1) Income Value from Rents
This is my favorite way to calculate the value of my personal properties. In six easy steps I’ll show you how to quickly calculate the value of a property.
- Determine your required rate of return / what percentage you want to make.
- Calculate the net income of the property.
- Calculate the expenses of the property.
- Note: Since a buyer may require a mortgage and interest rates fluxuate every day the cap rate does not account mortgage payments or purchase costs.
- Calculate the cap rate: Cap Rate Equals the Annual Net Operating Income divided by Cost (or Value) Cap Rate = Net Income / Cost (or Value)
- Understand Cap rate so if you are a buyer you know what to offer and if you are a seller you know where to price your property.
- An investor purchases a property for $100,000. The property is currently rented at $1,000 per month or $12,000 per year. There is a 10% maintenance fee, $1,000 in taxes, $800 in insurance and assumes a maintenance fee of 5%.
- $12,000 (Gross Income)
- - $1,200 in maintenance (Is it worth your time to manage the property yourself?)
- - $600 in maintenance
- - $1,000 in taxes
- - $800 in insurance
- Equals $8,400 in Net Income / $100,000 Purchase Price = 8.4% Cap Rate
2) Appraised Value of Investment Property
If you are purchasing a single family residence as an investment you will want to put extra time and consideration into the value of the property because the cap rate valuation may exceed the appraised value but when you sell the property a primary residence value may give no consideration to cap rate. Appraised value will also take the condition of the home into consideration where cap rate must account for it in the maintenance assumption.
3) Insurance Value
Insurance value is important in case of a fire or flood but has no real meaning to the purchase price. For instance if you purchase a property during a recession the replacement value / insurance value will remain high while the market conditions force the value down.
4) Tax Assessed Value
I rarely give much thought to the tax assessed value except for the cost of taxes. Taxes can vary by state and county but remember tax assessors are not appraisers.
5) Speculation of The Market (Know Your Market)
Do not base your values of where the market may be or was; your values should be based off of current market conditions. If market values are trending flat or downward you may require a higher rate of return than if a market is increasing in value. Always be cautions when purchasing property and due your due diligence (yes, I said that correctly). An investor can lose more money by the lack of due diligence or market knowledge than by a change in market values as a whole.