Real Estate Valuation

Real Estate Valuation



Real Estate Valuation
Real estate valuation for​ single family homes is​ typically done by using comparable sales .​
With income properties this just doesn't work well .​
Imagine if​ you are looking at​ a​ 24-unit building .​
It would be difficult to​ find similar ones nearby that have recently sold.
It's also not ideal to​ use replacement costs for​ income property appraisal .​
How do you figure replacement cost if​ there is​ no land for​ sale nearby with proper zoning? This is​ used as​ a​ secondary method, though, and​ can tell you if​ maybe you should be building instead of​ buying.
Real Estate Valuation By Cap Rate
Income properties are bought for​ the​ income .​
Income, then, is​ what is​ used to​ determine value .​
The rate of​ return investors in​ a​ given area expect gives you the​ capitalization rate, or​ cap rate for​ the​ area .​
This is​ what you use to​ accurately appraise an​ income property .​
Below is​ a​ somewhat simplified explanation.
The process begins with the​ gross income of​ a​ property .​
You then subtract all expenses, but not loan payments .​
For example, if​ a​ building's gross income is​ $82,000 per year, and​ the​ expenses $30,000, you have a​ net (before debt-service) of​ $52,000 .​
You then apply the​ capitalization rate to​ this figure.
Suppose the​ acceptable cap rate in​ the​ area is​ .10, for​ example (ask a​ real estate agent), meaning investors expect a​ return of​ 10% on the​ value of​ the​ property .​
You simply divide the​ income of​ $52,000 by .10 .​
$520,000, then, is​ the​ indicated value of​ the​ building .​
Suppose the​ usual rate is​ .08, meaning investors in​ the​ area expect an​ 8% return .​
Then the​ value would be $650,000.
Easy Real Estate Valuation?
Take net income before debt-service, and​ divide by the​ cap rate: It's a​ simple formula .​
However, the​ tough part is​ getting accurate income figures .​
Did the​ seller show you ALL the​ normal expenses? Did he and​ exagerate the​ income? Suppose he stopped repairs for​ a​ year, and​ also showed you the​ projected rents .​
In that case, the​ income figure could be $15,000 too high .​
The building would be worth $187,000 less (.08 cap rate) than your appraisal shows.
One thing smart investors do when buying, is​ to​ separate out income from vending machines and​ laundry machines .​
If these provided $6,000 of​ the​ income, that income would add $75,000 to​ the​ appraised value (.08 cap rate) .​
Instead, do the​ appraisal without this income included, then add back the​ replacement cost of​ the​ machines (probably much less than $75,000) to​ arrive at​ a​ valuation.
Of course, you should be careful with any real estate appraisal method .​
There is​ no perfect appraisal method, and​ all are only as​ good as​ the​ figures you plug into them .​
If used wisely, though, appraisal by capitalization rates is​ one of​ the​ most accurate methods of​ real estate valuation.




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