Valuation

Capital appreciation is one of the goals of managing a property. The real estate manager would like to see the market value of a property go up over time so that it can be sold for more than the purchase price.

Valuation is an estimation or calculation of the worth of a property; it is often the result of the process of appraisal. One of the most important tasks of managing real estate as an investment is obtaining an accurate valuation of a property. An accurate valuation is required to assess the risk of financing as well as the return to the investor. Valuation also underlies the manager’s ability to assess the benefits of renovations, the decision to sell a property, and local property taxes and insurance. An understanding of valuation facilitates the manager’s ability to work with owners.

In the context of income-producing real estate, real estate has two types of value:

• Market value
• Investment value

Market Value

Market value is the most likely price the asset would command in the open, competitive market (the price at which a willing seller would sell and a willing buyer would buy).

Increased market value can be due in part to factors over which the real estate manager has little control, such as improved market conditions, short supply, inflation, and changes in tax laws. On the other hand, an effective real estate manager has considerable influence in increasing NOI through cost control, collections, careful budgeting, and rent increases. In addition, innovative management techniques, such as adapting and rehabilitating properties and refinancing, can create higher value.

Investment Value and Investment Equity

A property may have different values to different investors, for example an adjacent property to a property owned by an investor may be worth more to that investor. Investment value of a property is its worth to a particular investor, based on the investor’s specific requirements. Investment value changes because it depends on an individual investor’s or company’s financial strength, skills, and cost of capital. Market value remains the same. Investment value is more subjective than the market value of a property, as will be shown later in the lesson.

Investment value is calculated for the purposes of making investment decisions, and the financial management of the property may be set to influence investment value in light of these decisions. Both the value of the debt and the value of the equity must be considered when making investment decisions. Investors often will want to see the value of the equity, investment equity (aka positive leverage), when considering the best use of the property.

The equity of the property can be derived by subtracting the outstanding loan balance and anticipated costs of sale, if sold, from the current market value.

A third type of value, replacement value, reflects the cost to replace or restore a building to its preexisting condition and appearance. It is a common method of determining insurance coverage. In appraisal, replacement value equals the cost at current prices to replace an existing building with one of equal utility.