The Three Methods For Determining The Value of a Property in Your MarketTopic: Real Estate Value
Nationwide the property values have nosedived significantly in 2008 and as a real estate investor you need to be sure you're "buying right" before you commit to any deal. It's more important now than ever before.
What you pay for a property now might be worth alot less a few months from now if the current market conditions are any indication. That's why you really need to do your homework to establish the value of your potential investment to avoid losing your shirt.
Generally speaking, there will be three methods you'll use as a real estate investor to determine the value of a property before you financially commit to purchasing it.
Method # 1 is Comparable Sales. If you're investing in primarily single-family homes or four-plex units (4-unit properties), by far the most popular method of establishing value is using comparable sales as a guideline. This method consists of locating recently sold properties that are very similar to the one you are considering purchasing and are located in the same general vicinity. For example, if you're considering buying a 3-bedroom 2 bath 1500 sq foot single family ranch house you don't want comparable sales of 3-bedroom 1 1/2 bath 2-story homes to be included in your comparables even though that particular property might be within a half-mile of your property and has sold for $10k more in the past 60 days. Your numbers will be skewed. A skilled appraiser typically has many years of experience in determining value and will most likely charge you $300 or more, but you can do the same thing by going to your county courthouse and compiling the information yourself. If you have a good relationship with a realtor you can see if he or she will run all the information for you as well. You can also get a rough estimate of values in many areas by utilizing various online resources. Do a Google search for comparable property values and work through the searches averaging them out. Once you have your comparable sales figures you'll need to compensate for any differences, such as the lack of a garage, fireplace, or even a swimming pool. In order to compensate for the differences in square footage of your subject properties, a little trick of the trade is to divide the sales prices by the square footage of living space to come up with a cost per square foot. You just want to make sure you're comparing "apples to apples" so-to-speak.
Method # 2 is Income Valuation. This method is sometimes also called the Net Income Approach. This particular method is generally used to determine the market value of commercial properties, or residential properties with over 5 units. First what you do is figure out what the gross income is for that property and then subtract all the expenses, including whatever the debt service is on an annualized basis. Then multiply whatever that figure is by ten. The answer you get is what your property is worth. If the number you get isn't to your satisfaction, the really nice thing is you can increase the property value by increasing it's net income (raising rents), reducing operating expenses, or both.
Let's take a look at the third and final method of establishing property values.
The 3rd method is figuring out what the Replacement Cost would be of your property of interest. You estimate what it would cost to replace or recreate the same property in the same area. Now, this particular method isn't nearly as popular as going the comparable sales route, however, if you have a contractor background it can be an effective method to use. You would need to determine all the building costs, the costs of the materials and make the necessary allowances for the depreciation of the property so it is as close as possible in similarity to the property you're considering purchasing.
If you choose to use the Replacement Cost method in determining the value of the property, and you're not an experienced contractor yourself, your first step would be to contact a local contractor and inquire what they would charge you per square foot to build a home similar to your subject property in the same area, remembering not to forget to factor in the depreciation to coincide with your subject property.
Now you have three methods of determining the value of your potential investment property and you can write an intelligent offer without fear of overpaying. Keep in mind though that real estate prices are very volatile in almost every area of the country right now so make sure your using recent sales numbers in your comparisons. With knowledge of accurate numbers you can submit bids that have a better chance of getting accepted and allow you to increase your real estate investment portfolio profits.
About the Author
Jeremiah Noswalc is a real estate investor located in mid-Michigan specializing in residential real estate for a very active real estate firm in West Michigan that specializes in Rent-2-Own properties, Lease Options, Wholesaling, Residential Turn-Key Properties, Property Mgmt, & Consulting with over 250+ successful transactions and 10 years experience in all facets of real estate investing. For more info go to our investor website http://www.MWISINC.com