Determining The Value of Investment Properties

One of the biggest and most frequently made mistakes people make when investing in real estate is paying too much for their investment properties. Paying too much is likely the top reason that many beginning real estate investors fail. Most people that begin investing in real estate do not have the financial resources to overcome purchasing their investment properties too expensively. Learning to accurately estimate the value of a property is the most crucial aspect of making money investing in real estate.

What is “Market Value?”

The Appraisal Foundation's Uniform Standards of Professional Appraisal Practice, defines market value as: "The most probable price a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the sale price isn't affected by undue stimulus.” Your goal when buying investment properties is to accurately determine the property’s market value and then purchase with a profit.

There are two common methods for determining the value of investment properties, the Comparison Sales Method and the Income Method.

The Comparison Sales Method uses the recent sales prices of comparable properties in the same geographical area to determine the value of the investment property in question. The properties used should be comparable to the subject property in size, quality, amenities and features.
The Income Method is used to estimate the investment properties value based on the net income produced by the property. Under the Income Method a property’s value is determined using the Capitalization Rate, which is the property’s net operating income divided by it’s purchase price and The Gross Rent Multiplier which is calculated by dividing the purchase price by the property’s monthly gross income.

When determining the property’s expenses always assume that the seller has not been completely honest. You should always review the following:

1. Schedule E (Supplemental Income and Loss) of the owner's latest federal income tax return.
2. The property's latest annual tax assessment.
3. All of the rental agreements for the past year.
4. Water, sewage, solid waste, gas and electric bills for the past year.
5. Repair and capital improvement bills for the past year.

You will often find that the seller understates his expenses to potential buyers and overstates his expenses to the taxing authority!

When trying to determine the market value for investment properties you should always do the following:

1. Use the internet to find comparable sales in the subject property’s neighborhood. Remember to use properties with comparable age, size, condition and amenities as the property you are interested in buying. Use this information to determine the comparable market value of the potential investment property.
2. Verify the property expenses and income. Determine net operating income.
3. Calculate the property’s Capitalization Rate by dividing the net income by the estimated comparable market value.
4. Estimate the property value by multiplying the Capitalization rate by the net operating income.

By following this advice you will be well on your way to profiting with investment properties.