How to Effectively Assess Property Value for Investment
Contents
A key thing for investors in any market to do before getting involved and making an investment, is to consider the value and potential return you could make. This is particularly important when it comes to investing in real estate. You need to know the value of your asset to establish if it a worthwhile investment.
With that in mind, there are a number of methods which investors use to value property which they plan to invest in. Here we will take a look at several of the most popular calculation methods, and you can select one which is ideal for your needs as an investor.
The Sales Comparison Approach
One of the most common methods employed when valuing real-estate, particularly residential properties, is the sales comparison approach. At its most basic, this is simply a comparison between the property which you are considering, and similar properties that have sold in the area over a particular period.
The most general consideration when conducting this type of valuation approach is the property type, and location. To establish s strong assessment though, this approach must also take in other key similar features of a property including bedrooms, bathrooms, and a multitude of other features. Anything which can make the property appealing. The value can also be commonly broken down into a price per square foot or meter.
The SCA is one of the easiest conduct in terms of property valuation, though it is also worth remembering that it is also the method which will produce the most generalized results. It will give you a good baseline to work from in terms of the general value of your real estate, without being perfectly precise. Of course, with this method, you should always try to use a qualified appraiser to receive the most accurate valuation possible.
The Cost Approach
The cost approach to real estate valuation is ideal if you are in one of several situations. You may have a vacant plot of land, you may have land with a current construction on it which you have a desire to change, or you have a special property type for which it is difficult to find others to compare to.
In any case, the cost approach looks at a number of key factors, including what is the actual best use of the land given its location, and potentially zoning. Once this has been decided, the approach will factor in the value of the land if it were vacant, and also what it would cost to rebuild any property from the ground up, with present day valuation and materials. This valuation method can also take into account the depreciation that a property has endured over the years since its construction.
As mentioned, this can often be the best valuation approach if you have a vacant piece of land, as the appraisal strongly factors in the best use of the land.
The Capital Asset Pricing Model
The Capital Asset Pricing Model (CAPM) is a more comprehensive approach to real estate valuation which can help you reach a more precise valuation taking into account several external factors. It is often looked at as a bigger picture approach.
What the CAPM takes into account most, is the potential return on investment (ROI) from rental of your property, and then compares this result to an investment in other forms of real estate which have no, or much lower risks than that of renting real property. The other forms of investment which this model often considers would be secure REITs or US Treasury Bonds, which have extremely low risk.
If the model concludes that the ROI on rental of the property, also factoring in any associated costs for redevelopment, furnishing, and more, comes in at less than the ROI of making another form of investment, then the conclusion would be to reconsider your property investment. This model as well as taking into account every cost associated with the property itself, will also factor in the opportunity cost of factors such as crime rates, education quality, and median incomes or the area in which your real estate in located. In this way, you can get a very detailed result from a CAPM which you may not always get from another valuation approach.
The Income Approach
The income approach is one which is ideal if your property is commercial or for rental. This approach will take into consideration the amount of money you are receiving for the rental and use this number to calculate the yield based on your property cost price.
Looking at an example and simple calculation, if your property cost $300,000 to purchase, and you expect to rent this property for $3,000 per month, then your yield would be 12% (3,000 * 12 = 36,000. 36,000 / 300,000 = 0.12 or 12%)
This figure is also known as the capitalization rate. In our example case this rate is 12%, though there are a number of other factors which are generally considered in this calculation including interest rates on mortgages, and the net present value of money. It is generally perceived that a figure of more than 5% is considered good for this kind of number if you are considering an investment. This form of calculation, as mentioned, works best if you have a commercial property on which you can guarantee a certain level of rental income.
Final Thoughts
As you can see, there are a number of methods at your disposal when it comes to reaching a valuation for your property, each of them quite different in the data they consider, and the type of results they can derive. The real key to choosing the right method depends on factors such as the property type, its intended use, and how precise or wide-ranging you need to be with your valuation. In many cases, you could also employ multiple valuation methods on your property if you want to reach a more in-depth, comprehensive valuation.
Kate Leaman is the Chief Analyst and author at InvestorGreg. She won the Sky News Fiona McDiarmad award and subsequently became a journalist for Sky News. Read more
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