Market Approach
What Is the Market Approach?
The market approach is a method of deciding the value of an asset in view of the selling price of comparative assets. It is one of three well known valuation methods, alongside the cost approach and discounted income analysis (DCF).
No matter what the type of asset being valued, the market approach studies recent sales of comparable assets, adapting for the differences between them. For instance, while evaluating real estate, changes may be made for factors like the square footage of the unit, the age and location of the building, and its conveniences.
Since the market approach depends on correlations with comparable assets, it is most valuable when there is substantial data free in regards to recent sales of comparable assets.
How the Market Approach Works
As its name proposes, the market approach looks to address the inquiry, "what is the fair market value of this asset?" To respond to this inquiry, the valuator needs to survey recent transactions including comparable assets. Since these assets are probably not going to be indistinguishable from the one being valued, different changes should be made.
In certain markets, for example, residential real estate or publicly traded shares, there is in many cases more than adequate data accessible, making the market approach somewhat simple to utilize. In different markets, like shares in private organizations or [alternative investments](/alternative_investment, for example, fine art or wine, it can turn out to be very challenging to track down comparable transactions.
In circumstances where limited data is accessible, the valuator might have to depend on alternative methods, for example, the cost approach or discounted income analysis (DCF).
The primary advantages of the market approach are that it depends on publicly accessible data on comparable transactions. Accordingly, it can require less subjective suspicions than alternative approaches. The primary disadvantage of the market approach is that it very well may be unrealistic in circumstances where scarcely any comparable transactions exist, for example, on account of a private company operating in a niche market with not many contenders.
Illustration of the Market Approach
To delineate, assume you are in the market to purchase another apartment. You find a listing for an apartment in your preferred area being offered for $200,000. The unit is a 1-room, 1,000 square-foot apartment with 1 restroom. It is in great structural condition yet requires a few minor renovations. Despite the fact that it is in a positive area, its view is darkened and it doesn't have an in-suite washing or drying machine.
In spite of the fact that you like the apartment, you feel that the asking price is too high. Since the apartment has been listed for north of a month, you start to think that assuming you make a fair offer, the seller could acknowledge it even in the event that it is below their asking price.
Keeping that in mind, you set about deciding the apartment's fair market value by looking into instances of comparable apartments in the very neighborhood that sold in the last year. You collect your discoveries in a table, as follows:
| Comparable Transactions | |||||
|---|---|---|---|---|---|
| Â | Transaction 1 | Transaction 2 | Transaction 3 | Transaction 4 | Transaction 5 |
| Price | $250,000 | Â $175,000 | $150,000 | $315,000 | $225,000 |
| Square Feet | 900 | 800 | 1,100 | 1,800 | 1,600 |
| Price Per Square Foot (Rounded) | $275 | $220 | $135 | $175 | $140 |
| Bedrooms | 2 | 2 | 1 | 2 | 2 |
| Bathrooms | 1 | 1 | 1 | 2 | 1 |
| View? | Yes | Yes | No | Yes | No |
| In-Suite Washer and Dryer? | Yes | No | Yes | No | No |
| Renovations Required | None | None | Minor | None | Minor |
Taking a gander at these outcomes, you start to draw a few general ends. To start with, you see that the apartments' price per SF ranges somewhere in the range of $140 and $275, with the higher prices having a place with those with additional rooms and washrooms, better perspectives, in-suite machines, and no requirement for renovations.
Paradoxically, the apartment you are seeking to purchase is priced at $200 per SF and has less of these elements than even the cheapest priced apartment in your table. This appears to legitimize your instinct that the apartment is overpriced.
In view of this data, you choose to make an offer for $150,000.
The seller acknowledges your offer.
Highlights
- It is one of three famous approaches, alongside the cost approach and discounted income analysis (DCF).
- The market approach succeeds in circumstances where bountiful data is accessible on comparable transactions. At the point when that data isn't free, alternative approaches might be required.
- The market approach is a method for deciding the value of an asset.
