The Economics of the Capitalization Rate for Farmland
There are three approaches that real estate appraisers use to value real property, namely, the market or sales comparison approach, the income approach, and the cost approach. The sales comparison approach is the primary way that residential real estate is appraised with the cost approach thrown in for good measure. For income producing properties, which includes commercial real estate as well as farm real estate, all three approaches are frequently used. When there are minimal improvements on farmland, the sales comparison and income approaches often provide competing estimates of value that must be reconciled so that an appraiser can render a single opinion of value.
From a financial economics perspective, it is difficult to ignore either approach when valuing farmland. The sales comparison approach confronts the notion that observed sales transactions are the direct result of what a buyer is willing to pay for a farm and a seller is willing to take as compensation for transferring ownership. As a result, it is hard to argue with market-determined sales prices. It can be difficult, however, when casually observing farmland transactions, to know all the information that impacted and ultimately resulted in a transaction with an observed price. Appraisers using the sales comparison approach often make numerous adjustments to the attributes of comparable sales to ensure that their opinion of value for a subject property is accurate.
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