Determining the Value of Real Estate
Once you have found the right type of real estate or the right property, you need to determine how much it is worth. Of course, value is a very subjective issue. Intangibles such as individual tastes or sentimental attachments often inflate the value of real property unreasonably. But as an investor, you must examine any piece of real estate from arm’s length, in the cool light of reality. And in the respect, determination of value is largely a question of numbers. Investors generally determine what they will pay for real estate by comparing the property and its generated income with other similar properties in the marketplace. Three methods are generally used: Comparable Method (or Market Data Approach)
Used mainly for single family residences, duplexes and land, the comparable method is an in depth comparison of the subject property with the price, utility and location of other similar properties. The steps in this method are: 1. Locate comparable properties that have recently sold. 2. Compare these similar properties with the real estate in question. 3. Make adjustments to the value of the subject property based on the differences between it and the comparable properties. (Adjustments will take into account differences in age, size, condition, features and date of sale.) 4. Estimate a value for the subject property based on the adjustments made, plus or minus. Cost or Reproduction Methods
The cost approach to value, perhaps, the most technical evaluation procedure, and is consequently utilized in appraising “unique” property. The cost approach is a process of combining a property’s land values with the current reproduction costs of all improvements, minus an allowance for depreciation. Income approach to Value
The income approach is especially important in determining the value of income producing properties. The larger the property (both in size and income), the greater the requirement for any mortgage costs to be supported entirely by the Net Operating Income flowing from the property. Net Operating Income (NOI) is simply the actual income minus all operating expenses. In other words, the money available to service the debt on the property. Some “Rules of Thumb” often employed in this method of determining value are the Gross Rent Multiplier (GRM) and Capitalization Rate (Cap Rate). GRM’s are based on a property’s scheduled income as compared to the income of similar properties in a given market. A major flaw with GRM’s is that they ignore variances in operating expenses and vacancy rates. However, for an experienced real estate salesperson or appraiser, the GRM can provide a quick method of deciding if a given property is appropriately priced. Cap Rates are determined by dividing the Net Operating Income of a given property by its sales prices. Like other rules of thumb, Cap Rates are a short cut for the experience professional in approximating property values. Whatever method is used, the intangible of value will always enter in the final estimation. All other things being equal, buy a property that fits your objectives. So, You’ve Purchased the Property, Now What?
Managing Your Property
Efficient management is essential to the profitable operation of any rental property. Some investors prefer to manage their property themselves. Others have neither the ability nor the inclination for self-management and turn the responsibility over to a professional managing agent. How to manage you investment is again, a very personal decision. But generally, the real estate investor should consider the following points in choosing whether or not to hire professional management.
In selecting a professional management company, it is also wise to evaluate the firm’s skills in negotiation, marketing and maintenance. The smaller the property, the less likely you will be to hire a professional managing agent. Remember, an income property is nothing more or less than a business, and it must be operated with careful monitoring and guidance. Find the Right Tenant
Whatever you management decision, the most important factor in relation to cash flow and return on investment is keeping a property rented. The tenant selection process will vary with the type of property owned and with the type of tenant applying to occupy it. But quite simply, you want to attract and keep the best of tenants. The first step in this challenge is to screen all prospective tenants carefully. Have every applicant complete a specific application form, and find out about everyone who will occupy the premises. Talk with previous landlords, look into rental history, verify employment, and check all personal and financial references. Some investment real estate owners order credit reports on prospective tenants. Decide in advance what your tenant review process will be and stick to it. Many inexperienced investors panic when a vacancy occurs, and in their frantic rush to rent the property, throw caution to the wind – with disastrous results. Remember, it is much easier to turn down a prospective tenant at the application stage than it is to remove tenants who are damaging the property or not paying their rent. Once the decision has been made, collect the first month’s rent in advance plus a sizeable security deposit. This deposit will encourage the tenant to take proper care of the property. Finally, spell out all the terms and conditions in your lease or rental agreement. In most cases, real estate law requires you to make these agreements in writing. Make certain tenants know their responsibilities as far as rent, late payments, expenses, and maintenance. And be sure you know yours. Seek the counsel of a lawyer to ensure you are adequately protected as you begin to make written, legal agreements. Cashing in on Your Investment
The skillful and timely sale of your income property is no less important than its purchase or management. The timing of the sale will depend largely on your investment goals. If, for instance, you have invested to earn money for a specific purpose, you will want to sell your property after it has appreciated substantially and take your profit. However, if your goal is continued, long-term financial growth, you will probably want to keep the property until you find another suitable investment. In any case, you should generally plan to own your property for at least three to five years. How much you can expect to profit is another question altogether. A variety of factors, among them local and regional economics, housing construction, lending policies, interest rates, and individual factors intrinsic to the property will determine the answer. Part of the answer to the future can be found in looking to the past. And if recent years are a fair indication, annual appreciation can vary greatly, depending on the area of the country. That means real estate could continue to yield both cash flow and capital returns – for big dividends. Real Estate Investment Will Require “Home” Work
For its combined advantages and benefits, there is no investment that can compare to real estate. But like any investment where the returns are high, real estate requires commitment and courage, savvy and sound judgment. So decide what you want. Do your homework and your legwork. And when you begin to look for your investment property, seek the advice of a trained professional with experience in investment real estate and specialized knowledge of your marketplace – like a Century 21 real estate broker or sales associate. Century 21 professionals can provide information on properties in your community. They can advise you as to which local areas are improving and which are in decline. But most importantly, they can help you analyze the financial elements of your potential purchases and help you choose a property with opportunities for both growth and profit. Let me help you select a real estate investment that meets your personal and financial requirements. Start your search now by clicking here or emailing me at jperez@c21callfirst.com |
