How to Accurately Estimate a Property's Current Market Value
by Thomas Lucier
The most common mistake that many beginning real estate investors make is that
they pay too much for property. Fact is overpaying for property is often cited
as the number one reason why so many newcomers fail to make it as profitable
real estate investors. That's because most beginning real estate investors are
woefully undercapitalized, and they don't have the deep pockets that are needed
to subsidize their overpriced real estate investments.
For many neophyte investors, paying too much for their first investment property
usually proves to be a very costly and fatal mistake, and marks the beginning of
the end of their foray into real estate. That's why it's imperative that you
learn how to accurately estimate the current market value of potential
investment properties! As far as I'm concerned, it's the single most important
aspect of the entire real estate investment business!
A Fast $15,000 Profit for Knowing the Value of a Condemned House
I once bought a real estate option on a filthy, neglected, run-down, but
structurally sound house in a neighborhood-in-transition in Winter Park,
Florida, a suburb of Orlando, that had been condemned for building, safety,
health and fire code violations. This place looked like something right out of
downtown Baghdad, Iraq! It had what code enforcement inspectors commonly refer
to as accumulations of every type of debris, garbage and junk known to mankind!
The property's owner lived in Westerville, Ohio, and wanted the steady stream of
threatening letters from the Winter Park Code Enforcement Board to stop.
I had done my homework, and knew the property was worth at least $110,000 after
it was cleaned up. I ended up paying $500 for a one-year option to purchase the
house for $75,000. It cost me $2000 to have all of the accumulations removed
from the property, and the house, driveway and walkways pressure washed. Three
weeks later, I sold my real estate option agreement for a $15,000 profit! This
never would have happened if I had been clueless about how to estimate property
values. Since I had an accurate estimate as to how much the property was worth
in its current condition, I was able to negotiate a below market purchase price
that was based on the property's filthy, neglected, run-down non-marketable
condition, and not on how much it might have been worth after it had been
cleaned up.
No Kelly Blue Book for Real Estate Investors to Look Up Property Values
Sadly, there's no Kelly Blue Book equivalent for real estate investors to lookup
used property prices in, so you're going to have to learn for yourself how to
estimate the current market value of potential investment properties. However,
thanks to computers and the Internet, in most real estate markets it's not that
difficult to get a rough estimate of a property's current market value. This is
especially true for real estate investors located in counties where all property
ownership, sale and tax assessment records are available online.
The Definition of Market Value
The Appraisal Foundation's Uniform Standards of Professional Appraisal Practice,
defines market value as: "The most probable price a property should bring in a
competitive and open market under all conditions requisite to a fair sale, the
buyer and seller each acting prudently and knowledgeably, and assuming the sale
price isn't affected by undue stimulus.”
The Difference Between Assessed Value and Appraised Value
The difference between a property's tax-assessed value and its appraised value
is as follows:
1. Tax Assessed Value: Tax-assessed value is the value established by the
local taxing authority for a parcel of land and the improvements placed upon the
land for property tax purposes. For example, in Florida, owner-occupied
single-family houses are generally assessed at around seventy percent of their
fair market value by county property appraisers.
2. Appraised Value: Appraised value is the value estimate given to a
property by a licensed property appraiser using accepted appraisal methods for
the type of property being appraised. For example, the accepted appraisal method
to accurately estimate the fair market value for an owner-occupied single-family
house is the comparison sales method where a property's value is based on the
recent sale of comparable properties within the same area.
The Three Common Methods Used to Estimate Property Values
The three most common methods used by property appraisers to estimate property
values are the:
1. Comparison Sales Method: The comparison sales method bases a
property's value on the recent sale prices of properties that are within the
same area and comparable in size, quality, amenities and features.
2. Income Method: The income method is used to estimate the value of an
income producing property based on the net income the property produces.
3. Replacement Cost Method: The replacement cost method is based on what
it would cost to replace the improvements on property using similar construction
materials and construction methods.
The Comparison Sales Method of Estimating a Property's Value
The comparison sales method of estimating a property's value is based on the
recent sale prices of properties within the same area that are comparable in
size, amenities and features. In order to be accurate, sale price adjustments
must be made for comparable properties that have been sold at unrealistically
low prices or on overly favorable financial terms not readily available to the
buying public.
The Income Method of Estimating a Property's Value
The income method is used to estimate the value of an income producing property
based on the net income the property produces. Under the income method value is
calculated using a:
1. Capitalization Rate. The capitalization rate, or cap rate, is
calculated by dividing a property's annual net operating income by its purchase
price.
2. Gross Rent Multiplier. The gross rent multiplier, or GRM, is
calculated by dividing the purchase price by the property's monthly gross
operating income.
Watch Out for Owners Using Fuzzy Math
A word to the wise: when you read a property's income and expense statement, you
should always go under the assumption that the owner is probably practicing
fuzzy math by fudging on the numbers, and telling little white lies to back them
up. Also, use a monthly income and expense analysis worksheet like the sample
copy below, to cross-check everything that's listed on a property's income and
expense statement in order to reconcile the statement with receipts and tax
returns against what's shown on:
1. Schedule E (Supplemental Income and Loss) of the owner's latest
federal income tax return.
2. The property's latest annual tax assessment income and expense
statement on file at the county property appraiser or assessor's office.
3. All of the rental agreements for the past year.
4. Water, sewage, solid waste, gas and electric bills for the past year.
5. Repair and capital improvement bills for the past year.
The Replacement Cost Method of Estimating a Property's Value
The replacement cost method of estimating a property's value is based on the
cost of replacing the improvements on the property minus the cost of the land to
estimate a property's value. Replacement costs are calculated on a per square
foot basis by dividing the total number of square feet in the building by the
per square foot construction cost. For example, a two thousand square foot
convenience store that cost $375,000 to build would have a replacement cost of
$187.50 per square foot, $375,000 divided by 2000.
How to Get Free Building Replacement Cost Estimates
You can usually get a free building replacement cost estimate by calling a local
independent insurance broker who represents insurers that specialize in
providing property and casualty insurance coverage for residential and
commercial buildings. When you call a broker, tell them that you want a
replacement cost quote. Property replacement costs are calculated by using a
replacement cost formula that's based on the property's geographical location
and its:
1. Street address.
2. Age.
3. Type of construction.
4. Number of stories.
5. Type of roof.
6. Current use.
7. Heating and cooling system.
8. Square footage.
Use the Eight-Step Approach to Estimate a Property's Current Market Value
Use the following eight-step approach and the current value worksheet on the
following page to get a rough estimate of a potential investment property's
current market value:
Step # 1: Log onto your county's property appraiser or assessor's Web
site to obtain the tax assessed value of the property under consideration.
Step # 2: Search your county's property tax rolls for recent sales of
three to five properties that are comparable in size, amenities and features,
and located within two miles of the property under consideration.
Step # 3: Carefully analyze any comparable properties that you find, and
make sale price adjustments for differences in amenities, special features and
the property's physical condition.
Step # 4: Verify the income and expenses that are listed on the income
and expense statement of the property under consideration.
Step # 5: Analyze the property's income and expenses for the past twelve
months to estimate its net operating income potential.
Step # 6: Calculate the property's capitalization rate by dividing its
potential operating income by the estimated value that you derived from
analyzing recent sales of comparable properties in step number three.
Step #7: Estimate the property's value by multiplying its net operating
income by the capitalization rate you came up with for the property.
Step # 8: Calculate the cost of replacing the improvements on the
property using the same building materials and method of construction.
Bio:
Thomas J. Lucier has been a real estate investor in Tampa, Florida since 1980.
Mr. Lucier is the author of six books on real estate investing and managing
Florida residential rental property. He is also a Florida licensed mortgage
broker, and an active member of the National Association of Real Estate Editors,
and the Real Estate Educators Association.