The current market in Walnut Creek, San Ramon, Danville, Lafayette, Pleasant Hill and surrounding areas is making investment properties in the area more and more lucrative. As an investor considers whether or not to pull the trigger on the purchase of a specific property, it’s imperative to be sure that they have calculated the proper valuation on the asset to ensure that it’s a good investment. In our last blog, we discussed some methods that can be used in order to assign proper value to a rental property. We discussed the following approaches:
- The income approach
- The sales comparison approach
- Gross rent multiplier
Please feel free to visit our last blog for more details on these three proven methods. In this blog, we’re going to go over a couple of additional methods that can be used to ensure the proper valuation of properties.
The Capital Asset Pricing Model
The Capital Asset Pricing Model is a bit more comprehensive and detailed than the methods we discussed in our last blog. This method strives to include opportunity cost and inherent risk as they pertain to the potential purchase of a specific real estate asset. CAPM sets a couple of different bases for comparison, such as the rate of return on US Treasury Bonds, or Real Estate Investment Trusts (REITs) in the area. These investments have basically zero risks. After the basis has been established for these safe investments individually, the model estimates the potential return on investment (ROI) for the property in question. If the estimated ROI for the property is less than the rate of return for one of the risk-free investment options discussed, it doesn’t make sense to purchase an asset with an inherent risk for a lower return.
The inherent risks to own real property vary from asset to asset. Location is one important factor to consider. If the property is located in a crime-ridden area, the amount of rent you can expect to charge will be significantly lower than the amount a safer neighborhood will command. You may also need to invest in additional safety precautions in more dangerous areas such as extra locks, fences, and even potentially bars on windows.
The age of the property is an important factor as well because the older a building is, the more maintenance you can realistically expect it to need. After taking these factors into consideration, the CAPM helps you determine what rate of return you deserve for putting your money “at-risk”. Once again, that ROI should be higher than the rate yielded by risk-free options in the market.
The Cost Approach
This approach is predicated on the notion that a piece of property is worth what it can be reasonably and legally used for. You calculate it by adding the depreciated value of any improvements on the property to the value of the land itself. This method is used frequently when assigning value to unimproved lots or vacant land.
Zoning factors heavily into the cost approach. If a parcel of land is not currently zoned for the use the investor intends, there will be a significant cost associated with getting the property rezoned. For example, if a property is zoned for single-family homes, an investor would need to get the zoning changed to high-density housing in order to build a condominium complex.
In the last couple of blog posts, we’ve covered five ways to calculate valuations on investment properties. Savvy investors will use a combination of some if not all of the methods we have discussed before to making an investment decision. Once these methods have been applied to a property and it’s deemed a good investment, the next logical step is to begin the process of securing the best financing for the purchase. We will go into this process in more depth in an upcoming blog.
As always, the experts in property management Walnut Creek California can be a tremendous resource for any investor. Please don’t hesitate to contact PMI Contra Costa with any rental property questions.
