Accurate real estate valuations lead to better decisions when buying and selling property. They help investors determine possible profits, probable property appreciation/depreciation, and potential return on investment. They assist in planning for maintenance costs, management fees, and other expenses. Sellers and buyers use property valuations to reach an agreement on the sale/exchange price of a property and valuations are necessary for legal, financial, and governmental due diligence. Accurately valuing property is an essential technique for residential and commercial real estate investors. So, how do you value real estate investment property?
What Is Real Estate Valuation?
Real estate property valuation is the process of or method for determining the economic value of a property. It involves discovering the fair market value and the maximum price payable while generating short-term and long-term profit.
Why Is Real Estate Valuation Important?
Real estate valuation is a vital concept as it’s the main factor for determining the possible results of an investment. The fair market value of a property affects:
- Investment loans: Lenders require appraisal reports that specify the value of a property before deciding to approve a loan, protecting the buyer from obtaining a loan not backed by the property value.
- Property taxes are calculated based on the fair market value rather than sales price.
- Rental property insurance: Landlords invest in insurance coverage related to the probable cost of rebuilding the property which is the same as the property’s current value.
- Legal matters: Divorces, settlements, inheritances, and lawsuits are often settled based on the valuation of real estate.
- Return on investment: The cap rate (the ratio between the annual rental income produced by a property and its market value) is calculated using the current value of the property. The higher the valuation, the lower the return. The lower the valuation, the higher the return.
- Listing price: The listing price of a property is affected by fair market value.
What Factors Affect Valuation of Real Estate Investment Property?
The elements affecting a property’s value include:
- Location: Some regions have higher property prices due to strong demand and limited supply, making location a determinant of value and price.
- Market conditions rise and fall, affecting property values.
- Property type: Some kinds of property have more value than others (detached single-family homes cost more than townhouses, homes located on the beach are more expensive than those in neighbouring towns, brownstones are pricey because of the material they’re made of, etc.).
- Property size: Larger properties (more bedrooms and bathrooms) generally cost more.
- Age and condition of property: Well-maintained newer homes are more valuable.
- Home improvements: Home repairs and/or improvements boost the value of a property.
How do you Value Real Estate Investment Property?
There are many approaches to valuing real estate.
- The income approach is most often used for commercial real estate but also works with residential rental property. It involves calculating the current value based on the net income it produces divided by the cap rate (the ratio between the annual rental income produced by a property and its market value). To use this method, you must collect income and expense statements for the property and similar properties in the same geographic area. Then you estimate the gross potential income, the effective gross income (potential gross rental income, plus other income, minus vacancy/credit costs), and fixed and variable property expenses (taxes, mortgage, utilities, management fees, etc.). This information helps determine the net operating income (used to assess the profitability of a property). Finding the NOI involves subtracting operating expenses from the revenue generated and then choosing an appropriate cap rate.
- The sales comparison approach uses market data regarding recent sale prices of similar properties to estimate the value of a real estate property. This comparison takes into account number of rooms, square footage, age, location, zoning regulations, condition, and defining features. Adjustments are made to account for differences between properties. This approach is typically used for residential real estate.
- The cost approach is a widely used valuation method that takes into account the cost of the land plus replacement/construction costs minus the functional and physical depreciation. Used mainly for properties that are difficult to sell (hospitals, government buildings, universities, medical clinics, schools, libraries, and colleges), this method utilizes information regarding proximity to population centers, transportation networks, and zoning.
The only way to buy, rent, and/or sell properties at a fair price is to determine the worth of the real estate. Commercial investors generally use the income approach or a combination of the income, sales, and cost approaches. Residential investors typically use the sales comparison approach. No matter the method utilized, thorough research is required and expert advice is recommended.
GIL Property Management & Sales Ltd. has been buying, selling, and renting properties for over 40 years! We’re detail-oriented and know how to value real estate. We provide exceptional service! Contact us today for your real estate needs!