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Being a successful investor requires you to have a thorough understanding of the costs, expenses and income generated by your investment property. It also requires you to have a deep understanding of the value of your real estate, and the ways it may impact your future investment abilities. Simply put: You need to correctly value real estate before making decisions.
But calculating the value of a property is anything but an exact science. It can be difficult to nail down a true value. And, even if you do, a mortgage broker or seller might have a different figure in front of them. Your goal as an investor should be to have the better number—one everyone can agree on, from sellers to brokers, to appraisers.
The right valuation can go a long way in helping you maximize returns. A poor valuation can leave you paying too much and earning too little!
The value in understanding… value!
The value of your investment property affects your net worth. It could play a significant role when you go to secure a line of credit or apply for a mortgage for another investment property. Having a recent, accurate valuation of your current investments will provide you with the knowledge to make informed financial decisions. This is precisely why understanding how to evaluate your investment property is important.
Even if you’re preparing to make your first real estate investment, accurately and thoroughly evaluating the property before purchasing it will ensure you’re making a wise fiscal choice. Valuations can help you project potential income from a property and help you determine whether you’re preparing to pay a fair price for the site.
Valuations are also helpful when you’re considering liquidating existing real estate assets. You can use your valuation to accurately assess the amount of capital you may be able to pull out of a property by selling it, or by refinancing your mortgage.
Rental Property valuation fundamentals
While the methods used to determine the value of an investment property differs, some fundamentals apply across all valuation methods.
For instance, a property’s ability to generate income will always play a role in real estate valuation. Additionally, local, current market conditions are significant when evaluating the property. There’s also the condition of the home, its history of improvements and any damages present. Don’t forget about liens against it, too!
Anything involving the property can be factored into its valuation. Some things are more important than others, but everything has a plus or minus value attached to it. New HVAC system? Plus. Water damaged basement? Minus. Every house is one big balance sheet!
But what about something like price appreciation potential? The intangibles can be even harder to value. Price appreciation does play a role when it comes to evaluation. However, it’s important to note that price appreciation is always viewed secondarily to the ability (or lack thereof) of the property to generate income. What’s known weighs more heavily than what’s predicted.
Valuating your investment property
There are several tools you can use to establish the value of your rental property. Different valuation tools have different applications, so it’s important to consider the benefits and drawbacks associated with each methodology. Here are some common ways appraisers and investors evaluate rental properties, to ascertain the best value of real estate:
Sales comparison approach
This is one of the most common types of property valuations available. It’s also among the easiest to obtain! It involves simply comparing a given property against other, similar properties for sale in the same market. Using recent market transactions, real estate valuators gain insight into the likely selling or renting rate of a given property by observing current conditions.
Capital asset pricing model
The capital asset pricing model is a much more comprehensive valuation tool. It assesses the risk associated with a potential real estate investment and weighs it against its ability to generate revenue. The capital asset pricing model considers age, location, the condition of the property and more when factoring the potential investment risk.
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This approach measures the potential passive income generated by a rental property against the investment necessary to purchase it. This type of valuation is most commonly associated with commercial real estate investments. At its core, the income approach to real estate valuation depends on the capitalization rate of the investment. Interest expenses, net present value and inflationary/deflationary risks are all accounted for in the income approach to real estate valuation.
The cost approach relies on appraisers determining what the highest, best and most valuable use for a piece of real estate is. Because of this, it’s most commonly associated with vacant plots of land. To determine the valuation, appraisers assess the actual value of the land itself and weigh it against the depreciated costs of any improvements required. A property’s location, its quality and zoning all play a role in the way it’s evaluated under the cost approach method.
It’s a good rule of thumb to run the numbers on your property through at least a couple of these models. It’ll give you a better idea of what the true value is. And, it’ll prepare you for any numbers a seller, mortgage broker or appraiser might throw at you. The last thing you want is for your estimation to be wildly different than someone else’s—especially before a transaction.
Understand the numbers first
Regardless of the tool you use to establish the value of your investment property, it’s important to have a thorough understanding of a rental property’s current market valuation and its ability to generate passive income. Working with a professional appraisal firm is often the best way to secure a comprehensive understanding of your investment’s current value, as well as its long-term outlook.
In the end, it’s hard to put an exact dollar and cents valuation on your property. It likely changes from day to day. What you can do, is have the best possible general understanding of its value and stand confidently by this figure when you make investment decisions.