Valuation among key factors in real estate investing

For individuals who are contemplating investing in real estate, and

specifically investing in income-producing real estate, there are several important steps to consider.

The first step is to enlist help. Contact a real estate professional who specializes in the sale of income-producing properties.

The multiple categories of real estate make it difficult for a real estate professional to claim proficiency in all categories. By selecting a real estate professional who adheres to the Realtors Code of Ethics and specializes in a specific real estate category, a prudent real estate investor should be assured of a knowledgeable adviser.

Once an agent has been selected, potential investors should be aware of how valuation is determined. There are three fundamental approaches or methods used to establish the value of income-producing real estate:

• Comparative method: This approach uses data from recent sales of similar property to compare the value of the subject property. Size, zoning, date of sale, age, price, and location all are contributing factors in determining the validity of a comparable property. Comparing similar property features and sale prices to the subject property will assist in determining value.

• Cost method: This approach includes the itemization and the assignment of cost to all components that comprise the subject property. Land, materials, labor, fees for professional services such as engineering and architecture and development profit are considered.

Next, a depreciation factor – based on the anticipated life of the improvements constructed and the current age of the subject property – may need to be applied to the cost determination. Assuming the cost of the land and improvements built on the land represent fair market pricing, then this approach will assist in determining value.

• Income method: The third – and most referenced – approach involves determining the earning power of the subject property. In short, the greater the earning power, the greater the property value. The earnings of an income-producing property are determined by totaling the gross potential income of the subject property and then subtracting from the gross potential income the anticipated vacancy and collection loss factor and the operating expenses for the subject property (i.e. real estate taxes, insurance, utilities, management fees, repairs, miscellaneous expenses). The resulting net income represents the investor’s net income or earnings from the subject property. This net income or earnings number should then be divided by a reasonable equity yield required by typical investors. This equity yield fluctuates, but right now is between 8 percent and 10 percent, meaning that the equity yield prudent investors would require is between 8 percent and 10 percent of the value of their investment. The net income or earnings, when divided by the equity yield, will result in the value of the property.

Once value has been determined, the potential investor should determine the expected holding period of the real estate and the potential income and estate tax ramifications by consulting with a tax adviser.

Because determining valuation is so dependent on local markets and submarkets, the advice of a local real estate professional is paramount when real estate investment is being considered. Southwest Missouri is blessed with a diverse economy with jobs distributed in the areas of manufacturing, retail, health care, services, public and state institutions, and agriculture.

In addition, the region’s recreational and entertainment attractions and moderate climate make southwest Missouri an ideal retirement area.

These factors all contribute to a robust local real estate market whereby prudent investors should anticipate satisfactory returns on their local real estate investments for the foreseeable future.

Ken Schwab is a Realtor with Wilhoit Properties, specializing in sales and leasing of commercial properties. He may be reached at kschwab@wilhoitproperties.com.