The income from their investment properties allows some real estate investors to make a comfortable living. However, not every investment property pays out for the investor. Calculate the property’s value before entering into a purchase agreement so you can make an informed investment. An investor can use market value, replacement cost, capitalization rate, and cash on cash return data to assess the investment’s viability.
Determine the fair market value of the property
The Fair Market Value (FMV) is the amount that a well-informed buyer would pay for the property and that the seller would accept. Consult a real estate agent to get comparables from the area surrounding the property to assess its value. Homes sold in the same region in the last 12 months that are equivalent in size, style, age, and condition are referred to as comparables. If you don’t want to hire a real estate agent, you can get these documents through the tax assessor’s office.
Evaluate the property using the replacement cost method
“How much would it cost to re-build this exact building on this same piece of property?” you’re essentially asking. The cost of all materials and labor, plus the value of the land, minus any depreciation, is used to calculate replacement costs. This method is used to value one-of-a-kind properties or those with no recent comparables. It’s also compared to the market information you’ve gathered.
Calculate the amount of income the property is likely to produce
If the house is currently being used as an income property, simply inquire about the rent received by the existing owners. Otherwise, inquire about rent pricing in the region by contacting local rental managers.
Determine the Annual Net Operating Income
Take the rental income for a year and subtract any costs that need to be paid to keep the property in good condition for the year. Management fees, repairs, upkeep, insurance, and property taxes are all included in these charges.
You can figure out the Capitalization Rate by dividing the Annual net Operating Income from the previous step by the purchase price or the market price you paid. The capitalization rate for investment properties is usually between 5% and 8.5%, but it can be as high as 10%. Compare properties based on capitalization rates to figure out which one is the best deal.
Calculate cash on cash return if you need to factor in a mortgage payment
When you figure out the Annual Net Operating Income, you need to take the mortgage payment out of the property’s annual income. Then, divide the annual NOI by the sum of the down payment and repairs that are needed to rent the house. There might be $5,000 in repairs that need to be done, so add $20,000 to that.
Then, divide the net income by $25,000. If the NOI is $2,500, then the cash on cash return is $2,500 divided by $30,000, which is 10%, or $2,500 divided by $2,500. In this example, the investment property would make 10% on the money that was put in.
The bottom line
There are many ways to value real estate that are very similar to how you value stocks and bonds. In addition to the discounted NOI and gross income multiplier method, many people also use other ways. Some people in their field, for example, know a lot about how cities grow and change.
As a result, they can figure out which areas of the city are most likely to see the fastest rate of appreciation. How well a strategy is researched is the most important thing to look at, no matter what kind of method is used.
We’re here to help
Investing in the real estate market requires knowledgeable partners and informed decision-making. To ensure you’re making the best commercial real estate investment decisions for your goals, reach out to us at Asset Point Capital today.