Investing in properties is a risk that can provide large returns when done properly. Making an informed investment decision involves valuing a real estate property and how much profit it can potentially make. This can be achieved through methods like property appreciation, rental income, or a combination of the two.
However, Real estate investment property investing can be tricky to navigate on your own. You need to consider quantifiable factors like the investment return, cost, and property value through proper appraisals. That’s why it’s best to work with a professional realtor to eliminate guesswork.
It will help to have a good understanding of how real estate valuation works. This article will guide you through the process and methods employed when it comes to valuing real estate investment properties.
What is Real Estate Valuation?
No two properties are the same. They often differ when it comes to area size, features like bedrooms and bathrooms, location, and upgrades made on the property, among other factors. But what makes an investment property different?
An investment property is real estate that’s purchased with the goal of earning income for the owner. Real estate often doesn’t have a fixed price and fixed value. Keep in mind that a property’s value isn’t always determined by its price. For example, a heritage property has a market value of $300,000, but building a similar property can cost buyers more than that, depending on material and labor costs.
Real estate valuation is a process that allows you to determine the economic value of a property. This takes into account the property’s fair market value that entails the price an informed seller puts on their property to an equally informed buyer.
Property valuation is used to determine factors like liquidation value, value-in-use or fair market value, assessed value, actual or replacement cost value, and potential future value.
Different Types of Value
- Liquidation value
Often lower than fair market value, liquidation value estimates the price a property can bring when it’s forcibly sold at auctions due to reasons like foreclosure or bankruptcy.
Value-in-use is the value of a property as determined by how it is used. Say you own a rental property. The value of this property will be based on the revenue it generates and this may vary from its posited fair market value.
- Assessed value
Value which is used for tax purposes.
- Actual or replacement cost value
Often used for insurance purposes, this shows how much it would cost if a property were to be replaced or if an actual property will be built.
- Potential future value
This often goes in conjunction with real estate investments that focus on commercial real estate.
Valuation methods may vary, depending on the value that an investor or real estate professional is trying to reach.
Methods on How to Value a Real Estate Property
There are several methods in valuing real estate property. However, you must remember that there is no one-size-fits-all approach when it comes to correctly valuing real estate investment properties.
This often applies to commercial properties that are valued using a capitalization rate. It refers to the potential rate of return that a property can generate and is determined by its net operating income (NOI). NOI is the gross income that is generated after expenses divided by the sale price. Often expressed in percentage, the formula for finding the cap rate would look something like this: Capitalization Rate = Net Operating Income/Value.
When should this method be used? This comes in handy when you want to quickly evaluate an asset in relation to other potential investment assets. It is also useful in the event of cap rate trends.
Income value approach is used to determine the fair market value of residential properties that are used as investment properties. Also known as gross rent multiplier, the income approach helps potential buyers determine if a property is a worthwhile investment when referring to its fair market value.
To get a property’s income value approach, you need to divide the NOI by the capitalization rate. If you’re a buyer, and you’re using the income approach to value real estate investment properties, you need to look at factors like the property’s condition, operating efficiency, and vacancy.
Why is Property Valuation Important?
There are many reasons why you might take an interest in real estate investment properties. South Florida, for example, has several cities that have high-yield rental markets and therefore present highly lucrative yields for the discerning and informed investor.
To help you gain a better understanding of real estate investment properties and real estate rental property investing, you want to be sure where you put your hard-earned money. Working with a professional realtor like Tammy Hernandez can help you make informed financial decisions when it comes to real estate investments.