How to Estimate Current Market Value ~ By Michael C. Zari
Real estate investing is a lot like buying stocks; ideally you want to buy low and sell high. While you do not make any money until both sides of the transaction are complete (i.e. buy and sell), there are things that you can do to make sure that you are getting in at a great price before you purchase. In other words, the experienced investor would first determine if he/she is getting a property at a great price before purchasing it. This is where most beginners in real estate investing fail. Beginners are usually paying too much in their initial investment project due to the lack of knowledge in estimating the current market value of a property. Then, most of these beginning investors do not have much capital to finance their overpriced investments. Overpaying discourages them and makes them fail to be profitable in real estate investing. You get the picture.
You can see the importance for all real estate investors to know how to estimate the correct current market value (CMV) of a property. This way, agents or developers will not take advantage and sell you the property at a price way over its current value. As an investor, you would want to get a property with built-in equity without overpaying. You will be able to know if a property offers the best deal when you know how to estimate its current market value.
Unfortunately, there is no single site on the web or any other source to know the current market value, especially for investment properties. You will not find a standard value for a real estate property, unlike cars or other personal property items that can you can buy online. Each real estate property or project is unique in itself. There are several factors that determine a property's or a project's current market value which include location, view, size, and income potential. This lack of a single, fixed-value for an investment property would require at least a standardized or unified method in accurately estimating its current market value. The good news is that there are different techniques that can be used by a real estate investor to estimate the current value. Let us first define the different terms you may encounter when estimating the current value of a property.
Market Value Defined
Market Value is defined by the National Residential Appraisers Institute as: "the most probable price which a property should bring a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus." In layman's terms, the market value of a property is the price most people would pay for in its current condition.
Assessed Value Vs. Appraised Value
Home buyers and sellers often use the terms appraised value and assessed value interchangeably. But what do these terms really mean?
Appraised value is the amount used by lenders to base upon the amount they will lend to the buyer. It is determined by, for example, the sales of comparable homes in the area, the property's location, its construction type, number of rooms and total size. This value is decided upon by a licensed appraiser with the use of the right method of appraisal for the property.
Assessed value, on the other hand, is used primarily for the purpose of taxes. Homes are evaluated by tax assessors based upon the recent sale prices of similar properties as well as the improvements done on the property. Since assessment practices vary with each community, the assessed value of a property is not a good indicator of its market value.
Different Appraisal Methods
Appraisers use three techniques in estimating the value of a property. These are the Income Method, the Replacement Cost Method, and the Comparison of Sales Method.
The income method, a.k.a. the Income Capitalization Approach, is used for properties producing income such as rental housing and commercial properties. It is the present worth of future rights to income. Value is computed as:
Value = (Net Operating Income) / Capitalization Rate
where the net operating income (NOI) is on an annual basis, and the "Cap" rate is determined for similar income producing properties that have sold (also on an annual basis). For example, a comparable income producing property is producing an annual net income of $30000 and is sold for $200000. In this case, the Cap Rate is $30000/$200000, or 0.15, or 15%. Some interesting things to note is that for a given NOI, as Cap Rate increases, the value goes down and as the Cap rate goes down, the value goes up
For single family homes and duplexes, a Gross Rent Multiplier (GRM) is typically used:
GRM = (Sales Price)/(Monthly Rent)
Here, the GRM is calculated for 4-5 comps and then is applies to determine the value of the subject property.
Replacement Cost Method
The Replacement Cost Method, a.k.a. Cost Method, or the appraisal by summation, is based on the principle of substitution and is most reliable for "Special Purpose Properties," single use properties, properties that have no sales comps, or income to value. The Cost approach consists of 5 steps:
In mathematical form, this approach can be described by:
Estimated Value = Land Value + Replacement/Reproduction Cost New - Depreciation
Sales Comparison Method
The comparison of sales approach determines the market value of the property by analyzing the recent sales of similar properties. The approach is based on the standard that no investor will pay more than he would on a similar investment. "Comps" are determined for similar properties and projects and then adjustments are made to the comps to compare it to the subject property. Typically, you would start off with 3 to 5 recent comp sales and then move on from there with your adjustments. Adjustments are made for price adjustments since each comp was sold, differences in amenities, physical features, etc. Once you determine an adjusted market price for your comps, you may then correlate your results (i.e. give more weight to the comps that are more similar to your subject property). For this and other reasons, it is always best to start off with comps that are as similar as possible to the subject property (i.e. compare apples to apples in terms of size, construction type, condition, location, end use, etc.).
As a real estate investor, you should do your own homework before getting into a deal, including estimating the current value of the property you are about to invest in. For this function, you can take your own initial stab at estimating the current market value, or you may want to enlist the help of a professional in this area; a professional who in the long run may be a valuable member of your investing "team" and who would be able to help explain the best method for determining value for the particular investment you are considering.