A registered valuer is valuing a unique heritage building with no comparable sales. The building generates $80,000 annual rental income, but the cost to replace it would be $2.5 million, while the land is worth $500,000. If the appropriate capitalisation rate is 6.5%, which approach would likely provide the most reliable value indication?
Correct Answer
A) Income approach at about $1,230,000
For an income-producing heritage building, the income approach ($80,000 ÷ 0.065 = $1,230,769) provides the most reliable indication as it reflects the property's actual economic performance. The cost approach overstates value as heritage buildings often have replacement costs that exceed their economic value, and averaging different approaches without proper weighting is not sound valuation practice.
Why This Is the Correct Answer
The building earns rent, so capitalising that income ($80,000 ÷ 0.065 ≈ $1,230,769) reflects what an investor would pay. Replacement cost says little about the value of an old heritage building.
Why the Other Options Are Wrong
Option B: Cost approach at $3,000,000
Adding full replacement cost to land overstates value when the heritage building's income cannot justify that cost.
Option C: Sales comparison using nearby residential sales
Residential sales are not comparable to an income-producing heritage building, so they give no reliable indication.
Option D: An average of the cost and income results, $2,115,000
Averaging two very different results without reasoned weighting is not sound valuation practice.
Deep Analysis of This Valuation Question
The large gap between cost ($3 million) and income value (about $1.23 million) is itself informative: the building would cost far more to replace than the market would pay for its income. For an income-producing property, investors buy the income, so the income approach carries the most weight.
Background Knowledge for Valuation
Valuers choose the approach that best reflects how buyers of that type of property think. Investors focus on income; owner-occupiers of homes focus on comparable sales; the cost approach is used for new or special-purpose buildings or as a check.
Memory Technique
Remember 'ICS' - Income first for Commercial properties with cash flow, Cost for new Construction, Sales comparison when Similar properties exist. For heritage buildings generating income with no comparables, Income approach wins because it shows the 'Cash' the building actually produces.
When you see a valuation question, immediately identify: Does it generate income? Are there comparable sales? Is it new construction? Apply ICS priority - if it's income-producing with no comparables, choose income approach.
Exam Tip for Valuation
For income-producing properties with no comparable sales, always choose the income approach. Calculate: Annual Income ÷ Cap Rate = Value. Heritage buildings typically have high replacement costs that don't reflect market value.
Real World Application in Valuation
A registered valuer is asked to value a converted heritage wool store now operating as commercial offices in central Wellington. The building generates $120,000 annual rent but would cost $3.2 million to rebuild due to heritage requirements. With no comparable heritage commercial sales in the area, the valuer applies the income approach using a 7% cap rate, arriving at approximately $1.71 million. This reflects what investors would actually pay based on the building's income stream, not its expensive replacement cost.
Common Mistakes to Avoid on Valuation Questions
- •Using cost approach for heritage buildings without considering economic obsolescence
- •Averaging different valuation approaches without proper weighting or analysis
- •Applying sales comparison approach when no truly comparable properties exist
Related Topics & Key Terms
Key Terms:
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A registered valuer is valuing a unique heritage building with no comparable sales available. The building would cost $2.5 million to construct today, but due to its age and condition, suffers from $800,000 in physical depreciation and $300,000 in functional obsolescence. The land value is assessed at $1.2 million. What is the total property value using the cost approach?
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