Valuation Methods Explained: Market, Income and Cost Approaches

More than one approach may be considered and reconciled, or one may carry the greatest weight when its evidence is more relevant and reliable. The report should connect its data, analysis and assumptions to the conclusion.

Approach versus method

An approach is a broad way of considering value through market, income or cost evidence. A method is a specific application, such as comparable transactions, income capitalisation or replacement cost adjusted for obsolescence. Naming an approach is not enough: the report should connect data, analysis and assumptions to the conclusion.

The market approach

The market approach considers transactions, offers or indicators for identical, comparable or related assets and analyses differences. For property those may include location, area, use, condition, transaction date and terms. For equipment they may include model, age, condition, operating hours, specifications, sale location, and removal or installation costs where relevant to the basis of value.

It is useful when comparable evidence exists and its circumstances can be understood. A simple average of advertised prices is not sufficient: an asking price is not necessarily a transaction, assets can differ materially, and older evidence may require time analysis. Thin markets or highly specialised assets may reduce the weight placed on this approach or require support from another.

The income approach

The income approach considers future economic benefits attributable to an asset and converts them into a present value through an appropriate method. For let property, analysis may consider rent, occupancy, expenses and income risk. For an operating asset or project, isolating income attributable to the subject can be more complex and requires supportable assumptions without including benefits that belong elsewhere.

Results can be sensitive to forecasts, capitalisation or discount rates, growth and risk. A client's financial model should not simply be copied without examining its valuation assumptions. The valuer also does not select accounting policy or make the investment decision for the client.

The cost approach

The cost approach considers the cost of obtaining or creating an alternative asset that provides equivalent utility, then addresses physical deterioration and functional or economic obsolescence, along with factors needed for the relevant value definition. It can be useful for specialised or infrequently traded assets when replacement cost and obsolescence can be researched appropriately.

Historical book cost is not automatically value, and the cost of a new asset is not the value of a used one. Effective age, maintenance, capacity, technology, utility and economic demand matter, as can transport, installation or removal under the stated basis.

How is an approach selected?

The valuer asks: what asset and interest are being valued; what are the basis, purpose and date; what evidence exists and how reliable is it; can income be isolated; are there meaningful comparisons; can equivalent utility and obsolescence be estimated? Results are then tested and differences interpreted rather than averaged mechanically.

For real estate valuation, evidence may be weighted differently for land, let property and development. For machinery and equipment valuation, specialisation, condition, integration within a production process and market availability affect the method.