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4 Main Property Valuation Methods for Real Estate Investors

Knowing how to do property valuation accurately and efficiently is a must-have skill in residential real estate investing.

To make profitable and successful investment decisions, you have to know how much a property is really worth. This number forms the basis of many processes and considerations in rental property investing and cannot be ignored.

Table of Contents

  1. What Is Property Valuation?
  2. Why Is Real Estate Valuation Important for Investors?
  3. How to Value Real Estate Investment Properties: 4 Methods
  4. 6 Factors Driving Real Estate Property Valuation
  5. How Much Does Property Valuation Cost?
  6. 6 Other Metrics to Consider in Real Estate Investments

Whether you’re buying an investment property, renting it out to tenants, or selling it, you should be aware of its precise value. The way to get this number is to evaluate the real estate asset.

In this article, we’ll look at everything you need to know about real estate valuation, from what it is, through why it matters, all the way to how to do it. We’ll also consider the price of different property appraisal methods.

Let’s get started!

What Is Property Valuation?

Property valuation is the process in which the economic value of a real estate investment is determined. This means finding out the fair market value of a real estate property. It is the maximum price that makes sense for an investor to pay for this property in order to be able to generate both short term and long term profit.

However, it is important to point out that a property’s value is not always equal to its listing or sales price. Indeed, most homeowners and investors list their homes for sale above the fair market value in hopes of getting a higher return.

Why Is Real Estate Valuation Important for Investors?

Valuation in real estate investing is a fundamental concept because it is the main factor in determining multiple elements affecting the results of an investment.

The fair market value of residential properties affects:

  • Investment loans: Mortgage lenders require professional appraisal reports that state the true value of a property before deciding how big of a loan to approve. In this way, the bank protects the buyer from taking out a loan that’s not entirely backed up by the property value.
  • Property tax: Property taxes are calculated based on the fair market value of the property, not the sales prices.
  • Rental property insurance: In most cases, landlords and Airbnb hosts get insurance coverage related to the cost of rebuilding the property. It is the same as the property’s current value.
  • Legal matters: Things like divorces, inheritances, settlements, and lawsuits can also be settled based on the valuation of real estate assets.
  • Return on investment: One of the most critical metrics of ROI in real estate – the cap rate – is calculated using the current market value of the investment property. The lower the valuation, the higher the return, and vice versa.
  • Listing price: If it’s time to sell your investment property, you want to make sure that you sell it for a minimum of its fair market value. Otherwise, you’re losing money to the new owner.

How to Value Real Estate Investment Properties: 4 Methods

A valuation is usually performed by a professional certified home appraiser, especially when it’s required for financing or legal purposes. But a real estate investor can also calculate the value of a home they own or plan to buy.

Following are the four most popular property valuation methods in real estate investing:

1. The Income Approach

The income approach is commonly practiced in commercial real estate but can also work with residential rental properties. The main idea behind the income approach is to calculate the current value of a real estate property based on the net income it generates divided by the capitalization rate (cap rate).

This appraisal process starts with collecting income and expenses statements for the real estate property under investigation and similar properties in the same area. These are needed to estimate the net operating income. Calculating the net operating income (NOI) is broken down into four steps:

Step 1: Estimate the gross potential income: The total income a real estate property generates with 100% occupancy.

Step 2: Estimate the effective gross income: It is done by estimating the vacancy cost based on rental comps in the area. This figure reflects the average loss of income caused by probable vacancies.

Step 3: Estimate property expenses: Expenses fall into two categories: fixed and variable expenses. Fixed expenses, like property taxes and mortgage payments, do not change with time. Variable expenses are all the other expenses, such as utilities and management fees.

Step 4: Calculate NOI: By subtracting the estimated expenses from the effective gross income.

The next step would be choosing an appropriate cap rate. Usually, investors aim for a cap rate of 8-12% as this is the best range to balance the profit and the risk associated with a particular investment property. However, this type of ROI is not feasible in every market, so appraisers need to find a reasonable rate for the calculation.

It brings the question: How do you find a reasonable cap rate for your evaluation?

Where Can You Find Reliable Cap Rate Estimates?

The best place to find reliable real estate data, including cap rates, is the Mashvisor platform. We collect data from dozens of reliable sources like the MLS, Zillow, Redfin, HotPads, Airbnb, and public records. Then we apply our proprietary AI-based algorithms to get solid analytics.

To find what cap rate an income property can be expected to generate, you can use the Mashvisor Investment Property Search engine. You can use several different filters to focus your search on properties located in your market and sharing the same characteristics as your property.

Some of these filters include:

  • City, neighborhood, and zip code
  • Property type
  • Number of bedrooms
  • Number of bathrooms
  • Square footage
  • Year built

After you enter all these variables, you’ll get a list of properties meeting your requirements. The rental property analysis performed on each of them shows the exact cap rate they are expected to generate when rented out on a short term or long term basis.

You can use these cap rate estimates to finish calculating the fair market value of a property you’re considering buying or already owning.

Property Value = NOI/Cap Rate

To get access to the necessary real estate data to start your own valuation of properties, sign up for a 7-day free trial of Mashvisor.

Before you get to property valuation, you must first find a suitable investment property that will generate a good ROI and revenue. Mashvisor’s Property Finder lets you find the best deals in the most profitable markets in the country.

2. The Sales Comparison Approach

Second among the real estate valuation methods is the sales comparison approach. This method uses the market data of sale prices to estimate the value of a property.

Finding out the fair market value of a house is done by comparing a property to other similar properties that have been recently sold. Comparable properties, also known as real estate comps, must share certain features with the property in question.

These include physical features such as square footage, number of rooms, property condition, and building age. However, the most important factor is, no doubt, the location of the property.

Adjustments are usually needed to account for differences, as no two properties are exactly the same. To make proper changes when comparing properties, real estate appraisers must identify the most important differences between the properties and know how to adjust for them.

The sales comparison approach is commonly used for single-family homes where many comparables are available to analyze.

Related: Where to Find the Best Comps Calculator

3. The Cost Approach

The cost approach is third on the list of the most widely used valuation approaches in real estate investing. This method considers the value of a property as the cost of the land plus the cost of replacing the property (construction costs) minus the physical and functional depreciation. This approach is mainly used for properties that are not easily sold, like schools, hospitals, and government buildings.

Land cost can be estimated using the sales comparison approach by studying recent sales of land close to the subject property. The land pieces should be comparable in size and location.

Meanwhile, there are different ways to estimate replacement costs. The most common one is finding out the cost to build a square foot of comparable properties multiplied by the total square footage of the building.

4. Hiring a Home Inspector or an Appraiser

If you don’t know where to find all the necessary data or don’t have the time to do all the required calculations, you can get a professional home inspector or real estate appraiser to do the work. Using professional property valuation services will help you save a lot of time and energy while getting you the most accurate results.

Meanwhile, if you want to take a mortgage loan to buy an investment property, you will need to get a professional appraisal.

Related: Appraisal Value vs. Market Value: What Is the Difference?

6 Factors Driving Real Estate Property Valuation

When we discussed the most common appraisal methods in real estate, you might have noticed some similarities among them. In specific, certain factors affect real estate valuation no matter which approaches you go for.

The factors impacting a property’s value include:

  • Location: Where a property is located is the most important driver of its price and value. Certain markets have higher real estate prices because of limited supply and strong demand. You cannot compare properties’ values in New York and Los Angeles to Dallas and Raleigh.
  • Market conditions: Each real estate market undergoes temporary ups and downs, and these can majorly affect property values. A generally cheap market might see price increases due to a shock and vice versa.
  • Property type: Some types of properties have greater value than others. For example, single-family homes are more expensive than townhouses because of the external walls and the land around them.
  • Property size: Bigger properties with more bedrooms and bathrooms tend to cost more.
  • Property age and condition: Newer houses that are well maintained are more valuable.
  • Home improvements: Any positive home repair and improvement boost the value of a residential real estate property.

How Much Does Property Valuation Cost?

The cost of real estate valuation can vary widely. If you decide to do it on your own, the cost comprises access to the data you need and the time you’ll spend on this process. The cost can be anything from zero (if you already have access to data and experiences in the market) to a few hundred dollars.

In terms of professional home inspection, the average price is between $300 and $500 per property. But it can be significantly less or more, depending on the market and the property size.

A more formal appraisal, on the other hand, can reach up to $2,000 in the US housing market.

6 Other Metrics to Consider in Real Estate Investments

The fair market value of a property is definitely one of the factors that should affect your decision whether to invest in a home for sale or not. But it’s not the only one. There are many other measures that you need to consider in order to make profitable real estate investment decisions.

Other real estate metrics to look at in your investments include:

Rental Rate

The rental rate is the amount of money you will charge renters to use your property. If you invest in long term rentals, that’s the same as the monthly rent. For short term rentals, this is the daily rate you set for your property on Airbnb, Vrbo, etc.

The rental rate is so important because it directly affects rental revenue and returns on investment.

Occupancy Rate

Occupancy is the opposite of vacancy which is considered a cost in real estate investing. You want your property rented out for as many days as possible to maximize income and ROI.

With long term rentals, occupancy is basically taken care of once you find good tenants and do everything possible to keep them for the long haul.

But with vacation rentals, you need to continuously market and optimize your property to enhance its Airbnb occupancy rate. You may even consider working with one of the best property management companies in your local market to boost this number.

Rental Income

Another metric you need to look at is the monthly rental income. This is the product of the rental rate and the occupancy rate. It is also known as the rental revenue. Together with the valuation of a property, the rental income is present in all formulas for return on investment in real estate.

The more money you collect from renters monthly, the higher profit you’ll be able to generate.

Cash Flow

Yet another number that should be part of the rental property analysis is the cash flow. It is calculated as the difference between the rental income and the rental expenses necessary to run a property business.

A positive cash flow indicates that you’re making money from real estate as you get more than you spend. Negative cash flow, on the other hand, means that you’re losing money to your investment property. It is something you should avoid at all costs, and one of the most certain ways to do this is to know the exact value of a property before buying it.

Related: 3 Housing Markets Where Investors Can Earn Positive Cash Flow With Airbnb in 2023

Cash on Cash Return

The cash on cash return is one of the two most widely used ROI metrics with rental properties. The formula comprises the annual cash flow before tax divided by the cash invested in the property.

Cash on cash return is arguably the best return measure in real estate as it takes into consideration the method of financing to buy a property. It is important as most people purchase income properties through a loan, not cash.

Cap Rate

Last but not least, when evaluating a rental property, investors need to look at the cap rate. You can calculate the cap rate by dividing the net operating income (NOI) of a property by the property’s current market value. If the home has been recently obtained, you can use the sales price. But if you’ve held the house for a while, you need to find its valuation at the moment.

Unlike the cash on cash return, the cap rate does not consider ROI a fraction of the cash investment. Instead, it looks at the value of the entire investment property.

Property Valuation for Profitable Real Estate Investing Decisions

Knowing the exact worth of a property is a must in real estate investing. It is the only way to buy, rent out, and sell properties at a fair price that makes sense for your investment portfolio. Alternatively, you risk not maximizing your gains or even incurring losses as a rental property investor.

No matter which of the real estate valuation methods you go for, it helps to have access to the most reliable source of real estate and rental data in the US market. Mashvisor can give you all the data and analytics you need to make profitable income property investments across the US.

To learn more about how Mashvisor can help you evaluate and analyze residential investment properties, schedule a demo with our team of experts.

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Daniela Andreevska

Daniela has been writing about real estate investing for over 6 years, analyzing markets and giving advice to beginner investors. Most recently, she was VP of Content at Mashvisor. Previously, she worked in economic policy research and fundraising. Daniela holds a Master degree in Middle East and Mediterranean Studies from King’s College London.

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