In today's age of computers and technology, it seems we are losing touch with some common helpful calculations that are important even if you do have a laptop, smart phone and all the other gadgets and gizmos. One simple valuation tool that all Realtors® who regularly deal with investors and investment properties should remember is a simple calculation that can be used to assess value absent any comps, though it still requires a certain amount of knowledge of the market and the area the property is located within.
All areas have their own range of market capitalization rates, but absent access to a computer to do a full CMA you can still assess value of investment properties by using the 1% rule with several simple adjustments. The 1% Rule is easy to use when evaluating investment property or other streams of cash flows and states that in general property should command rents equal to about 1% of its value. Determine the level of rental income the property commands or should command. If you know the rents a property receives, all you need to do is reverse the equation. Rents of $1,500 per month divided by 1% is $150,000. The beauty of this simple equation is that most people can do a the 1% calculation in their head to come to these figures. There is a catch, however, there always is.
First, most people leverage into a property, in other words, they only pay a small percentage of the value of a property and borrow the rest. Second, there are expenses associated with all property management that reduce the income. Third, interest rates and investment rates of return are constantly in flux. For these reasons, very few properties command rents equal to 1% of the value of the property. In my experience,however, most properties tend to command between 80% and 95% of that number. So once you determine rents and divide by 1%, you usually have to adjust upward to approximate value. But the beauty of the calculation to Realtors® and investors can be shown in the following example.
I was on a listing presentation for a large 18 acre developmental commercial property with premium road frontage. It is listed at $3.9 million, so you can imagine my desire to impress the owner of the property. I determined while talking with the owner that she also owned several other rental properties and she was curious about my knowledge of investment properties (as she had tried to sell a property but then taken it off the market). To demonstrate my knowledge I asked her what the rents of one property commanded. She replied that it received about $3,000 or so in monthly income. Knowing the general area that it was in I jumped in and told her that she had probably had it listed around $330,000 (a bit higher than $300,000 because of the above listed exceptions). She looked at me in shock and told me it was listed at around $340,000. Simple calculation, exceptional results. She thought I was a whiz with numbers (like Dustin Hoffman in the movie "Rainman", hence the title of this post). Needless to say, I got the listing. Now, are you perhaps interested in 18+ acres of land just north of Dallas with great road frontage, quite a steal at only $3.9 million...