How does real estate appraisal work in a tokenized real estate project?

1. What is Real Estate Appraisal?

Real Estate Appraisal also known as Real Estate Valuation is the process through which the market value of the subject property will be determined via the form of a written opinion, by a qualified professional. The appraised value will normally be tied to a specific purpose such as financial reporting, purchase and sale, mortgage or refinance…etc. Appraisal or valuation can be applied to multiple asset classes, not just real estate, but can also be antique collections, machinery, automobiles… In the context of this writing, we will only consider commercial real estate, especially the one in a tokenized real estate project.

2. Method of Real Estate Appraisal 

For existing income-producing properties, there are three basic approaches that may be applicable and utilized, then reconciled to arrive at an estimate of market value. An approach to value is included or eliminated based on its applicability to the property type being value and the information available. In different situations, we can use different approaches, depending on the current market data and the thinking of property buyers. The approaches are summarized below:

2.1. Cost Approach

The Cost Approach is based on the proposition that an informed purchaser would pay no more for the subject than the cost to produce a substitute property with equivalent utility. In the Cost Approach, the appraiser forms an opinion of the cost of all improvements and depreciation from physical, functional, and external causes. The land value, entrepreneurial profit, and depreciated improvement costs are then added, resulting in an indication of value.

2.2. Direct Comparison Approach

The Direct Comparison Approach (or Sales Comparison Approach) compares sales of similar properties with the subject property. The values derived from each characteristic of a property will form its final value. Investors are less likely to buy this property when its price is higher than another similar property.

2.3. Income Approach

The Income Approach reflects the market’s perception of a relationship between a property’s potential income and its market value. This approach calculates the estimated net income from owning property into a total value through capitalization. The primary methods are direct capitalization and discounted cash flow analysis, with one or both methods applied, as appropriate. In some cases, we can use P/E (for example P/E = 12) or ROI (for example 8.33%). This approach is highly suitable for appraising income-producing properties.

In the tokenized real estate market, the price firmly bases on the token price and its market cap. So this income approach with clear data of P/E or ROI enables investors to calculate the investment years to get the same returning amount.

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