In this market, property valuation can be tricky. There are several methods used by professionals and investors to arrive at reliable, actionable valuations. There are also several other methods used by amateurs that should be avoided. First, let’s consider the methods to be avoided. Most of these have a “denial component” factored in somewhere designed to achieve a certain end. Of course, we’re all guilty of this type of rationalization but wishful thinking can get us hurt in a real estate transaction.
The bubble notwithstanding, Naples real estate has always been a stable investment. To win the game, though, we have to understand valuation better than the next guy. The simplest definition of value is the price at which a seller and qualified, educated buyer can agree. It’s simple enough, right? It starts to get cloudy pretty quickly, though. If we want to sell, we need to price our home competitively,or, if we’re buyers, to offer properly. We get taxed on the governments valuation of our property and, our mortgage will be calculated as a percentage of the banks valuation of our property. So, it stands to reason, we should polish our valuation skills a little bit.
These days, valuation is probably the most difficult and disappointing to sellers, so we’ll focus on them. As sellers, we need to look carefully at those “denial components” that must be removed from the equation. First, ignore what you paid for the house. This means that you should not bother calculating expected rates of appreciation or adding up how much you’ve invested in improvements. The market doesn’t care and you will, invariably, arrive at whatever number you’re looking for. Next, don’t listen to your parents, your kids, or your uncle who has his license. Unless they are willing to back up their appraisal with cash, it’s meaningless. Lastly, understand that you have an attachment to your home and your bias is not necessarily shared by the market.
Alright, so how to the pros value property. Appraisers and investors use a few simple methods to arrive at true value. They are primarily the Cost Approach, Sales Comparison Approach and the Income Approach.
The Cost Approach
This approach is based on the idea that total value can be determined by adding the value of the land to the depreciated value of the improvements. For example, let’s say there is a Naples golf home you’re considering that is priced at $1,000,000. Next door is a vacant lot that is virtually identical in all aspects that is priced at $200k and it is determined that the house could be built new for $600,000. Using this approach, we could conclude that the home was over-priced by at least $200,000. In hot or cold markets, I find this to be a good reality check on the next method, the Sales Comparison Approach.
The Sales Comparison Approach
This approach is probably the most used of the three and the most reliable, in my opinion. It is based on the simple concept that a qualified buyer will not pay more for a home than a comparable substitute would cost. To illustrate this, it’s easiest to use a condominium like Bay Colony in Pelican Bay. Let’s say you have three condos with identical floor plans and views of the Gulf. Variation in furniture or condition would be the only factors that might influence value. If two of the condos are priced around $5,000,000 and the third is $7,000,000, it’s unlikely the $7,000,000 condo will sell. As obvious as this appears, we see sellers price their property like this every day – no joke.
The Income Approach
Not really useful for residential Naples homes, this method is the primary way investors value multi-family property, apartment complexes and commercial property. And, if you’re shopping for a beach condo you intend to rent out, you should add this method to your valuation as well. There are several ways to apply this approach but the simplest is the GRM, the Gross Rent Multiplier. The GRM is the ratio produced when dividing the monthly (or annual) rental income into the selling price. If several similar properties have recently sold in the area, the GRM can be calculated for those and compared to the projected rental income for the subject property.
For more info on valuation, check out Wikipedia.
As always, the more prepared we can be, the better outcome we can expect. Apply these easy techniques to your next real estate transaction and prevail.