The current market in the greater Hampton area is making owning investment properties in the area a more and more lucrative proposition. As a potential buyer considers whether or not to make a purchase, it’s essential they are sure they have calculated the proper valuation on the property. This can help determine that it’s actually a good investment. In our last blog, we discussed some different methods that you can utilize in order to assign accurate valuation to a property. We discussed the following approaches:
- The income approach
- The sales comparison approach
- Gross rent multiplier
Please feel free to visit our last blog for more details on these three methods. In this blog, we’re going to discuss additional calculations that can be used to determine the proper valuation of properties.
The Capital Asset Pricing Model
The Capital Asset Pricing Model is more detailed than the methods we discussed previously. This method focuses on including things like opportunity cost and inherent risk as they pertain to a potential purchase. CAPM establishes a couple of different bases for comparison, such as the rate of return on US Treasury Bonds, or Real Estate Investment Trusts (REITs) in the local area. These established investments have essentially zero risks associated with them. After the basis has been established for these non-aggressive types of investments individually, the model estimates the potential return on investment (ROI) for the property in question. If the estimated ROI is less than the rate of return for one of the risk-free investment options, then it doesn’t make much sense to purchase a property with inherent risks that has a lower expected return.
The risks of owning property vary widely from property to property. Location is a very important factor to consider. For example, if the property happens to be located in a crime-ridden area, the amount of rent you can expect to collect each month will likely be significantly lower than the amount deemed to be collectible in a safer neighborhood. You may also need to allocate more investment dollars for additional safety precautions in more perilous areas. Extra locks, fences, and even potentially bars on windows may be considered wise purchases to protect the asset.
Another important factor is how old the property is because the older a building is, the more maintenance you can realistically expect the property to require. After carefully considering these factors, the CAPM helps you determine what rate of return you should realistically expect and deserve to get for putting your money “at risk”. Once again, that number should be higher than the rate yielded by risk-free options in the market. Otherwise, it is probably not the best investment to make.
The Cost Approach
This approach is predicated on the notion that a piece of property is only worth what it can be reasonably and legally used for. The cost approach assigns value by adding the depreciated value of any improvements on the property to the value of the actual land itself. This method is frequently used when assigning value to unimproved lots or vacant land.
Zoning also factors heavily into this approach. If a parcel of land is not currently zoned properly for the use the investor intends it for, there will be a significant cost associated with getting the property re-zoned. For example, if a property is zoned for single-family homes, you would need to get the zoning changed to high-density housing in order to build a condominium complex there.
In the last couple of blog posts, we have covered five different ways to calculate valuations on properties. Successful investors will use a combination of at least some if not all of these methods before making an investment decision. Once these methods have been utilized to analyze a specific property, and that property is deemed to be a good investment, the next step is to begin the process of securing the best financing for the purchase. We will go into this process in more depth in an upcoming blog.