It’s common knowledge that a real estate property changes in value over time. Its value can either increase (appreciation) or decrease (depreciation) after purchase. This change can be due to certain factors such as the property’s structural condition, the developments in its location and surrounding areas, or regulations concerning the real estate industry.
As a potential buyer and investor, you must understand the concept of valuation. Having a good grasp of this subject can help you make a well-informed decision about your investment plans.
This article will provide a top-to-bottom guide on real estate valuation, especially in the Philippines. In particular, it will discuss some of the most commonly used terms in real estate valuation, the different valuation methods, and the factors that affect a property’s value.
What is Real Estate Valuation?
Real estate valuation refers to the process of determining the economic value of a real estate investment. This is used in both residential and commercial real estate and can only be conducted by a licensed appraiser. Several variables are used in assessing how much a property is worth, including the market conditions and capitalization rate. The latter estimates the rate of return on a real estate investment.
A property’s price (the cost to purchase it) is not necessarily the same as its value (the actual worth of the property). Even two identical houses next to each other can be very different, as they will vary in terms of condition, fixtures, and presentation. Therefore, their values will differ accordingly.
As a buyer or investor, understanding the complexities of real estate valuation will guide you in making informed decisions, helping you get the most of your real estate investment.
Real Estate Valuation in the Philippines
In the Philippines, determining the fair market value of real estate properties is a rather complicated approach.\
According to expert studies, one of the main causes of the problem is the presence of multiple valuation systems imposed by different government agencies. Contributing to this complexity is the lack of proper understanding by local government officials of the pricing of real estate properties in their respective localities.
To address the problem, experts note there is a need to establish a comprehensive property administration database and reliable real estate price index system in the country. These systems can guide policymakers in assessing existing valuation legislations, which can lead to the creation of an efficient and effective valuation system comparable to international standards.
4 Key Terms to Know
Real estate is full of jargon, and it can make the already complicated process even more confusing. Whether you’re buying or investing in real estate, it helps to know some of the most common terms used in real estate valuation so you can better understand the system.
1. Value Versus Cost and Price
Value is different from cost or price. Cost involves the expenses incurred in building the property, such as the expenditures allotted for labor and the purchase of construction materials. Meanwhile, price refers to the amount that a buyer pays to own the property.
While cost and price affect a property’s value, these two factors do not necessarily determine value. For instance, if a buyer finds a flaw in the house, such as defective gutters or leaky pipes, the value of the property could be lower than its price.
2. Market Value
Market value refers to the most probable price a property would sell for in a competitive and open market. Factors that may influence market value include the features and benefits the potential buyer would derive from the property.
Market value should not be confused with market price, which is the price at which the property actually sells. If a seller is under duress because of the threat of foreclosure, they may sell the property below its market value.
3. Appraisal
Appraisal is the process of estimating how much a property would sell in the current real estate market. The estimate is usually given by a real estate agent or professional who is familiar with the neighborhood and local market.
Besides evaluating the property’s probable market price, the appraisal process also involves predicting the seller’s possible return on investment or profit margin.
4. Equity
Equity refers to the investment an owner has in their property. It is calculated by deriving the difference between the property’s value and its price. In estimating equity, any mortgages or liens against the property are deducted from its market value. The amount left then becomes the equity.
For example, if you buy a house worth Php1.4 million and sell it for Php1.5 million, you gain equity, which is Php100,000. You get to keep the Php100,000 equity after the close and once the expenses are paid.
5 Valuation Methods in Real Estate
There are various methods employed in determining a property’s value, and each one is used for a specific situation. Here are five of the widely used valuation approaches.
1. Sales Comparison Approach
The sales comparison approach determines the value of a property by comparing the selling prices of similar, recently sold properties in the same geographical area. This method relies on sales data, where at least three properties should be used by the appraiser to determine the current value of the property in question.
While evaluating the value of a particular property, there may be price adjustments to expect. If the subject or target property does not contain a feature or two found in the comparable property, the price is reduced according to the value that can be had from the given feature. Accordingly, if the subject property possesses a valuable feature not found in the other property, the former’s value increases.
2. Cost Approach
The cost approach estimates the value of a property based on how much it would cost if it were to be reconstructed. In this method, the property’s value is determined by calculating the cost required to build an equivalent structure. The estimate particularly includes the cost of land and construction expenses.
3. Income Capitalization Approach
The income capitalization approach is often used in estimating the value of income-producing properties such as apartments, office buildings, and shopping centers. This method is based on expected future benefits; hence, the value of the property is tied to its yearly potential gross income.
4. Discounted Cash Flow (DCF) Method
Similar to the income capitalization approach, the discounted cash flow (DCF) method estimates the value of an investment based on the expected profit it will generate in the future. The difference is that the DCF approach mainly relies on projections of future cash flows.
Here, investors use the present value of money to determine whether the future cash flows of the property are equal to or greater than its initial value. If the DCF is higher than the cost of the investment, the opportunity is typically considered, as it could potentially result in positive returns.
5. Gross Rent Multiplier Method
The Gross Rent Multiplier (GRM) valuation method measures a property’s potential value by getting the ratio between the property’s price and its gross income. This formula is generally used to identify which properties have a low price in terms of their market-based potential income. For instance, if you purchased a commercial property for Php5 million and it generates Php800,000 in gross rents each year, your GRM would be 6.25.
This means that the property will take a little over six years to pay off its property price. Typically, you want your GRM to range from four to seven. This allows you to get as much rent as you can in the least amount of time.
7 Factors That Determine a Property’s Value
From location to size, various factors affect a property’s value. These things can either increase or decrease the property’s worth. If you’re looking to buy or invest in real estate, here are some valuation factors worth knowing.
1. Location
Location is one of the most important factors that impact a property’s value. Properties close to areas with high foot traffic usually have greater chances of appreciation. Likewise, the more accessible a property’s location is, the more valuable the property is.
Is the property close to restaurants, schools, hospitals, or the city center? Are gyms, shopping malls, parks, and other attractions found in the area? If yes, then there’s a great chance the property will have a high value.
2. Development
A property situated within the vicinity of areas being improved and developed is more likely to have a higher value compared to one located in a remote neighborhood. This is because developments tend to attract more population, which means higher demand for residential and commercial real estate.
As a home buyer or real estate investor, you have to think about future developments that can make your property more attractive for the general population, as this will play a major role in determining its value. You have to think that you are investing in the potential of the property and its surrounding areas.
3. Accessibility
Accessibility likewise plays a key role in determining real estate valuation. Properties that can be easily reached using various modes of transportation are likely to increase in value over time. The concept is that the lower the cost (in terms of time, comfort, and money) it takes to reach the property, the higher the property’s value is.
Various studies affirm this trend, noting that accessibility has a positive impact on a property’s value. Hence, properties developed with ease and convenience in mind are more likely to enjoy a higher market value, and derive a bigger ROI for the investor.
4. Renovation
Most real estate investors and homebuyers consider the property’s renovation potential when deciding to purchase or invest in one. This includes the likelihood of increasing the floor space, laying a patio, installing a pool, or adding an extra story. If the property provides an allowance for the buyer to personalize or improve the structure, then its value will likely increase.
5. Property age
Age is another factor used to determine a property’s value. Typically, newly constructed properties appraise at a higher value because the critical parts like plumbing, electrical elements, and roof are newer and, therefore, less likely to break down.
Aside from age, buyers also consider the condition of the structure when choosing a property to invest in. Ideally, you want a property that is structurally and aesthetically maintained to enjoy a higher market value.
6. Size and space
The value of a property in the Philippines is estimated per square meter. As of the second quarter of 2021, the average cost per square meter of residential-type construction is Php10,409. Generally, the closer the property to an urban area is, the higher its value is.
Apart from size, the usable space in the property is also factored in when determining real estate values. Bedrooms, bathrooms, and kitchens that can be extended are highly valued. Finished attics and well-developed basements also elevate the property’s value.
7. Building regulations
Building regulations often determine how the property may be used for residential or commercial purposes. For instance, if the policies allow restaurants, convenient stores, or boutiques to operate within the area, then the property’s value would increase due to its improved desirability and increased accessibility to shops.
Likewise, if a city rezones a residential area into a commercial zone, trendy businesses will move in, increasing the values of the residential properties due to the vicinity’s enhanced appeal.
Real Estate Valuation Helps You Get the Most of Your Property
Real estate valuation plays a major role in determining how much a property would sell. As a real estate buyer or investor, knowing how the process works can help you get the most of your property while helping you avoid bad deals and mistakes.
If you’re not seriously thinking about purchasing or investing in real estate at the moment, knowing the basics of the valuation process, along with the latest trends in the industry, can still guide you should you be ready to go into real estate in the future.
Now, if you’re in the market for your first or next real estate property in the Philippines, Mandani Bay is the property you should be looking at. In particular, if you’re on the hunt for a condo for sale in Cebu, our well-designed spaces offer vibrant living at their finest!