When you want to invest in real estate, you want to make sure that you pay the right price. Determining what that price is is known as real estate property valuation – and it is a critical step in deciding whether or not to invest. By simply looking at the specs of a property, you are only looking at the surface.
For instance, you can see two seemingly similar properties you are interested in. But while they look the same on the surface, valuations can prove they are very different. Suppose you are interested in investing in rental properties. If that’s the case, you need to understand how to value your investments – both in your portfolio and in the ones you’re looking to purchase.
Understanding Real Estate Property Valuation
The different values placed on a home, such as an assessor’s value, market value, and sale price, are all great in giving you an idea about the property when it comes to determining how you handle this property investment – or if you even invest at all. But, these numbers don’t give you an accurate indication of a property’s value.
To get that, you need to understand real estate property valuation. Define property valuation; is the process used to determine the actual economic value of a real estate investment. When purchasing a new property, the price you pay for that property is just the price, not the value. It isn’t necessarily priced so high because it is such a fantastic value, nor is it priced low because it doesn’t have any value.
Market prices predict sales prices. So a home in one area may sell for $600,000, and a house built the same year with comparable specs in another place may sell for $200,000. Is one any more valuable than the other? Not likely. Some sellers need to sell fast, so they price their property to sell, not because it has a lower value. In general, many factors go into determining a home’s value, such as:
- Age and condition of the property.
- Size of the property (incredibly usable space).
- Location and local market conditions.
- Neighborhood comps.
- Economic indicators and interest rates.
As an investor, it is essential to know how to properly evaluate your property to always know you are making a sound investment. We’ve got three ways to help you do just that.
The Sales Comparison Approach
This is an excellent valuation option when it comes to single-family homes. You can look at local comps, analyze a few of them, and estimate the property’s market value. These homes need to be in the same neighborhood and of the same size and age and have recently sold. You would then adjust your property based on the research.
Yes, they are comparable, but if your SFH has a newly upgraded kitchen or a new air conditioner and the others do not, you need to adjust the number accordingly. Keep in mind that no two properties are alike, so there should always be some adjustment to the property.
The Income Approach
The income approach is made using a simple calculation when it comes to multi-family properties such as duplexes, apartment buildings, and other properties that generate revenue. You divide the net operating income (NOI) by the capitalization rate. The NOI is your revenue minus your expenses. Estimating this before investing in a property can be done easily, as highlighted below:
- What’s the gross potential income would be at 0% vacancy.
- Estimate the adequate gross income by estimating the costs of vacancy based on other like-properties nearby.
- Your property expenses, both variable and fixed.
- Calculate the NOI by subtracting the estimated costs from the estimated gross income.
And your capitalization rate is found by dividing your NOI by the property’s current market value and then multiplying by 100 to get a percentage. For many property investors, this cap rate is determined using the information from comps of properties recently sold in the area. And the market value is the NOI divided by the cap rate.
The Cost Approach
This is a great option to use for those properties that aren’t big generators of income and are not as easy to sell, for instance, hospitals, schools, and churches. The cost approach helps determine the value of a property as the land cost and the construction cost needed to replace the property.
Use the sales comparison approach to help you determine the value of the land alone as if it were a vacant piece of property. Then you will want to calculate the value of the building you want to build. The easiest way to do this is to determine the cost of building something new per square foot based on local comp properties – and then multiply it by the square footage of the building.
Importance of Real Estate Property Valuation
Every investor has strategies for determining their next steps. But it usually always involves doing some real estate property valuation before they invest and checking those properties that they currently own to make sure it is still valuable. While the calculations remain the same for anyone who uses them, how the results are viewed will vary based on the investor. For example, determining the value of one property may cause an investor to lose interest, while it may cause another to put down an offer.
For those with multiple rental properties, having a property management team like RPM Evolve can help free up your time to focus on making sound investment decisions. After all, finding a strategy that works for you when building your real estate portfolio involves total focus and no distractions. So, as you move forward, which real estate property valuation method will you use?