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| Real Estate Valuation |
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 |
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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.HousesU
nderFiftyThousand.com
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