Market Value v Investment Value. You're Not Overpriced; We're Not Lowballing
A valued colleague came to me with a question:
"My investor-client wants to purchase a home to rent out. He asked me 'what the rate of return is'. How do I figure that out? Is that the IRV formula?"
Well, yes, no, and wait.
Why is your client asking YOU what HIS yield is? He should be TELLING YOU his required yield!
This is a red flag, indicating that your 'investor' is really . . . not.
Measures of investment performance depend on many factors, not the least of which is property type and use.
You may not want to use the IRV formula (which calculates Cap Rate) to value a single family home used for rental. I wouldn't.
Cap rate determines the value of a property at a given moment in time. It's more useful in comparing the risk factor of several potential investments TODAY than measuring performance over time.
Your 'investor' needs to be thinking in terms of their initial investment, the property's annual net cash flows and its projected sale proceeds at the end of the holding period.
Internal Rate of Return (IRR) and Net Present Value (NPV) are useful in figuring out how each dollar you spend on an investment will work for you over your holding period.
Those are measures of INVESTMENT VALUE.
**Don't confuse Investment Value with Market Value.**
In many markets, it's literally a universe apart.
Investment value is unique to the investor, based on factors such as the investor’s individual requirements, investment alternatives, tax rate, and ability to finance the property.
So when you get an insultingly low offer on your single family home in an appreciating area of a hot market, don't get too upset.
I mean, you can roll your eyes, but consider the possible source of confusion.
And feel sorry for the hapless buyer's agent who did not dialogue with their 'investor' about whether they need to be buying at another time or in another place when/where they can get THEIR deal, instead of wasting time on a seller who will get THEIR deal from a non-investor buyer.