In The Real Estate Business School, we say that profit in modern real estate is made in one (or both) of two ways:
- Buy way below market value to allow for repairs and holding costs.
- Increase value significantly by adding buildings, tenants, or repair/rebuilding the property.
Of course, we can teach you the basics, if you’re willing to learn. Here’s a quick step-by-step guide to analyzing the profitability of properties. It differs for residential and commercial properties, so let’s split them up first.
The Real Estate Business School’s Guide in Analyzing Residential Property Profits
Residential properties are typically divided into one of three listing types necessary to determine profits. There are obviously more listing types than this, but only three are used for your purposes. To perform a residential comparable market analysis (CMA), you’ll need to gather active, expired, and sold listings in the area to determine a fair market value of the property being listed.
Each listing type has a different value expectation:
1. Active Listing Values
Active listings are the competition. These are properties currently on the market that your potential buyers will be looking at alongside your listing. It’s important that you look as good as the active listings in your area (preferably better), meaning properties need to be in a general median range.
Properties that are listed well below or above other houses require further investigation to find out why. Listing lower than market value is a sign these are likely distressed properties that can be easily negotiated. Listing above market value means there are premium upgrades to the house. Both require a professional inspection to find out if the value is realistic.
2. Expired Listing Values
Expired listings are typically overpriced and under-marketed. That’s why they didn’t sell. Sometimes the property is still technically on the market, but the owner is exploring other options to reprice the property. These listings should be separated in the CMA to explain variances in the values.
There’s no way to know how much these properties are overvalued until it sells. Of course, you can’t wait that long, so it’s time to check sold listings.
3. Sold Listing Values
Sold listings are the most important values in the CMA. This tells you what buyers are willing to pay for similar properties in the same geographic area right now. There’s no better gauge of consumer sentiment than a purchase, so treat these like gold.
In addition, residential properties need an appraisal, which is similar to a CMA but more details. A RealtorⓇ licensed to sell real estate may perform CMAs (aka Broker’s Price Opinion or BPO), while an appraisal license is required for an official appraisal. These truly dig into the property’s condition and any defects.
An appraisal shows active and sold properties for the sales comparison approach. The other approaches are cost and income. The cost approach is most commonly used in residential real estate, while commercial properties are evaluated using the income approach.
The Real Estate Business School’s Guide in Assessing Commercial Real Estate Values
Commercial real estate is much more refined than residential, as the appraiser analyzes income streams generated by tenants in the property. It’s known as the income capitalization approach or cap rate, and it’s one of the most important online real estate courses in Texas. Cap rate measures the ratio between Net Operating Income (NOI) and market value.
Divide the NOI by the cap rate, and you have a purchase price that buyers will be willing to pay. For example, an investor who requires a 6% cap rate for a $50,000 NOI will be willing to pay $833,333 for the property, or $50,000/.06.
Other methods of calculating the value of commercial properties are the Gross Rent Multiplier (GRM), COC (cash-on-cash return), and the Internal Rate of Return (IRR). Each method uses a different methodology, and each investor has different acceptable risk portfolios and cap rates they look for.
Make Your Property More Valuable
Ultimately, there are plenty of variables that determine a property’s value. The biggest wild card is what a buyer is willing to pay for it. No matter what every other property sold for, the only one that matters is the one you’re listing today.
Take online real estate courses in Texas with The Real Estate Business School. We offer the best online real estate investment courses for beginners and experts. If you have questions, call us at 800-624-5440 or email firstname.lastname@example.org.