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How to get a real estate investment appraisal?

Thomas Miller
30.10.2022
12 min
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What is an investment property?

An investment property is a land or a building, or both, that is owned for rental income or capital growth (or both). Owner-occupants, producers, and providers of goods and services do not use investment property. It is not kept for sale in the regular course of business or used for any administrative purposes. Investment property appraisal deduces the value of investment properties and helps investors to estimate how much a particular investment property might be worth.

How to determine if an investment property is worth it

Being certain about the worth of an investment property is quite refreshing and an eye-opener on the profits that will come out of that particular investment opportunity. There are a few things to appreciate to see the worth of an investment property; namely:

  • Financing: Also, the use of financing can leverage the property while maintaining a risk low factor if most importantly there is a low-interest rate environment. Financing allows you to use less of your money and diversify your portfolio. It also gives room for the building of a long-term income generation real estate investment range.
  • Affordability: An investment should not hurt your savings hence it must suit your overall budget profile. Just be able to afford investment properties without any repercussions.
  • Expectedreturn: the outcome of your investment matters a lot when finding the worth of that potential investment opportunity. This is determined when you have thoroughly done your due diligence on investigating and finding answers to every possible question on your list. Such questions we hope that at the end of this article will mostly be answered.

What Is an Income Property?

A piece of real estate is referred to as an "income property":

  • if it is bought or constructed primarily to generate income by renting 
  • or leasing it to others, with price appreciation as a secondary objective. 

Residential or commercial assets can be classified as income properties, which are a subset of investment properties.

An income property is:

  • bought or 
  • built to generate revenue through price appreciation or 
  • by renting or leasing it to others. 

Price appreciation, broadly speaking, is a growth in an asset's worth over time. Both commercial and residential properties can be used as income sources.

Income property appraisal?

The income property appraisal or income approach and also known as the income capitalization approach. This is a kind of real estate evaluation technique that enables investors to calculate the worth of a house or a building based on the income it produces. It is calculated by dividing the net operating income (NOI) by the collected rent by the capitalization rate.

Appraisals and Valuations

property's appraised value is not its final market worth. Instead, you receive an evaluation from a real estate expert that details the rough value of a property. Simply it is an act of assessing property or something. Although the true value can be slightly higher or lower, it provides you with a good idea of how much a property is worth. However, a valuation does reveal the "real value" of a piece of property. A valuer with professional training follows a meticulous process to determine the precise value of a property. The valuer accounts for every aspect, from the building's condition to zoning to accessibility. If a property issue is to be resolved in court, this appraisal is essential.

How to Value Real Estate Investment Property - The Real Estate Valuation Methods You Should Know

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The process of determining a real estate investment's economic value is known as real estate valuation. Similar techniques are used in the fundamental analysis of stocks and real estate investments to determine the value of an investment. 

The goal of creating profitable investments is achieved by 

  • examining the cash flow and 
  • the ensuing rate of return because real estate investment is often not a short-term venture. 

Investors who want to make money must understand how to assess real estate and make accurate assumptions about how much profit each investment will yield. This can be from capital gains, rental income, or both. When purchasing and selling properties, investors can make smarter judgments with the aid of accurate real estate valuations. The procedures are outlined below:

1% Rule 

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The one percent rule which is very popular can help you determine the worth of your investment property. It admonishes that the monthly rent of your property should not be less than the actual cost and the purchase price, including any additional costs due to renovations. A typical example is that if a property costs £500,000, the rental price should be at least £5000 per month. It is easily calculated by multiplying the purchase price (including any additional incurred costs) by 1% (0.01). The result should be the minimum monthly rent charge.

Sales Comparison Approach (SCA)

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This type of appraising and assessing is arguably the most popular. It's simple to use this method; the appraiser compares the property to others that have recently been sold or rented nearby. This is a great technique to demonstrate comparisons over time to investors to identify new patterns. 

In the case of a residential property, this could include 

  • the number of bedrooms, 
  • bathrooms, 
  • garages, 
  • or driveways. 

The appraiser also considers characteristics and features that the property has with similar properties that have been sold. A property will be compared to other adjacent homes if it has a feature that sets it apart. Price per square foot is typically a dependable benchmark. Find out the price per square foot of the townhouse that is identical to your 500-square-foot rental down the street to get a general idea of what you might charge.

Capital Asset Pricing Model (CAPM)

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The capital asset pricing model (CAPM) extends your understanding of a property's value by factoring in both risk and opportunity cost. This model examines various low-risk investments, such as real estate investment trusts, as well as the possible Return on Investment (ROI) from rental properties. At the end of the day, there is no need to incur risk if the potential ROI of a rental property is smaller than that of a risk-free investment.

Which danger elements exist? Before signing any paper, you should take into account a few risk variables and related components. You should take into account a few risk concerns, such as:  

  • the fact that not all properties are created equal, 
  • older buildings require more frequent upkeep, 
  • and good properties often are situated in undesirable areas. 

If your property is located in a high-crime area, you should also take insurance and other safety measures into consideration. A property management business for investment properties can help you navigate the dangers and enjoy a substantial return on your investment by determining whether the risk is worth the possible gain using the CAPM.

Income Approach

The income model can work for you if you're considering investing in commercial real estate. This strategy considers a property's potential income from the initial investment.

You must first figure out your investment's yearly capitalization rate. Divide your gross rent multiplier by the assessed value of your property to arrive at this figure. To put it another way, if an office building costs £100,000 to buy and your anticipated monthly revenue is £1,000, then the anticipated yearly capitalization rate is predicted to be:

£12,000(£1,000 x 12 months) ÷ £100,000 = 8.3%. 

8.3% becomes the capitalization rate then if you are an investor, you can divide the investment property’s Net Operating Income (NOI) by that rate. For example, an investment property with a net operating income (NOI) of £500,000 and a capitalization rate of 8.3% is worth £6.02million.

Gross Rent Multiplier Approach (GRM)

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Finding out whether a property is profitable for your investment is quick and simple with the gross rent multiplier approach (GRM). This method bases the worth of a certain property on the annual rent that can be collected. Use this method for what it is: a quick way to determine what a property can do for you since it does not take taxes, utilities, or insurance into account.

While there are similarities between this and the income strategy, the cap rate in this case is your gross rent rather than operating income. For the most accurate comparison, look at the GRM and rental revenue of similar properties. The value of your next investment should be established before you invest any money in it. Doing so will increase your chances of long-term success now that you are familiar with this comprehensive guide on investment property appraisals.

Valuation of multifamily and multiple-unit properties

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Multi-family homes and Multiple-unit properties

What is a multi-family home? There are distinct living quarters for multiple families in the same building. They can be single-family homes or modest apartment complexes with up to four separate apartments, or they can be duplexes, which have two homes within one structure. Most commonly, commercial properties are buildings with more than four apartments.

A multi-family home's owner has two options: either live in one of the apartments while renting out the others or live somewhere else while renting out all of them. Depending on whether the owner will reside there or not, there are several rules for financing a multi-family property: You are regarded as an investor if you don't intend to reside in your property. The anticipated rental income from the property might be used to help you qualify for a mortgage, and you might also be eligible for a larger loan amount.

A multi-family home requires you to approach it more like a business: What will your tenants' demands be? How much money will it bring in, and what will your costs be?

Types of multi-family

Townhome: Townhouses or townhomes are dwellings that are connected by a common wall, much like duplexes. There are typically two or three storeys in them. They are larger than apartments and typically require far less upkeep and maintenance than a single-family home.

Semi-detached house: Semi-detached houses also have a wall that is shared with another house, just like townhouses. Townhomes tend to be smaller than semi-detached residences.

Duplex/Triplex: Two apartments or houses that are joined by a common wall, ceiling, or floor are referred to as duplexes.

Condo: A condo is often an individually owned unit in a building or community made up of other independently owned units.

What are multi-unit properties?

Multi-duelling units, or MDUs, are another name for this kind of dwelling. Multi-Unit Properties In this type of housing, various flats or units are usually occupied by private individuals within a single building. A unit may be next to another or stacked on top of another.

Examples include structures that have areas for both residential and commercial uses or structures that have several flats with shared amenities like parking, gardens, and walkways. Typically, these structures are on a single title, and each unit has its own Assured Shorthold Tenancies (AST) agreement.

Why invest in a Multi-Unit Property?

Higher returns make for the ideal investment properties for your portfolio. By way of illustration, investing in a house divided into three flats can provide a better return than renting the entire house as a single-family home because multi-unit properties can offer good yields.

How to evaluate multifamily and multiple-unit properties

Even if a property is ideal in every way, if an investor pays too much, it may be challenging to get the necessary return. Even though the reasoning for value is a little more complicated, the computation itself is relatively straightforward. The income capitalisation technique is excellent for valuing properties that meet these requirements since it concentrates on Net Operating Income (NOI) and Capitalization Rate (cap rate).

Net Operating Income

Commercial assets are valued depending on the amount of NOI they generate, whereas residential properties are evaluated based on similar sales. The NOI of a property is determined by deducting operational costs from gross income. Examining each element of this equation in detail can help you understand it. 

For commercial property, gross income is the total of all sources of income. Although rent payments make up the majority of income, there may also be supplemental sources like: 

  • pet rent, 
  • application fees, 
  • parking rent, 
  • storage unit rent, 
  • or laundry/vending money. 

The costs associated with maintaining a property daily are known as operating expenses. 

The line items are often the same, even when the amounts differ depending on the property. Taxes, insurance, utilities, maintenance, property management, law, and administration are a few of them. The resulting net operating income is the first important factor in the value equation. Income and expense predictions are entered into a financial pro forma for an assumed holding period.

Cap rate

The capitalization rate, or cap rate, represents the rate of return an investor may anticipate if they paid cash for the property. NOI is multiplied by the value of the property to determine it. However, this equation has a problem because the value cannot be determined, making it difficult to determine a buying price. 

The cap rate must therefore be estimated in many cases. Reviewing previous sales of comparable properties and figuring out their cap rate based on the NOI at the time of sale and the sales price are required to generate an accurate estimate. To establish the suitable value to apply, these cap rates must next be contrasted with the target property and the present market situation. 

Numerous variables, all of which are connected to the perceived risk of buying the property, influence cap rates. The cap rate could be raised if the property is riskier. Alternatively, the cap rate might be reduced if the property is thought to be less risky than the market.

Once the entry cap rate is determined, the value of the property can be calculated by multiplying NOI by the selected cap rate.

Pros And Cons of Using This Valuation Technique

The main advantage of calculating value by utilising the income capitalization approach is that the inputs are readily available and the process is quick and simple.

The drawback of this strategy is that it depends on estimates and presumptions regarding variables like 

  • typical rental rates, 
  • occupancy,
  • and income/expense growth. 

One of the dangers of investing in commercial real estate is found here. There is no assurance that the valuation projections will be accurate, and the property's actual performance might differ significantly (better or worse). Although it is an imperfect science, the consequences of getting it wrong could be very costly.

Special Recommendation

To determine a buying price, we advise doing two things. Firstly, we constantly urge people to take into account a variety of values (buy prices) and the rewards that arise from them. The best-case and worst-case possibilities should be included in these ranges. It is considered along with the base case scenario, which represents the conclusion they believe to be the most probable. Potential investors will then be better able to understand how the cost of purchasing a property may ultimately affect the returns realised.

Secondly, the valuation of a multifamily asset is an estimate, and it might change depending on the analyst's biases. Therefore it is vital to recognise this upfront. Some investors might adopt a more upbeat stance, but others might identify concerns that aren't immediately obvious. There isn't a single "correct" response; rather, there are two: one that is backed up by evidence, and the other not.

It is important to note the following to appraise investment properties, such as industrial, commercial, residential or:

  1. Do get advice from experts to essentially steer you in the right direction towards your investment opportunity.
  2. Per your building type, make sure to do your due diligence on settling on numerous approaches when evaluating your real estate property.

FAQ

Is real estate property a risky venture?

Real estate is a type of physical asset. This means that, in contrast to other sorts of investments, real estate investments are actual properties; they are things that actually exist. These investments are extremely low-risk due to precisely this feature.

What is the average ROI on property investment?

It depends on several factors. The acceptable ROI, for instance, depends on several factors, including the property's size, location, and risk exposure. Generally speaking, an excellent investment returns 15% or more, and a decent return on rental properties is 10% or more.

How much should I charge for the rent?

A percentage of the market worth of your home should be used to determine the rent you charge tenants. The rent that landlords demand typically ranges from 0.8% to 1.1% of the value of the property. For instance, a landlord might charge between £2,000 and £2,750 per month for a house worth £250,000.

Thomas Miller
Thomas Miller has been a real estate agent for over 4 years now, when he is not in the field, he is dedicated to his second passion, writing, especially in the real estate market.
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