Fair market value determines a property's worth. It is simply the amount someone in the current market would be willing to pay for a property. Every piece of real estate has some value whether it is in good or poor condition. If a property is priced right, no matter the market conditions, it will sell. If a property sits on the market without interest from any buyers, the seller is asking for too much. There are a number of methods that can be used to determine fair market value: Comparable Approach: You can determine a property's fair market value through the use of comparables by assuming that the property will sell for the same price that other properties similar to it have sold for. This is a very accurate way of determining what a property is worth. Make sure to compare the property of interest solely to properties that have sold recently, no longer than a year ago. Properties that have sold recently are proof of what someone is willing to pay for them; properties for sale merely show you what the seller hopes to get. Before you can use this method of determining fair market value, you need to understand what makes a property comparable to another. Most important is the comparable property's neighborhood. It must be located in the same neighborhood to achieve an accurate comparison. This does not mean they have to be on the same street, but in the same general region and caliber of neighborhood. Secondly, the type of properties to be compared must be alike. Do not compare a duplex with a single family home or a manufactured home with real property. The values of these types of properties vary significantly. Thirdly, the properties must share similar amenities: number of bathrooms, bedrooms, appliances, square footage, parking, landscaping, fencing, etc. Lastly, the condition of the properties: do they need any major repairs, and if so, how much will the repairs cost? If you struggle to find similar properties that have sold recently, you may need to deviate from the amenities a little, but compensate for the difference. For example, if you are trying to find the fair market value of a three-bedroom home, but only two-bedroom homes have sold in the neighborhood, you can still use them as comparable properties to the three bedroom. You just need to add some value above and beyond the sales price of the two bedrooms to compensate for that extra bedroom. Income Approach: With the income approach method of determining a property's fair market value, an investor uses the income that the subject property produces in comparison to the income that is produced by properties that have sold. This comparison can be made in two ways: with the property's capitalization rate (cap rate) or with the property's gross rent multiplier (GRM). Capitalization Rate: To determine a property's capitalization rate or cap rate, you divide the property's Net Operating Income or NOI by the purchase price. The higher the cap rate, the greater the returns will be for the buyer. By asking what a property's cap rate is first, an investor can save time. If the cap rate is not even close to what the investor finds satisfactory, instead of going through the list and routine of analyzing a property, he can move on to the next property of interest. Many owners, especially of small properties, do not know what a cap rate is, but if you know the property's Net Operating Income, then you can quickly determine it yourself. Similar properties usually sell for similar cap rates. By becoming familiar with the market cap rate, you can determine quickly if a seller is asking for more or less than fair market value. Whether the seller provides you with the cap rate or you determine it yourself, it must still be verified with the property's financial statements; income and expense statements and more importantly its Schedule Es. Gross Rent Multiplier: To determine the gross rent multiplier of a property, or a property's GRM, you divide the sales price by the property's gross annual rent. If a property has a gross annual income of $10,000 and can be purchased for $80,000, the seller believes that an annual GRM of 8 is appropriate, (80,000 / 10,000 = 8). The lower the GRM of a property, the higher the returns will be for the buyer. By knowing the average GRMs of similar properties that have sold, a prospective purchaser will have a general idea as to the value of a property being offered. For example, if the GRM for most properties in an area is 9, then a property whose gross annual rents are $10,000 will be worth $90,000. Because a property might have unusually high or low expenses, a gross rent multiplier gives only a rough idea of value; you should not rely solely on the GRM to determine a property's fair market value. Professional Appraisal: A professional appraiser can be hired to determine the fair market value of a property. The problem with relying on the value that an appraiser determines is that you are relying on what someone else is telling you before making an important decision. It is important to be self sufficient and verify the information that you receive from outside sources. Appraisers are not always accurate; some inflate the value of the property reported in their appraisal due to requests from property owners and loan officers. Although this is grounds for their licenses to be revoked, it still occurs. This is not to say that you cannot find a reliable appraiser. They are out there, but the only way to recognize one is to be able to determine fair market value yourself. In that case, you won't need to hire someone to do it for you. Also, it would be very expensive to hire an appraiser to determine the value of every property you analyze for purchase, especially when you will only purchase a small percentage of these properties. County-Assessed Value: The county periodically has an assessor determine the fair market value of a property in order to apply the appropriate property tax fee. The assessor does not go inside of the property but has information on the property's square footage, number of rooms, year built, available covered and uncovered parking, etc., to assist him. You can find the assessed value of any property by calling or visiting the county assessor's office. This information is public and available to you at no charge. These assessments are usually lower than the property's actual fair market value. They are sometimes outdated, or the county uses conservative assessments to prevent overcharging property taxes, which would create an uprising of disgruntled homeowners. Although the county assessor's valuation is often lower than fair market value, it is the investor's responsibility to verify this. Do not assume that the property is a great deal simply because the purchase price is thousands of dollars below the county assessment. Always run your numbers and rely only upon what the market is indicating. |
