Real estate valuation for single family homes is typically done by using comparable sales. This basis however is not as effective in the case of rental properties. Imagine if you are looking at a 24-unit building. It would be difficult to find similar ones nearby that have recently sold.
To base the income property appraisal on replacement costs would not be realistic. You will have a problem if there is no real estate property in the vicinity with no proper zoning that is on sale. This form of appraisal however will be a good indicator of whether to buy or build.
The Cap Rate as the Basis of Property Valuation
The income motive is the reason for the purchase of income properties. Income, then, is what is used to determine value. The cap rate (capitalization rate) is the expected return on the investments of the property owner in that area. This is one approach when making an evaluation of the value of an income property. Below is a somewhat simplified explanation.
Compute the gross annual income of the property. You then subtract all expenses, but not loan payments. For example, if a building's gross income is $82,000 per year, and the expenses $30,000, you have a net (before debt-service) of $52,000. Then divide this figure with the capitalization rate.
If the cap rate in the area is estimated at say 0.10, then your expected return on your property value would be ten percent. What you do then is divide your $52,000 net income with .10 which would give a market value of $520,000 for your property. Supposing further that the property investors in the area presuppose an 8% ROI. Your property then will be valued at $650,000.
A Straightforward Property Valuation?
The process of using the "cap rate" as a divisor for the net income is a simplified formula for property valuation. However, the tough part is getting accurate income figures. Are all the standard expenses included? How factual is the declared income? If there are no repairs done for the year and you are given an income estimate? That would have resulted to the income being overstated by $15,000. The building would be worth $187,000 less (.08 cap rate) than your appraisal shows.
Experienced investors do not include incidental income from vending and laundry machines and other sources. If incidental income accounts for $6,000, that would result to an overvaluation of $75,000 based on the .08 cap rate. A more favorable process would be to exclude incidental incomes from the gross, and to include the replacement costs of the machines (should be less than $75,000) to get the appraised value.
Of course, you should be careful with any real estate appraisal method. Considering that there is no perfect procedure for every situation, be sure to get the right figures in order to get the right answers. If used wisely, though, appraisal by capitalization rates is one of the most accurate methods of real estate valuation.
To base the income property appraisal on replacement costs would not be realistic. You will have a problem if there is no real estate property in the vicinity with no proper zoning that is on sale. This form of appraisal however will be a good indicator of whether to buy or build.
The Cap Rate as the Basis of Property Valuation
The income motive is the reason for the purchase of income properties. Income, then, is what is used to determine value. The cap rate (capitalization rate) is the expected return on the investments of the property owner in that area. This is one approach when making an evaluation of the value of an income property. Below is a somewhat simplified explanation.
Compute the gross annual income of the property. You then subtract all expenses, but not loan payments. For example, if a building's gross income is $82,000 per year, and the expenses $30,000, you have a net (before debt-service) of $52,000. Then divide this figure with the capitalization rate.
If the cap rate in the area is estimated at say 0.10, then your expected return on your property value would be ten percent. What you do then is divide your $52,000 net income with .10 which would give a market value of $520,000 for your property. Supposing further that the property investors in the area presuppose an 8% ROI. Your property then will be valued at $650,000.
A Straightforward Property Valuation?
The process of using the "cap rate" as a divisor for the net income is a simplified formula for property valuation. However, the tough part is getting accurate income figures. Are all the standard expenses included? How factual is the declared income? If there are no repairs done for the year and you are given an income estimate? That would have resulted to the income being overstated by $15,000. The building would be worth $187,000 less (.08 cap rate) than your appraisal shows.
Experienced investors do not include incidental income from vending and laundry machines and other sources. If incidental income accounts for $6,000, that would result to an overvaluation of $75,000 based on the .08 cap rate. A more favorable process would be to exclude incidental incomes from the gross, and to include the replacement costs of the machines (should be less than $75,000) to get the appraised value.
Of course, you should be careful with any real estate appraisal method. Considering that there is no perfect procedure for every situation, be sure to get the right figures in order to get the right answers. If used wisely, though, appraisal by capitalization rates is one of the most accurate methods of real estate valuation.
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