Our topic today is how investors place a value on their properties. We’re going to discuss three valuation approaches that we can use to value investment property.
Cost Approach
Using the cost approach, you will take the value of the land and the value of the improvements that are made, whether it’s a rental house or a commercial building. What you’re considering when it comes to value is whatever type of improvement you’re making. This approach is primarily used for insurance purposes and new construction purposes. It has limited use unless you’re doing new construction or you’re in insurance. The best approaches to take are income and sales comp. Those are the ways most Memphis investors will establish a value for their property.
Income Approach
The income approach takes the economics of the rental property and boils it down to the essence of what that investment is worth in dollars. It’s a way to make all things equal and compare it to other investments. So, from an income approach you’re going to look at the rent and the expenses. The first thing the investor will do is to look for rental property comps. What are the rent rates for the subject property and the comparable properties based on physical characteristics, distance to the subject property, time, etc. You want good rental comps, and when you add that to the expense assumption, you will create a model that allows you to value the rental property with this income approach. You can compare stocks, bonds, rental houses and any other type of investment. This approach is also used in commercial real estate because it’s a way to take rent and minus the expenses.
Sales Comp Approach
The sales comp approach is what you think of when you think of a traditional appraisal. When you’re buying a home and the appraiser comes out to value the property, that appraiser will use this approach. They’ll find homes in the neighborhood and come up with a value, whether it’s based on price per square foot or the physical characteristics of the property. Once the appraiser determines how it compares to other properties, you can establish how much the property is worth. You’ll use this approach when you’re determining how the market values the property. It tells you what a willing buyer or seller would pay for the property.
That’s a lot to absorb. We do an in-depth hour long presentation on this topic, which we would also be happy to share with you. If you are interested in that, or you have any questions, please contact us at CrestCore Realty and Property Management.
