What is a property valuation?
Property valuation is the process of assigning a precise economic value to a piece of real estate. As a real estate owner, one must familiarize oneself with the Demand, Utility, Scarcity, and Transferability (DUST) pillars of property valuation, as well as the two basic notions of property and the real estate lifecycle.
Why property valuation is important?
As a business owner plans for future development and eventual transfer, an accurate valuation is an important tool for evaluating both potential and opportunity costs.
Here are 3 approaches used in property valuation
- Sales comparison approach
Market data or comparable sales approach are other names for the sales comparison approach- the most commonly used approach for evaluating real estate. For single-family houses, where there are generally numerous comparables to study, the sales comparison technique is widely utilized. Compare the property that has been priced to similar properties that have recently sold in the area.
- Income or investment approach
Another commonly used method for commercial real estate and rental properties is the income or investment approach. The income capitalization methodology uses a property’s return on investment as well as its net income. For real estate valuations, the income method is similar to the discounted cash flow (DCF) method used in finance. The income method’s cap rate and estimated value are inversely related; reducing the cap rate raises the estimated value.
- Cost approach
The third approach to property valuation is the cost approach. Based on valuation methods, the sales comparison approach is used to determine the worth of the property’s land. The property’s construction expenses are then calculated, taking depreciation into consideration. The cost approach is a real estate property valuation method that analyses the cost of the land plus the cost of replacing the property (construction expenses) minus physical and functional depreciation to calculate the cost of a property.
Another feature that distinguishes this method from others is the aspects of the real estate for which it is applied. For residential and income property real estate, the cost technique is not applied. Schools, religious organizations, government buildings, and hospitals are examples of properties that are mostly built but not sold.
Each valuation technique is independent of the others. It is common for an evaluator to utilize only one strategy to assess the worth of a property rather than a mix of all three.
At REMI we have designed a module on Property valuation and 3 main methods that an investor should know with regard to real estate investments.