A real estate valuation is necessary for a variety of endeavours, including financing, sales listing, investment analysis, property insurance, and taxation. Conducting a property valuation is a critical part of making the best investment decision possible. That’s because not every rental property provides the same yield to investors. By accurately valuing rental property, you can profitably scale up your investment portfolio and avoid making costly mistakes. This article will provide an introductory guide to property valuations and everything a real estate investor needs to know to perform one.
What is a property valuation?
A property valuation is an assessment of your property’s value, based on the location, condition and multiple other factors. Property valuations typically seek to determine fair market value. This is the price at which a knowledgeable seller willingly sells a property and a knowledgeable buyer will willingly purchase it.
Before doing a property valuation
Before you can begin calculating property value, you’ll need to collect some key financial data for your property valuation:
- Mortgage payment and whether or not the payment includes property taxes and insurance.
- Down payment amount which will vary based on the type of mortgage loan and the investment strategy being used.
- Rental income including an allowance for vacancy and the amount of rental cash flow left over after paying the mortgage and normal operating expenses.
- Price to income ratio which compares the median home price to the median income in the market.
- Gross rental yield which is measured by dividing the total purchase price of the house and improvements needed by the annual gross rent.
- Cash flow which is the money that’s left over after all expenses, including the mortgage, have been paid.
Guide to property valuations
Here are the general factors that affect a property’s value:
Property size and floor plan
The most popular metric for valuing residential real estate is the price per square foot. In addition to the house’s square footage, the number of bedrooms, bathrooms, and the property’s overall floor plan all have an impact on its value.
Condition of the property
The overall condition of a property has a huge bearing on the value of the property. As such, deferred maintenance items reduce property value because of the money which will soon be needed for updating.
Age of the property
New properties usually have higher values than older ones because fewer routine repairs and capital improvements are needed in the foreseeable future.
Property values will rise in a seller’s market, where there are more buyers than sellers due to a supply and demand imbalance.
The location of a residential property directly affects its market value. Each location represents different values in variables such as accessibility, neighbourhood, traffic and socio-economic level, among others.
How to evaluate investment property value
Determine fair market value
Fair market value is the price an informed buyer is willing to pay, and a seller is willing to accept.
Establish the replacement cost
The replacement cost is the amount of money it would cost to build the same property today. It takes into account things like land value as well as labour and material costs.
Ascertain the fair market rent
Fair market rent is best determined by checking what other landlords are charging their tenants for comparable rental properties in the area. You should find out the rent for at least three similar properties currently rented out in the area and then find an average.
Calculate the net operating income (NOI)
The net operating income is calculated by subtracting normal operating expenses from gross income. Normal operating expenses include the cost of routine repairs and maintenance, utilities, insurance, property management fees, and property taxes.
Perform financial calculations
Common financial calculations used to conduct a property valuation are cap rate, ROI, and cash-on-cash return.