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How To Value An Investment Property
Raul Chavez 2016-10-27
Investing in real estate is kind of like investing in stocks. To make money in real estate, you have to figure out the value of the properties you buy and guess how much profit these investments will generate for you through rental income, property appreciation, or a combination of the two. You can also use an appraiser to get an estimate of the market value of a property so you have something to start with when you’re doing your calculations.
An appraiser can give you an unbiased estimate of the true or fair market value of what a property is worth. All lenders will order an appraisal during the mortgage process, but if you don’t need a mortgage, you can still hire an appraiser to come look. The appraiser will likely look at several things to give an estimate: the current condition of the property, the recent sales info for similar properties, and the location of the property. An appraiser will also give you the current market value for tax purposes, in writing, for when you rent out the property for income purposes.
An appraisal will cost you starting around $350 plus HST and can go above $500 plus HST.
Here’s how to find a property’s income-generating capacity and its net operating income:
Determine the Property’s Income-Generating Capacity
The gross income multiplier method uses the assumption that properties in the same area will be valued proportionally to the gross income they help to generate. The gross income of a property is the total income before you take away any operating expenses. You need to also forecast vacancy rates to get an accurate gross income statement.
Next, figure out the gross income multiplier. If you have access to historical sales data, this will help. Look at the sales price of comparable properties and divide that value by the gross annual income they generated to see the average multiplier for the area.
Calculate the Property’s Net Operating Income
The net operating income reflects the earnings that the property will generate after you figure in operating expenses, but before you take off taxes and interest payments. Before you deduct expenses, you have to determine the total revenue gained from the investment. If you are unsure, some market research can show what prices tenants are paying in the area, and assume that a similar per-square-foot rent can be assumed in this case.
Operating expenses include those that are incurred through day-to-day operations like management fees, property insurance, utility costs, and maintenance fees. Depreciation is not included here.
Gross Rent Multiplier
One way to determine if a property is worth buying for the investment is a very simple calculation where you take the price and divide it by the rent. A lower ratio is better than a higher ratio. This method might be helpful for you to determine if you even want to take the time to go look at a property. The capitalization rate (where you look at the net profit instead of the gross income) to see the ratio. You can learn more about the capitalization rate at PropertyMetrics.
Overall, real estate valuation is often done using strategies similar to equity analysis. Some experts know migration and development patterns and figure those into their calculations, while others use other methods (repayment method, investment method, residual method, cost method, comparison method, etc). They are able to figure out which local areas are most likely to have fastest rates of appreciation. Whichever method you use, the most important indicator of how accurate your estimation will be is how well you do your research.