How to value property — A Beginner’s Guide
Today we have more information than ever before. One area in which knowledge is power and a few right decisions can set you up for life is property, so listen up. If you have a dream to buy a property or are already looking at taking the leap, here is how to value them. The best thing about valuations is that different properties are worth different amounts to different people, so there really aren’t any wrong answers.
There are three ways we can value property…
The Comparable Sales Method
The best option for Residential Property and my favourite of all three methods, the Comparable Sales Method is simply Comparing a subject property to other, similar properties that have sold recently. The trick is to make sure you are comparing the “Big Five” attributes, and only those attributes.
The only five things that effect the value of a property are:
1. Location — this includes the suburb, position within the street, location of the building and orientation of the block.
2. Land — this includes the size of the land, the zoning of the land and how it can be used. It also includes things like the slope or gradient of the block, the frontage to the street as well as any other restrictions on how the land can be used.
3. Accommodation — this refers to how many bedrooms, bathrooms and other areas the home offers, as well as the space offered by each. It is important that when comparing two similar properties, the size of each room and the size of the house or building overall are also compared.
4. Condition — this includes the condition of the building and renovations, how old they are and what lifestyle is offered. Examples of more objective categories that could be used here are:
i. Luxury Renovation
ii. Renovated
iii. Refurbished
iv. Unrenovated
v. Unliveable
By breaking the condition down into these five more objective criteria you can start sorting properties more quickly and be more accurate in your assessments.
5. Market Conditions — this refers to the wider economic climate at the time of the sale. The Global Financial Crisis may have skewed properties prices negatively for a couple of years. During times of relative wealth in the economy (a peak market), prices are higher. In order to compare properties, it is best to find sales within 6 months of each other to ensure they are comparable. In low turnover areas you can widen this search to 12 months but be wary, if a similar property has been sold 6 months or longer ago it may not be comparable at all. If you follow the market changes over time it is easier to adjust your pricing based on this criteria, if you don’t it is important to speak to a few people that do to get the right information when pricing.
A Practical Exercise in Valuing
When I purchased my house I outlined the Comparable Sales Attributes (Location, Land, Accommodation, Condition & Market Conditions) along one side of a spreadsheet (left to right) and then the comparable properties I found along the other (from top to bottom). You can see by the example I found 8, usually a minimum of 3 is standard but I recommend 4 to 6 similar properties is best (if you can find them). I then ranked each on a 1–10 scale. Each property starts at a 5, being the median, and then you gain one point for “better than” and lose a point for “worse than”. E.g. if the house is in a worse location, it goes from a 5 to a 4. If it has less land it loses another point. You can then get an objective look at how much better or worse they are. After a bit of practice you won’t need to do this exercise but with all our innate (and learned) human biases it is best to try and be as objective as possible. It could set you up for life…
Here is an example of my setup:
The Capitalization Method
Don’t be scared by the name, just think of the Capitalization as what the property is worth purely as an investment. Essentially you are turning property into money. One definition of Capitilization is the conversion of assets into Capital! If you are looking at apartments, a commercial office, retail or other investment the Capitalization Method is a great way to set yourself some targets and value what you see. The real trick is to ask yourself, “What is the purpose of my investment?” Ask yourself this not just once, but throughout the process to make sure you are pointed directly towards your goal. If you want a recurring “passive” income, that is the Yield, or often just called a great return. If you want a property that is going to grow in value substantially over time, that is referred to as Capital Growth. There is a balance between both for every property, but it is very difficult to find a property with both. Most small apartments which offer you a great return every month may not increase in value over time as much. Conversely, large family homes on big blocks may not give you the best yield every month but will grow in value over time substantially more. Once you have decided which you prefer you can take the steps below to weigh up your options.
Steps for the Capitalization Method
- Find the recent sold prices of a particular investment
If you are looking at apartments, just stick to sales in the building or nearby, if three apartments have sold between $350,000 and $400,000 then you now have a rough guide on where the value range will be. Now pick a figure! Let’s say we would like to think we can negotiate the lower end of that range — $350,000.
2. Work out the Net Operating Income
The Net Operating Income is the rent that you will receive after subtracting all outgoings or associated costs for the property. Holding the investment might include paying fees to a Body Corporate, paying your local Council Rates as well as an agent to manage the property. These costs do not include your mortgage. Work out everything else on an annual basis.
e.g The rent is $300 per week:
300/7(days)*365 = $15,642 per annum
Outgoings = $4,500 per annum
The Net Operating Income is $11,142
3. Divide the Net Operating Income by the Purchase Price
$11,142/$350,000 = 0.0318
We want to represent this number as a percentage so we just need to times it by 100 and round it up.
0.0318 = 3.2%
This figure represents a return of 3.2% on the money you are investing. If you find a similar apartment with lower associated fees and costs or a lower purchase price, it will increase your returns. Most quality residential properties in the inner-city have a 3–5% yield (or return). Set the bar as high or as low as you want but remember — there is always a balance between Capital Growth and Rental Yields.
The Summation Method
The word “Summation” is defined as “the process of adding things together.” That is, in this context, the process of adding the land value, the building’s value and all improvements on the land to come to a value for the property. The summation method is commonly used for industrial properties, machinery included, and is good for a quick “cross-check” for residential property. For most residential properties, however, this is not the best method.
Steps for the Summation Method
- Find out a per square metre rate for the location where the property is situated
This can be found through a Real Estate Agent, Property Developer or other Property Professional. If you want to get serious, the most accurate way is by utilising a data service, three of which I use are:
REIV — Property Data: https://reiv.com.au/
pricefinder — https://www.pricefinder.com.au/
Core Logic — RP Data: https://www.corelogic.com.au/subscribe
2. Multiply the rate per square metre by the amount of land
For example the Per Square Metre (psqm) Rate in a suburb is $2,142psqm . If the property you are looking at is 350sqm in size then the valuation of the land you would come to utilising the Summation Method is $750,000.
3. Add the cost of the building & any improvements on the land
Simply put, what is on the block? If it is an old weatherboard house with a garage, it could be $500,000 to replace. There could be a pool, beautiful gardens, or just a bird bath worth $50! Speak to a builder about replacement costs or talk to an insurer about how they value these improvements.
If more information was the answer, we would all be billionaires with perfect abs…
Now that you have an idea of how properties are valued, don’t let this information go to waste. The real difference between those who are successful in property and those who aren’t isn’t information, it’s knowledge. Knowledge is putting the information to good use, so go ahead and take over the world…one property at a time. Start by practising, pick a few properties you like the look of before you are ready to buy and value them. Try the methods above and then compare your numbers to the actual sales prices later on. Once you are comfortable and ready to become a billionaire with perfect abs, go out, negotiate and buy something. You never know, you might just make some money along the way and set you and your family up for a happy future.
