How to appraise any Investment Property

If you want to know how to crunch the numbers and work out how much an investment property is worth then it is worth watching this video, updated July 2016. It shows you the calculations you can use to work out if any property is a good buy for you.

Newbies, as well as seasoned investors might find this interesting, and learn how to evaluate their own properties with this methodology. Below the movie are all the figures.

Now, here's some appraisal calculations with examples.

** Some appraisal firms use maintenance costs of $500 per unit. A fixed percentage of 5 % is most commonly used.

Investment Property Appraisal Methods:

How does one determine the value of an income producing residential property?

There are a number of methodologies that can be employed to determine value. Some of them are as follows:

1. Cap Rate. Comparing the "capitalization rate" of the subject property to those of other properties recently sold, in the immediate area. This creates a percentage return on investment from the perspective of the Buyer having paid for the property in cash, with no mortgage.

It is calculated by dividing: Net Operating Income x 100 divided by the selling price.
ie. $35,566 divided by $639,900 = 5.5 % cap rate

A lower cap rate (ie. 5.5%) reflects an expensive neighbourhood, low risk, and good long term capital appreciation (a blue chip stock analogy)

A higher cap rate reflects a higher risk. IE. a rooming house in a run down area may have good cash flow, but there are inherent problems with this type of property.

Conversely value or sale price is calculated by:

Sale Price = NOI x 100 divided by the Cap Rate.

2. Gross Income Multiplier.: Comparing the gross income generated by the subject property to that of other properties recently sold, in the immediate area, times a "multiplier". If similar buildings in the area have sold for an average of 12.4 times the ERI gross, then the value could be assumed to be $639,900.

ERI of $51,648 X 12.4 = $639,900

Use when the operating expenses are unknown or suspect. There are two G.I.M.’s:

A) Scheduled Rental Income Multiplier (SRIM) It ignores vacancy and bad debt allowance.

B) Effective Gross Income Multiplier (EGIM) It takes into account vacancy and bad debt allowances (deduct 4% from SRIM)

3. Net Income Multiplier: Comparing the net income generated by the subject property to that of other properties recently sold, in the immediate area, times a "multiplier". For example if a building nets $ 35,566 and similar buildings have sold for an average of 18.0 times the net, then the value could be assumed to be $639,900.

NOI of $35,566 X 18.0 = $639,900

4. Average Price per Apartment: If similar buildings to the subject property have sold for an average of $106,650 per apartment and there are 6 apartments in the building, then the value could be assumed to be $ 639,900.

5. Cost of Replacement Value: Separating the land value from the value of the building, how much would it cost to construct a new building on the site of the subject property. Is construction replacement value $85 per square foot or perhaps $125 per square foot?

6. Operating Expense Ratio: While this is not specifically a valuation method of an income producing property, it will tell you about the financial efficiency of your costs as compared to income.

The OER generally ranges between 25% to 45% and is affected by the age of the building and who pays for utilities.

OPERATING EXPENSE RATIO = TOTAL OPERATING EXPENSES (TOE) divided by the EFFECTIVE RENTAL INCOME (ERI)

IE:* TOE x 100 divided by ERI = $16,082 divided by $51,648 = 31.0 %

RETURN ON INVESTMENT CALCULATION - Example:
(Assume a five-plex building sold for $600,000 and the Buyer used a 25% down payment which is $150,000)