Investing in real estate won’t lead you to your long-term wealth goals without thoroughly evaluating each potential property before adding them to your portfolio. Building long-term income while balancing short-term cash flow and excellent ROIs is easier when starting with good properties.
Similar to investing in the stock market or making any other investment, it is important to ensure you understand the value and potential of any real estate investment you make. So how can real estate investors value a potential property? Our Detroit property management team has several tips to follow to help you with real estate investment property valuations.
Understand Net Operating Income (NOI)
Ultimately, the value of any property is based on the income that it can produce. Due to this, coming up with a fair projected NOI (Net Operating Income) is very important. There are various factors investors should consider when calculating NOI to value a potential investment property.
The expected revenue you can earn in an investment property depends on market conditions and how well you manage a property. Access to the right data should help you answer questions like "how much can I rent my house for" to set the monthly rent amount without issue. In addition, working with a property manager can ensure you have accurate market data to estimate a competitive rental rate for a property.
However, most rental properties don’t generate income throughout every month of the year. Property owners should assume a specific vacancy rate, which can range from 5% to 10% depending on market data—and again, how well you manage a property. After factoring vacancy costs into your numbers, you’ll have a good idea about annual rental income potential.
The operating expenses for a rental property are also essential to calculate when valuing an investment. Your operating costs can include projected property taxes after the sale, insurance, landscaping, maintenance, property management services, leasing costs, and any other costs that go into owning and managing your property.
It’s also important to include a provision for expected capital repair and improvement needs. Ideally, property owners should reserve an amount equal to 1-2% of a property’s value each year for these costs.
Once you know your annual revenue and expenses, you will be able to calculate your NOI. To do this, subtract all the annual expenses from the annual revenue. If, for example, your revenue is $19,000 per year and expenses are $4,500 per year, the NOI will be $14,500. While that’s an important number, you need a few more steps to learn a property’s value.
Determine and Apply Capitalization Rate to Conclude Value
Real estate investors can also utilize a capitalization rate (cap rate) to determine the property's value. Capitalization rates can vary based on location, type of asset, and asset quality. Obtaining market data about your target asset is important and will help you calculate a fair cap rate.
Once you have determined the cap rate, you can value the target asset by taking your projected NOI and dividing it by the cap rate. For example, if the NOI was $14,500 and the concluded cap rate was 10%, the value would be $145,000. If the concluded cap rate was 5%, the value would be $290,000. If the concluded value is higher than your purchase price, you can have peace of mind that you’re making a good purchase.
Challenges with NOI and Cap Rate Valuation
While these tips can help you develop a fair value for your investment purchase, you may find that gathering all the necessary data can be difficult. Determining local capitalization rates, occupancy, rental rates, and projected operating costs can be challenging. Work with the best property management company Detroit offers to find the information you need and evaluate potential investment properties.
Other Ways to Value Real Estate as a Good Investment
While using NOI and cap rates is a good way to value an asset, there are other ways to determine a fair value. Some different strategies are as follows.
Determine Cash on Cash Return
If your goal is to earn additional income based on your capital investment, calculating cash-on-cash return is a good idea. With this approach, a property owner can take excess cash each month after mortgage payments and compare it to the contributed capital.
Property managers can tell you that assuming appreciation when valuing a property is also important. Value appreciation can come with general market improvements or renovating the rental unit. Taking this approach into consideration and calculating a long-term investment return can be important when evaluating a property’s potential.
Value an Investment With Detroit Property Management Experts
While building a significant real estate portfolio is an excellent way to generate more wealth, properly valuing a potential investment property can be challenging. By following these tips and working with the best professional property management company Detroit offers, investors can understand potential ROI and avoid bad investments. If you need help valuing a property or analyzing (and improving) returns, Own It Detroit is here! Reach out to learn more about our full-service property management.
Use our free Calculate Your ROI resource to learn more about your rental property returns!