Property Valuation Methods

Professional appraisers use three methods. Understanding all three makes you a better investor:

1. Sales Comparison Approach (Comps) Most common for residential. Compares to similar recently sold properties.

2. Income Approach Used for investment properties. Values based on income potential.

3. Cost Approach Land value plus cost to rebuild. Used for unique properties or new construction.

For investors, the sales comparison and income approaches are most relevant.

Finding Good Comps: - Sold within last 6 months (3 months preferred) - Within 0.5-1 mile radius - Similar size (within 20% square footage) - Same bedroom/bathroom count - Similar age and condition - Same neighborhood classification

Making Adjustments: - Add/subtract value for differences - Extra bedroom: +$10,000 (market dependent) - Extra bathroom: +$5,000-10,000 - Updated kitchen: +$10,000-20,000 - Larger lot: +$2,000-10,000 - Pool: +$10,000-25,000

Example: Subject Property: 3/2, 1,500 sf, needs updating Comp 1: 3/2, 1,600 sf, updated, sold $220,000 Adjustments: -$5,000 (size), -$15,000 (condition) Adjusted Value: $200,000

The Cap Rate Formula: Cap Rate = Net Operating Income (NOI) ÷ Property Value

Rearranged to Find Value: Value = NOI ÷ Cap Rate

Example: Annual Gross Rent: $24,000 Operating Expenses: -$8,000 NOI: $16,000 Market Cap Rate: 8% Estimated Value: $16,000 ÷ 0.08 = $200,000

Cap Rate Benchmarks: - A-class: 4-6% - B-class: 6-8% - C-class: 8-12% - Multi-family: varies by market

Limitations: - Doesn't account for financing - Assumes current income is accurate - Market cap rates can shift

A quick valuation shortcut:

Formula: GRM = Property Price ÷ Annual Gross Rent Property Value = Annual Gross Rent × Market GRM

Example: Annual Rent: $24,000 Market GRM: 8 Estimated Value: $24,000 × 8 = $192,000

Typical GRMs: - Cash flow markets: 6-10 - Appreciation markets: 12-20+ - Most markets: 8-15

Pros: - Quick screening tool - Easy to calculate - Good for comparing similar properties

Cons: - Ignores operating expenses - Assumes similar expense ratios - Less accurate than cap rate

For properties needing work, ARV is what matters:

ARV = Value After All Improvements Completed

Calculating ARV: 1. Find comps in similar condition to your end product 2. Adjust for remaining differences 3. Be conservative—lenders won't finance based on optimistic ARVs

The 70% Rule for Flips: Maximum Purchase = (ARV × 70%) - Repair Costs

Example: ARV: $250,000 Repair Costs: $40,000 Maximum Purchase: ($250,000 × 0.70) - $40,000 = $135,000

Why 70%? Leaves room for: - Carrying costs (6-12 months) - Transaction costs (buying and selling) - Profit margin (10-15%) - Unexpected expenses