Do you know what your property worth? As an investor, you need to make sure you know what the property value is. The best way to do this is to view value in the same way that a property valuer would determine property value.
Now obviously, property valuers spend years studying and have rigours exams to pass, so you’re not going to get the same level of knowledge by reading one short article. However, you can learn about their approaches and how they work and we’ve covered this at a very high level in this article.
Valuers typically use three approaches to determine the property value.
- Sales comparison approach – this is the most common method. A valuer will determine a property value based on recent selling prices of similar properties in the same location
- Income approach – estimates the property value based on the income which it generates
- Cost approach – property value is determined to be the cost of a building an equivalent property considering the costs of the land and construction expenses, less depreciation. This approach only has merit in certain scenarios such as for an insurance valuation .
Importantly, there is no absolute truth when determining price for real estate, because the real estate market is not a perfect market. So, you will not and should not arrive at an absolute price, this would not be a realistic number – you are likely to fall within a range of values.
Do your homework
You are not going to be able to work out the property value without doing some homework. The most challenging thing for everyone working in the real estate market is access to transparent market data.
Without transaction data you will not be able to come up with an accurate view of price. Remember there is a difference between asking price and purchase price.
You will need to collate the following information:
You will need to collect some sales data on between 5 – 10 transactions for similar properties, these should be:
- In the same location
- Have the same or similar physical aspects
- Have been sold in the past 12 months
You will need to have a sense of what is going on in the property market, so you will want to get an understanding of the following information:
- At what point in the real estate market cycle are you at?
- Is the market active?
- How hard is it for buyers to obtain mortgages? And on what rates?
- Are there any specific incentives for buyers?
You will need to collect rental comparison data again for similar properties, these should have the same number of bedrooms and have been let in the past 3 months.
You will also want to have a look at real estate market portals to determine what other rental competition is out there and how much is it available for? The point of having this data, although it may not be comparable, is it will set a rental ceiling for your property, as no one is going to pay more for your property than other similar properties if there is a lot available.
It is important for you to understand what yields are being achieved in the market. This will give you an understanding of the rental levels and capital values which are being achieved. Now you’ve collected the data, we can return the different methods that surveyors use to determine value.
1. The Sales Comparison Method
The comparable sales method is the most prevalent method in the residential property market. This estimates the property value by comparing it to the prices which similar properties have sold for.
The process for using comparable sales can be highly subjective and requires the following:
- Systematically assembly of data on comparable properties. The factors impacting value then have to be weighed against each other. The relevant elements can be split into various characteristics:
- Transactions Characteristics – such as date of transaction and means of payment
- Physical characteristics – size, location, condition, etc
Once the data has been obtained and collated the task is to draw informed conclusions on the value of your property – for example, a valuation price range – based on the evidence collected. Those properties that are most similar to yours should receive a greater weighting than those which are less comparable.
2. The Income Approach
There are several ways to arrive at a property value considering its income; some of the most common are:
- Discounted Cashflow (DCF) – Makes assumptions as to the income generated by the property and its resale value. The annual rental returns are then ascertained and those future cash flows are discounted back to a present value. This is a reasonably complex process.
- Capitalisation method – estimates the value of a property based on the income it generates. The capitalization rate (cap rate) of a real estate investment is calculated by dividing the property’s net operating income (NOI) by the current market value.
- Income in Perpetuity – calculated by dividing the gross rental income by gross yields
In reality, you will be able to use the income in perpetuity model because you will most likely be able to find the best quality information to determine value. And this is more important to your analysis than having a highly complex model – you can develop a highly complex DCF model but the reality is if the inputs you put into the model are incorrect your out
put price will be wrong.
We hope you have found this article useful, feel free to comment or ask any questions. For more information on about property investment check out our other articles and request your copy of our Buyers Guides from [email protected]
Important notice: Proptech Pioneer and its associated companies seeks to provide investors with guides, information and tools, but we cannot guarantee this information to be accurate or perfect. You use the information at your own risk and accept no liability if you rely on this information. Proptech Pioneer is not a tax advisor, accountant conveyancer, lawyer, financial advisor or mortgage advisor. You should seek independent advice from independent professionals before making any investment decision