We all want to own multiple properties, that’s the dream. Real estate investing is perhaps one of the most lucrative ways to grow wealth and own tangible assets at the same time. With real estate investing not only does your wealth multiply but also the value of your property appreciates over the long term making your net worth increase. Minor fluctuations and crashes such as the real estate crash of 2008 in the US do occur, but in the long run real estate prices always increase with excess demand provided supply is comparatively less. Currently in Mumbai, the real estate market is in the doldrums mainly because of excess supply. The real estate market is mainly governed by supply and demand and also increase/decrease in average income levels and savings throughout the country apart from important factors such as demographics, interest rates, location and the state of the economy.
What we don’t usually do is sit and calculate the value of the property.
I recently stumbled upon a study of methods to determine the value of a real estate property so here I am sharing them with you.
If you’ve located the property that you are potentially interested in purchasing, have looked at it, and determined that it meets your basic investing goals. Before you pat yourself on the back for a job well done, you need to establish its value to avoid potential financial disaster. If you take the word of the seller to establish its value, you could end up over paying.
Depending upon the kind of investor you are, you’ll utilize one of the three methods of establishing the value of a property.
If you’re investing in primarily single-family or multifamily properties with fewer than five units/rooms, by far the most popular method of establishing value is the comparable sales method. This method consists of locating recently sold properties that are substantially similar to the one you are considering purchasing and are located in the same general vicinity. A skilled appraiser typically has many years of experience in determining value, but you can do the same thing either by going to your local courthouse and compiling the information yourself, or by working with a realtor who might be willing to provide these figures to you. You can also get a rough estimate of values in many areas by utilizing online resources. Once you have your comparable sales figures, you’ll need to compensate for any differences, such as the utilities available. In order to compensate for the differences in square footage of your subject properties, you can divide the sales prices by the square footage of living space to come up with a cost per square foot.
While not nearly as popular as the Comparable Sales method, another way of determining the value of a property is by estimating what it would cost to re-create the same property in the same area. You would need to determine building costs, the cost of materials, and also make allowances for depreciation of the property so that it is substantially similar to the property you are considering purchasing. If you’re experienced at estimating building costs accurately, and are aware of the current cost of building materials and supplies, the replacement cost method may be one which you will want to utilize.
However, it isn’t utilized very frequently. If the Replacement Cost method is one that you’d like to use to determine value, you could very quickly arrive at a figure by contacting a local contractor, and asking them how much they would charge you by the square foot to build a building in the area of your subject property. Don’t forget to factor in depreciation to match the condition of your subject property.
Income Valuation Method –
The third method of determining the value of a property is to use the Income Valuation Method, sometimes referred to as the Net Income Approach. This method is used to determine the market value of a commercial property, or a residential property. It’s a relatively simple process. First, determine what the gross income(appreciation and rental income) is from the property, and then subtract all expenses(insurance, management/broker fees, maintenance fees and utility costs) including debt service on an annualized basis. This does not include taxes and interest payments.
Multiply that figure by a factor of ten. The resulting number is about what your property is worth. What’s nice about this sort of property is you can increase its value simply by increasing its net income, reducing operating expenses, or both.
Once you’re able to determine the value of a property you can write an intelligent offer that doesn’t cause you to run the risk of overpaying for a property. If you have accurate numbers, you can pay exactly what the property is worth or lesser and allow you to turn average returns into explosive profits.
These are mainly methods to determine value of properties outside India but it applies here as well.
A word of advice – If you are utilizing a housing loan to buy a property, then the rule of thumb is to pay off the loan in 10 years. Always pay it off in 10 years to avoid disaster.
I hope this helps you.