Total Future Cash Inflows =
Amount of cash that should be received from all future payments buy home-buyer/tenants of a property. Can also include resale value if the investor expects to sell the property in the future to another buyer or investor.(Number of Payment Periods Left x Payment Received per Period) + Property Value (If it will be sold)
Visit the Calculating Value in Real Estate Page to learn how to value properties using calculations such as CAPM, NPV, and Capitalization Rate.
Calculating Value in Real Estate
There are many ways to evaluate potential real estate investments. To name a few:
1. Sales Comparison Approach – Evaluate potential real estate using metrics that are known about similar properties. Price per square foot is a common and easily understood metric that evaluates at what value a property should be priced. Furthermore, if a property is properly priced and the value per square foot is calculated, the investor can evaluate the rental income earned by properties with a similar value per square foot. Other metrics can also be used for comparisons.
2. Capital Asset Pricing Model (CAPM) – This model focuses on the risks and opportunity of a potential investment. It looks at potential return on investment (ROI) earned from rental income and compares this return to other investments that have no risk, such as United States Treasury bonds or alternative forms of real estate investments with less risk, such as real estate investment trusts (REITs).CAPM is a great way to evaluate whether the appropriate return is likely to be earned in relation to the amount of risk that the investor is taking on.
3. Income Approach – This approach evaluates the level of income that can be earned relative to the initial investment. This approach relies on the calculation of the capitalization rate. The capitalization rate is used to estimate the investor’s potential return on his or her investment.
Capitalization Rate = Net Operating Income / Current Market Value
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4. Cost Approach – This approaches goal is to fully evaluate the possible uses of the property in a less than ideal scenario. If for some reason the property cannot be marketed in the best case scenario, what value can still be extracted from the investment and what costs would be further associated with the second best scenario. Value that can still be extracted can include land value, mineral rights, another form of marketable real estate, assets, etc. and the costs that could be associated are renovation or rezoning costs. While this method is useful for evaluating all scenario, it is very subjective.
Sage Resources Investor’s Spreadsheet
There are also ways to combine these barometers for real estate investment profitability and other equally or more complex calculations. We have combined the calculations that we believe are most useful for evaluating potential investments and we made this downloadable spreadsheet. The spreadsheet has a description page that explains how to input minimal information to receive useful financial projections and profitability ratios.
Other useful resources:
- Rental Properties: 4 Ways To Value A Real Estate Property Article on Investopedia
- How to Determine an Income Property’s Value using Capitalization Rate Article on About Money