How To Evaluate What a Property Is Worth

According to Andrew Baum, for anyone who is considering buying or selling a house, looking into an investment property, or managing a large property portfolio, it’s important to know the market value of such a significant asset. A simple way to accomplish this is by using one of three different valuation approaches: direct capital comparison, the income approach, or the cost approach.

Transcript

So why is valuation important? And, in this context, we were talking about valuation as a way of assessing the most likely selling price of something.

 What it’s really about keeping the score, and for a variety of purposes, people need to keep the score.

Imagine, for example, that you are a large property owner, how do you know what your balance sheet looks like? You need to know what the most likely selling price of your property assets is and are in order to assess your asset value. Keeping the score in a balance sheet.

 If you’re an investment manager, how well is your portfolio performing? And in keeping that particular score, you need to know how the capital value of your property assets has improved or maybe fallen over, let’s say a year, in order to assess your performance, your total return on those assets.

There’s also a strong need for, for property valuations, if you are a bank lending money secured against those assets. Property investors use a mixture of their own equity and, and lenders debt in order to buy any assets. And that’s true for all of us buying houses and bank-lending or mortgages. The bank will want to know what our property is worth, in the event that they have to take it back and sell it to recover their loan.

 When we think about assessing the most likely selling price of something or the market value, we’re likely to use one of three different valuation approaches.

These are direct capital comparison, the income approach, and the cost approach.

Direct capital comparison is most likely to be used in a homogeneous sector like residential property, where we have lots of similar houses or apartments, where we can use the selling price of one apartment as an indicator of the most likely selling price of a very similar apartment nearby.

The income approach is a way of building a discounted cashflow model for the most likely cashflow, that an investment property will throw off. So if we’re buying a residential property in order to receive a rental flow from it, what will that rental flow be? How can we discount that rental flow, and what will the resulting present value of that cashflow be?

And then finally, in a rare number of cases, it may be that we can’t use direct capital comparison because the asset is much too individual, or rare or unique, and we can’t use the income approach because it produces no income.

 So let’s, let’s take as an example a university building in Oxford. It’s very unlikely that there are any direct comparisons of recent sales. And it’s probably very unlikely that this building is achieving a market rental income that we can discount. The only thing we’re left with is working out what it would cost to build that building. How much would the land cost, how much would it cost to build the asset? And then we would make an adjustment for the depreciation of the building, to get the best possible estimate we can of something approaching a value, a market value.