In real estate valuation. The concept of market value or actual worth must be interpreted differently from its meaning in stocks or bonds.
The difference arises for a number of reasons.
1)Each property is unique.
2)Term and conditions of sale may vary.
3)Market information is imperfect.
4)Properties may need substantial time for a market exposure time that may not be available to any given seller.
5)Buyers, too, sometimes need to act quickly.
By all this factor no one can say the true value of a property. It results properties sell for prices significantly above or below their estimated market value.
Estimating market value
In real estate, estimating the current market value of a piece of property is done through a process known as real estate appraisal. Using certain techniques, an appraiser will set the value on a piece of property. Using three complex techniques and then correlating results to come up with one best estimate.
Three approaches to real estate market value are.
1)The cost approach
2)The comparative sales approach
3)The income approach
The procedure for estimating market value.
1)The cost approach -In the cost approach investor should not pay more for a property that .it would cost to rebuild it today’s prices for land, labor, and construction materials. This approach to estimating value work well for a new building. Older properties, however, often suffer from wear and tear and outdated materials or design, making the cost approach more difficult to apply.
To value these older properties one would have to subtract some amount for physical and functional depreciation from the replacement cost estimates.
2)The comparative sales approach-This approach uses as the basic input variable the sales prices of properties that are similar to a subject property. This method based on that idea value of all given property is about the same as the prices for which other property recently sold.
If the investor can find at least one sold property slightly better than the one he is looking at, and one slightly worse their recent sales prices can serve to bracket an estimated market value for a subject property.
3)The Income approach -The most popular income approach is called direct capitalization.
Annual net operating income(NOI) is calculated by subtracting vacancy and collection losses and property operating expenses, including property insurance and property taxes from an income property’s gross potential rental income.
As estimated capitalization rate which technically means the rate used to convert an income stream to a present value. Obtained by looking at recent market sales figures and seeing what rate of return investors currently require.
Using an expert
Real estate valuation is a complex and technical procedure. It requires reliable information about the features of comparable properties, their selling, and applicable terms of financing. As a result, rather than relying exclusively on their own judgment.As a form of insurance against overpaying the use of an expert can be well worth the cost.