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Real Estate Valuation Methods Sellers Need to Understand

Real estate valuations are tricky, and although there are several shortcut approaches, a thorough and in-depth valuation should be done by a professional real estate agent. They have the knowledge and experience required to do it right.
Real estate valuations are tricky, and although there are several shortcut approaches, a thorough and in-depth valuation should be done by a professional real estate agent. They have the knowledge and experience required to do it right.

When considering buying anything from toothpaste to a new car, people comparison shop. They look at the prices of similar items, they compare features, and ultimately decide which option is best for them. Real estate is no different.

It’s important to make smart financial decisions about buying and selling real estate, and this is tough to do without understanding the true value of your home, office, or other property. This is why getting a professional real estate valuation is so important. It provides you with the information needed to make the best decision you can.

Why Do You Need a Real Estate Valuation?

Anyone considering buying or selling a home or commercial property should consider getting a real estate valuation. Doing your homework about the property, the neighborhood, and the market will help you to make the best decisions about your sale or purchase.

Although you can do a rough valuation (thanks internet!) yourself, your best option is always to work with a licensed real estate agent who has experience in evaluating properties. They have access to data, current and historical, that they can use to determine the value of your property.

Types of Valuations

There are three main types of property valuations. Each one is used for a slightly different type of property, primarily based on the specific use of the subject property. The three types of real estate valuations are:

  • Income approach (commercial and investment properties)
  • Comparable sales (residential and sometimes investment properties)
  • Cost approach (non-traditional real estate)

Each of these types will provide an accurate assessment of the subject property being considered but are performed in different ways. Your real estate agent will be the best person to decide what type of valuation to use for your specific situation.

Income Approach

This method is most often used for income properties. Although thanks to sites like AirBnB and HomeAway, just about anything can be considered an income property, in this case it refers to commercial properties and investment property.

As the name suggests, a commercial property is one that is used for retail or business purposes, not for residential purposes. An investment property is most often a multi-family home or apartment building that someone is purchasing strictly to lease to tenants and collect rent money.

The income approach bases the valuation of the property on the income that it produces. To do this the process is broken down into four main steps:

  1. Estimate the potential income a property can generate in one year at full occupancy.
  2. Estimate the potential vacancy rate (based on similar properties in the area)
  3. Figure out the property expenses (upkeep, repair, taxes, mortgage, etc.)
  4. Calculate the net operating income (NOI) by subtracting #2 and #3 from #1.

If you wanted to take this a step further, you could calculate what is called the capitalization rate. This is done by dividing the NOI by the property purchase price. 4% to 10% per year is considered a reasonable cap rate and is the metric typically used by investors.

Comparable Sales

They use the comparable sales approach most often for residential properties (single-family homes and condominiums).

And it's exactly what it sounds like.  You find similar properties to yours and see what the sale prices were.

Additionally, It is important to note that you should not base this valuation on list price. Homes don’t often sell for the exact list price. Depending on the market, some may sell under and some may sell significantly over.

Because each home is different, you'll want to keep an eye out for different things. Depending on your type of property and any unique characteristics, finding truly comparable properties may be challenging. Most often comparing size (square footage, number of bedrooms and bathrooms, acreage) is the basic criteria. If you have a very special property you may want to get a little more granular with your search.

Using a Real Estate Professional

Although there are many online real estate sites that can facilitate a comparable sales real estate valuation, it really is best to trust this to a professional real estate agent. They will have access to historical property data, specific numbers, and information that you may not.

It’s important to keep in mind that the specific neighborhood a property is located in can drastically affect it’s value, for good or for bad. An area with high crime will bring down the value whereas an area with top rated schools will drive up the value.

Most real estate agents, including Clever agents, will provide a real estate valuation free of charge. If you are looking to sell your home, they will come to your residence, take notes and follow up with a detailed summary of your property, comparable properties and a real estate price valuation.

If you are looking to buy a property, your agent can do something similar, but obviously the subject property would be the one you are considering purchasing. Either way, using a professional is the quickest, easiest, and most accurate option.

Cost Approach

The cost approach method is the least common way of doing real estate valuations. The reason is that most real estate transactions are residential or commercial. They use this approach for non-traditional transactions such as buying and selling schools, churches, etc.

Unlike the income or comparable approach, the cost approach bases the value of the subject property on the cost of the land plus the cost of constructing the property. It then deducts the physical and functional depreciation.

To calculate the cost of land, they use a method similar to comparable sales. An agent would look at recent sales of acreage near the subject property and then use a price per square foot valuation to determine the cost of this plot.

The construction costs may vary depending on location, season, and demand. Again, looking at comparable properties and finding out the price per square foot for construction, then doing the math on the subject property is the best way to determine this.

If you have a truly unique property like a campground or a hospital, it’s going to be challenging to find something exactly like it. Finding things similar in a different location, for example, or nearby but slightly different size, will help you to at least come up with a solid estimate.

Ask an Agent

No matter if you are looking to buy residential or commercial property, or are in the market for a church, your best option is always to ask a reputable and skilled real estate agent. Clever agents can help you with all three types of real estate valuations.

Beyond that, property appraisers also charge a fee for a property valuation, and some real estate offices charge as well. If you are looking to sell your home or other types of real estate, a Clever agent can provide a free property valuation for you.

Even though you have lots of information at your fingertips, the best way to get an accurate understanding of the value of your property is to work with an agent.

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Andrew Schmeerbauch

Andrew Schmeerbauch is the Director of Marketing at Clever Real Estate, the free online service that connects you top agents to save on commission. His focus is educating home buyers and sellers on navigating the complex world of real estate with confidence and ease. Andrew has worked on projects for the United Nations and USC and has a particular passion for investing and finance. Andrew's writing has been featured in Mashvisor, L&T, Ideal REI, and Rentometer.

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