From a quantitative viewpoint, investing in real estate is to some degree like investing in stocks. To benefit in real estate speculations, investors must decide the estimation of the properties they purchase and make instructed surmises about how much profit these ventures will create, whether through property appreciation, rental pay or a mix of both.
This is what real estate valuation analysis deals with. You have a property in which you want to invest, you need to calculate how profitable this property is and use this to formulate a strategy. That is basic and very important. Many investors think they have all this done and dusted, but still make uneducated guesses and fall into the trap of bad investments.
In Andrew Baum and Neil Cosby’s book “property investment appraisal”, they think property valuations are critical. According to them “Valuations are important: they are used as a surrogate for transactions in the construction of investment performance and they influence investors and other market operators when transacting property. “
Hold on! So, how do you calculate this value? There are two ways to go about this. You can either hire a valuer or take a hands-on approach to valuing your real estate investment. If you choose to take the second option, then check out these two approaches from Investopedia.
HOW TO DETERMINE MARKET VALUE OF YOUR INVESTMENT PROPERTY YOURSELF
1. NET OPERATING INCOME APPROACH.
Net Operating Income reflects the gain that a property will generate after taking into account operating expenses, but before deducting taxes and interest payments. Before deducting expenses, the total income obtained from the investment must be determined. This can be done by looking at rental income from comparable properties in the area. Therefore, considerable marketing research is needed at this stage.
Anticipated increments in rents are represented in the growth rate which we will incorporate in our calculation. Working costs including those that are directly brought about by day to day operations, for example, property insurance, management expenses, maintenance fees and utility expenses will also be added. So according to the net operating income approach, the value of your real estate is calculated by:
Market value = NOI/r-g = NOI/R
NOI = Net operating income
r= Required rate of return on real estate assets
g= Growth rate of NOI
R= Capitalization (Cap) rate (r-g)
2. THE GROSS INCOME MULTIPLIER APPROACH
The gross income multiplier method assumes that the price of property in an area is proportional to the gross income it helps to generate. To calculate the market value using this approach, we have to take into account an element that is called a gross income multiplier. The gross income multiplier takes into account historical data and sales in an area.
The selling price of comparable properties divided by the annual gross income they generate will produce the average gross income multiplier for a region. In essence, we are saying:
Market value = gross income * gross income multiplier
You have to realize that there will be unavoidable assumptions in these calculations. You can’t always be perfectly right. But you can look at the signs and make well-informed guesses to determine profitability of your investment.