Are you saving up to invest in real estate? That’s wonderful!
However, have you learned how to calculate the value of your investment before putting down your money? If not, we will tell you how.
You need to invest in a property that produces the highest Return on Investment (ROI). For which you need to compute the ROI, the present, and the future value of your investment property.
Real Estate Investment Strategies
We have listed down several methods and approaches to find out the actual value of a property you are investing in.
Here are a few methods that can help you decide whether to invest in a property to gain its ROI.
1. Sales comparison approach (SCA)
The sales comparison approach is a real estate appraisal approach. It compares a property with other similar properties that are recently sold in the same neighborhood.
This approach helps calculate the potential value of a property you are investing in. This way you can know the current listing price of the property and derive the current maximum value the investment can yield.
To find the value of the property based on SCA, you need to match the features of the comparable properties as closely as possible and then make certain adjustments to arrive at the actual value.
For example, if you own a 2-bedroom 1000 square foot home, you need to compare that with 2 to 3 most recent sales in the same locality with the same characteristics.
To reach the market value of the property, you need to make certain adjustments in the property’s cost.
For example, if someone sells a similar property at $200000 with a finished basement, and your property has an unfinished basement, you need to adjust the cost for the unfinished basement from the property cost.
Here, the cost of constructing a basement is $10000. To reach the present market value of your property, you need to adjust downward by $10000 to compensate.
2. Gross rent multiplier (GRM) approach
To put it in simple terms, it is the amount of rent the investor can collect annually after investing in the property. The gross rent multiplier is the ratio of the property price to its annual rental income.
It is one of the ideal approaches for presenting, evaluating, and comparing investment properties. This approach allows you to evaluate real estate investment and is also one of the most used tools.
For example, if a property sold in the neighborhood is at $500000 and the annual income from the property is $50000, then
GRM = Sale price/annual rental income
GRM = $500000/$50000 = 10
This way, you can find the GRM of all the comparable properties in the neighborhood.
3. Capitalization rate
The rate of return that is expected to be generated on a real estate investment property is the capitalization rate. The capitalization rate method allows you to gain insights into the return on your investments (ROI).
For example, Andrew bought land worth $350,000, and the expected earnings would be $85,000 on the land. The capitalization rate, i.e., earnings potential from the land, is $85,000/$350,000.
Calculation of the cap rat for Andrews’ deal.
($85,000/$350,000) * 100 = 24.28%
In theory, an investment property with a higher cap rate translates into a higher ROI. A low cap rate reveals the investor putting more money into a property which will provide lower ROI.
A good cap rate in real estate is between 8%-12% but it involves other factors.
In our case, with an over 24% cap rate, Andrew has a great deal in hand.
4. The discounted cash flow model
According to the corporate finance institute; the DCF model evaluates the net present value (NPV), internal rate of return (IRR), and capital accumulation comparison.
- The NPV is the sum of the present value and all the debits and credits.
- The internal rate of return is the average annual return you can expect from a real estate investment in the long run.
- Capital accumulation comparison refers to the growth in your wealth through investment.
This method of valuation depends on the number of cash flows a property can generate in the future.
5. Estimating annual net operating model
The net operating model is an evaluation method used to calculate profits after deducting the operating costs from the gross operating income of a property.
Net Operating Income = Gross Operating Income – Operating Expenses.
6. Cash on cash return
You can calculate Cash on cash return by dividing the first year’s estimated amount of cash inflows and outflows by total initial investment. With the help of this formula, you can also calculate the market value of a property.
For example, consider the apartment price is at $200,000 generates a monthly rental income of $1,000. Then cash-on-cash yield on an annualized basis would be 6%.
(($1,000 * 12) / ($200,000)) * 100 = 6%.
7. Income approach
Lastly, the income approach is a real estate valuation method. We can apply the method to properties that can generate income for the owner. It is an estimated fair value of the income or an expected income the property can generate. It’s determined by net operating income (NOI) divided by the capitalization rate of your property.
To sum up, you can use the above methods to find the value of your investment property. Using these methods will safeguard your investment in the property and help reduce your financial risks as well.