The three appraisal approaches and depreciation types, with worked examples

The three approaches at a glance

Every appraisal question on the exam starts with one decision: which approach fits this property? PSI's national content outline lists all three by name under Valuation, an area weighted at 8% of the national outline: the sales or market comparison approach, the cost approach and the income analysis approach, each "and appropriate uses." That last phrase is the hint. The test wants you to match the approach to the property as much as it wants the math.

Lenders follow the same logic. Fannie Mae's Selling Guide says it does not require the cost approach except for manufactured homes, that the income approach is required for two- to four-unit properties, and that an appraisal relying solely on the cost approach or solely on the income approach is not acceptable. That leaves sales comparison carrying most of the weight for a typical house.

Sales comparison: adjust the comparable, never the subject

The subject is the property being valued. The comparables (comps) are similar properties that recently sold. You already know what each comp sold for, so you change the comp's price to show what it would have sold for if it looked exactly like the subject. The subject never gets adjusted, because its value is the unknown you are solving for.

1. Find a feature where the comp and the subject differ.
2. Ask: is the comp better (superior) or worse (inferior) than the subject on that feature?
3. Comp superior: subtract the feature's value from the comp's price. Comp inferior: add it.
4. Repeat for every difference, then total the adjustments to get the comp's adjusted sale price.

HUD's Section 8 renewal guide states the rule plainly for the appraisers who prepare its rent comparability studies: when a comparable is inferior to the subject, adjust the comparable upward; when it is superior, adjust it downward. Fannie Mae adds that adjustments must reflect the market's reaction to a difference, and that sales or financing concessions get a negative adjustment on the comp, never a positive one.

Worked example (illustrative numbers). Grace, an appraiser, is valuing a 3-bedroom, 2-bath house with a fireplace and no garage. In this market, a garage is worth $15,000, a full bath $10,000 and a fireplace $4,000.

Notice that Comp C has a net adjustment of minus $6,000 but a gross adjustment of $14,000. Gross adjustment (every adjustment added up, ignoring the sign) is a rough measure of how different a comp really is. Comp B, with only $10,000 of gross adjustment, is the closest match. Fannie Mae says it has no specific limits on net or gross adjustments, so treat this as a judgment tool, not a pass or fail rule. We use these three adjusted prices again in the reconciliation section below.

Cost approach: replacement vs reproduction, and land on its own

The cost approach asks what it would cost to build the same utility today, then subtracts what the existing building has lost. The formula is: land value plus (cost new of the improvements minus accrued depreciation).

• Reproduction cost: the cost to build an exact replica, with the same materials, design and craftsmanship, flaws included. Use it for historic or unusual buildings where the exact replica matters.
• Replacement cost: the cost to build a building with the same utility using modern materials and methods. Textbooks treat this as the usual choice for most properties, because nobody rebuilds lath and plaster walls to get a functional house.
• Land is valued separately, as if vacant, usually by comparing land sales. Land does not wear out, so it does not depreciate. Only the improvements (the building, driveway, landscaping) lose value.

Worked example (illustrative). Omar's house has 2,000 square feet, and building it new would cost $210 per square foot. The house has an effective age of 12 years and a total economic life of 60 years. Comparable lot sales put the land at $150,000.

The land was never multiplied by the 20%. Depreciating the land along with the building is a classic distractor. Fannie Mae's guide points to the same weak spots: the cost approach is only as reliable as its site values, its reproduction cost estimates and its depreciation estimates.

Physical, functional and external depreciation

In appraisal, depreciation is any loss in value from the property's cost new. It comes from three sources, and the exam wants you to sort a fact pattern into the right one.

Curable or incurable is an economic test, not a physical one. The standard textbook rule: an item is curable when the cost to fix it is no more than the value the fix adds. Replacing worn carpet for $6,000 when the fix raises the value by $9,000 is curable. Moving a load-bearing wall for $80,000 to fix a bad floor plan when the fix adds $30,000 is incurable, even though a contractor could do it.

Straight-line depreciation math

Most exam depreciation problems use the straight-line (age-life) method: the building loses the same amount every year of its economic life. Three formulas cover nearly every question.

• Annual depreciation = cost new / economic life. Example: $420,000 / 60 years = $7,000 a year.
• Total depreciation = annual depreciation x effective age. Example: $7,000 x 12 = $84,000. Same as 12 / 60 = 20% of $420,000.
• Age from depreciation = total depreciation / annual depreciation. Example: a $300,000 building with a 50-year life is now worth $240,000. It has lost $60,000 at $6,000 a year, so it is 10 years into its life.

Effective age is the age the building looks and functions like, given its condition. A well-kept 30-year-old house might have an effective age of 15. Remaining economic life is total economic life minus effective age. When a problem gives you both actual age and effective age, the age-life method uses effective age.

For more practice with these formulas, use the math lessons and keep the printable NJ real estate math formulas sheet next to you.

Income approach: NOI, cap rate, GRM and GIM

PSI lists "rate of return/capitalization rate" under Real Estate Calculations, so cap rate problems are fair game. The income approach turns a property's yearly income into a value. Build NOI step by step:

1. Potential gross income (PGI): all rent if every unit were full all year.
2. Subtract vacancy and collection loss to get effective gross income (EGI). Add any other income, such as laundry or parking.
3. Subtract operating expenses to get net operating income (NOI). Operating expenses include property taxes, insurance, utilities the owner pays, maintenance, management and reserves for replacement.
4. Do not subtract mortgage payments (debt service), depreciation or the owner's income taxes. NOI describes the property, not the owner's financing.
5. Value = NOI / cap rate.

Worked example (illustrative). Lena is looking at a 4-unit building with each unit renting for $2,100 a month. Vacancy and collection loss run 5%. Operating expenses total $33,760 a year. Similar buildings sell at a 7.75% cap rate.

The cap rate moves opposite to value. The same $62,000 NOI is worth $775,000 at an 8% cap rate and about $826,667 at 7.5%. A lower cap rate means buyers accept a lower yield, so they pay more. If a problem gives value and NOI and asks for the rate, divide: NOI / value = cap rate.

Gross multipliers are the shortcut version, and neither one looks at expenses. In most exam problems, a gross rent multiplier (GRM) uses monthly rent and is used for houses and small rentals, while a gross income multiplier (GIM) uses annual gross income and is used for larger income property. Some textbooks build a GRM on annual rent, so always check which period the comps use and apply the multiplier to the same period.

• GRM from a comp: sale price / monthly rent. A house that rents for $2,500 and sold for $400,000 has a GRM of 160.
• Apply it: subject monthly rent x GRM. A subject renting for $2,400 x 160 = $384,000.
• GIM works the same way with annual income: a building with $150,000 of gross annual income sold for $1,200,000, a GIM of 8. A subject with $135,000 of gross annual income x 8 = $1,080,000.

Fannie Mae requires the appraisal to show the comparable rental and sales data and the calculations behind the gross rent multiplier, so in real appraisals the multiplier comes from the market, not from a rule of thumb. To drill this kind of problem under time pressure, try the math drill.

Reconciliation: weighted, not averaged

Reconciliation is the last step, where the appraiser turns several value indications into one opinion of value. Fannie Mae's guide is blunt: reconciliation must never be an averaging technique, except a weighted average that includes a proper explanation, and the appraiser must report which approach or approaches got the most weight.

Back to Grace's three comps. A simple average of $397,000, $399,000 and $399,000 is about $398,333. Grace instead gives Comp B the most weight because it needed the least adjustment.

The same logic applies across approaches. As a general rule, the sales comparison result gets the most weight for a house, the income approach for an apartment building, and the cost approach for a new firehouse with no sales to compare. The exam answer that says "add the three approaches and divide by three" is the trap.

New Jersey: a CMA is not an appraisal

PSI's outline also tests "situations which require appraisal by a licensed or certified appraiser" and "brokerage-related actions that constitute unauthorized appraisal practice." In New Jersey the line is drawn by two separate bodies of law.

• Appraisers have their own law and board. The Real Estate Appraisers Act, N.J.S.A. 45:14F-1 and following, creates the State Real Estate Appraiser Board in the Division of Consumer Affairs (45:14F-3), not under the Real Estate Commission. Section 45:14F-21(c) says only a State licensed or certified appraiser, or someone assisting one under direct supervision, may perform or offer to perform an appraisal assignment of New Jersey real estate.
• The same subsection lets an unlicensed person give counsel and advice, for a fee or otherwise, about pricing, listing, selling and use of property directly to an owner or prospective purchaser, solely for that person's own knowledge or use. A separate exemption, 45:14F-21(f), covers work for state or federally chartered banks and savings institutions in federally related transactions where federal law does not require a licensed or certified appraiser.
• Commission rule N.J.A.C. 11:5-6.1(m)1i says a comparative market analysis (CMA) is not an appraisal. Any written CMA a licensee gives a consumer must say that it is not an appraisal and should not be considered the equivalent of one, in print as large as the predominant print. The January 20, 2026 rule amendments left subsection (m) unchanged.
• DOBI Bulletin 13-05 treats preparing a CMA or a broker price opinion (BPO) as real estate brokerage activity. Salespersons and broker-salespersons may be paid for one only by their employing broker, never directly by a consumer, including individuals or banks, and a referral agent may never prepare one. The bulletin also reports the Appraiser Board's November 2012 advisory opinion that a BPO is an appraisal under the appraisal law unless one of the two exemptions above applies.
• Because of that opinion, the bulletin lets licensees put this kind of statement on every written CMA and BPO: it "should not be considered the equivalent of an appraisal prepared by a New Jersey licensed or certified real estate appraiser," in print as large as the predominant print.
• Under P.L. 2024, c.32, s.11(h), a brokerage services agreement is not required when a firm's services are limited to a broker's price opinion, a comparative market analysis, or a referral to another firm when the referring firm provided no brokerage services in the transaction (DOBI Bulletin 24-11).

Your 75-hour course spends only 2 hours on appraising, so these rules are easy to skim past. For the full set of New Jersey-only rules on one page, see the NJ-only rules sheet, and for the national valuation material, the valuation study guide.

Exam traps to watch

• Adjusting the subject instead of the comparable.
• Adding when the comp is superior. Comp better, subtract.
• Depreciating the land in the cost approach.
• Calling external obsolescence curable.
• Subtracting mortgage payments to get NOI.
• Using annual rent with a GRM built on monthly rent, or the reverse.
• Averaging the approaches instead of weighting them.
• Treating a CMA as an appraisal, or using 27.5 years of tax depreciation in an appraisal problem.

When these feel automatic, take a timed practice exam and see whether valuation questions still cost you points.