As the economic environment brings about change, so property valuation must change to meet these new conditions. For property investors the value of a property affects everything from the purchase, property income, and importantly the investor’s ability to leverage for further investment. Before looking at any property valuation, an extremely important property investment tip is to understand what approach or property valuation method was used to determine it. From there you can cast a more critical eye over this vital element of property investment.

Property Investment Tips will look at the three most common methods of valuation and compare them as to how they relate to property valuation in 2010. There are three basic valuation approaches used to value property, with each using different means of finding the property’s place in the market. The methods include ‘the market date approach’, ‘the cost approach’ and ‘the income or investment approach’. The market data approach looks at the value of property sales in the area and finds how this property compares to the ones that have been sold. The cost approach uses the actual value of land and how much the property cost to build. The income or investment approach uses a formula based on the cost and income of a property to determine its value.

This series of property investment tips on property valuation articles will discuss the three different property valuation methods. The first article will discuss the market data approach, the second the cost approach and the third will explain the income or investment approach.

Click here to continue reading the property investment tips series on property valuation.

Next: The Market Data Approach.

The first article in the Property Investment Tips series on Property Valuation Methods looks at The Market Data Approach.

The market data approach to valuation looks at recent sales of comparable properties in order to ascertain a market value of the property. This approach relies on the marketplace dictating the acceptable price of property in an open market situation. One valuation principle that this approach relies on is the principle of substitution. The substitution principal dictates that a practical purchaser is believed to pay no more for a property or rental than it would cost to buy or rent an equally desirable alternative property that is on the market. Essentially what this is saying is that, people will not pay more for one particular property when there is an equally desirable property available for a lesser price.

Worldwide economic conditions have seen jobs lost and businesses close. With limited jobs available, the number of consumers who have defaulted on mortgage payments has increased. The flow on effect from this is that there has been a steady increase in the number of forced sales of residential properties through mortgagee and foreclosure situations. At the same time, financial markets around the world have had to tighten lending conditions due to a shortage of money flowing around the world. Interest rates, lending guidelines and requirements for greater equity behind investments have all contributed to a decrease in the number of active investors in the marketplace. Governments around the world are also getting involved, finding ways to regulate their respective property markets.

So in effect we have three different scenarios affecting the market, in very different ways. On one hand we have forced sales due to inability to pay for the associated lending against the property, and on the other we have tighter lending conditions for people looking to enter the market and we also have uncertainty surrounding the tax and structure of investment properties from the government. All these issues have the same outcome, which is to generate caution within the real estate market and reduce prices of those that are on the market.

In this current situation, it would seem that the market data approach to valuations may be the most appropriate. Given that so many variables are interfering with the value of homes, the best way to determine what a fair price is, would be to look at the most recent sales for comparable properties. The drawback to this approach would be that some of the comparable sales may have been under a forced sale condition and hence may not necessarily be in an open market environment. A counter argument to this could be that due to the number of people exiting the market at this point in time, especially through forced sale conditions, then this is in fact a reflection of the current market, and hence prices are fairly reflected. As prices are considered to be low (compared to 12-24 months ago) then it could be argued that those who are trying to sell their property at the moment, are only doing so because they need to do so for some reason, for example upgrading property or leaving the country etc. If you did not have to sell at the moment, when prices are down, then why would you? The substitution principal supports this methodology in the fact that people will only want to pay the cheapest price for an equivalent property, all things being equal.

Another drawback to the market approach is the heterogeneous nature of property, meaning that no two items of land are the same. For the market approach to work (a comparison of similar properties needs to be collected). This means, properties with similar sized sections in the same area, with similar sized and aged dwellings and improvements on the site. Nowadays many new developments are built to similar specifications (same house design on multiple sections) and hence new areas of cities can all look very similar. This works in the market approach’s favour as determining comparable sales is easier.

Next up on the Property Investment Tips series on Property Valuation Methods is The Cost Approach.

Click here to read the Cost Approach to Property Valuation.

The second article in the Property Investment Tips series on Property Valuation Methods looks at The Cost Approach.

The cost approach takes a different look at the value of a property. Essentially the value of the property is derived by first establishing the value of the land or section (the market approach may be used for this) then adding to this is the current value of the structure (adjusted for depreciation) and other improvements to give an overall value for the property. This approach has some limitations in terms of residential valuations, the key one being able to accurately calculate the depreciated value amount of the building and improvements. One situation where it would be used in the residential market would be to calculate the value of a property that is yet to be constructed.

An ‘on completion’ valuation would take into account the land value and the construction costs to determine the final value of the finished product. This is a highly subjective technique and can vary from valuer to valuer. There are times where external influences may interfere with this method, one of those being a market where supply is short and demand is high, in cases like this the value of an older property under the cost approach may not be in line with the value of the property using the market approach. The heterogeneous nature of property plays into the cost approaches technique when it comes to unique homes and properties. Where there may not be suitable comparable sales under the market approach, the value can be assessed by determining the land and building cost.

One needs to be careful when using this method that the amount spent on the property may in some cases not accurately reflect its value. A unique architecturally designed home that has had no expense spared in terms of its construction, may have been overcapitalised and the final value would be less than the actual construction costs. A couple building their dream home in which they plan to retire in may undertake such a development. In a situation like this, the valuer would need to apply common sense and perhaps undertake an additional valuation approach in order to conclude a fair value. The substitution principal is one of the paramount considerations to apply in the cost approach to valuation, taking into account that someone will not pay more for a property that they could acquire a similar site and construct a similar building for a cheaper price.

Next up on the Property Investment Tips series on Property Valuation Methods is The Investment or Income Approach.

Click here to read the Investment or Income Approach to Property Valuation.

The investment or income approach to property valuation looks at the income producing potential of a property and determines a value based on this. It is ideally suited to situations where the property in question is to be used as an income producing investment. By assessing the “present value of future benefits of future ownership” the income approach can determine the suitability of an investment. This method is not very common in application for residential investments due to the market approach being a more consistent and proven method. The income approach is used on a number of commercial property valuations but is often overlooked in residential. For this method to work, a suitable capitalisation or cap rate must be determined, which is then used to determine the total value of the property based on the proposed income stream. To determine the income stream, a fair rental amount must be calculated. This is then summed to come to a total amount for the year and depending on what the cap rate is, a final value is reached.

For example a 3 bedroom home may attract $350 pw in rent. Over a year this calculates to $18,200. Assuming the valuer used a cap rate of 5%, the total value of the property would be $364,000 ($18,200/5%). This may seem to be a reasonable assessment of the buildings value and not far off the mark for a house in that particular area. The issue lies in determining an appropriate cap rate. How was that 5% determined? Depending on the location (town, suburb, street) a different cap rate would need to apply. Using the market approach in that same area, we can work backwards to determine the cap rate. We take two properties, one in a new suburb that is classed as highly desirable, the other in a older suburb that is classed as less desirable. Their respective values are $350,000 and $240,000 (this example from my actual portfolio). The $350,000 home has a fair market rental figure of $360 per week or $18,720 per year. This equates to a cap rate of 5.35% ($18,720/$350,000). The less desirable house has rental income of $285 per week or $14,820 per year. This equates to a cap rate of 6.18% ($14,820/$240,000).

In the commercial property market, it is easier to determine the cap rate of a property, as the market values of similar properties are found using the market approach, the rent or lease returns are easier to calculate and from there a cap rate is found. By assessing the cap rate of a number of similar properties an appropriate rate can be found and based on the existing lease and expense details a fair value can be determined.

Click here to read the conclusion of the Property Investment Tips series on Property Valuation Methods.

Property Valuation Methods: Conclusion.

Finally, the conclusion of the Property Investment Tips series on Property Valuation Methods

As we can see, the three valuation techniques discussed in this series all use different methods to determine the value of a property, and all three have different situations and property types where their use may be more appropriate.

The market data approach determines the value of a property based on sales of similar properties in the area. This is the most commonly used method of residential valuation but has limitations in the fact that all property is heterogeneous and sometimes locating sales of a similar property may be difficult. The cost approach assesses the value of the land and then determines the depreciated cost to construct the building and improvements that exist on the land. This approach is suited to properties that may be difficult to value under the market approach. Properties that have one-off designs, unique construction or special purpose properties are all difficult to compare and so a cost approach may be a better method to use. The limitations of this method become apparent when a building has been built at great expense and is actually worth less than it costs to build; overcapitalisation of a property can be difficult to account for under the cost method. Finally the income, or investment, approach to valuation looks at the income earning potential of a property and bases the value of the property on the projected revenue that the building can earn. This method is extensively used when valuing income producing properties such as commercial buildings, but is not often used in the residential market due to the difficulties in assessing a fair income return on the property. In the case of an owner occupied home, the income potential from the home may be argued as being zero.

The best property investment tip is to use combination of the three valuation methods is recommended. By applying one technique and then confirming this through a second or third method, an accurate idea of the property’s value can be determined. Of course, the more experience that a valuer has in a particular market, the greater ability they will have in determining an accurate value and only one method may need to be applied.

Apartment buying for property investment can be risky. Therefore, it is important to keep some property investment tips in mind. For example, being mindful of oversupply and questionable quality can be an issue.

Location is linked with oversupply. There needs to be an actual need for apartments in a given area. If a city is closely surrounded by suburbs and is easily accessible, then apartments are not really required. The success of your property investment therefore hinges on the novelty or glamour aspects attached to it, and not the practicality, which is not ideal.

Investing in ApartmentsIn regards to quality, leaky building syndrome can be a particular problem. In New Zealand, if the building has it then the entire building (ie all the tenants) may be required to foot the bill as many of the building companies responsible have declared bankruptcy. The Government makes some contribution but ultimately the bill falls back on the owner.

Leaky building syndrome is caused by the use of inappropriate materials, installation or improper design, resulting in weather tightness issues. In New Zealand, the use of untreated timber has also been an issue as it was considered acceptable to building requirements until recently. Now that the untreated timber used in construction has been exposed to moisture, it has deteriorated and rotted.

When buying any building, but in particularly when investing in apartments, one of the key property investment tips is that an inspection process should be thoroughly undertaken. Leaky building syndrome can cripple you if your apartment or home has it. Repair bills in the hundreds of thousands are not uncommon. Those cheap deals you see may not have been a year or two ago but due to circumstance the owner may now be taking a huge hit to get rid of the property. There are a heap of stories of people losing lots of money in apartments. There are success stories of course, but they are less common.

Another big issue with apartments is obsolescence, in 5-10 years time the building can look like a slum from the outside, which will drive your value no matter what you do to the inside.

When buying apartments for a property investment you need to consider that all you actually own is a small chunk of a large building. It is harder to control your interests in the investment compared to a house, for example.

It’s not all negatives though. Apartments can be a cheap investment that probably has ok cash flow; just don’t bank on any capital gains to be safe, and remember these property investment tips of being thorough with your inspection and research!

Responsible property investment means having a good Properties Team.It is one of the most important Property Investment Tips.

John Donne once said “No man is an island”.

When talking about Property Investment, this expression could not be more fitting. Whilst it may be possible to build a property empire all on your own, it is a lot easier to build upon the knowledge and skills of others where possible. By employing the help of an expert, the amount of time that you can save as well as the amount of money you may save in the future should make the decision a “no-brainer”.

Who are these mystery experts that no Property Investor can do without? I’m talking about Solicitors, Accountants, Real Estate Agents and of course the support of Family and Friends. They can all be very valuable for Property Investment Tips and advice.

1) A Solicitor
Now a Solicitor may sound like a dirty word to some of you, but I guarantee that a good solicitor is worth his or her weight in gold. However, they will need to be specialized in the property field. A commercial litigator will not be a lot of help to you in this respect but a good property lawyer will be. They can examine all the legal aspects of any prospect you have, they can set up trusts, partnerships and companies for you to structure all your dealings and they can advise you on any legal obligations you may be accountable for, now or in the future. Solicitors are very easy to find and most should advertise their credentials. Shop around and ask people in the know who they may recommend for your properties team.

2) An Accountant
An accountant will be able to advise you on the best ways to set your respective empire up from a tax and benefit perspective. They will prepare your financial accounts at the end of the financial year and the really good ones will be able to set out your finances in a way where you may be able to save yourself a bit of tax. You may have to liaise with both your accountant and solicitor to set out your portfolio in the best way possible. Like a solicitor, accountants are very easy to source. Try to find one that specialises in property. Most accountants will offer a free consultation before they commence working with you. Talk to them and get a feel for how they operate, if you don’t feel comfortable, then try someone else. Remember they are there to work for you, not the other way around.

3) A Real Estate Agent
Real Estate agents are the men and women on the ground in your properties team. Until you are in a position to know your market 100%, these are the people to talk to. From sales volumes to what prices are doing and where the place to buy is, a real estate agent should be able to give sound advise. Once you have been in this game for a while you will develop your own feel for things and may not need to rely on an external agent as much. It’s always good to have the contacts in place to have a catch up every once in a while, just to double-check your own thoughts. In real estate circles, big would appear to be better, with the most popular sales agents generally being popular because they sell more property and have a good idea on what the market is doing. Try to stick with these people, they will not be hard to locate.

4) Your Family & Friends
Whilst these particular people may not offer any particular specialist skills, they will be able to offer help, support and ideas to assist you with your decision-making. Having the support of family can do wonders for stress levels and having good friends you can call upon from time to time to help out with the odd job (as long as it is reciprocated) can save time and costs. Friends may have undertaken a similar endeavour as yourself, of which they may be happy to steer you in the right direction. Remember a problem shared is a problem halved.

Whilst there will be many others who will no doubt provide you with information and guidance along your path to investment nirvana, I believe that the 4 groups listed above are probably the most important components of your Properties Team.

Everyone has at some stage of their lives heard the saying “You can’t go wrong with property”. Some would have taken property investment tips like this and invested everything they had the very next day. Most of us probably smiled and thought nothing more of it. Here is a list of some property investment tips as to why property investment is the way to go.

1) To Build Wealth:

Property is seen as a proven way to build wealth. Millionaires have been made exclusively through property, and most successful investors will have a significant chunk of their portfolio in property. As long as a long-term view is used, even the most conservative investor can reap the rewards. There is a common saying out there that house prices double every 7/9/10 years (depending on what publication you read). Whilst this has been proven over certain time frames, it is important to remember that there have also been periods of time where prices have stagnated or even reduced. Over a long enough period of time prices will generally increase, hence the need for a long-term view when investing with property.

2) It’s Easy To Manage Yourself:

Whether it’s a Residential Investment Property, a Commercial Property or even a Shareholding in a large Syndicated Investment, it is something that everyone can get to grips with. Sure you will more than likely need an accountant to sort out your tax obligations and a solicitor to set your investment up in the best way possible, but that goes without saying. Once you get your head around the terms associated with your investment you won’t look back. There are a number of clubs, associations and forums for people in exactly the same boat as you where you can get property investment tips, and where information can be exchanged freely.

3) There’s Something For Everyone:

Whether you’re someone that likes to see exactly what you own and have total control or someone who likes the idea but can’t really be bothered with all the details, there is something for you in property. You can purchase a small rental and manage it in your spare time; you can purchase several properties and manage them as a full time occupation. You can even just hand the control over to a third party, let them take care of all the day-to-day requirements and you can watch your investment appreciate over the years. There is something to suit all personality types.

4) Tax Benefits:

Depending on what type of investment property you purchase and the structure in how you set it up, you may be eligible for a number of benefits. For example in New Zealand by holding your property in a special company you can negatively gear an investment property and then claim a tax rebate from the losses achieved in your company thorough your personal tax. You are able to claim back costs that you have incurred in the process of managing your rental such as accountants fees, travel costs, phone and office expenses. Whilst the benefits are an added bonus, I don’t know of any investors that got into property purely for the tax benefits that may be achieved. For a comprehensive summary on what you may be entitled to, a chat to your accountant and solicitor is recommended.

5) Retire Early And Enjoy Life:

By investing in property and building a successful portfolio the possibility of retiring early and enjoying your twilight years could become a reality. A smart and prudent investor could build a sizable portfolio from minimal investment. Having someone else paying off your mortgage or loan lets you:

a) Build wealth faster than you would have originally thought

b) Achieve financial goals and milestones a lot sooner

Once you have achieved your goals, you then have the option to reassess those goals and maybe continue to let it grow or else sell up and live out your days in comfort. You may be in a position to give your children a “kick start” on the property ladder and allow them to build a portfolio of their own.

There are many reasons to get yourself on the property ladder, be it for financial reasons or for the challenge of doing something you haven’t done before. There is a range of different property options with enough variety to suit most people.