Income only
- Cost only
Show answer and explanation
Answer: B. Sales comparison
Sales comparison analyzes competitive transactions. Cost needs cost and depreciation inputs; income needs earning-power evidence. Book value is not the market comparison described.
2. A comparable sold for $300,000 and is inferior by a stipulated market-supported $12,000 feature difference. All other factors are accounted for. What is its adjusted indication?
- $312,000
- $288,000
- $12,000
- $300,000
Show answer and explanation
Answer: A. $312,000
Add $12,000 to the inferior comparable: $312,000. Subtracting reverses the direction; no adjustment ignores the stipulated difference; $12,000 alone is the adjustment, not the adjusted indication.
3. A feature cost $30,000 to install but contributes a supported $18,000 in this market. Which amount represents that feature's supplied sales-comparison adjustment?
- Always the average, $24,000
- Neither, because contribution cannot differ from cost
- Always $30,000
- $18,000
Show answer and explanation
Answer: D. $18,000
The market-supported contribution is $18,000. Cost and contribution can differ. Averaging the two without evidence does not establish a market reaction.
4. Site value is $80,000; total improvement cost new is $320,000, already including all site improvements; total accrued improvement depreciation is $50,000. No other items apply. What is the indication?
- $450,000
- $270,000
- $350,000
- $400,000
Show answer and explanation
Answer: C. $350,000
$80,000 + $320,000 - $50,000 = $350,000. Do not add site improvements again, omit the site, ignore depreciation or add depreciation.
5. Which description is replacement cost?
- The owner's original invoice
- A modern substitute with equivalent utility
- The loan balance plus repairs
- A replica using the original design and materials
Show answer and explanation
Answer: B. A modern substitute with equivalent utility
Replacement concerns equivalent utility with current methods. Reproduction is the replica; historical cost and outstanding debt are different quantities.
6. Which statement about external obsolescence is best?
- It is always physical wear inside the building
- It is generally incurable by the owner, even though the outside condition can be temporary
- It can never affect site value
- A temporary outside influence is necessarily curable by the owner
Show answer and explanation
Answer: B. It is generally incurable by the owner, even though the outside condition can be temporary
Outside-source loss and its duration are separate from an owner's ability to cure it. It is not simply physical wear, and a site influence can affect separately supported site value.
7. Annual NOI is $54,000 and the matching overall cap rate is 6%. What is the direct-capitalization indication?
- $57,446
- $900,000
- $324,000
- $3,240,000
Show answer and explanation
Answer: B. $900,000
$54,000 / 0.06 = $900,000. Multiplying income by the rate or using a percentage as a whole number answers a different calculation. Check: $900,000 x 0.06 = $54,000.
8. Monthly rent is $2,000 and the supported monthly GRM is 150. What is the indicated value?
- $300,000
- $150,000
- $3,600,000
- $13.33
Show answer and explanation
Answer: A. $300,000
$2,000 x 150 = $300,000. Annualizing rent while retaining a monthly multiplier creates a twelvefold error; dividing reverses the relationship. No operating expenses are deducted in this supplied gross formula.
9. Which statement correctly describes the identified Fannie Mae reconciliation rule?
- A reasoned explanation alone permits any number outside the range
- Every weighted calculation is prohibited
- A properly explained weighted technique can be used, and the final value must remain within the approaches' indicated range
- Always choose the highest approach
Show answer and explanation
Answer: C. A properly explained weighted technique can be used, and the final value must remain within the approaches' indicated range
B4-1.3-11 and its UAD 3.6 counterpart allow the explained weighted technique and impose the range requirement. They do not authorize a highest-number rule or an out-of-range final value merely because commentary is supplied.
10. An appraisal's income analysis defines NOI before debt service. An extra $20,000 mortgage-payment figure appears in the facts. What follows?
- Use it as the capitalization rate
- Keep it separate from the stated NOI; financing cash flow is a different measure
- It is another word for operating depreciation
- Deduct it automatically because it appears in the stem
Show answer and explanation
Answer: B. Keep it separate from the stated NOI; financing cash flow is a different measure
Debt service reflects financing, not this defined property-level NOI. It is neither depreciation nor a rate. The correct income definition matters more than using every number in the stem.
11. Under the cited Fannie Mae rule, what is required when valuing a two- to four-unit property?
- No income work if nearby homes are owner-occupied
- A universal simple average of three approaches
- Cost analysis alone in every case
- Income analysis, with the applicable program's supporting data requirements
Show answer and explanation
Answer: D. Income analysis, with the applicable program's supporting data requirements
B4-1.3-10 requires the income approach for two- to four-unit properties and rejects sole reliance on income as the market-value indication. The nearby owner-occupied market does not erase the requirement; cost-only and simple averaging are not the prescribed substitutes.
12. In a cost approach, what should happen to an adverse site influence?
- Treat the land as a building with age-life depreciation
- Reflect it in supported site value without duplicating the same loss elsewhere
- Always subtract it only from building cost
- Ignore it because land is never affected
Show answer and explanation
Answer: B. Reflect it in supported site value without duplicating the same loss elsewhere
The September 2026 UAD supplement distinguishes site value from improvement depreciation. Land can lose market value, while the building-depreciation formula is applied to improvements. Double-counting the same loss is not justified.
13. An exercise explicitly supplies justified weights of 75% for a $400,000 sales indication and 25% for a $440,000 cost indication. What is the weighted result?
- $440,000
- $410,000
- $840,000
- $420,000
Show answer and explanation
Answer: B. $410,000
$400,000 x 0.75 + $440,000 x 0.25 = $300,000 + $110,000 = $410,000. It is within the indicated range. The supplied unequal weights do not produce the simple $420,000 mean; the calculation does not independently justify those weights in a real appraisal.
Common questions
What are the three approaches to value?
Sales comparison, cost and income. They organize transactions, production and depreciation, and anticipated benefits respectively. All rely on evidence for the subject property and effective date; they are not three guaranteed shortcuts to the same number.
Which approach is best for a house?
Sales comparison is often central when reliable competitive sales show how the home's buyers choose alternatives. The closest or newest sale is not automatically the best one. Property rights, market competition, condition, transaction terms and available data matter.
Do I adjust the subject or the comparable?
Adjust the comparable price toward the subject. Subtract for a superior comparable feature and add for an inferior one, using supported market contribution. A construction invoice or fixed price-per-square-foot rule does not establish the adjustment by itself.
What is the cost-approach formula?
Site value plus current improvement cost new minus accrued improvement depreciation. Add a separate contributory site-improvement amount only if it was excluded from the other figures. Identify the scope of each input so the same component or loss is not counted twice.
Does new construction always equal market value?
No. Current costs can be useful evidence, but over-improvement, functional problems and external influences can matter even in a new building. The cost of creating a feature need not equal what purchasers will pay for it.
Can land depreciate?
Land can decline in market value. In this cost-approach structure, the site is valued separately rather than receiving the building's accrued-depreciation deduction. Reflect a site influence in site value and improvement losses in the appropriate improvement analysis without duplicating the same loss.
Are all forms of depreciation curable?
No. Physical and functional losses can be economically curable or incurable. External obsolescence is generally treated as incurable by the owner. An outside condition disappearing later does not mean the owner can economically cure it now. Appraisal loss in value also differs from tax depreciation.
What formula should I use for the income approach?
Identify the method first. Direct capitalization uses consistently defined annual NOI divided by a matching decimal cap rate. A gross rent multiplier uses rent times a multiplier derived for the same rent period. Discounted cash flow analyzes multiple expected cash flows and is not identical to either shortcut.
Are replacement reserves always outside NOI?
No single convention applies to every source. The OCC and Fannie Mae multifamily materials use different named income and reserve treatments. State the definition in the exercise and match it to the capitalization rate. Debt service remains different from property operating income.
Do appraisers have to use all three approaches?
Not in every assignment. Develop the approaches necessary for credible results and follow applicable requirements. For example, the cited Fannie Mae topic generally requires cost for manufactured homes and income for two- to four-unit properties, and does not accept a market-value appraisal relying solely on cost or solely on income. These are program-specific rules. Under UAD 3.6, the reason for excluding an approach must also be provided. Do not confuse a reasoned exclusion with permission to omit a program-required approach.
Is reconciliation just averaging?
No. Explain the applicability and reliability of the approaches and their data. Fannie Mae permits a properly explained weighted-average technique, while requiring its final reconciled value within the range of the approaches used. Unsupported equal weighting and choosing the highest number do not resolve weak evidence.
What changed for the October 2026 review?
This lesson checks the June 2025 Fannie Mae topics alongside the September 2026 UAD 3.6 supplement where applicable. The supplement preserves the explained-weighting and final-range requirements and gives specific rental-comparable instructions. The Appraisal Foundation lists 2024 USPAP as current; the 2026 Guidance and Reference Manual is a separate publication. The practice questions are original and do not predict an exam score.
Keep practising
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Put valuation into practice
Choose the approach or value principle that fits the facts, then check your reasoning.
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Official sources and scope
The PSI booklet supplies exam placement. Fannie Mae topics and the applicable UAD 3.6 supplement supply the identified mortgage-program rules, including the explained-weighting exception. The DRE reference supports general cost and depreciation teaching, not Illinois licensing law; OCC and Fannie multifamily materials show why reserve conventions must be identified. The Appraisal Foundation distinguishes current USPAP from its separate guidance manual. Worked figures and questions are original examples.
- Fannie Mae B4-1.3-08: comparable selection
- Fannie Mae B4-1.3-09: market-supported comparable adjustments
- Fannie Mae B4-1.3-10: cost and income approach
- Fannie Mae B4-1.3-11: reconciliation and explained weighting
- Fannie Mae UAD 3.6 supplement: September 2026 income policy
- California DRE Reference Book, chapter 15, printed pages 406-412: general cost approach, depreciation and age-life teaching
- OCC Commercial Real Estate Lending handbook: income and value analysis
- Fannie Mae multifamily: defined NCF subtracts replacement reserve from NOI
- PSI June 24, 2026: national Valuation outline
- The Appraisal Foundation: current USPAP and separate guidance manual
This is exam preparation, not advice for a specific transaction. State law and the applicable facts control. Our editorial and corrections process explains how to report an issue.