For those in real estate, understanding property valuation is critical. It plays a role in the buying and selling of property, refinancing mortgage, and tax assessment.
To get a sense of property value, identify properties of comparable size, age, and in the same vicinity, and evaluate the sale price of the property.
Comparable Sales Approach
Considerable expertise is not required to understand that a key element of a successful investment in real estate is accurate property valuation. There are numerous ways to establish property value which will be discussed in this guide. Additionally, we will look at online resources and tools to assist in valuation and the role that a licensed appraiser plays in the process.
The sales comparison approach involves reviewing the sale prices of peer properties to establish a property value. This method is most successful with residential properties, but can be employed with valuation of investment properties.
Valuation systems that rely of market data are freely available and verifiable. Appraisers take the time to record the peers they considered and the data analyzed. Appraisers make “adjustments” to data and documented their rationale. The process appraisers use ensures clarity and assists to build a relationship of trust with their clientele.
Income Approach
The Income Approach assesses real estate based on the future revenue it could potentially generate. This approach is particularly useful when assessing commercial rental properties for investment and management purposes. This approach does have its drawbacks and this guide outlines the steps to assess value based on income, develop a property management budget and examine alternative valuation approaches including the comparable sales approach, direct capitalization and gross rent multiplier methods among others.
The most important aspect of assessing the value of income-generating properties is the relationship between net operating income and value. When developing an opinion of the value, the appraiser will need to estimate future income as well as select a capitalization rate. The value may be significantly distorted if these assumptions are incorrect. The best way to minimize these concerns is to have a strong understanding of the applicable financial concepts and supporting market information.
Cost Approach
Dream houses and commercial buildings have a price, but estimating the cost can be quite tricky. Fortunately, this is where real estate appraisal methods come to the rescue. The Income Approach and Cost Approach are two methods of property valuation that look to assist in estimating that price. Each has its strengths and ideal application.
The Sales Comparison Approach establishes a property value by surveying recently sold properties of a similar nature. This method is likely the most used in 1-4 family mortgage lending related assignments. The Cost Approach establishes value by ascertaining replacement cost, subtracting depreciation, and adding site value. This approach works best for unique construction projects, new construction projects, and construction projects that cannot be compared to sales. This approach is also valid for construction projects for insurance purposes, especially where construction and the land are valued separately. The GSE form assignments do not require an appraiser to formulate the cost approach. Contrary to this, the USPAP states that there must be a comprehensive explanation if the appraiser decides to omit this approach for credibility.
Gross Rent Multiplier Approach
The Gross Rent Multiplier (GRM) is a quick method to evaluate the viability of different commercial or residential investments. As GRMs do not consider operational costs, they should only be used to evaluate investments preliminary.
Generally, a GRM of 4-7 is considered good, though this is dependent on geographic area and market conditions. Other determinants include recent property improvements, property characteristics, and location desirability.
An extensive understanding of a rental property's value comes from using a variety of valuation methods. The Sales Comparison Approach establishes objective market value by identifying comparable property sales, whereas the Income Analysis Method focuses on the income potential of the property. Stessa Valuations provides both methods in real time, along with a variety of other tools, to help you assess the value of rental properties by integrating the Zestimate valuation tool in your Stessa dashboard. These tools help narrow down the variety of investment options available so you can better keep your end goals in mind.