Real estate analysis too often overlooks an important item: Other real estate. I mean, if there were a dozen homes of equal size and condition on a single street, wouldn’t the value of each tend to the same? Of course. Because they’re stores of value – stores of wealth – we purchase them for, we buy them to maintain and grow that wealth as long as we can as capital owners.
In this post I’ll share the steps I took to analyze data from over 2000 real estate transactions in my city. In a nutshell, It’s a real estate appraisal & analysis application written in Angular 2+. The data is fetched by REST calls made to the relevant APIs. This project covers how to send http requests for getting real time data.
What is a Real Estate Market Analysis?
A real estate market analysis is often called a comparative market analysis (CMA). It’s basically an analysis of the current market values of properties, comparable to a property you are looking to buy or sell. A CMA is a helpful tool to determine the market value of your own property, especially if you are trying to decide an accurate selling price prior to listing.
Something important to note is that a real estate market analysis is different than an appraised value, which is determined by a professional appraiser. A comparable market analysis is considered subjective and gives the seller information on the value of similar houses in the area.
While there are many factors to take into account when performing a real estate market analysis, it is completely manageable with an organized approach.
Your real estate agent may conduct a CMA for you to determine what price to list when selling or a price to offer when buying a home. Because no two properties are exactly the same, adjustments must be made to account for differences.
Why Should I Do a Real Estate Market Analysis?
You should always do a real estate market analysis, whether you are buying or selling a property and I’ll explain why. This analysis will help you understand the current housing market, how much properties similar to yours are worth, and if it’s an investment property, how much you can charge for rent.
The information gathered through a real estate market analysis or CMA helps the seller choose a listing price and helps buyers see if the asking price is too high, low or reasonable. A CMA should always be conducted to make sure both buyers and sellers are getting a fair deal, based on the value of the property.
By comparing similar properties on the market, you will be able to accurately put a price on a home.
What is a Real Estate Market Analysis?
A real estate market analysis is often called a comparative market analysis (CMA). It’s basically an analysis of the current market values of properties, comparable to a property you are looking to buy or sell. A CMA is a helpful tool to determine the market value of your own property, especially if you are trying to decide an accurate selling price prior to listing.
Something important to note is that a real estate market analysis is different than an appraised value, which is determined by a professional appraiser. A comparable market analysis is considered subjective and gives the seller information on the value of similar houses in the area.
While there are many factors to take into account when performing a real estate market analysis, it is completely manageable with an organized approach.
Your real estate agent may conduct a CMA for you to determine what price to list when selling or a price to offer when buying a home. Because no two properties are exactly the same, adjustments must be made to account for differences.
Why Should I Do a Real Estate Market Analysis?
You should always do a real estate market analysis, whether you are buying or selling a property and I’ll explain why. This analysis will help you understand the current housing market, how much properties similar to yours are worth, and if it’s an investment property, how much you can charge for rent.
The information gathered through a real estate market analysis or CMA helps the seller choose a listing price and helps buyers see if the asking price is too high, low or reasonable. A CMA should always be conducted to make sure both buyers and sellers are getting a fair deal, based on the value of the property.
By comparing similar properties on the market, you will be able to accurately put a price on a home.
How to Value Real Estate Investment Property
The Capitalization Rate
One of the most important assumptions a real estate investor makes when performing real estate valuations is to choose an appropriate capitalization rate, also known as the cap rate.
The capitalization rate is the required rate of return on real estate, net of value appreciation, or depreciation. Put simply, it is the rate applied to NOI to determine the present value of a property.
For example, assume a property is expected to generate NOI of $1 million over the next ten years. If it were discounted at a capitalization rate of 14%, the market value of the property would be:
\begin{aligned}&\$7,142,857\bigg(\frac{\$1,000,000}{0.14}\bigg)\\&\textbf{where:}\\&\text{Market value}=\text{Net operating income}/{\text{cap rate}}\end{aligned}$7,142,857(0.14$1,000,000)where:Market value=Net operating income/cap rate
The $7,142,857 market value is a good deal if the property sells at $6.5 million. But it is a bad deal if the sale price is $8 million.
Determining the capitalization rate is one of the key metrics used to value an income-generating property. Although it is somewhat more complicated than calculating the weighted average cost of capital (WACC) of a firm, there are several methods that investors can use to find an appropriate capitalization rate, including the following:
- Build-up method
- Market-extraction method
- Band-of-investment method
The Build-up Method
One common approach to calculating the cap rate is the build-up method. Start with the interest rate and add the following:
- Appropriate liquidity premium—arises due to the illiquid nature of real estate
- Recapture premium—accounts for net land appreciation
- Risk premium—reveals the overall risk exposure of the real estate market
Given a 6% interest rate, a 1.5% non-liquidity rate, a 1.5% recapture premium, and a 2.5% rate of risk, the capitalization rate of an equity property is 11.5% (6% + 1.5% + 1.5% + 2.5%). If net operating income is $200,000, the market value of the property is $1,739,130 ($200,000 / 0.115).
It is very straightforward to perform this calculation. However, the complexity lies in assessing accurate estimates for the individual components of the capitalization rate, which can be a challenge. The advantage of the build-up method is that it attempts to define and accurately measure individual components of a discount rate.
The Market-Extraction Method
The market-extraction method assumes that there is current, readily available NOI and sale price information on comparable income-generating properties. The advantage of the market-extraction method is that the capitalization rate makes the direct income capitalization more meaningful.
It is relatively simple to determine the capitalization rate. Assume an investor might buy a parking lot expected to generate $500,000 in NOI. In the area, there are three existing comparable income-producing parking lots:
- Parking lot 1 has NOI of $250,000 and a sale price of $3 million. The capitalization rate is 8.33% ($250,000 / $3,000,000).
- Parking lot 2 has NOI of $400,000 and a sale price of $3.95 million. The capitalization rate is 10.13% ($400,000 / $3,950,000).
- Parking lot 3 has NOI of $185,000 and a sale price of $2 million. The capitalization rate is 9.25% ($185,000 / $2,000,000).
Taking the average cap rates for these three comparable properties an overall capitalization rate of 9.24% would be a reasonable representation of the market. Using this capitalization rate, an investor can determine the market value of the property they’re considering. The value of the parking lot investment opportunity is $5,411,255 ($500,000 / 0.0924).
The Band-of-Investment Method
With the band-of-investment method, the capitalization rate is computed using individual rates of interest for properties that use both debt and equity financing. The advantage of this method is that it is the most appropriate capitalization rate for financed real estate investments.
The first step is to calculate a sinking fund factor. This is the percentage that must be set aside each period to have a certain amount at a future point in time. Assume that a property with NOI of $950,000 is 50% financed, using debt at 7% interest to be amortized over 15 years. The rest is paid for with equity at a required rate of return of 10%. The sinking fund factor would is calculated as:
\begin{aligned}&SFF=\frac{i}{(1+i)^n-1}\\&\textbf{where:}\\&\text{SFF}=\text{Sinking fund factor}\\&i=\text{Periodic interest rate, often expressed as an}\\&\phantom{i=}\text{annual percentage rate}\\&n=\text{Number of periods, often expressed in years}\end{aligned}SFF=(1+i)n−1iwhere:SFF=Sinking fund factori=Periodic interest rate, often expressed as ani=annual percentage raten=Number of periods, often expressed in years
Plugging in the numbers, we get:
- 0.07 / (1 + 0.07)15 – 1
This computes to 3.98%. The rate at which a lender must be paid equals this sinking fund factor plus the interest rate. In this example, this comes out to 10.98% (0.07 + 0.0398).
Thus, the weighted average rate, or the overall capitalization rate, using the 50% weight for debt and 50% weight for equity is:
- 10.49% [(0.5 x 0.1098) + (0.5 x 0.10)]
As a result, the market value of the property is:
- $9,056,244 ($950,000 / 0.1049)
If you’re interested in entering the world of real estate investment, there are five types of real estate to consider:
- Office
- Industrial
- Housing (multi- or single-family)
- Hotel
- Retail
Each type of real estate has nuances, including lease length, building permits, and property laws. Make sure to research these nuances by geographic location when deciding which real estate investment type makes sense for you.
There are several ways you can get involved as an individual investor, including owning property outright and contributing capital to a real estate venture or real estate investment trust (REIT). Each has its advantages and disadvantages, namely when it comes to control over the investment property and opportunities for diversification.
Owning property provides you with the most control over your investment. For instance, imagine you decide to buy an apartment building in Boston and do so by leveraging debt. As the landlord, you can choose who to lease the apartments to, how much to charge for rent, and how much money to put into the property to increase its appeal and value. Owning one building doesn’t make for a diverse portfolio, however, leaving you vulnerable to anything that could damage the building or its appeal, such as a fire or pest infestation.
Conclusion
Real estate is a lucrative investment for many individuals and companies today. More and more people are starting to buy property on a regular basis. This has been on the rise ever since the real estate market shifted from being on the brink of collapse to fully recovering from the damage done by the housing bubble burst. This surge in popularity has led many people to question what factors can affect property values, and how they can benefit from this important information.