The Three Approaches to Value, Their Applicability, and the Role of Reconciliation in ARB Protests

1. Overview: Three Approaches, One Statutory Duty

Section 23.0101 of the Property Tax Code directs the chief appraiser to consider the cost method, the income method, and the market data comparison method, and to use the method most appropriate to the property. Sections 23.011, 23.012, and 23.013 then set out what each method requires: market-derived depreciation in the cost method, market-derived rent, vacancy, expenses, and capitalization rate in the income method, and comparable sales that are similar, appropriately adjusted, and representative of market conditions in the sales method.

Consideration is not the same as application. A district's model may technically touch all three methods while producing a value that rests on only one — most often a cost schedule or an unscreened comparable set — because that is what scales across tens of thousands of accounts. Mass appraisal is a defensible administrative response to volume. It is not, for any individual commercial asset, a substitute for analysis of that asset.

The gap this creates is predictable. Model inputs are class-wide rather than subject-specific. Depreciation is scheduled rather than observed. Comparable selection is proximity-driven rather than competitively driven. Each of these is a point at which a subject-specific analysis can show that the district's indicator does not describe the property being taxed.

2. The Sales Comparison Approach

The sales comparison approach derives value from recent arm's-length sales of comparable properties, adjusted for differences in property rights, financing, conditions of sale, market timing, location, size, age, and condition.

2.1 Where it fits

• Owner-user commercial assets, where the buyer purchases occupancy rather than an income stream.
• Stabilized properties in submarkets with an active, transparent sale set — single-tenant retail pads, small office and flex buildings, and commercial land.
• Any asset class where the volume and quality of confirmed sales exceeds the quality of available income data.

2.2 The protest angle

District comparable sets are assembled at scale and frequently include transfers that do not meet the §1.04(7) definition of market value: related-party transfers, portfolio allocations, deadline-driven exchange purchases, distressed dispositions, and sales requiring adjustments that were never made. Screening the district's comp set for qualifying status is often the fastest and most persuasive way to undermine a sales-comparison-based value, because it does not require the owner to prove an alternative number — only that the district's evidence does not support its own.

The adjustment mechanics, the correct sequence of adjustments, and the treatment of sales that cannot be confirmed are addressed in detail in The Sales Comparison Approach: From Sale Price to Fee Simple Value.

2.3 Caution: single-tenant net-leased credit tenants are a poor fit

Single-tenant properties occupied under a national credit lease — Walgreens, McDonald's, Dollar General, and comparable tenants — are commonly treated as ideal sales-comparison candidates because their sales are numerous, well documented, and easy to find. That is exactly backwards.

Sales of occupied net-leased assets reflect the leased fee investment value of the lease: tenant credit quality, above-market contract rent, remaining term, escalation structure, and bond-like income characteristics. Under §23.01 the district must appraise the real property at market value — not the value of the business enterprise or of the lease contract attached to it. A comp set composed of other occupied national-credit sale-leasebacks is evidence of investment value, not of fee simple value, and is a strong basis for challenging the indicated value. Texas ARBs and courts have increasingly recognized this distinction, which is conceptually the same issue litigated nationally as dark store theory.

The defensible comparable set for these properties is vacant or re-tenantable single-tenant buildings of similar size, quality, and location. The income approach — built on market rent and a market-derived rather than credit-compressed capitalization rate — is typically the stronger primary approach. The full analysis appears in Fee Simple vs. Leased Fee.

3. The Cost Approach

The cost approach values the property as land value plus the depreciated replacement or reproduction cost of the improvements, with depreciation measured in three categories: physical deterioration, functional obsolescence, and external or economic obsolescence.

3.1 Where it fits

• New or near-new construction, where accrued depreciation is minimal and estimation error is correspondingly small.
• Special-purpose improvements — heavy industrial, self-storage, single-use retail — that rarely trade and generate little usable sales or income data.
• Situations where the cost approach functions as a check on an income or sales conclusion rather than as the controlling indicator.

3.2 Depreciation becomes speculative with age

This is generally the weakest approach for older commercial improvements and the easiest to challenge at an ARB hearing. Physical, functional, and external obsolescence are difficult to quantify with precision, and small percentage differences translate into large dollar swings. A ten-percentage-point disagreement about accrued depreciation on a $10 million replacement cost is a $1 million disagreement about value, and neither side can demonstrate its figure with the same rigor available in an income analysis built on actual leases.

The depreciation percentage is rarely argued on its own terms, because it is not an independent input: it falls out of an effective-age assumption that neither side observed at the property.

3.3 Effective age is a modeled input, not an observed fact

Accrued depreciation in a cost schedule is typically computed as effective age divided by total economic life, applied to replacement cost new. Both terms are estimates. In mass appraisal, effective age is set by a district schedule keyed to actual year built and a class or condition code — a model default applied across a neighborhood or property class, not an inspection finding for the subject.

• Two buildings of identical vintage with very different renovation histories, deferred maintenance, roof and HVAC condition, and tenant-driven capital spending receive the same effective age from the model.
• Effective age is also circular in practice: an appraiser working toward a target value can move effective age a few years to reach it, and nothing on the face of the cost schedule discloses the adjustment.
• Total economic life is equally assumed. Changing it from 50 to 40 years moves every depreciation figure in the schedule without any change at the property.

The protest angle follows directly. Ask the district what evidence supports the effective age assigned to the subject: the inspection date, the observed condition, the renovation records relied on. When the answer is that the schedule produced it, that is the point. Ask the same question of the total economic life assumption and its source. An effective age developed for the subject and supported by condition evidence is the counter-exhibit.

3.4 Highest-and-best-use divergence

The cost approach assumes the existing improvements represent highest and best use as improved. When a site's highest and best use has shifted — a 1970s single-story retail building on a site the market now prices for higher-density redevelopment — the cost approach values what was built rather than what the market is pricing. Legal non-conforming improvements compound the problem: reproduction cost becomes a legal fiction, because the improvement could not lawfully be rebuilt, and replacement cost requires a judgment about what could be built today under current zoning, parking, setback, and code requirements.

Where highest and best use as improved diverges from highest and best use as vacant, the cost approach has stopped answering the relevant valuation question. In those cases it should be treated as a floor or sanity check — land value plus a scrap-level improvement contribution — rather than as a controlling indicator, and that argument should be made explicitly to the ARB rather than left implicit.

The mechanics of replacement versus reproduction cost, entrepreneurial incentive, and the identification of economic obsolescence are covered in The Cost Approach in Texas Property Tax Valuation.

4. The Income Capitalization Approach

The income approach values the property on its capacity to generate income, through direct capitalization — net operating income divided by a market-derived capitalization rate — or through discounted cash flow analysis where the income stream is irregular.

4.1 Where it fits

• Leased commercial property of every type — office, retail, multifamily, and industrial — where buyers and sellers price the asset primarily on income performance.
• Properties with atypical lease structures, rollover exposure, or occupancy problems that a class-wide model cannot see.
• Single-tenant credit-leased assets, where a market-rent, market-cap-rate analysis isolates the real estate from the lease contract.

4.2 Why it usually controls in a Texas protest

District income models are built for mass appraisal. They apply market-wide or class-wide assumptions for rent, vacancy, and operating expenses rather than the subject's actual rent roll, expense history, and lease terms. Those assumptions are reasonable on average and frequently wrong in the particular — which is the entire opportunity. A subject-specific income analysis using actual net operating income, verified market rent comparables, and a capitalization rate derived from recent confirmed sales is usually the single most persuasive exhibit available in an informal settlement conference or ARB hearing.

Two cautions apply. First, §23.012 requires market-derived inputs, so an analysis built on contract rent that exceeds market rent undermines the owner's own fee simple argument. Second, the capitalization rate must be derived from sales that have themselves been screened and adjusted; a rate extracted from a credit-tenant sale-leaseback carries the same distortion as the sale did.

5. Comparative Summary

6. The Importance of Reconciliation

Reconciliation is not an average of the three indicated values. It is a judgment process that weighs each approach according to four criteria.

• Reliability of the underlying data — the quality and quantity of verified comparable sales, the accuracy and currency of cost data, and the level of verification behind income and expense figures.
• Applicability to the property type — income carries far more weight for a leased retail center than cost; cost carries more weight for a two-year-old special-purpose facility than sales.
• Purpose of the appraisal — a tax protest, litigation, lending, and insurance assignment each justify different weighting, because each defines the interest and the value premise differently.
• Market behavior — which approach actual buyers and sellers of that asset class rely on when they transact. This is the most persuasive criterion in a hearing and the most often omitted.

In an ARB or informal settlement context, reconciliation is where the protest narrative is built. The goal is not to present three numbers side by side and let the panel choose. It is to explain — clearly and defensibly — why one approach should control for this property, and why the district's indicator, frequently a mass-appraisal cost schedule or a thin unscreened comp set, is less reliable for the specific subject. A transparent, well-reasoned reconciliation is often what separates an evidence-based protest package from a client simply objecting to a number.

7. Reconciliation in Practice

Consider a 62,000-square-foot multi-tenant office building, built in 1986, currently 78% leased, in a submarket where investors underwrite to in-place income and a rollover reserve. Three approaches are developed.

The reasoning that supports that weighting, stated in the order a panel can follow:

• The asset is 39 years old, so cost-approach depreciation is the least supportable input in the file; the indication functions as an upper bound, not a conclusion.
• Two of the four sales required net adjustments above 25%, which reduces their reliability; the remaining two bracket the income indication.
• Every buyer identified in the submarket over the trailing eighteen months underwrote to in-place income with a rollover reserve — the income approach describes actual market behavior for this asset class.
• The district's value tracks the cost indication almost exactly, which identifies the model that produced it and the approach the protest must address.

Note what the reconciliation does not do. It does not discard the cost and sales indications; it explains their role. A panel is far more receptive to an analysis that assigns each approach a defensible function than to one that presents a single number and dismisses the rest.

8. Common Errors

8.1 Averaging the three indications

The mistake: treating reconciliation as arithmetic. An average imports the error of the weakest approach into the conclusion at equal weight and produces a number the market would not pay.

8.2 Developing an approach the data cannot support

The mistake: presenting a cost approach for a 1970s improvement, or an income approach with no verified rent comparables, because all three approaches are expected. A stated, reasoned omission is stronger than a weak indication that invites cross-examination.

8.3 Using leased fee evidence to conclude fee simple value

The mistake: extracting a capitalization rate from credit-tenant sale-leasebacks, or grid comparables from occupied net lease trades, and calling the result fee simple market value. The distortion carries straight through the analysis.

8.4 Ignoring highest and best use

The mistake: developing all three approaches on the existing improvements without testing whether the improvements remain highest and best use. When they do not, all three indications answer the wrong question.

8.5 Reconciling silently

The mistake: stating a final value without explaining the weighting. The weighting is the argument; leaving it implicit concedes the most persuasive part of the presentation.

9. Conclusion

The three approaches to value are not three attempts at the same calculation. They are three different theories of what a buyer is purchasing — a substitute property, a bundle of construction costs, or an income stream — and only one of them usually describes the market the subject actually trades in.

• Identify the approach the market uses to price the asset class, and build the case around it.
• Treat the cost approach as a floor or check for older improvements, and say so explicitly.
• Screen the district's comparable set before conceding the sales approach any weight.
• Build the income analysis on the subject's actual leases and market-derived inputs, not on class-wide model assumptions.
• Keep leased fee evidence out of a fee simple conclusion, in both the grid and the capitalization rate.
• State the reconciliation reasoning on the record — the weighting is the argument, not a footnote to it.

A protest package that does this is not asking the panel to prefer one number over another. It is showing the panel how the market prices the property, and where the district's model stopped describing it.

References

1. 01Texas Property Tax Code §23.01(b): appraisals must be based on generally accepted appraisal methods and techniques, with the same or similar methods applied to similar property.
2. 02Texas Property Tax Code §23.0101: the chief appraiser shall consider the cost, income, and market data comparison methods and use the most appropriate method.
3. 03Texas Property Tax Code §23.011: cost method of appraisal — replacement or reproduction cost less depreciation, with market-derived depreciation.
4. 04Texas Property Tax Code §23.012: income method of appraisal — market-derived rent, vacancy, expenses, and capitalization rate.
5. 05Texas Property Tax Code §23.013: market data comparison method — comparable sales must be similar, appropriately adjusted, and representative of market conditions.
6. 06Texas Property Tax Code §1.04(7): definition of market value, including reasonable exposure, absence of compulsion, and both parties seeking maximum advantage.
7. 07Texas Property Tax Code §41.43: burden of proof at the Appraisal Review Board in an excessive-value protest.
8. 08Texas Property Tax Code §42.26: equal-and-uniform remedy based on a reasonable number of appropriately adjusted comparable properties.
9. 09The Appraisal of Real Estate, 14th ed. Chicago: Appraisal Institute, 2019 — Ch. 12 (Highest and Best Use), Ch. 17 (Sales Comparison), Ch. 19–20 (Income Capitalization), Ch. 25 (Reconciliation).
10. 10The Dictionary of Real Estate Appraisal, 7th ed. Chicago: Appraisal Institute, 2022 — “reconciliation,” “fee simple estate,” “leased fee interest,” “external obsolescence.”
11. 11USPAP 2024–2025 Edition, Standards Rule 1-4 and 1-6: development of the three approaches and reconciliation of value indications.
12. 12Texas Comptroller of Public Accounts, Appraisal Review Board Training Manual — Ch. 4 (Approaches to Value) and Ch. 5 (Evidence).
13. 13IAAO, Standard on Mass Appraisal of Real Property (2017): model calibration and the limits of uniform application to atypical commercial properties.