A reliable modern-day property valuation guide for aspiring real estate buyers, sellers, and investors…
If you aspire to become a real estate investor one question that you’re certainly going to bump into is ‘how to appraise and value real estate?’
In most cases, real estate is valued by a licensed real estate appraisal expert…
But you’d probably want to work it out yourself first to then see if it’s worth hiring an expert to back up your calculations or not…
Because, if your own calculations give you a value that makes you feel like backing out, there’s no point paying an expert for a full-fledged appraisal, right?
So, in this article, we’re going to see how to roughly estimate a property’s value yourself (with minimum info available).
And help you save time and money with tools that let you quickly judge a property’s value without relying on and waiting for a paid expert.
Before we begin with the 4 best methods of valuation let’s first find out…
How Important Is Correct Property Valuation, Anyway?
Well, how can you expect to profit from real estate if you don’t even know the true value of the property you’re buying or selling?
By getting the value precisely accurate, you get a clear picture of the investment in your head.
This helps you plan, perfectly time your property sale, or set up a strategy for property improvement that builds value from your home.
That’s why when it comes to real estate investments…
The property’s value is the most important thing that people focus on. Property valuation determines whether an investment will make a profit or not.
Unaware of the estimated value you can easily fall for opposite-party agents’ sweet talk (which they use so often) and end up in a real mess.
But knowing the true value will keep you protected and on the right track!
Now, let’s take a good look at the methods you could use to value your property in real-time…
1) The Net Income Approach (NOI)
The income method is very commonly used to value rental properties…
In this method, the value of a property is calculated with the help of the actual rental income it generates – to get at the offer price!
For this purpose, the actual income must be known (obviously).
You’ll need to ask the property owner for their current income and expenses and compare them against each other to arrive at the NOI – Net Operating Income (gross income minus the expenses).
Once you know the NOI, put it in the formula below for the average cap rate:
Capitalization Rate = NOI / Trending Property Value
Use the trending market price for your type of property (which you can get from a Google search or any local realtor) and find out the cap rate.
With this cap rate known, go on to find the property’s real worth by rearranging the formula!
Here’s what it looks like now…
Property Value = NOI / Cap Rate
Pop in the figures (the NOI and cap rate) and there you have the value for your property based on its income!
2) The Cost Method
This is not as common as the income method and it’s used for special kinds of real estate projects like new construction or redevelopments.
The method is focused on the cost of a property as opposed to its income.
Basically, what investors do in this method is look at the property as the property and its land plus the costs of replacing the structure that is currently on it – of the old home, parking lot, etc. – with a new one (restructuring costs) minus any depreciation.
Got it? Does it make sense?
OK, let’s see an example:
If you’re considering buying an old building to turn it into a multi-unit luxury complex, you’ll take into account the original cost of the land plus the costs of converting the old structure into the new one minus any depreciation…
And that’s your property’s value!
Now it makes sense, right?
But, of course, the method is a tough one and you’ll most likely be requiring an expert to give you a hand with your property value appraisal based on this model, as well as a construction expert to guide you through the restructuring costs.
So with that in mind, let’s see a method that you’re much more likely to use…
3) Valuing Through Sales Comparison
This method gives you a fair idea of what the property is worth, but it’s not (usually) even close to what eventually will go down on paper…
The sales comparison method uses a wild guess at the property’s overall worth with no thorough calculations involved.
But still, it is very widely used by real estate investors for its speed, and ease of use.
The method compares the values of similar properties in the local area (found on Realtor.com or Zillow) to determine a rough average…
And that’s it! It’s that easy.
For example, a property similar to yours was recently sold for $80,000 in the neighborhood and from that you know the price for your property must be somewhere around the same amount.
This is a super useful tool! And very easy to use.
But, it’s also just a ‘stepping stone’ and you can move ahead from there to more accurate appraisal methods…
If you go deeper into it with the mortgage costs, taxes, the age of the real estate, structural condition, etc., a totally different number might come up in the end!
Remember that sales comparison can be a good start BUT only very similar properties must be compared.
You can’t weigh up your two-bedroom apartment against a penthouse in the same building… They are worlds apart. Right?
4) The Capital Asset Pricing Model (CAPM)
This is a pretty useful and all-inclusive kind of valuation model as it takes into account the risks and opportunity costs of investing in a particular real estate property.
The model is mainly used by professional investors who face the dilemma of choosing between multiple investment options…
Like, whether it’s safe and sensible enough to invest in real estate, or better in bonds/stocks instead?
The CAPM considers the return on your real estate investment in the form of rental income and compares it with returns from other investment options such as treasury bonds, real estate trusts, stocks, etc.
Such a comparison will deliver a good estimate of what the property is actually worth to you, or if you’d be better off investing in another asset altogether!
The Bottom Line!
So, the top four property valuation methods are at your disposal now…
If you want to get the value right on the money you would want to be practical and consider in detail the necessary specifics of the property in question.
For rental properties you’ll most likely find the income method best, but sometimes a customized combo of two or three approaches can be most effective.
Finally, it’s up to you to choose and decide whichever method you think is right for you…
Good luck from our end!