Imagine having to spend loads on a property after you have paid a lot to buy it. You waste time and effort just to discover that you are on a wild goose chase. That’s the sort of ordeal that many real estate investors go through. Many times, it is because they fail to pay attention to numbers. Detecting good investments could be reduced to a simple calculation, as described in this article.
From a quantitative viewpoint, investing in real estate is to some degree like investing in stocks. To benefit in real estate speculations, investors must decide the estimation of the properties they purchase and make instructed surmises about how much profit these ventures will create, whether through property appreciation, rental pay or a mix of both.
This is what real estate valuation analysis deals with. You have a property in which you want to invest, you need to calculate how profitable this property is and use this to formulate a strategy. That is basic and very important. Many investors think they have all this done and dusted, but still make uneducated guesses and fall into the trap of bad investments.
In Andrew Baum and Neil Cosby’s book “property investment appraisal”, they think property valuations are critical. According to them “Valuations are important: they are used as a surrogate for transactions in the construction of investment performance and they influence investors and other market operators when transacting property. “
How do you calculate this value? You can either hire a valuer or take a hands-on approach to valuing your real estate investment. There are two ways to do this if you follow the second approach.
HOW TO DETERMINE MARKET VALUE OF YOUR INVESTMENT PROPERTY YOURSELF
1. NET OPERATING INCOME APPROACH.
Net operating income reflects the gain that a property will generate after taking into account operating expenses, but before deducting taxes and interest payments. Before deducting expenses, the total income obtained from the investment must be determined. This can be done by looking at rental income from comparable properties in the area. Therefore, considerable market research is needed at this stage.
Anticipated increments in rents are represented in the growth rate which we will incorporate in our calculation. Working costs including those that are directly brought about by day to day operations, for example, property insurance, management expenses, maintenance fees and utility expenses will also be added. So according to the net operating income approach, the value of your real estate is calculated by:
Market value = NOI/r-g = NOI/R
NOI = Net operating income
R= Required rate of return on real estate assets
G= Growth rate of NOI
R= Capitalization rate (r-g)
2. THE GROSS INCOME MULTIPLIER APPROACH.
The gross income multiplier method assumes that the price of property in an area is proportional to the gross income it helps to generate. To calculate the market value using this approach, we have to take into account an element that is called a gross income multiplier. The gross income multiplier takes into account historical data and sales in that area. Investopedia puts it this way: “Looking at the selling price of comparable properties and dividing that value by the annual gross income they generate will produce the average multiplier for the region.”( http://www.investopedia.com/articles/mortgages-real-estate/11/valuing-real-estate.asp) In essence, we are saying:
Market value = gross income * gross income multiplier
You have to realize that there will be some unavoidable assumptions in these calculations. However, these will help you make educated guesses on profitability of investment properties in any area.
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