Property valuation, real estate appraisal, or land valuation is the process of developing an estimated value for real estate properties. In simple terms, it is a well-detailed report of a property’s value in the market. The process can be very complex, ranging from knowing what your residential property is worth, to knowing how to invest in real estate, it is important to have knowledge on how property valuation works, and how it can vary based on the type of the property involved (residential or commercial), and how it will be used.
Knowing the value of a real estate property can be very difficult because no property is the same. Each has different and unique features such as the number of bedrooms, bathrooms, square footage, rentable units, location, etc. A key determinant in knowing the value of a property is the real estate market itself; it is the reason why a duplex in Ajah can be millions of naira less than the same property type in Banana Island, so the real estate market matters. For example, areas with high supply and low demand will be lesser in value compared to areas with high demand and low supply.
In this article, we’ll be touching on two important things as regards property valuation, they are:
- Conditions that affect property valuation
- 3 Methods of property valuation
Conditions that affect property valuation
There are 4 conditions that affect property valuation. Hence, to make an estimate of a property’s value, economic and social trends, governmental regulations and environmental conditions must be taken into consideration. These conditions are:
Transferability: How easy it is to transfer ownership rights from buyer to seller
Demand: The desire of a person to be a property owner, and having the financial means to fulfill this desire
Scarcity: The limited amount of competitive properties that are supplied
Utility: Being able to satisfy the desires and needs of a prospect or intending buyer.
3 Methods of property valuation
The primary method of carrying out property valuation is referred to as a real estate appraisal. Engaging in appraisal can be a very complicated method, and it includes some of the methods or processes that are preferable for determining the value of such property. Whatever method will be applied in an appraisal is solely dependent on the type of property involved, and the reason for the appraisal. Real estate professionals or appraisers, use 3 major methods of appraisal or property valuation to determine the value of such property. The 3 most used methods of property valuation are:
- The Sales Comparison Process
This method is one of the popularly known and most used methods known to real estate professionals and appraisers. This method is solely used for appraising properties, mostly for the reason of wanting to apply for a mortgage. As the name states, the sales comparison process makes use of information or data from the real estate market, the sale prices in particular, so it can be used to estimate the value of a property.
It involves the appraiser or real estate agent making use of the sales price of a property in a certain area to compare to a similar property that is about to be appraised, the property with which another property is being compared is referred to as comparable or comps. Here’s an example, you’re looking to purchase a residential property and it has 2 bedrooms and 3 bathrooms, then the comparable should have the same thing, and the location of both properties must be close.
“Should” because, as earlier stated no property can be the exact same thing, so in a situation when there are differences, adjustments are usually needed in order to account for these differences. Appraisers must be skilled in identifying the differences between the comparable, and how to value these differences in order to make the right adjustments to the property that is to be appraised.
2. The Income Approach Method
The income approach method is a method of property valuation that specifically common to rental properties and commercial real estate, the overall process revolves around the ROI (Return on Investment) value of the property, and this ROI value is usually estimated by how much the said property can generate.
This method involves the appraiser or real estate agent calculating the gross potential income, and then subtracting the expenditure and vacancy period, in order to figure out the total income that is gotten from such property. After this is gotten, the appraiser then applies a capitalization rate in order to get an estimate of the total value of that property.
A capitalization rate is defined by investopedia.com as “the rate of return that is expected to be generated on a real estate investment property”.
3 Cost Approach Method
The cost approach method involves considering the value of a property as the cost of that property plus the cost of replacing that property (costs of construction) and subtracting the functional and physical depreciation. It deals with different estimates of value for the property, and taking depreciation into consideration, these estimates are then added together to get the value of the entire enhanced property. This method is commonly used for specialized and unique properties that are not easily sold like government buildings, hospitals, and schools.