How To Value Real Estate Property
For real estate investors, it’s all about the value. In order to be successful at what they do they need to properly value real estate properties in order to invest.
Learning how to value real estate property takes time and skill to master, but comes down to the 4 basic questions. These questions make it easy to get the numbers investors need to invest.
While property valuation is a well-developed field, it is more art than science. Many new real estate investors find it organic. Despite involving so much money, real estate investment lends itself to creativity and flexibility for each investment.
Approaches For Valuing A Property
Seasoned real estate investors know what property can and can’t sell. They also have a strong sense of knowing what the market and trends will sell, and what will flop. Property valuation amounts to predicting what someone is willing to pay for the property in question. In most cases, there are some fairly solid parameters involved. Although like the weatherman, no one predicts accurately 100% of the time!
Here Are The Top 3 Approaches For Valuing A Property:
- The Income Approach
- The Sales Comparison Approach
- The Cost Approach
The income approach is a property valuation method that is particularly common in commercial real estate and rental properties. Ideally, you calculate the current value of a real estate property based on the net income it could generate divided by the capitalization rate. This is perfect when wanting to forecast potential earnings for your investments. The income approach formula looks like this: PROPERTY VALUE = NOI/CAP RATE
The Sales Comparison approach uses the market data of sale prices to estimate the value of a real estate property. This is a good method for house flippers who are looking to make quick repairs and flip for a profit. You would adjust for repairs needed to be made and the after repair value of a home.
The cost approach is a real estate property valuation method that considers the value of a property as the cost of the land plus the cost of replacing the property (construction costs) minus the physical and functional depreciation. This approach is most commonly used for real estate properties that are not easily sold like schools, hospitals, and government buildings.
No approach is 100% accurate, and certain parameters such as location can greatly impact your value. Many will rely on comps to see how to estimate the value of a real estate property.
Using Comps To Value Your Real Estate Property
The central means by which real estate property value is determined is through comps. This is an industry term that is shorthand for comparable properties. In essence, you go looking for properties that are similar and you find out what they are worth.
If you have enough properties that are very much like the property in question, you can get a pretty solid idea of what the property is worth. The more alike they are, the better.
When you pull comparisons for your properties, you want a property in the same neighborhood that is as similar as possible in terms of the number of bedrooms, number of bathrooms, style of the house, and other particulars.
Some neighborhoods have many houses that were built around the same time by the same builder reusing a shortlist of floor plans. In such cases, you may be able to find several houses that are nearly identical.
If you can find at least three properties that are nearly identical and which each has a recent sale price that is very close to the same number, you can pretty confidently value that property at roughly that figure. But this ideal situation is not the norm. Big gaps in sales will not be accurate comps, as the market can change quickly in a manner of days. Use the most recent sales and similar properties to see a more accurate comparison.
In most cases, you will find homes that are similar, but not identical. This is especially true in older neighborhoods where houses have been altered over the years or in areas with a lot of custom homes where the houses simply didn’t start out with the same floor plans. If you cannot find comparisons, you can use the following method below!
How To To Value Your Real Estate Property With No Comps
In these cases, you will need to find houses that are somewhat similar. Then adjust the price based on the differences. For example, if two houses are nearly identical, but one has a pool and the other does not, you need to figure out roughly how much that pool adds to the value of the house, then adjust accordingly.
You may need to make multiple adjustments for multiple details. Two properties may have started with an identical floor plan, but one may have had many upgrades in terms of materials or even additions to the house. The more information you have about the similarities and differences between the two properties, the more power you have to adjust the price accordingly.
You can also use the cost method we outlined earlier, or the income approach when valuing an investment. Another useful formula is after repair value. By using homes with similar upgrades, bedrooms and size you can see an estimate of how your home would value stacked against these.
Some homes are essentially one of a kind. These can be especially challenging for an appraiser to assess. The industry standard is comparing comparable properties. When nothing else is anything like it, you simply can’t rely upon that standard.
Type Of Market
In hot markets, real estate property value can change rapidly. In very hot markets, the estimated value can go up from one day to the next.
Buyer’s and seller’s markets function differently. In a seller’s market, you can expect multiple offers on a property and bidding wars. In a buyer’s market, you may need to cut the asking price to try to shorten the length of time to sell in order to reduce carrying costs.
This may not seem related to what a property is worth, but it is. Ultimately, a property is worth what someone is willing to pay for it. This is impacted by a great many factors, including the desirability of the area in question, but boils down to a willingness to pay.
You don’t have to be a professional appraiser to get a rough idea of how much a property is likely to be worth. These days, you can dig up a fair amount of information about a property via the internet. If you can find a few properties similar to the one in question and find recent data on their sale price, you can start to get a reasonable idea of what the house in question is likely worth.
Commercial properties get a little trickier. They tend to be more unique. The American tradition of building tract housing means that residential real estate frequently offers multiple properties that are strongly comparable.
Real estate investors need to upgrade their properties to be profitable. Rentals and flips both benefit from higher home values and increase the ROI of investments. That is why more real estate investors use hard money loans for fast and profitable investments. You can easily get approved for your rental and start upgrading your property in as little as two days! Apply for a hard money loan here!
When you apply for a hard money loan, you will get free access to our home rehab valuator, which is perfect for estimating the cost of your investment. Get it for free here!