Let’s talk about determining a property’s value.
Determining the value or estimated value of an investment property is crucial when acquiring or potentially acquiring a property. When considering your possible exit strategies, the investor needs to have a pretty good idea of the value of the property to run numbers and figure out if the deal will work.
For example, if an investor were to determine that a property value was somewhere between $50k and $70k, and the estimated acquisition price was $35k and potential rehab costs of $15k, then the investor has a problem. The estimated value isn’t accurate enough and the deal is potentially too tight. The investor would need to nail down the estimated market value, after repairs are completed, to really know if the deal would work.
The natural tendency for people is to overvalue or exaggerate the value of investment properties. We want to make more money, so consciously or subconsciously, we naturally pad our numbers. It’s very important to keep your emotions in check and value potential investment objectively.
A proper assessment of value ensures investment security. The number one thing to research is the value of the property.
Different investment strategies require varying degrees of research. A good general rule is the more money that you invest, the greater the research that you need to perform.
Tax lien investing typically requires only a superficial evaluation, but a tax deed or redemption deed investor needs to know more specific information about the property because property acquisition is likely.
There are a couple formulas that can be used to determine property value:
- Comparable Market Formula
- Net Operating Income Formula
The most commonly used method is the comparable market formula.
Comparable Market Formula
To use the comparable market formula, the investor prices similar homes that have recently sold, and homes that are currently for sale within close proximity to the home being valued. These similar homes are called “comps” and should have the same features and characteristics as the property being valued. Here is an example:
Home 1 Home 2 Home 3
|1700 Square feet||1850 square feet||1950 square feet|
|3 bedrooms||3 bedrooms||3 bedrooms|
|2 baths||2 baths||2 baths|
|2 car garage||2 car garage||2 car garage|
|Built 1970||Built 1961||Built 1969|
|Sold Price $105,000||Sold Price $110,000||Sold Price $107,000|
|Sold in 30 days||Sold in 90 days||Sold in 65 days|
|$62 per square foot||$60 per square foot||$55 per square foot|
(Determine the price per square foot by dividing the selling price by the number of square feet.)
The investor would then take the price per square foot determined in the comp evaluation and multiply it by the square footage of the property in question to determine the estimated market value.
Please understand that the market value of a property is ultimately determined by buyers in the marketplace. This is still an estimation until a purchaser signs and money is transferred.
Net Operating Income Formula
The Net Operating Income (NOI) method is often used to determine property value of a cash flowing rental property. An investor may be more interested in this value as opposed to the Comparable Market Value because the investor intends to hold the property as a rental, so they’re more interested in the rate of return.
In order to calculate the NOI for an investment property, take the total rents for the year, let’s assume the renter is paying $1,000 a month, so the total annual rent would be $12,000, and you’d subtract the expenses from that number.
Expenses that you should include in this calculation are the following:
- Property management fees
- Property taxes
- Property insurance (not paid by tenant)
- General maintenance
- Legal fees
- Utilities (not paid by the tenant)
Expenses that should not be included in this calculation are the following:
- Income taxes
- Property depreciation
- Tenant improvements
- Mortgage interest
- Debt service
Let’s assume that the gross rents for the year are $12,000 and total expenses for the property are $4,000, that would give a NOI of $8,000.
Let’s go one step further and calculate the Cap Rate or Capitalization Rate. Let’s assume that the investment property was purchased for $60,000, and the previous numbers are true giving an NOI of $8,000. Divide the NOI by the initial investment, which will give you a Cap Rate of 13%.
Property Value Terms
Appraised Value: A licensed professional real estate appraiser determines the appraised value of a property. An Appraiser will usually consider similar properties that have sold recently in the area. They may also use properties that are currently for sale and properties that were for sale but have since expired.
Wholesale Value: The wholesale value is usually placed on properties by investors, and tends to be the lowest estimated price. Wholesale pricing usually means it will be sold for below market value. Investors do this to make a quick profit. These properties often include tax liens that went into foreclosure, and tax deeds properties.
Tax Assessed Value: The assessed value will be the value placed on the property by the county tax assessor. This is a great way to check the value of a property when working with tax liens and deeds. However, this should not be your only resource to determine what the property value might be. Tax assessed values can be above or below market value. As a general rule, they run about 20 percent below current market values.
Insured Value: This is the value insurance companies place on the improvements and structures on the property. This will usually be the amount it would cost to replace or rebuild the structure.
Mortgage Value: This is the value that a mortgage company would loan on a property. The mortgage value is generally close to the appraised value of the property.
Retail Value: This is the value that a homeowner or property owner places on the property. This is the price they feel their property is worth, and is usually above market value and the highest value placed on real estate.
What’s the real value?
The real value is the price that someone is willing to pay for it.
Use the following acronym when evaluating property value:
STUD – Scarcity, Transferability, Utility, and Demand.
Scarcity – How many similar properties are currently on the market? Is the property located in a desirable area? How ling are similar properties on the market before they sell?
Transferability – What is the condition of the deed to the property? Is there a loan against the property? If dealing with a tax deed, is your objective to wholesale the property?
Utility – What can the property be used for? Does the property have zoning restrictions? What is the primary use for the property?
Demand – How much demand is there for the property you are selling? How long does it take for similar properties to sell? Do you have interested buyers lined up?