When we talk about what a property is “worth” we are making a judgment as to the value of that property. As real estate investors, it is crucial that we be able to accurately determine the values of our current holdings as well as our potential investments. In this article I am going to discuss the three main methods used to value property and how each of them pertains specifically to real estate investors.
Comparables
Sales comparables, or “comps”, are the most widely discussed and understood method for valuing residential real estate. This method of valuation has absolutely zero correlation to any tangible or permanent value (such as the cost of materials or land.) It is based solely on the laws of supply and demand. According to sales comparables, a property is worth exactly what consumers are willing to pay for it at that time. The most important aspect of correctly using comps to determine the value of a property is making sure that there is an apples to apples comparison. Every effort should be made to compare the home being valued with homes of similar size, location, amenities, finishes and condition.
Unfortunately, in the last year, we have run into major difficulties in the Las Vegas real estate market obtaining fair and accurate appraisals for our newly rehabbed properties. This is because some appraisers insist on valuing our completely turn-key, fully renovated properties at the same price per square foot as damaged foreclosures or REOs in the same neighborhood. I have spoken to numerous colleagues around the U.S. who are encountering similar difficulties. As an investor, when you are looking to value a property prior to purchase, it is important to note the condition of your prospective investment in comparison to other properties that might be listed as comparables.
Capitalization Rate
The most popular method used by investors to evaluate a potential purchase is capitalization or CAP rate. CAP rate is determined by dividing the Net Operating Income of a property by it’s acquisition cost. For a more detailed explanation of how to determine a CAP rate CLICK HERE to read my article on this subject.
Several factors go into determining what makes a “good” CAP rate for a particular investment property. Here in Las Vegas, we tell our investors to shoot for CAP rates of 10% or greater. For a more thorough discussion of what makes a good CAP rate please CLICK HERE to ready my article.
Builders’ Replacement Cost
The final method used to determine property value is builders’ replacement costs. This references how much it would cost in the current market to rebuild a particular property in the event of a total loss. To determine this, the total square footage of a structure is multiplied by the current cost per square foot of new construction in the area. This valuation is often used by insurance companies who are underwriting properties for homeowners’ policies.
For investors, builders’ replacement costs can provide a helpful benchmark for giving properties a more tangible valuation then comps alone. Investors who took note of the huge gap between builders’ replacement costs and actual market prices in Las Vegas in 2007 realized that a market correction was imminent and inevitable.
With completely renovated properties selling below builders’ replacement costs and CAP rates higher than we’ve seen in decades, now is the time to invest in real estate in Las Vegas. If you are interested in learning more about what Team Plantone has to offer investors, please contact Glenn.
