How to Make Your Rental Properties a Cash Cow!
How to Make Your Rental Properties a Cash Cow!
Introduction:
Some individuals feel that
producing a valuation is unnecessary if a certified appraisal has been
completed. However, an investor's valuation may differ from an appraiser's
for several reasons.
The investor may have different
opinions about the property's ability to attract tenants or the lease rates
that tenants are willing to pay. As a prospective purchaser or seller, the
investor may feel that the property has more or less risk than the appraiser.
Appraisers conduct separate assessments
of value. They include the cost to replace the property, a comparison of recent
and comparable transactions and an income approach.
Some of these methods commonly lag the market, underestimating value during
uptrends, and overvaluing assets in a downtrend.
Finding opportunities in
the real estate market involves finding properties that have
been incorrectly valued by the market. This often means managing a property to
a level that surpasses market expectations. A valuation should provide one's
estimate of the true income-producing potential of a property.
The income approach to evaluating real estate is similar to the process for valuing stocks, bonds, or any other income-generating investment. Most analysts use the discounted cash flow method to determine an asset's net present value.
Highlights
Ø Some
individuals feel that producing a valuation is unnecessary if a certified
appraisal has been completed
Ø Valuing
real estate using discounted cash
flow or capitalization methods is similar to valuing stocks or
bonds
Ø The
only difference is that cash flows are derived from leasing space as opposed to
selling products and services
Ø An
investor's valuation may differ from an appraiser's for several reasons
Ø Properties
are valued by discounting net cash flow or
the cash available to owners after all expenses have been deducted from leasing
income
Ø If
the assessed value is in line with the market and the required rate of
return offers an adequate return for the risk involved, the
owner may decide to hold the investment until there is a disequilibrium between
the valuation and market value
Summary
·
Some individuals feel that
producing a valuation is unnecessary if a certified appraisal has been
completed.
·
Valuing real estate using discounted cash
flow or capitalization methods is similar to valuing stocks or
bonds.
·
The only difference is that cash flows
are derived from leasing space as opposed to selling products and services.
·
NPV is
the property value in today's dollars that will achieve the investor's
risk-adjusted return.
·
The NPV is
determined by discounting the periodic cash flow available
to owners by the investor's required rate of
return (RROR).
·
Since the RROR is
an investor's required rate of
return for the risks involved, the value derived is a
risk-adjusted value for that individual investor.
·
By comparing this value to
market prices, an investor is able to make a buy, hold, or sell decision.
·
Properties are valued by
discounting net cash flow or the cash available to owners after all
expenses have been deducted from leasing income.
·
Valuing a property involves
estimating all the rental revenues and deducting all expenses required to
execute and maintain those leases.
·
Tenants usually pay their
portion of the increase in expenses for the period after they move into the
property.
·
In triple-net leases, the tenant
pays a pro-rata share of all property expenses.
·
The following are the types of
expenses that have to be considered when preparing an income valuation: Leasing
costs
·
The capitalization rate for
determining the reversion value of the property in year 10 is estimated at 10%.
·
This capitalization rate equals
K-g, where K is the investor's RROR and
is the expected growth in income.
·
The value of the property in
year is derived by taking the estimated NOI for
year and dividing it by the capitalization rate.
·
Figure 2 provides a basic format
that can be used to value any income-producing or rental property.
·
Investors purchasing residential
real estate as rental property should prepare valuations to determine
whether rental rates being charged are adequate enough to support the purchase price
of the property.
·
If the assessed value is in line
with the market and the RROR offers
an adequate return for the risk involved, the owner may decide to hold the
investment until there is a disequilibrium between the valuation and market
value.
·
After gaining some rudimentary
knowledge about local market standards, lease structures and how income and
expenses work in different property types, one should be able to forecast
future cash flows.
Results
The valuation assumes a property that creates an annual rental income of $100,000 in year one, which grows by 4% annually and 3% after year 10.
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