Property valuation is an essential concept of real estate investing. If you are an investor, knowing the value of any property helps you make a sound decision on how much to charge on rent and how much should go into property taxes.
Similarly, if you are a homeowner, knowing the value of your property gives you the knowledge of how much you should pay for its insurance.
Now that we’ve understood the importance of property valuation, let’s examine the three main methods used to evaluate a property:
- Comparison Approach
The comparable sales approach is one of the most common property valuations methods. This method uses recent past transactions of similar properties (same location, size, nature, etc.) to determine your property’s value.
But as you may know, no two comparable properties can be an exact match. Therefore, some adjustments are made to sales prices to account for the differences in the comparison. After the best factors are chosen, analyzed, and differences adjusted, then an estimated value for the property at hand can be determined.
- Income Approach
The income capitalization approach is all for income-generating properties, including apartments and commercial buildings. Therefore, this method relies heavily on the return on investment and the net income of a particular property.
Under the income approach, there are two subdivisions of property valuation methods.
The first division under the income approach is known as Direct Capitalization. To determine the value of a property using this method, a property’s gross income is estimated. This is done by considering the influence of vacancies and the net operating income, which is calculated by subtracting expenses. After that, direct capitalization uses the property’s capitalization rate and net operating income to estimate its value.
Gross Income Multipliers is the second subdivision of the income approach valuation method. It’s dedicated to valuating properties that weren’t primarily bought for income-generating practices but ended up being used as such.
The technique works by first calculating the monthly or annual gross income of the property. After that, the sales price of the property at hand is divided by its rental income. This arrives at the gross income multiplier, which then estimates the property’s market value.
- Cost Approach
The cost approach method determines the value of a property depending on its replacement costs. It also declares that the value of any property equals the market value of the land to which it stands, as well as the cost of construction of similar properties.
Knowing the commonly used methods for property valuation is essential for real estate appraisal. It might seem too basic, but it has an added advantage.