How Much Is Your Investment Property Worth?
The valuation of investment properties is a bit different compared to the valuation of residential properties. Whether you are investing in a property as a buy-to-let to rent out to tenants or are investing in a commercial property to rent to a business tenant or to run your own business from, understanding how much your investment property is worth, and how much it could be worth in the future, is important.
Although land will often hold its value, the structures on it can degrade over time, leading to depreciation in the selling value. On the other hand, improvements to the property, or simply ensuring that it is well-maintained and kept in good repair over time, can lead to appreciation, or a rise in property value.
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What is Depreciation in Property Valuation?
Depreciation of property value refers to the drop or decrease in the selling value of a property. This is calculated as the ‘factor’ product of the total property value along with the construction age. Bear in mind that the depreciation value is usually only valid for the structures rather than the land itself. The value of the land will typically remain the same and will be benchmarked to the market value of the investment property.
How is an Investment Property Valuation Conducted?
There are various methods that can be used to determine the value of an investment property. Since investing in property is not typically short-term, it is essential to analyse the cash flow and the subsequent rate of term in order to ensure that the investment property is profitable. Investors should be aware of this or bring in somebody who is aware of how to value real estate and make educated estimates regarding how much profit it is likely to make through appreciation, rental income, or a combination of both of these factors.
Income Property Valuation
Determining how much income an investment property is likely to bring in is a common method used in valuation. This refers to the capitalisation rate or cap rate, which is important for all property investors to understand. When performing a valuation on an investment property, it is important to ensure that an appropriate capitalisation rate is chosen. This refers to the required rate of return on the property. There are several different methods that can be used to determine the appropriate capitalisation rate including the build-up method, band-of-investment method, and the market-extraction method.
What is Fair Value Property Valuation?
‘Fair value’ is a term that can have several different meanings in the world of finances and investments. When it comes to investing in properties, it refers to the sale price of the property that is agreed upon by both the buyer and seller. It assumes that both parties are equipped with the necessary knowledge to agree to this and are entering the transaction freely.
IFRS Property Valuation
IFRS 13 Fair Value Measurement provides a single framework for measuring fair value. It requires disclosures regarding fair value measurement. It defines fair value on the basis of the notion of an ‘exit price’ and uses a fair value hierarchy resulting in a measurement that is market-based rather than entity-specific.
Directors Valuation of Investment Property – The Different Methods Used
Several different methods are used to value investment properties. These include:
Comparable Method
The comparable method is the simplest method of valuing a property and mainly focuses on what similar properties in the area have sold for. This method is generally used by estate agents and RICS surveyors in the valuation of residential properties or in some cases, investment rental properties. Once you have determined this, appropriate adjustments can then be made for condition, differences, time, and more to get a more accurate value estimate. This provides you with the market value, which is the estimated amount that a property could sell for on the date of the valuation.
Residual Method
Property developers who are interested in purchasing land or existing properties for development purposes may use the residual method to determine the value. This method is carried out by using a simple calculation to determine the actual value of the property or land to be purchased. It can be a helpful method for developers who are interested in finding out more about how much they should invest in the land or property, or how to develop it, in order to make the highest profits.
Cost Method
Another method that may be used when valuing an investment property is to make an estimate of how much the property would cost to replace. This considers each component of the property and how much it is worth. It may be used as part of a condition survey before buying an investment property or even a residential home. However, it is most often used alongside other methods of making property valuations rather than as the main method of estimating the property’s value. This is because it is not generally considered to be accurate or reliable enough.
Factors Considered When Valuing an Investment Property
Just like with getting a valuation of any property, there are several important factors that should be taken into consideration when valuing an investment property. Choosing the right method is important due to the fact that investment properties can vary a lot by type. Whether you are investing in land to develop a property to rent out in the future or a commercial building, for example, could make a huge difference to the best way to figure out its value. Some of the main factors that are considered when evaluating an investment property include:
Type of Investment
Whether you are investing in commercial property, rental property, development property or land, or something else may have an impact when it comes to determining the value. It may also have an impact on the type of valuation method that is used. For example, the income method may be preferred for commercial properties such as hotels that bring in a regular income, while the comparison method may be a better option for residential rental properties.
Location
The location of the property will always play a part in its value regardless of the type of property. For commercial properties, proximity to cities, residential areas, and transport links will be taken into account. For investment residential properties, a desirable location, closeness to amenities, transport links, schools, healthcare, shopping, dining venues, and more may impact how the property is valued. Along with the property value itself, this may also have an impact on the rental value of a buy to let investment property.
Potential ROI
The potential return on investment for some properties may be a key factor in determining their value in some cases. For example, if you are investing in a property that has been home to an established business for many years, the income method of property valuation can be used to determine how much income the investment is likely to generate over a comparable period, which may impact how the investment is valued overall.
Condition
The condition of any investment property will have an effect on how high or low it is valued. Like any property, an investment property of any type that is in good condition and has been kept in good repair will typically be valued higher compared to a property that requires a lot of work to be carried out on it before it can be used.
Potential
For many investment properties, the potential of the property plays a huge role in the value it is given. This is especially true for developers who may be willing to pay more to invest in a property that has a lot of potential for improving over time to ultimately raise the value of the property further and maximise their return on investment.
Improvements
In the case of some investment properties, any improvements that have already been made to the property before the valuation might impact how much it will be valued. For example, a rental property that has been extended or has had the loft converted to include an additional bedroom and bathroom is likely to be higher in value compared with similar properties that have not had the same improvements made.
Issues to Consider
While there are several methods and factors to consider when it comes to investment property valuation, the truth is that determining the value of any property can be quite complicated. Along with this, most models of valuation do not factor in major changes to the property market such as a housing boom or a credit crisis. Because of this, no matter which method you choose to use to figure out how much your investment property is worth, it’s important to conduct further analysis to factor in potential changes in different economic variables and how this might impact the value.
Valuing an investment property is often more complicated compared to residential property. There are several factors to consider and different methods that might work for you.
