If you are a real estate investor or end use buyer how do you know if you have found a good deal? You cannot know if you have a good deal unless you know what the property is worth currently. In the stock market the current day’s trading price can give you an idea and you will be able to compare that to earnings report of the company. In the world of real estate the current valuation is not so cut and dry as the stock market.
Most novice property investors are either clueless or have wrong ideas when it comes to property values. If you want to be successful as a real estate investor then you will need to do extensive research, verify all assumptions and you should be extremely conservative when estimating property values.
The Art & Science of Valuating Property
When it comes to valuating a property and determining the exact value of the property, some people look at appraisals, others look at the Ready Reckoner rate of the property whereas the smart alecks say that – the house is worth whatever someone is willing to pay for it!
To further confuse this issue, one can also consider the rental income that the property generates to decide the value or the insurance replacement value. In some cases, the land itself is worth more than the value of the structure that stands upon it and thus any improvements to the house is ignored when setting the value.
All these above factors have relevance when you valuate a property and we will discuss these factors in more detail. Do remember though that valuation is more of an art than a science. But by employing some formulas and practicing them you can learn to valuate any property in the correct manner.
Common Methods to Estimate Property Value
For correct property valuation you need to go to a good property appraiser. A good appraiser can generally speaking pinpoint your home’s value within 1 – 2 %. Experienced property investors can also get the same accuracy rate because of their experience in buying and selling properties. Appraisers usually employ the following three methods to estimate the value of a property.
- Comparable Sales Method
- Replacement Cost Method
- Income Method
Comparable Sales Method
The comparable sales method is the most common approach to valuate homes and apartments. Comparable sales approach is also known “comps” in Appraiser parlance. This involves comparing the property that you intend to valuate with other similar properties that have sold recently in the same area. It goes without saying that all the comparable properties that you consider should be roughly the same size and style. They should have the same number of bedrooms, bathrooms and other rooms, parking spots etc. And they also have to be in the same neighbourhood. Comparable sales figures are a very good indicator of the market value of a flat because the market is dynamic and always changing which is reflected by “comps”.
Replacement Cost Method
In this method of valuating property one adds the value of the land, the age of the building and the cost to redevelop a new property on the land. In this case you should go by today’s cost and not the original construction cost because it would be naturally more expensive to reconstruct the property at today’s prices. The goal here is to understand what it would cost today to replace the building if it is destroyed by a natural calamity like fire, earthquake or any other unexpected event. The Replacement cost method is not as accurate as “comps” because land value varies. For example a shack on a beach in Goa can be replaced for a few thousands of rupees but does not take into account that the new construction could be a beachfront villa that can cost crores to develop.
The Income method is used more for valuating commercial property and rental-giving units usually if there are more than 4 rental units in one building. The valuation of properties that earn income for the owners is based on it’s capitalization or “cap rate”. “Cap rate” is the value of the property compared to the income that it generates. Cap rates are usually used on income properties to make comparisons to other income properties. When using this method to valuate property you base your figures on the building’s actual current revenue.
When valuating a property using the Income approach, you should not be misled by the property seller’s argument that he is renting out the property for less than market value because he wants to avoid tenant turnovers and always wants tenants in his property. Also do not go by the “full occupancy” estimates on paper. If properties are vacant then that is because they are real factors that are determined by the market and the condition of the property and the building in which it is situated in. Using the income method is helpful for valuating income generating properties thought its not as accurate as the Comparable sales method for apartment units and villas because it is usually the owners and not tenants who occupy most apartment units and villas. We will go into the above three property valuating methods in much more detail in future articles. Stay tuned to India’s no. 1 Real estate agency blog for more valuable insights whether you are a buyer or a seller 🙂