What Is a Property Cost Evaluation?

Selling

Determining an accurate asking price for your property is crucial. Rather than being based on how much was invested in the property or what the property cost initially, a property’s price should be reflective of the current market value.

Most buyers nowadays are savvy and for the most part may be able to tell whether a property is priced correctly. If you underprice your property, you may end up selling your property for less than it’s actually worth in today’s market, warns Tacoma PMC.

Similarly, if you overprice your property, you’ll drive away potential buyers and therefore increase the amount of time the property stays on the market. Buyers may wonder what is wrong with the property and why it hasn’t sold yet.

Are you thinking about selling your property? If so, then you need to know how to price it correctly. In this article, we will walk you through the entire property cost evaluation process. Let’s get started!

 

Property Cost Evaluation Basic Concepts

Value: A property’s value, technically speaking, is defined as the existing worth of forthcoming benefits arising from a property’s ownership. To estimate the value of a property, you must consider social and economic trends.

Other considerations include environmental conditions and government regulations or controls.

The reason for this is that the benefits of property are realized over a long time, unlike many consumer goods that are quickly used.

Value Versus Price and Cost: Does value equal to price or cost? Not necessarily. Here’s an example. Suppose a house is priced at $150,000. If a new owner finds something faulty with the home, will its value still hold? Of course not!

So, the value may not necessarily equate price. The house value in our example above could be lower than the $150,000 price tag.

Appraisal: An appraisal is basically an opinion on a property’s value on a certain date, by the appraiser, as of a certain date. Mortgage companies, property investors, government agencies, and businesses commonly use appraisal reports.

An appraisal’s goal is to determine a property’s market value.

Market Value: A property's market value is what that property might sell for, regardless of what its assessed or appraised values are.

 

Property Cost Evaluation Methods

To determine a property’s value, appraisals use three fundamental approaches. The approaches are as follows:

 

Method 1: Income Capitalization Approach

This approach considers two things: the expected rate of ROI and the net income of the property. Often, appraisers use this method to evaluate the net income of rental properties. For example, shopping centers, office buildings, and apartment complexes.

Generally, when the subject property can be expected to generate future income, and when its expenses are predictable and steady, appraisals using the income capitalization approach can be straightforward.

When using the direct capitalization approach, appraisers will perform the following steps:

·         Estimate the yearly gross income of the income generating property

·         Determine the effective gross income. This takes into consideration rent collection losses and vacancy.

·         Calculate the annual net operating income. This means deducting the annual operating expenses from the effective gross income.

·         Estimating the capitalization rate, or rate of return.

·         Estimate the property’s value by applying the capitalization rate to the property’s annual net operating income.

 

Method 2: Cost Approach

This method considers depreciation to determine property value based on additional upgrades.

The appraisal method of depreciation is a calculation of the decline in value of an asset from the beginning to the end of a reporting period. For appraisal purposes, it takes into consideration economic obsolescence, functional obsolescence, and physical deterioration.

The cost approach essentially estimates building costs. The approach assumes that an investor shouldn’t pay extra for an existing upgraded property than the price to construct the building from scratch.

Construction costs can be estimated in various ways. Such ways include the quantity-survey method, the unit-in-place method, and the square-foot method.

When using the cost approach, appraisers will perform the following steps:

·         Assess the land value.

·         Evaluate the current construction costs on site upgrades.

·         Calculate the depreciation amount of the improvements arising from economic and functional obsolescence and deterioration.

·         Subtract the depreciation from the costs of estimated construction.

·         Determine the total property value by adding the calculated depreciation amount.

 

Method 3: Sales Comparison Approach

Appraisers oftentimes use this approach to value single-family homes. The approach compares other properties with similar characteristics to determine a property’ value. For the property to qualify as a comparable, it must:

·         Be similar in characteristics to the subject property as possible

·         Have been sold under typical market conditions

·         Have been sold within the last 12 months in an open, competitive market

Usually, a minimum of three comparables is used in the sales comparison approach.

 

To sum, accurately valuing real estate is vital to everyone involved in a real estate transaction. Be it sellers, buyers, insurers, investors and mortgage lenders.

Although skilled professionals commonly perform appraisals, any party in a real estate transaction can benefit from gaining a basic knowledge of the property cost evaluation approaches.

Post courtesy of Ian Joseph

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