How to Value Investment Property

Doug Fath and Jeff Greco discuss how to value investment property (income vs sales approach) in their latest video. Click the video below to watch now.

How to Value Investment Property

 

Doug Fath: Hey, I’m Doug Fath.

 

Jeff Greco: And I’m Jeff Greco from Legacy Capital.

 

Doug Fath: And today, we’re gonna be talking about valuing investment properties. And this is actually a conversation that’s come up recently with a handful of our clients just with some of the properties that they were looking to purchase. And properties from an appraisal standpoint are valued differently for residential vs. commercial properties. And it’s important just to understand, high level, the differences between the two, so that when you’re going to value a property and look to invest in a property, you understand how that’s gonna be valued from an appraisal standpoint.

 

And so residential is considered one to four units, and then commercial is considered five units or more. And for residential properties, whether it’s a single family, or a two, three, or four unit, typically an appraiser is going to use the sales approach to value that piece of real estate. So they’re gonna look for other comparable sales for square footage, unit mix, all that good stuff, to come up with a value for the property vs. for five units or more, or on commercial properties, appraisers are … They’re gonna use two approaches, but it’s gonna be more heavily weighted to the income approach. So in other words, they’re gonna look at the net operating income for that property and what that generates, and they’re gonna use a cap rate to determine the value of the property off of the income. And they will also take into consideration the sales approach, where they will look for comparable sales for, let’s say it’s a five-unit building, they’ll look for other five-units that are comparable and see what those have sold for. And they will take into account both approaches, but it’s typically driven by the income approach.

 

And sort of where this has come up in our business and with some of our clients and the importance of being able to distinguish the two is some of our clients have done a great job at identifying one to four unit properties that produce a lot of cashflow, and so, rightfully so, they’re looking at the asset as, “How much money is that putting in my pocket every month?” And just as an example, let’s say … Let’s say there’s a three-unit building that is gonna generate $4,000 a month in rent, whereas other three-unit buildings are generating $2,000 dollars a month in rent. That’s a significant difference, and so it’s easy to think, “Well, the building that’s generating $4,000 a month should be worth more.” But on the residential side, they’re taking the sales approach, not the income approach. And so that’s not always accurate that just because it produces more income is actually going to give you a valuation on residential properties.

 

Jeff Greco: Yeah. And on the residential side, when our appraisers or when our clients are looking at buying properties and are either doing their analysis or maybe they call us to just double check some things before they pull the trigger on something, really when you’re talking about a sales approach, at the end of the day, whether it’s before you buy a property that needs to get rehabbed, or if you’re talking about an after-repair value, as Doug has explained, when you’re talking about the sales approach, really the only thing to quote/unquote “argue” is, are they using the right comps? And so, at the end of the day, if you’re looking at a one to four-unit residential property, you’re looking at comps either on the purchase side to determine an as-is value, or you’re looking at comps on the ARV side, depending on the level of rehab and the types of finishes and stuff you’re gonna use, which is what our appraisers use when they’re doing the residential appraisals.

 

Doug Fath: Yeah. So in some, even if you’ve identified a residential property that’s producing more income and more cash flow, obviously you, as the investor, are gonna be interested in buying that property, because it’s putting more money in your pocket. But from a valuation standpoint, you need to value it from the sales approach, because that’s how an appraiser is going to value.

 

Jeff Greco: Yeah, and it’s important to understand that. Certainly, we use appraisals, and then especially if you’re creating an income property or further developing the income, you wanna understand how your refinance bank or lender is gonna value that so there’s no surprises at the end, and so you don’t have to fight the fight of, hey, I thought it was this or that. We really want you to be empowered to understand what the lending institution is gonna value at so you know what to expect, if you’re expecting money out of your refinance, or expecting when you do ultimately go to sell it, really empowering you with that type of data to be able to make good, smart investment decisions.

 

 

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