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Knowing the value of a property you are considering for purchase is critical. Accurate information helps you understand how much to pay for an asset that you want, enables you to avoid overpaying, and assists you in identifying an opportunity. There are several methods of valuing property: Sales Comparison As with homes purchased for residential use, sales comparisons are the most common valuation method used when buying investment properties. The approach involves comparing the property to others with similar features nearby and reviewing the relative prices. This method is simple but not precise. No two properties are the same, and conditions may vary widely. For a comparison to be helpful, it must be extremely close and very recent. Gross Rent MultiplierThe GRM is a straightforward calculation that can be helpful if potentially oversimplified. The point of caution is because it doesn't account for costs like taxes, insurance, utilities, and vacancies. You just take the property's value and divide it by the amount of rent you expect to collect annually. For example, if you purchase a rental for $700,000 and expect to collect $130,000 in rent, you will divide $700,000 by $130,000 for a GRM of 5.38. On the other hand, if you know the annual rent and the GRM, you can reverse the equation and determine the value (5.38 X $130,000 = $699,400). Using the GRM (Gross Rent Multiplier) approach can be helpful as one of several factors when evaluating a property. If a potential acquisition has a lower GRM, it may indicate that the older property will need repairs and renovations. A higher GRM may signal a newer, more up-to-date property with a higher purchase price but less maintenance cost in the near term and potentially higher rental income availability. GRM scores should also be considered relative to the location and other risk factors for a comprehensive view. Income ApproachUsing this method, the investor divides the net operating income by the capitalization rate of the property. (The capitalization or cap rate is obtained by dividing the NOI by the property value. For example if the property value is $1.25 million and the NOI is $100,000 the cap rate is $100,000/$1,250,000 or 8.0%). If you turn this around because you have access to the NOI and the cap rate but not the property value, you can run the formula in reverse to determine the property value. Special Considerations Using the Capitalization RateKeep in mind that using the cap rate to assess value assumes that a return is the product of an all-cash transaction. The cap rate doesn't include financing or acquisition costs (like real estate agent commissions, for example). If you are using this valuation method, you may want to consider adding an element to account for these costs. Also, remember that the cap rate may change as the asset matures. If the property value increases (as you hold it over time) but the rent collected remains stagnant, the cap rate will decrease. Key Takeaways
Any investor knows that performing property value estimations is a crucial aspect of making smart investment decisions. Using a good property value estimator, whether your system or an online tool, can help minimize confusion and errors that occur too often when making complex financial calculations. Below you will find a discussion of several approaches to property valuation estimations, including step-by-step guides on making those calculations. Read on to identify the best property value estimator for your investing niche. 8 Numbers For Accurate Property Valuation CalculationsAny property value calculation will require a working knowledge of key numbers, such as the down payment, mortgage payment, and interest rate, to name a few. Before sitting down to calculate property value, make sure you have taken the preliminary step in gathering the figures that are commonly required in these analyses:
[ Know your numbers! Download this FREE Cashflow & ROI Calculator for rental property investments. ] Methods For Determining Capitalization RateThe capitalization rate is a key metric when it comes to comparing potential investments. This is because the cap rate considers the costs incurred when owning a rental property and can provide a complete picture of the potential income a property could generate. While there are no clear standards for a “good” or “bad” capitalization rate, this number can be beneficial within the context of a particular investment. Luckily, there are several ways to determine the capitalization rate depending on the information you have available. The Band-Of-Investment MethodAccording to Investopedia, the band-of-investment method is best used for financed real estate investments, as it relies on properties’ interest rates. The formula for this method requires two main variables: the financing component and the equity component. The financing component refers to the lender’s amount of capital and can be determined by multiplying the mortgage rate by the loan to value ratio. The equity component refers to capital coming from the investor and is determined by multiplying the yield rate by the percentage of cash equity. Market ExtractionMarket extraction is perhaps the most user-friendly method for evaluating the cap rate of a given property. Investors who can calculate the net operating income should have no problem working with the market extraction method. Start by adding the total expenses for a property, including repair costs, taxes, insurance, fees, and vacancy costs. Next, take the annual rental income and subtract the total expenses (calculated above). Divide the resulting number by the total property cost. The final percentage is your capitalization rate. The Build-Up MethodThe build-up method is arguable the second most common way of determining the capitalization rate. Investors will need to start with the interest rate and then determine the liquidity, recapture, and risk premiums. This will be the most difficult part of the formula, though it can be done. Once you have identified these variables, add up the percentages for the cap rate. To learn more about calculating the mentioned premiums, check out this guide by Investopedia. [ Know your numbers! Download this FREE Cashflow & ROI Calculator for rental property investments. ] How To Evaluate An Investment PropertyThe following steps demonstrate how to evaluate an investment property using several of the eight commonly-used numbers identified above. There is no one correct approach to evaluating an investment deal; rather, seasoned investors should make several method calculations to analyze an investment deal from multiple angles. To get started, follow the steps below:
Calculating Property Value Based On Rental IncomeFrom a real estate perspective, a rental property’s value can be compared with similar properties recently sold in the neighborhood. However, this valuation does not take into account the income component. To estimate property values based on rental income, investors can use the gross rental multiplier (GRM), which measures the property’s value relative to its rental income. To calculate, divide the property price by the annual rental income. The GRM can then be utilized as a benchmark when evaluating comparable income properties. Variables When Calculating Property ValueThere are numerous calculations used when analyzing property value, each with unique variables involved. Finding this information can take a lot of time, and may be a challenge to find in general. A variable that is not accounted for when looking at your valuation models are large shifts in the real estate market. These shifts must be interpreted and forecasted on their own, thus adding another step to your real estate valuations. Many of these numbers can be hard to obtain or even estimate, especially at first glance. The process of calculating property value is complex; but that does not mean investors should just give up. Instead, be aware of the variability that can occur when analyzing a property. In time, these numbers will be easier to estimate and predict. Along the way, you will learn valuable skills on analyzing deals. When done correctly, this process will have a significant payoff as you decide which properties to add to your portfolio and which to pass on. What Is Multifamily Real Estate?Multifamily real estate is commonly thought of as apartment complexes, which can host more than one space to be rented out. There is a multitude of strategies when it comes to real estate investing. Still, when narrowed down to the category of residential real estate, there are two main types of properties: single-family and multifamily. As one might assume, single-family properties are designed to fit the dwelling needs of up to one family. As mentioned above, multifamily real estate comes into play when a property provides more than one rentable unit. Investors may choose to pursue the multifamily real estate investing niche due to the unique advantages it has to offer. Multifamily Property Value Estimator: A Step-By-Step GuideThe income method approach is widely agreed upon as the best way to analyze the value of a multifamily property. This method utilizes the net operating income (NOI) and the capitalization rate of the property.
How To Price A Multi-Unit PropertyFiguring out the current market value of a multi-unit property can be tricky, so most investors choose to borrow from the income method approach discussed above. To estimate property values in the current market, divide the net operating income by the capitalization rate. For example, if the net operating income were $100,000 with a five percent cap rate, the property value would be roughly $2 million. However, note that a property’s net operating income and capitalization rate can fluctuate from month to month, so this figure is only an estimate. Investors can also perform a local market comparison of similar multi-family properties in the area or calculate the price via the replacement method discussed earlier. Investment Property Value CalculatorIt should be apparent by now that there are several approaches to calculating property value, with each method requiring a working knowledge of key measures and calculations. Even the most seasoned property value estimator may feel challenged when making complex calculations while keeping track of measures that fluctuate over time. Luckily, investors can utilize an investment property value calculator found online. It is best practice to understand how to calculate property value based on rental income or using cap rate to calculate property value. Still, there is no reason not to make use of helpful tools that are made available. The Importance of Home ValueHome value is important as you consider purchasing any property, whether it’s a primary residence or investment property. The reason is that the value of a home essentially tells you how much it is worth. This number will influence all aspects of a real estate transaction, from raising financing to negotiating the final purchase price. In essence, the home value will help you determine the properties you can afford and the ones that are priced appropriately. The importance of home value also extends beyond the initial purchase of a property, as it can help you anticipate other expenses. For example, home value can help determine tax rates, insurance premiums, and even future refinances. Home value is also necessary for several property estimations. These numbers can give you a complete picture as you look at homeownership. How To Increase Property ValueThere are many factors that go into the value of your home. Location is a large factor in the value of your home, as well as the development of the area that your home is located in. As the area around your home develops and gets more shops, restaurants, parks, schools, etc., the value of your home goes up. While it’s hard to control the external factors that go into the value of your home, you do have control over your own property and what you do to improve it. Landscaping can provide a huge boost to your home value, as well as home improvement projects in and around your house. Every type of project has a different ROI, so before spending a fortune on upgrades you may want to do some research. Maintaining and keeping your house clean, working, and up-to-date will also help your home hold or increase in value. Finally, listing your home for sale at the peak of a seller’s market will inherently increase your property value by letting you sell it at the highest possible price. Refinancing After Increase In Home ValueRefinancing after your home value increases is a choice that many homeowners will be faced with. Some homeowners will refinance their homes to receive a lower interest rate, lower the payment term, or a new type of mortgage. Other homeowners will opt to cash out their equity in their home and using it to finance other projects or home improvements. At the end of the day, it’s completely up to you to decide what is best for your current situation. Hiring A Professional AppraiserHiring a professional appraiser is a great way to get a lot of information fast. You can have a property appraised both for its current value and for its value on specific dates in the past. On top of a valuation for the actual property, an appraiser will also evaluate the market around the property; which includes the region, city, and neighborhood of the property. Finally, a professional appraiser will give you information on comparable properties in the area. This information will include sales, current listings, prices, historical depreciation, and more. Getting an appraisal done by a professional is an efficient way to help you fast-track your real estate valuations. SummaryWhether choosing to utilize a property value estimator tool or make every calculation by hand, investors are sure to develop an appreciation for property evaluation. Property valuation estimators are critical resources that allow investors to identify the difference between good and bad investment deals. The property’s purchase price only scratches the surface in terms of the value a property has to offer, especially in the long run. Familiarize yourself with the above methods for determining capitalization rate, gross rental multiplier, and more; by practicing these calculations now, you will be better prepared to evaluate (and compare) investment opportunities when it counts. Don't invest without knowing your numbers! Click the banner below to download WealthFit's FREE Cashflow & ROI Calculator for rental property investments.
How do you value rental property based on rental income?Also known as GRM, the gross rent multiplier approach is one of the simplest ways to determine the fair market value of a property. To calculate GRM, simply divide the current property market value or purchase price by the gross annual rental income: Gross Rent Multiplier = Property Price or Value / Gross Rental Income.
How do you calculate property value based on income?Gross rent multiplier (GRM)
For example, if the property value is $162,000 and the gross rental income is $18,600, the GRM would be: GRM = property value or purchase price / gross rental income. $162,000 property value / $18,600 gross rental income = 8.7.
How do you calculate if a rental property is worth it?One popular formula to help you decide if a property is good investment is the 1 percent rule, which advises that the property's monthly rent should be no less than 1 percent of the upfront cost, including any initial renovations and the purchase price.
What is the average ROI on commercial property?A good return on investment for commercial properties falls between 5% and 12%. While this is an average figure, it should be noted that a 'good' return is based on conditions such as property type and the local market.
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