In South Florida, real estate is fast approaching and in some locales even surpassing record-setting valuation figures. Individuals who are current property owners are reaping the benefits of the increased equity they are achieving.
Additionally, Investors are flocking to the market and looking to profit on the current market climate. The value of property is climbing steadily. In addition, the rent you can charge is also climbing at a fairly substantial pace. Despite the hot market, people still need to be prudent and wary of overpriced assets that are available for sale. If you neglect proper and accurate valuations prior to purchasing a property, you can significantly damage your investment portfolio.
In this blog post, we’re going to go over some methods you can use to ensure you’re properly valuing a potential addition to your portfolio before purchasing the asset.
The income approach
The income approach determines the value of a property by figuring out the annual capitalization rate. It’s calculated by taking the annual projected income and dividing it by the current value of the asset. For example, if a property costs $200,000, and the annual rent collected is $18,000 ($1,500 per month x 12 months) the annual capitalization rate would be 9%.
In most geographic areas, a property with anywhere between an 8-12% cap rate is considered a sound investment. It’s important to remember that the higher the demand locally, the lower the cap rate will be. Desirable metropolitan areas like Miami and West Palm Beach can yield a cap rate of closer to 4%, yet still be considered a solid value. The income approach is a quick and fairly simple calculation, so it’s important to take potential additional expenses like mortgage interest into consideration after the fact.
The sales comparison approach
The sales comparison approach is the most widely utilized valuation model in residential real estate. Real estate agents and real estate appraisers alike use this method. The sales comparison approach is based on having similar properties in the local geographic area that have been recently rented or sold.
When searching for an investment property to acquire, potential investors often ask to see the sales comparison approach factored out for a few years prior. They will often look at forecast numbers for the next few years as well so that they can analyze any positive or negative trends that may be occurring.
This method relies heavily on comparing apples to apples. Things like square footage, number of bedrooms, and lot size factor in immensely when making these value comparisons. Many appraisers and real estate agents will also calculate a price per square foot. Once you have determined what that number is, it’s reasonable to expect a similar value in similar properties nearby.
Gross rent multiplier
GRM is based on estimating the amount of rent that a property owner can expect to pull in from the property annually. This number is calculated before factoring in things like utilities, taxes, and insurance expenses. This method is similar to the income approach but doesn’t calculate a capitalization rate. Instead, this method isolates the gross rents that are expected to be collectible.
To calculate the GRM, divide the cost of the property by the rent you expect to collect each year. If a property is priced at $450,000 and you think you will receive $36,000 in annual rent ($3000 per month) the gross rent multiplier would be equal to 12.5. You are hoping to get a low number.
A good range to look for is a GRM of somewhere between 4 to 7. However, if the number comes in higher, it doesn’t necessarily mean that the investment is a poor choice. It means that the asset might take a while longer to pay for itself than one with a lower GRM figure.
These methods should be used in properly evaluating the worth of real estate. Be sure to look for a future blog post where we will continue the discussion. As always, please contact PMI Key Partner with any Sunrise property management questions or inquiries.