I was on the phone with a real estate investor last week and they asked a really good question. In fact, the more I thought about it, I wondered why more long-term buy & hold investors don’t ask the same question themselves. I was asked for my honest opinion on how many values can one property have…and how in the heck do I know which one is correct?
It seems like today, buying real estate and knowing an accurate value of the property is getting harder and harder. Investors are having to rely on putting together multiple pieces of information to arrive at a comfortable value and then make a determination on whether they should buy. What makes everything more difficult is that there are often reasons for the different values and they can often vary wildly. Here are four values that most real estate investors will run up against and at some point rely on for some input on determining value.
1.) Tax Assessed Property Value
A tax assessed value is usually determined by the local taxing authority as a way to quickly place a value on property in order to collect property tax. It would be so easy if every taxing authority used the same formula throughout the country, but that is not the case. Tax assessed values can be determined in multiple different ways and at varying times which, in short, means they are not always reliable.
Some cities and counties int he country assess properties at a percentage of their value. That would be the value that the city or county thinks the property would sell for under normal circumstances. Unless you’ve been under a rock, then you are aware that these are not normal times for the investment real estate market. So a taxing authority reaches a conclusion about a property’s value, then what?
Usually a taxing authority will use a percentage of a property’s value for calculating taxes. How high that percentage is really depends on where you live. In some areas, the municipality might get money from the state to help with things like roads and schools and municipal buildings. In others they may not. In those cases, property tax is often the area that cities look to get their income.
As you can imagine, in those scenarios is makes sense to assess properties at the highest value possible. Does it always mean that is a true value? Does that mean an investor can look at that number and have confidence that this is a value they can buy it at or sell it for at a later date? In most cases, this is going to give an investor a pretty good indication of a property’s value, but not one they should look at with any confidence when buying or selling.
2.) Rental Property Income Value
This is a valuation approach that focuses primarily on the income potential of a property. Ilyce Glink gives a great formula for determining a properties income value by determining the capitalization rate:
The formula for calculating the cap rate is as follows:
Annual Gross Rental Income – Annual Net Operating Expenses = Annual Net Operating Income
Cap Rate = (Annual Net Operating Income/Purchase Price) x 100
Is this a good way for determining value? Probably not. Is it a good way for determining if the price you are paying relative to value is a good investment? I think yes. Still, this is not really helpful for an investor who wants to know the value of an investment property.
This just lets an investor know if the property has the potential to generate a positive outcome at a particular purchase price. I think most investors would agree that regardless of value, when the property has a negative capitalization rate, the risk goes up and you are only left with one investment option and that is selling the property retail.
That pretty much eliminates any long-term buy & hold strategy from the equation…unless, of course, your strategy involves losing money on a property each month.
3.) Investment Property Appraised Value
I think this is the value that gets most people upset the fastest. Sometimes it is warranted and sometimes not. Either way, appraised values of homes is one of the most hotly debated topics on real estate forums and often because appraisers are either unable or unwilling to meet a contracted sales price.
One important thing to remember when you are buying property, an appraisal is simply an opinion of value. In almost all scenarios, the appraiser will be licensed and trained on how to determine value, but they are still going to use their own personal opinions and approach to that appraisal. Some will see no problem with using certain comparable that are favorable to a sell price, while others will not. Some will see no problem with distances and time frames of comparable sales and calculate for those additions, while others will be so strict that even when appraising a retail sale, they will use foreclosure comps because they are the only sales that meet strict location and timing of sale criteria.
I’m not here to tell you which is right and which is wrong, I’m only reminding you that is subjective. Can an appraised value hurt a deal and even cause one to fall apart? Yes. Does is happen all the time? I doubt it. But what does happen on a daily basis is that investors get values back form an appraiser that they have a hard time reconciling because they are coming to a different conclusion when they look at information themselves.
Investors have a hard time accepting the very personal opinion approach that an appraised value often brings and that makes this value sometimes hard to accept. Add in the fact that financial institutions are the ones hiring these opinion makers and the widely held belief that this hiring process influences the values and you have the makings of conspiracy theories and upset investors.
4.) Income Property Insurance Value
This is one of those values that really has a double edge as far as how investors should look at it. It is a value that many turn-key companies use to sell properties because it looks at a very from a very artificial, yet standard way. If this house were to be rebuilt today, what would it cost to do it.
In many low-cost areas of the country, properties are being purchased, renovated and resold and often for below $65 a square foot. If the property were going to be built from the ground up, the cost could be as high as $95 a square foot. Unfortunately, some investors view this as buying a property at a 30% discount. That is not the case. You are buying the property for 30% less than it would cost to build it new. The properties insured value is $95 per square foot if insured for full replacement value. IN cases where there is a lien on the property, insurance companies require an owner to carry a full replacement policy. So it is easy to fall into the trap of this being a “true” value of a property. It is not. If the property were a total loss after a catastrophic event, an investor would receive a windfall for their trouble but the property is gone! Not exactly why we invest in real estate. But that is such a rare occasion and likely to be investigated very carefully, that even considering this value before buying a property — especially independently of the other values — does not make sense.
Insurance values are important, but have no real meaning in the over-all performance of a property. Their real purpose is to show an investor how far below new property building prices they are purchasing a property. There is definitely some value there, but only when taking everything else into consideration as well. It is a good number to know, but may not really mean anything by itself.
Notice that not once did I mention any of the online aggregating sites like Zillow. I simply have no time to even discuss how far off their values can be. At a minimum, the four values I listed are often compiled after on-site visits or with detailed analysis from someone or an entity near the property.
A taxing authority, a hired on-site appraiser or with real local data. In my opinion, on-line resources that give a pretend value should never be used whether they line up with other values or not. Too often, they are not accurate enough and the lack of on-the-ground information makes them unreliable.
In truth, I’m not going to tell you exactly which values you should and which you should not use. So much is going to depend on where the property is that you are purchasing, what your ultimate game plan is for the investment property and who you get your information from. But I will tell you that sometimes, having four different values is a good thing. It gives you a lot to look at as an investor and makes you really concentrate on what matters most to you. If everything lined up perfectly all the time, sooner or later we are bound to slip up and overlook something!
Stay attentive to the details and learn why and how each value is calculated on each property you buy and you should have the data you need to make great investment decisions. Are there any values I missed that you like to determine before buying a property?
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