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How to Estimate a Rental Property’s Fair Market Value

There are three basic methods used by appraisers to determine the fair market value of income producing real estate that real estate investors might find helpful when buying investment property.

In this article, we’ll discuss how each one works and then show you how you would estimate the market value of a subject income property based on each method.

Income Approach

The income approach method for determining a property’s market value is where you use the return you desire from your cash investment and then capitalize that percentage by the net operating income being produced by the property.

Let’s say, for example, you desire a 8.5 percent return on your investment and you estimate the net operating income (NOI) for the subject apartment to be $38,500.

Computation: $38,500 / 8.5 = $452,940

Result: You would be willing to pay $452,940 for the apartment complex based upon its income stream and your desired return on investment.

Market Data Approach

The market data approach makes use of a list of properties comparable to the subject property and determines a property value-price per unit. In this case, these comparable properties should be in similar areas, with similar apartment sizes, amenities, appearance and rent structures, and should all be buildings that have sold recently.

You would then divide the prices at which each building sold by the number of units in each apartment complex to determine an average price per apartment to use as a multiplier. The average price per unit is then applied to the subject income property.

Let’s say, for example, you create a list of six comparable apartment complexes in the local area and determined that they sold for an average of $60,000 per apartment and your subject property contains seven units.

Computation: $60,000 x 7 = $420,000

Result: You arrive at market value of $420,000 for the subject property based on the market value approach.

Cost Approach

The cost approach method estimates what it would cost to replace the entire apartment complex. In other words, what would it cost to buy the land and build a building identical to the subject property?

First, you must determine the land value. If a study indicates comparable land is selling for $10 a square foot and the subject property is on a 100 x 200 foot lot or 20,000 square feet, then the land is worth $200,000.

Second, you must determine what it would cost to replace the site improvements such as the parking area, lawn, shrubs, trees, etc. You determine it would cost about $30,000 to replace them.

Finally, you must compute what it would cost to duplicate the building. If the subject apartment complex has seven one-bedroom apartments of 600 square feet each or a total of 4,200 square feet, and it would cost $60.00 a square foot to build, then the cost of a replacement structure will be $252,000.

Computation: $200,000 + $30,000 + $252,000 = $482,000.

Okay, but the subject income property is several years old, so we must establish a comparable by figuring a depreciated value on the $252,000. In this case, assume the subject income property has depreciated 20 percent or $50,400, thus leaving a depreciated value for the building of $201,600.

Re-computation: $200,000 + $30,000 + $201,600 = $431,600.

Result: You arrive at market value of $431,600 for the subject property based on the cost approach.

Estimate of Fair Market Value

By correlating all three of the appraisal methods and in this case, making the judgment to put a slightly heavier emphasis on the income approach, you arrive at a final estimate of the subject property’s market value equal to $440.000

Yes, the final estimate of market value is subjective, and other real estate investors might arrive at a different estimate of market valueArticle Submission, but hopefully you get the idea.

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