In the busy real estate market, a million-dollar question is what the worth of a certain property is. It holds value, regardless of whether you want to finance, invest, list for sale, tax, or insure a real estate. A ballpark figure does not cut it, not when you have proper assessment tools at your disposal. The goal is not only to establish a current worth but also future benefits of property ownership.
Unlike most consumer goods, the nature of the real estate investment persists over a longer period of time. Hence, a proper estimate must factor in complex elements such as economic and social trends that shape the real estate market. There are many other factors at play here, so there is also a lot of ground to cover.
An appraisal takes the form of an opinion or estimate as of a specific date and in certain market conditions. In other words, it represents the most likely market value that a property has in an open, competitive environment. The exact model depends on the methodological collection of data and the first approach we address is sales comparison, typically used in valuing single-family homes and land.
Also known as a market data approach, it compares the property in question with several of the recently sold, similar properties (comparables). The latter must meet the criteria of being sold within the last year and under regular market conditions. Price adjustments apply to account for dissimilar features in properties.
The next method is utilized to ascertain the value of properties improved with buildings. It distinguishes the value of the property from the value of the land. And in order to come up with a value of the total property, these two figures are simply added together. Note that this model is mostly used to determine a value of a property which was not frequently sold and does not generate income.
One of the most important considerations involves building costs. This can be figured out via a square-foot method or the unit-in-place method. Cost approach also takes into account depreciation and how factors such as physical deterioration and functional obsolescence affect the value of an improvement to a real estate.
Subsequently, we come to the income capitalization technique. This approach is rooted in a relationship between the net income of the property and the rate of return investor seeks. It is common practice in the area of income-producing properties such as units for sale found in apartment complexes. The whole appraisal process can play out smoothly provided that income and expenses are predictable and non-volatile.
A direct capitalization variation follows the logic of gauging potential gross and effective gross income as well as deducting annual operating expenditures to calculate the net operating income, a value to which the capitalization rate is applied. Gross income multiplier method, on the other hand, is pretty straightforward, as it compares the price of the property to its expected rental income.
Capital asset pricing
The model of capital asset pricing relies on comprehensive valuation tools. It encompasses risk and opportunity costs as integral parts of the equation. The first step is to take a potential return on the investment (ROI), which is derived from rental income, and then compare it to other investments that bear virtually no risk (U.S. Treasury Bonds, for instance).
In case that the potential return on a risk-free investment exceeds ROI from a rental real estate, it is safe to conclude that it doesn’t make financial sense to invest in the latter. Location and age of the property are examples of risk factors that may pose deal—breakers, as they call for extra caution and potentially expensive measures.
A real deal
Real estate investment is not a gamble, but it is far from a risk-free game. Fortunately, by grasping facts and figures, once can minimize the risk and ensure good value for the money. Although the appraisals are usually carried out by skilled professionals, anyone involved in real estate transactions can reap benefits from developing a deeper understanding of the commonly used methods.
It pays off to get back to the basics and consider the four pillars on which the value of a property stands: Demand, utility, scarcity, and transferability (of the ownership). These elements are quite self-explanatory, but remember that in concrete practices, the implications are never as simple as ABC.