Real Estate Valuation (Real Estate Appraisal)

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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.

About the Author

Steve Gillman has invested in real estate for years. To learn more, get a free real estate investing course, and see a photo of a beautiful house he and his wife bought for $17,500, visit http://www.HousesUnderFiftyThousand.com

Real Estate (Real Estate Appraisal) Value

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What is real estate value? It isn’t what you have into your house. It isn’t what you feel it is worth. It is what the market will pay. How do you figure out what the market will pay? For single family homes, the best way is by seeing what similar homes have sold for.

Figuring replacement cost isn’t very useful. It’s difficult to say what land is worth in a city center where none is left for sale, for example, and tough to gauge depreciation of the home itself. Valuation from replacement cost is used as a secondary method, and for unique homes that can’t be compared easily with others. However, the primary method of real estate appraisal used for homes is a market analysis using comparable sales.

Real Estate Value 101

First find at least three similar homes in the same area that have sold within the last year, and preferably within the last six months. You can find this information is in county records (sometimes online now), or from a real estate agent with access to the multiple listing service. Make sure you have the basic sales information: sales price, terms of sale, description of the property, etc.

Here is how you use this information to find real estate value. Write down the selling price of your first comparable. Review the description item by item, adding to the sales price of the comparable for each thing it doesn’t have that your subject home has, and subtracting for each thing it has that your subject home doesn’t have.

This sounds confusing, but it will make sense once you try it a couple times. For example, if your subject home has a second bathroom, and the a comparable doesn’t, you add the value of the bathroom to the sales price of the comparable. If a comparable home has a blacktop driveway, and the subject home doesn’t, you take the value away. What you are doing is rectifying differences, to see what the comparable home WOULD have sold for if it was just like yours. Suppose a comparable sold for $140,000, with one less bathroom than your subject home, and a bathroom is worth $15,000 in your area (ask a real estate agent for help with these figures). You ADD $15,000 for the bathroom it doesn’t have. You subtract, say $4,000, for the paved driveway it does have, that your home doesn’t have. $140,000 plus $15,000, minus $4,000 gives you a comparable sales price of $151,000.

Do this with all differences between the subject home and each comparable. Once done, average the three comparable prices. If, for example, the three comparables now have adjusted sales prices of $151,000, 162,000, and 149,000, add the three figures and divide by three. The indicated value of the home is $154,000.

All appraisal is an inexact science. You might only find comparables sold over a year ago, and have to estimate appreciation in the area. If a comparable sold with seller financing, you have to decide how much this affected the price. Still, for all of it’s flaws, for single family homes this is the most accurate method for finding true real estate value.

About the Author

Steve Gillman has invested in real estate for years. To learn more, get a free real estate investing course, and see a photo of a beautiful house he and his wife bought for $17,500, visit http://www.HousesUnderFiftyThousand.com

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