Valuing Real Estate – The Art of Appraisal Done Right!
Real estate appraisal is a key service for mortgage lenders, investors and buyers of income property. But a true valuation is much more than a simple number.
Valuation is based on many factors, including at what cost a substitute property could be obtained; and the rate of return an investor would expect over time.
It’s no secret that location is one of the most important factors when determining a property’s value. Even if two properties are the same, their location can dramatically impact their value. For instance, a house with a great view or located near a lake or river is likely to be more valuable than a home that sits next door to a gas station or grocery store. This is because a great location increases demand and therefore, the property’s potential to appreciate over time.
Real estate investors and aspiring homeowners alike need to know how property valuation works. Valuation is the process of determining what a property is worth, and it can be done using several different methods. This determination is an essential piece of the puzzle when it comes to obtaining a mortgage, projecting ongoing costs like property insurance and taxes, and determining how much to offer for a home or business opportunity.
The best way to determine a property’s value is by comparing it to similar properties that have sold recently. This is called the sales comparison approach. Appraisers use specific data about the subject property, including square footage, number of rooms, and renovations/improvements to make apples-to-apples comparisons. Then they adjust the comparable properties’ values up or down to match the subject property.
However, this method of valuing real estate has its drawbacks. For one, it can be difficult to find comparables with the exact same property characteristics as the subject property. This is because no two properties are exactly the same — even houses that are located within a block of each other can vary significantly in their condition and features.
Another common method for determining a property’s value is the cost approach. This method involves calculating the actual expenses and capital improvements that are needed to bring the property up to standard. It is most commonly used for evaluating single-family homes, and it can be very accurate for this type of property.
Investors can also measure the potential return on their investment by looking at the cap rate and cash on cash return. These measurements take into account the method of financing used to buy the property and the current market price of the property, respectively.
When valuing real estate, the condition of the property plays an important role. If a property is in poor shape, it will usually sell for less than if it was in good repair. This is true whether the property is a home or commercial building. Homeowners will often replace or upgrade items in a home to keep it in good condition, and this can impact the value of a home. Likewise, real estate investors will make improvements to the property when possible in order to increase its value.
Getting a property valued is critical to many elements in real estate investing, from understanding the cap rate of an investment to making sure that it will provide a return on the capital invested. Most mortgage lenders require a professional appraisal report before extending an investment loan, and this helps to protect the lender from lending money that is not backed by the value of the property.
The property valuation process consists of collecting and analyzing both specific and general data to determine the value of a particular piece of real estate. Specific data is collected regarding the individual property and its unique characteristics, while general information about the market, neighborhood, and similar properties are also analyzed. Squatters’ rights, a legal concept related to the occupation of a property without ownership, may also be considered in some cases. A professional appraiser is a disinterested third party with no emotional attachment to the property, so they can use objective and statistical data to arrive at a valuation of the property.
A common method for determining the value of a property is the sales comparison approach, which involves looking at comparable properties that have recently sold. An appraiser will then compare the features of these properties to the subject property and make adjustments accordingly. For example, if a comparable house has a pool but the subject property does not, this will be taken into account and the value of the property will be reduced.
Another commonly used valuation method is the cost approach, which considers the cost of replacing the property minus any accrued depreciation. This method is particularly useful for evaluating new construction or special-use property that does not have enough comparables to analyze using the sales comparison or income capitalization approaches.
The ability to evaluate a property’s income potential is a valuable skill for prospective and current real estate investors. Accurate real estate valuations can ensure that investment properties are acquired at a fair price and sold for no less than their true value.
Real estate appraisals determine a property’s worth by looking at various factors, including the amount of income it can generate and how much expenses are expected to be incurred. A property’s overall profitability is measured by the return on investment (ROI).
A typical ROI is calculated as net operating income divided by current market capitalization rate (cap rate). This formula takes into account both fixed and variable costs, as well as the method of financing used to purchase a property. This is an important factor because most investors acquire rental properties through loans, rather than cash.
However, it is important to note that this method of evaluating a property’s value only considers the property at a specific point in time. Real estate investors should also look at how the property will perform over its estimated hold period, which is usually ten years. The DCF (discounted cash flow) valuation model is one of the best ways to evaluate a property’s long-term performance and future profit potential.
Another property evaluation technique is the sales comparison approach, which uses data from comparable properties that have been recently sold. This method compares a property to other similar properties that have been sold in the same market and neighborhood. The properties used in this method should share several features, such as square footage, number of bedrooms and bathrooms, and location. Adjustments are often needed to account for differences between the properties, but this real estate valuation method is usually more reliable than others.
The gross income multiplier method is another way to assess a property’s value by using historical sales data. This method calculates the price-to-gross-income ratio by taking the market average of comparable properties and multiplying it by the generated gross annual income from a property. This is similar to how companies are valued, and it’s an efficient way to evaluate a commercial or residential property’s income potential. However, it’s important to note that this method doesn’t take into account market fluctuations and doesn’t consider a property’s potential to generate more income over the long term.
One of the key factors in property valuation is the type of financing available. For example, a loan from a bank may help to increase the overall value of a property, while an equity share in real estate can make the property more appealing to investors or buyers who are seeking a steady source of income.
A real estate appraisal can also be used for mortgage loans, tax appeals, divorce settlements and more. While there are several different ways to evaluate a piece of real estate, the three most common methods include sales comparisons, cost approach and income capitalization. Each of these methods provide an accurate look at property value for different use cases.
The most common method for residential real estate is comparing the subject property with similar properties that have recently sold, known as comparables (or comps). A professional appraiser will consider a wide range of factors when choosing comps, including location, size, condition and more. Then, the appraiser will calculate a price per square foot for the subject property based on the prices of the comps.
For commercial and industrial properties, the value-per-door or cost-per-rentable-square-foot approaches are more common. These methods can be more difficult to calculate than the price-per-square-foot approach, but they can offer a more accurate picture of the value of a property.
Another common financial calculation for evaluating real estate is the cap rate, which is used to estimate the investment return on a property. This is a useful metric for investors who are looking to get the highest returns on their investments, and can be found by subtracting a property’s normal operating expenses (such as insurance, utilities, management fees and more) from its gross revenue. Then, the result is divided by the capitalization rate.
The most comprehensive way to determine a property’s value is through the discounted cash flow (DCF) method. This method is best for assessing long-term value, and requires significant research and expertise. However, a DCF analysis can be a great way to see how a property might perform over a long period of time, and can be helpful in comparing different properties for potential investment opportunities.