What You Should Know About Real Estate Valuation
Estimating the worthiness of real estate is necessary for a variety of endeavors, including financing, sales listing, investment analysis, property insurance, and taxation. But also for a lot of people, determining the asking or price of a piece of real property may be the most useful application of real estate valuation. This article will provide an introduction to the basic concepts and ways of real estate valuation, particularly when it comes to sales.
KEY TAKEAWAYS
Valuing property is difficult since each property has unique features such as location, lot size, floor plan, and amenities.
General market concepts like supply and demand in a given region will surely play right into a particular property's over-all value.
Individual properties, however, must be at the mercy of appraisal, using one of several methods, to ascertain a good value.
Basic Valuation Concepts
Technically speaking, a property's value means the present worth of future benefits due to the ownership of the house. Unlike many consumer goods that are quickly used, the advantages of real property are usually realized over a long period of time. Therefore, an estimate of a property's value must take into consideration economic and social trends, as well as governmental controls or regulations and environmental conditions that could influence the four elements of value:
Demand: the desire or dependence on ownership supported by the financial means to satisfy the desire
Utility: the opportunity to satisfy future owners' desires and needs
Scarcity: the finite supply of competing properties
Transferability: the ease with which ownership rights are transferred
Value Versus Cost and Price
Value isn't necessarily equal to cost or price. Cost refers to actual expenditures ? on materials, for instance, or labor. Price, however, is the amount that someone pays for something. While cost and price can affect value, they don't determine value. The sales price of a house might be $150,000, but the value could be significantly higher or lower. For example, in case a new owner finds a serious flaw in the house, such as a faulty foundation, the worthiness of the house could possibly be lower than the price.
Market Value
An appraisal is an opinion or estimate regarding the value of a particular property as of a specific date. Appraisal reports are used by businesses, government agencies, individuals, investors, and mortgage companies when making decisions regarding real estate transactions. The goal of an appraisal would be to determine a property's market value ? probably the most probable price that the property will bring in a competitive and open market.
Market price, the price of which property actually sells, might not always represent the marketplace value. For example, if a seller is under duress due to threat of foreclosure, or if a private sale is held, the house may sell below its market value.
https://charteredsurveyorsurrey.com/best-valuation-surveyor-surrey/ depends upon the methodical collection of data. Specific data, covering details regarding the particular property, and general data, regarding the country, region, city, and neighborhood wherein the house is situated, are collected and analyzed to reach at a value. Appraisals use three basic approaches to determine a property's value.
Method 1: Sales Comparison Approach
The sales comparison approach is often found in valuing single-family homes and land. Sometimes called the market data approach, it is an estimate of value derived by comparing a property with recently sold properties with similar characteristics. These similar properties are referred to as comparables, and in order to give a valid comparison, each must:
Be as like the subject property as possible
Have been sold in the last year within an open, competitive market
Have been sold under typical market conditions
At least 3 or 4 comparables should be used in the appraisal process. The most important factors to consider when choosing comparables will be the size, comparable features and ? perhaps most of all ? location, that may have a tremendous influence on a property's market value.
Since no two properties are exactly alike, adjustments to the comparables' sales prices will be made to account for dissimilar features and other factors that would affect value, including:
Age and condition of buildings
Date of sale, if economic changes occur between your date of sale of a comparable and the date of the appraisal
Terms and conditions of sale, such as if a property's seller was under duress or in case a property was sold between relatives (at a low price)
Location, since similar properties might differ in price from neighborhood to neighborhood
Physical features, including lot size, landscaping, type and quality of construction, number and kind of rooms, square feet of living space, hardwood floors, a garage, kitchen upgrades, a fireplace, a pool, central air, etc.
The market value estimate of the topic property will fall within the range formed by the adjusted sales prices of the comparables. Since some of the adjustments made to the sales prices of the comparables will be more subjective than others, weighted consideration is typically given to those comparables that have the least amount of adjustment.
Method 2: Cost Approach
The cost approach can be used to estimate the worthiness of properties which have been improved by a number of buildings. This method involves separate estimates of value for the building(s) and the land, taking into consideration depreciation. The estimates are added together to calculate the value of the complete improved property. The cost approach makes the assumption a reasonable buyer would not pay more for a preexisting improved property compared to the price to get a comparable lot and construct a comparable building. This process is useful when the property being appraised is a type that's not frequently sold and does not generate income. Examples include schools, churches, hospitals and government buildings.
Building costs can be estimated in several ways, like the square-foot method where in fact the cost per square foot of a recently built comparable is multiplied by the amount of square feet in the subject building; the unit-in-place method, where costs are estimated using the construction cost per unit of way of measuring the average person building components, including labor and materials; and the quantity-survey method, which estimates the quantities of raw materials that will be needed to replace the subject building, together with the current price of the materials and associated installation costs.
For appraisal purposes, depreciation identifies any condition that negatively affects the worthiness of a noticable difference to real property, and takes under consideration:
Physical deterioration, including curable deterioration, such as for example painting and roof replacement, and incurable deterioration, such as for example structural problems
Functional obsolescence, which refers to physical or design features which are no longer considered desirable by home owners, such as for example outdated appliances, dated-looking fixtures or homes with four bedrooms, but only 1 bath
Economic obsolescence, due to factors which are external to the property, such as being proudly located close to a noisy airport or polluting factory.
Methodology
Estimate the worthiness of the land as if it were vacant and open to be placed to its highest and best use, using the sales comparison approach since land can't be depreciated.
Estimate the existing cost of constructing the building(s) and site improvements.
Estimate the amount of depreciation of the improvements caused by deterioration, functional obsolescence or economic obsolescence.
Deduct the depreciation from the estimated construction costs.
Add the estimated value of the land to the depreciated cost of the building(s) and site improvements to look for the total property value.
Method 3: Income Capitalization Approach
Often called basically the income approach, this technique is based on the partnership between the rate of return an investor requires and the net income that a property produces. It is used to estimate the value of income-producing properties such as for example apartment complexes, office buildings, and shopping malls. Appraisals utilizing the income capitalization approach could be fairly straightforward when the subject property can be expected to create future income, so when its expenses are predictable and steady.
Direct Capitalization
Appraisers will perform the next steps when using the direct capitalization approach:
Estimate the annual potential revenues.
Consider vacancy and rent collection losses to determine the effective gross income.
Deduct annual operating expenses to calculate the annual net operating income.
Estimate the price a typical investor would pay for the income produced by the particular type and class of property. This is achieved by estimating the rate of return, or capitalization rate.
Apply the capitalization rate to the property's annual net operating income to create an estimate of the property's value.
Gross Income Multipliers
The gross income multiplier (GIM) method can be used to appraise other properties which are typically not purchased as income properties but that may be rented, such as one- and two-family homes. The GRM method relates the sales price of a property to its expected rental income. (For related reading, see "4 Ways to Value a genuine Estate Rental Property")
For residential properties, the gross monthly income is typically used; for commercial and industrial properties, the gross annual income will be used. The gross income multiplier method could be calculated as follows:
Sales Price � Rental Income = REVENUES Multiplier
Recent sales and rental data from at least three similar properties can be used to establish a precise GIM. The GIM can then be applied to the estimated fair market rental of the topic property to find out its market value, which is often calculated as follows:
Rental Income x GIM = Estimated Market Value
The Bottom Line
Accurate real estate valuation is essential to mortgage lenders, investors, insurers and buyers, and sellers of real property. While appraisals are generally performed by skilled professionals, anyone involved in a genuine transaction can benefit from gaining a basic knowledge of the different methods of real estate valuation.