Real estate valuation is essential for Adelaide Property Valuers, including financing, listing sales, investment analysis, property insurance, and taxation. But for most people, determining the asking or purchase price of a property is the most useful application of real estate appraisal. This article will provide an introduction to the basic concepts and methods of real estate valuation, especially as it relates to sales.
Valuing real estate is difficult because each property has unique characteristics such as location, lot size, floor plan, and amenities.
General real estate market concepts such as supply and demand in a given region will certainly play a role in the overall value of a particular property.
However, individual properties must be appraised using one of several methods to determine fair value.
Basic Valuation Concepts
Technically speaking, property value is defined as the present value of the future benefits of owning the property. Unlike many consumer goods, which are used quickly, the benefits of real estate usually accrue over a long period of time. Therefore, estimating property value must take into account economic and social trends, as well as Adelaide Property Valuers controls or regulations and environmental conditions that can affect the four elements of value:
- Demand: a desire or need for ownership supported by financial means to satisfy the desire
- Utility: the ability to satisfy the wants and needs of future owners
- Rarity: limited supply of competitive properties
- Transferability: the ease with which ownership rights can be transferred
Property Valuation versus cost and price
Value does not necessarily equal cost or price. Costs refer to actual expenses – for example, materials or labor. Price, on the other hand, is the amount someone will pay for something. While cost and price can affect value, they do not determine value. The sale price of the house may be $150,000, but the value may be significantly higher or lower. For example, if the new owner finds a serious flaw in the house, such as a faulty foundation, the value of the house may be lower than the asking price.
An appraisal is an opinion or estimate regarding the value of a particular property on a certain date. Appraisal reports are used by businesses, government agencies, individuals, investors and mortgage companies to make decisions about real estate transactions. The objective of the appraisal is to determine the market value of the property – the most likely price that the property will fetch in a competitive and open market.
Market price, the price a property actually sells for, may not always represent market Property Valuation. For example, if the seller is under duress due to the threat of foreclosure or if a private sale is taking place, the property may sell below market value.
Accurate assessment depends on methodical data collection. Property-specific data and general data regarding the nation, region, city and neighborhood where the property is located are collected and analyzed to arrive at a value. Appraisal uses three Adelaide Property Valuers approaches to determine a property’s value.
Method 1: Property Valuation Compare sales
When valuing family houses and land, the sales comparison method is commonly used. Sometimes called the market data approach, it is an estimate of value derived by comparing a property to recently sold properties with similar characteristics. These similar properties are referred to as comparables, and in order to provide a valid comparison, each must:
- Be as similar as possible to the properties of the subject
- They were sold in the last year on an open, competitive market
- They were sold under typical market conditions
At least three or four comparables should be used in the evaluation process. The most important factors to consider when choosing Land Valuation Adelaide are size, comparable features and – perhaps most importantly – location, which can have a huge impact on a property’s market value.
Since no two properties are exactly the same, adjustments will be made to comparable sales prices to account for differing features and other factors that could affect value, including:
Age and condition of buildings
- Sale date if economic changes occur between the sale date of the comparable and the valuation date
- Conditions of sale, for example if the seller of the property was under duress or if the property was sold between relatives (at a discounted price)
- Location, as prices for similar properties may vary from neighborhood to neighborhood
- Physical features, including lot size, landscaping, type and quality of construction, number and Adelaide Property Valuers rooms, square feet of living space, hardwood floors, garage, kitchen upgrades, fireplace, pool, central air, etc.
- The estimated market value of the property in question will fall within the range formed by the adjusted sales prices of comparables. Because some adjustments to the selling prices of comparables will be more subjective than others, weighted consideration is usually given to those comparables that have the least amount of adjustment.
Method 2: Property Valuation Price approach
The cost approach can be used to estimate the value of properties that have been improved by one or more buildings. This method involves separate estimates of the value of the building(s) and land, taking into account depreciation. The estimates are added together to calculate the value of the entire improved property. The cost approach is based on the assumption that a reasonable buyer would not pay more Property Valuation for an existing improved property than the cost of buying a comparable lot and constructing a comparable building. This approach is useful if it is an appreciating property of a type that does not sell often and does not generate income. Examples include schools, churches, hospitals and government buildings.
Construction costs can be estimated in several ways, including the square foot method, where the cost per square foot of a recently constructed comparable is multiplied by the number of square feet in the building in question; the unit-in-place method, where costs are estimated based on construction costs per unit of measurement of individual building elements, including labor and materials; and a quantitative survey method that estimates the amount of raw materials that will be needed to replace the subject building, along with the current cost of the materials and associated installation costs.
- For valuation purposes, Land Valuation Adelaide refers to any condition that adversely affects the value of improvements to the property and takes into account:
- Physical deterioration, including curable damage, such as painting and roof replacement, and incurable damage, such as structural problems
- Functional obsolescence, which refers to physical or design features that property owners no longer find desirable, such as outdated appliances, outdated-looking fixtures, or homes with four bedrooms but only one bathroom.
- Economic obsolescence caused by factors external to the property, such as location near a noisy airport or polluting factory.
- Estimate the Property Valuation of the land as if it were vacant and available for highest and best use using the sales comparison approach because land cannot be depreciated.
- Estimate the current cost of constructing the building(s) and improving the site.
- Estimate the amount of depreciation of improvements resulting from deterioration in quality, functional obsolescence, or economic obsolescence.
- Subtract depreciation from the estimated construction costs.
To determine the total value of the property, add the appraised value of the land to the depreciated value of the building(s) and site improvements.
Method 3: Property Valuation Income capitalization approach
This method is often called simply the income approach and is based on the relationship between the rate of return the investor requires and the net income the property produces. It is used to estimate the value of income producing properties such as Adelaide Property Valuers complexes, office buildings and shopping centers. Valuation using the income capitalization approach can be relatively straightforward when the property in question can be expected to generate future income and when its expenses are predictable and stable.
When using the direct capitalization approach, appraisers perform the following steps:
- Estimate the annual potential gross income.
- Take into account vacancy and rental losses to determine effective gross income.
- To calculate annual net operating income, subtract annual operating expenses.
- Estimate the price a typical investor would pay for the income generated by a Property Valuation asset type and class. This is achieved by estimating the rate of return or capitalization rate.
- Apply the capitalization rate to the property’s annual net operating income to create an estimate of the property’s value.
Gross Income Multipliers
The gross income multiplier (GIM) method can be used to value other properties that are not typically purchased as income properties but can be rented out, such as single-family homes and two-family homes. The Land Valuation Adelaide method links the sale price of a property to its expected rental income. (For related information, see “4 Ways to Value a Rental Property”)
For residential properties, gross monthly income is usually used; for commercial and industrial properties, the gross annual income would be used. The gross income multiplier method can be calculated as follows:
Sales Price ÷ Rental Income = Gross Income Multiplier
Recent sales and rental data from at least three similar properties can be used to create an accurate GIM. The GIM can then be applied to the estimated fair market rent of the property in question to determine its market value, which can be calculated as follows:
Rental Income x GIM = Estimated Market Value