PROPERTYSPARK ARTICLE

What is a property valuation and how do you calculate it?

The first important step in a real estate transaction is determining the property’s sale price or market value. Not all properties are the same. Hence, property valuation conducted by a professional appraiser is necessary.

Determining the property value is very important, but working on complex calculations can be difficult without the right tools to help you with the computations. You can manually do the computations, but this can lead to many errors and confusion.

This article will explain what property valuation is and the different methods of evaluating it. If you aspire to become a homeowner, this article can help you make a wise decision for your real estate dreams.

Understanding Property Valuation

Property Valuation is the calculation process used by a real estate investor to determine a property’s value. Aside from real estate investors, a property valuation can be done by licensed appraisers and real estate brokers with a BPO.

Below are important financial data needed to compute property valuation:

1. Cash Flow

The cash flow is often measured monthly or annually. This is the amount left when all expenses are paid. The goal is to maintain a positive cash flow. A negative cash flow happens when expenses and debt exceed the income received.

2. Mortgage Payments and Property Taxes

If the property is on loan, there is a monthly mortgage payment that the lendee needs to pay to the lender. The mortgage loan may or may not include property tax and insurance. The loan payment pays off the principal loan and interest.

3. Down Payment

A down payment serves as a guarantee or reservation for the desired property not to be sold to someone else. It is an initial cash payment, a percentage of the full purchase price.

The down payment amount varies depending on the mortgage loan. A down payment can be as low as 3.5% of the property value or, at most 25%.

4. Rental Income

A rental income projection is needed to easily qualify for a mortgage loan. You can secure a suitable loan if your rental income can pay for the mortgage payment and operating expenses and still have an extra amount after paying all the liabilities.

5. Gross Rental Yield

The gross rental yield is measured using the formula gross yield = property price/gross annual rental income (rent roll).

The property’s purchase price includes fees, closing costs, and improvements. A high rental yield percentage means the property is a suitable investment property.

6. Capitalization Rate

The capitalization rate or cap rate shows how fast the rate of return is on a particular real estate investment. Using the cap rate, you can look into comparable properties because it doesn’t consider the financing cost.

The formula for capitalization rate is cap rate = market value/net operating income.

7. Price-to-Income Ratio

This ratio shows the comparison of renting against buying a house. A high ratio means purchasing a rental property is better, while a low ratio means lesser tenants and more homeowners (better to buy their own homes).

The formula for the price-to-income ratio is ratio = median home price/median annual rental income.

Steps in Evaluating Rental Property Value

If you have eyes on residential real estate or rental property and have collected all the necessary financial data to calculate property value, the next step is to evaluate the subject property.

Listed below are the steps necessary to evaluate rental property values.

1. Establish the Fair Market Value

Fair market value is the amount a buyer is willing to pay, and the seller can accept. To determine the fair market value, you can use comparable properties in the area.

2. Determine the Replacement Cost

The replacement cost is the amount needed to build a replica of the desired property. This method is used when comparing similar properties is impossible. The replacement cost method considers the land value and the expenses for labor and materials.

3. Determine Fair Market Rent

When determining the fair market rent, you are basically projecting the potential rental income of the property. You want the rental fee to be easy on the pocket for all tenants.

If the market rent is high, you may expect the tenants to terminate their contract or not renew it. On the other hand, if the market rent is low, you would expect tenants to renew their lease contract and eventually attract new tenants.

4. Computing the Net Operating Income

You can compute the net operating income (NOI) by deducting the operating expenses from the gross income generated by the property. The common operating expenses are repairs and maintenance, property taxes, insurance, management fees, and utilities. The mortgage payment is not considered an operating expense.

Operating expenses are not fixed. They can fluctuate every month. Hence, the yearly net operating income is an estimation.

5. Conduct Financial Calculations

There are three widely used financial calculations used for property valuations. These financial calculations are capitalization rate (cap rate), ROI, and cash-on-cash return.

The capitalization rate is calculated by dividing the property’s market price by the NOI. The use of a capitalization rate can project all expenses in detail allowing real estate agents and investors to get the best real estate deal.

You can use the cash-to-cash return method if there is a mortgage payment. This method results in a percentage of the property’s potential income relative to the invested money on the property.

You can compute the cash-to-cash return percentage by dividing the yearly NOI by the downpayment cost and expenses before it was rented out.

Frequently Asked Questions

1. Are property valuation and appraisal the same?

Property valuation and appraisal are not the same. An appraisal is often an established opinion or estimate of the property’s market value or purchasing price. While real estate valuations are scientific and more accurate processes of determining the property’s value. This is a written report and comes with a fee.

2. What are the three approaches used in property valuation?

Sales comparison, income, and cost approaches are the three methods used in property valuation.

Conclusion

The real estate market means serious business. Buying, selling, or renting a property entails a lot of planning.

Accurately determining a property’s value is important in making a wise decision about whether to buy the property or not. You can avoid making a huge mistake and wasting precious money if you know the value of a property.

Making use of property valuation calculator templates can be of big help to investors to differentiate between a good or bad investment deal. Knowing how to compute the property’s value can lead to a smart and successful investment decision.