The current market in the greater Atlanta area is making the ownership of rental properties in the area an increasingly lucrative prospect. When debating whether you should purchase a rental property or not, it is necessary to check that proper valuation on the property has been determined to ensure that it is a potentially profitable investment opportunity. In our last blog, we covered a few methods that can be used to determine accurate valuation for a property. We went over the following approaches:
- The income approach
- The sales comparison approach
- Gross rent multiplier
Please feel free to visit our last blog for more specific details on these three approaches. In this blog, we are going to go over additional methods that can be used to calculate the proper valuation of properties.
The Capital Asset Pricing Model
The Capital Asset Pricing Model is more comprehensive than the methods we discussed previously. This approach is predicated on the estimation of the opportunity cost and the inherent risk as they pertain to the purchase of a property. CAPM establishes bases for comparison, such as the rate of return on US Treasury Bonds, or the rate of return on Real Estate Investment Trusts (REITs) in the area nearby. These investment instruments have essentially zero risks associated with them. After the basis has been determined for these relatively worry-free investments, the Capital Asset Pricing Model focuses on estimating the potential return on investment (ROI) for the property. If the estimated ROI is less than the return associated with one of the risk-free investment options, then it wouldn’t be a smart decision to purchase an asset that contains built-in risk but has a lower expected return.
The inherent risks of owning property vary greatly. Location is an important variable that warrants consideration. For example, if the property happens to be located within a crime-ridden area, the amount of rent you can expect to collect each month will most likely be significantly lower than the amount that would be collectible in a safer neighborhood. You may also need to plan on additional monetary investment for safety precautions in these more dangerous types of areas. Extra locks, fences, and even potentially bars on windows may be good ideas to help protect your investment.
The age of the property is also an extremely important factor to consider. The older a building is, the more maintenance you can expect it to require. After taking all of these factors into consideration, the CAPM helps you determine what rate of return you should expect for putting your hard-earned money “at risk”. Once again, that return should be higher than the rate yielded by risk-free options available in the market. Otherwise, the property is probably not a very lucrative investment option.
The Cost Approach
The cost approach is predicated on the notion that a piece of property is in reality only worth what it can be reasonably and legally used for. This method computes value by adding the depreciated value of any improvements made on the property to the value of the land itself. This method is commonly used when assigning value to vacant lots or unimproved parcels of land.
Zoning is a key factor to consider when it comes to the cost approach. If the parcel of land in question isn’t currently zoned properly for the purpose that the investor wants to use the land for, there will be a significant cost associated with getting the property re-zoned. If a specific piece of land is zoned for single-family homes, the zoning would need to be changed to high-density housing in order to build a condominium complex on that parcel of land.
In the last couple of blog posts, we have discussed a few ways to calculate valuations on investment properties. The focus has been mainly on evaluating properties for investment purposes, but the principles also apply to the purchase of property for personal use. Seasoned investors will use a combination of some if not all of the methods we have discussed before making a decision on whether or not to purchase a specific property. Once these methods have been applied you can conduct a thorough analysis of the property. If it is determined to be a potentially profitable investment, the next step would be to begin the process of securing the best financing for the purchase of the asset. We will go into this process in more depth in an upcoming blog.