Valuing Real Estate Deals

So you want to start investing in real estate or even flipping homes and found a property that you’re interested in purchasing. Before you get too excited, you need to establish its value to avoid potentially making a bad investment. Taking the seller’s word or just looking at the county tax records to determine the value could lead to you losing money on the deal which, of course, we never want. The marketplace is filled with ups and downs but if you can do a good job of establishing value there is a lot of money to be made.

Depending upon what type of investor you, are you’ll likely utilize one of these three methods of establishing the value of a property.

Comparable Sales Approach – If you’re primarily investing in single family residential properties, by far the most popular method of establishing value is the comparable sales approach. In this method you will locate recently sold properties that are similar to the property you’re considering and are located in the same general area. An appraiser will have many years of experience in determining value, but you can do the same thing by either pulling public data yourself or by working with a realtor who might be willing to pull data from their MLS account for you. In this day and age a great deal of information can be found online. Sites such as Zillow or Red Fin could be a big help in this process. Once you have data on your comparable sales, you’ll need to adjust 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, you can divide the sales price by the square footage of the home to come up with a cost per square foot.

Cost Approach – While not nearly as popular as the Comparable Sales Approach, another way to determine the value of a property is by estimating what it would cost to re-create it in the same area. This will take some knowledge of construction as you’ll need to determine building costs, value of the land, and also make allowances for depreciation of the property so that it is in similar condition to the one you are considering to purchase. If you’re experienced at estimating building costs the replacement cost method may be one which you will want to utilize. This approach is used most often in determining the value of properties with not many properties that are truly comparable.

Income Valuation Approach – The last method of determining the value of a property is to use the Income Valuation Approach. This method is typically used to determine the market value of commercial properties (which include apartments). This method values the property as more of an investment since there will hopefully be a recurring cash flow stream associated with rents from the property. First, you’ll want to determine the income from rental income. Next you will subtract all operating expenses associated with the property other than the cost of debt. This is what’s called Net Operating Income (“NOI”). From here you’ll want to divide the NOI by the “cap rate.” The cap rate is essentially the return an investor would require if they were to purchase with all cash. To find these you can typically look for research from big brokerages such as CBRE.

Once you’re able to determine the value of a property you can now make an intelligent offer that eliminates the risk of overpaying. Remember that real estate prices may vary and the value you have today might not be valid in the near future (this can work for better or worse).

Hopefully this helps in your real estate investing endeavors! If you have any need for financing on investor properties contact Loan Ranger Capital.

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