There are various reasons you may need to evaluate the value of a real estate property, such as taxation, financing, and insurance. However, one of the most common reasons people seek to determine house valuation is when they're planning on buying or selling a place.
Being aware of the accurate market value of the property can help one make the right decision without facing any monetary loss. Read on to learn everything you need to know about the house valuation system.
What is Property Valuation?
In simple terms, a property valuation is the assessment of a real estate property's value. It factors in the location, size, floor plan, amenities, age, wear and tear, and other aspects to determine the market value of the house.
While the present worth of the house is essential while determining its value, it is also crucial to factor in the future benefits. Unlike most consumer goods that are used for a temporary period, real estate property can increase over time. This is especially true for houses that are located in up-and-coming neighbourhoods but applies to almost all houses. Therefore, the social and economic trends also need to be considered while determining the value of a house.
Some people confuse property valuation with mortgage lender's valuation. However, both of these are different things. While property valuation is generally very detailed, a mortgage lender's valuation is a much less in-depth assessment of the property.
For instance, let's say you're buying a house whose market value is $500,000. However, its mortgage lender's value is around $450,000. In this case, the mortgage lender will only lend you $450,000 for the house, and you'll either have to renegotiate the price with the seller or find other ways to gather $50,000. You also have the option to find another mortgage lender, but there's a low chance that they would put a higher value on the same house.
In general, you pay for the mortgage value evaluation as a part of the mortgage fees. It is only 2 to 3 pages in most cases and is solely for the mortgage lender's use. But keep in mind that having a mortgage lender's valuation does not mean you know the precise value of a house.
House Valuation Metrics - What is House Valuation Based on?
As discussed earlier, there are a number of factors that need to be considered to determine the market value of a property. However, there are three key financial metrics that play an essential role.
- Capitalization Rate
Commonly referred to as cap rate, this is the ratio between the original capital invested in a property to the amount of income produced over time. Basically, it is the real estate equivalent of the return on investment in the stock exchange market, as it helps evaluate the profit percentage of a property. Since real estate is a long-term investment, being aware of the cap rate can be very helpful.
- Internal Rate of Return
IRR is basically the rate of growth that a property can potentially generate over time. It estimates the interest that will be earned on each dollar invested in the property. For this purpose, it isn't enough to just consider the purchase price and net operating income. The projected cash flows for each year you plan on holding the property must be taken into account.
- Cash-on-Cash Return
This gives you an estimation of the total return on the money you can expect on your real estate investment. Cash-on-cash return is an important metric because it is the only one that takes your debt service and mortgage into account.
What is a House Valuation Report?
As the name suggests, it is a report that is generated after taking all of the above metrics and factors into account. From the capitalization rate to the location and even the mortgage lender, valuation is factored in to get a detailed house valuation report.
However, a house valuation report doesn't inform about any structural damage to the house. Therefore, if there are some impending repairs that need to be taken care of, the valuation report may not be 100% accurate.