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graph and calculator-How to Calculate the Purchase Price of Your Investment Property

How to Calculate the Purchase Price of Your Investment Property

Determining your key financial calculations will make or break your real estate investment. Although you might think your  work is done after you’ve decided where you’d like to invest, unfortunately, the work has only started. To determine the viability of an investment, the first factor you need to accurately evaluate is the purchase price of the property. This article shows valuable calculations used to evaluate the purchase price of an advertised property. In the coming weeks, you will learn to do more key financial calculations, including:

  • How much rent to charge
  • Income earned from the property
  • Return on the investment
  • Cash flow
  • Whether to factor in depreciation

A word of advice, before you get into the nitty gritty. NEVER GET EMOTIONALLY ATTACHED TO A PROPERTY. Emotions are best left out of business decisions. Emotions can trick you, but numbers don’t lie.

Key Financial Calculations

There are a few ways to try evaluating the purchase price of a property. One is to look at the assessed value of the property. But government assessments don’t reflect the actual value of a property. For example, if the assessment for this year was done in January, and now it’s November, almost a year of real estate activity has occurred which can dramatically impact prices.

A second method is to pay for an appraisal. However, each appraisal costs hundreds of dollars and this becomes very expensive when shopping properties. The home seller probably isn’t going to let an appraiser onto the property until you’ve made an offer.

The third and best method that is used by realtors is called comparables. This article describes how to use comparables to evaluate the purchase price of a property.

Evaluating Purchase Price With Comparables

What is a comparable? It is a reasonably similar property to the one you are considering buying. By comparing the price of a comparable it’s easier to determine if your property is reasonably priced. The rule of thumb is to look at three to six comparables, that sold in the last three months.

Evaluating the purchase price with comparables is easy to do in these 3 simple steps.

  1. Find Comparable Properties

One method is driving through neighbourhoods looking for comparable properties. If the property has a sold sign, the website honestdoor.com will show the most recent purchase price.

Honestdoor.com is also a great resource for finding comparables. By typing in a neighbourhood name, it will list all the properties sold within the neighbourhood.

If you’re lucky you will find an identical property to the one you are considering purchasing but you’re not likely to get that lucky.

A workaround is to search for the most similar property on honestdoor. Determine the differences between these two properties. Assign the value of those differences, and adjust the comparable property’s value to the value of the potential property. If they’re the same, then you know that the potential property is priced appropriately.

  • Other Methods of Finding Purchase Price

If your search didn’t come up with the comparable’s purchase price, try the government registry.

In Alberta, the government’s registry (Spin 2) keeps the actual purchase price of  houses (barring any financial malfeasance).  Find the SPIN 2 site here. It’s not the easiest user interface to work from but it does provide accurate information. CBC did a great article Here’s a free way to find the actual sale price of a home in Alberta on finding a comparable’s purchase price. If the map search that CBC described in their article, you can always get the legal title information from your municipality. In Calgary, there is a cost to this.

Once you have found the price of the comparable, it’s time to assign a value to the differences.

3 .Assign a Value to the Differences

All properties are not created equal. Location, amenities, age, neighborhood, among others, all factor into the equation to determine the value. Find three to six properties that have some of the following similarities:

  • Location
  • Amenities
  • Square footage
  • Number of bedrooms
  • Number of bathrooms
  • Garage
  • Construction material
  • Age of building
  • Access to transportation
  • Noise levels
  • Zoning
  • Basement Development
  • Condition/currency of building systems
  • Condition of interior
  • Condition of exterior

How do you gauge the value of these differences?  Here are two examples, one which estimates the value of a garage, and another that estimates the value of a bedroom.

Example 1: Property With Garage vs. Property Without Garage

The first option is to arrive at a dollar amount. Let’s say that you’re looking at a three bedroom property without a garage that is selling for $500,000. During your search you’re able to find a comparable three bedroom property, with a one car garage that sold for $510,000. You’re unable to find a three bedroom property without a garage. However, you find a couple of two bedroom properties with one car garages that sold recently.

Property one sold for $495,000 and property two sold for $485,000.

You also find comparable two-bedroom properties without a garage.  Property one, a two-bedroom without a garage sold for $480,000 and property two, a two-bedroom without a garage sold for $470,000.

The next step is to find the average value of the two-bedroom properties with garages in the same neighbourhood:

Average Price of 2 Bedroom With Garage
First 2 bedroom property with garage $495,000.00
Second 2 bedroom property with garage $485,000.00
Average price with garage $490,000.00

Then find the average value of the two-bedroom properties without garages in the same neighbourhood:

Average Price of 2 Bedroom Without Garage
2 bedroom property without garage $480,000.00
2 bedroom property without garage $470,000.00
Average price without garage $475,000.00

This gives you the ability to estimate the dollar impact that having a garage has on the property’s value:

Difference of Price With and Without Garage
Average price with a garage $490,000.00
Average price without garage $475,000.00
Difference $15,000.00

From the above calculations, you have estimated that a one-car garage adds a value of $15,000.

You can now adjust the value of the comparable three-bedroom property with a garage, by subtracting the value of the garage. That will make it comparable to the prospective property.

Estimate of Value of 3 Bedroom Without Garage
Value of 3 bedroom with garage $510,000.00
Value of a garage $15,000.00
Value of 3 bedroom without garage $495,000.00

Now it’s time to compare:

Comparing Calculated Value to the Asking Price
Asking price of property we are considering $500,000.00
Value of comparable $495,000.00
Difference $5,000.00

The difference between the asking price of the property and value of the comparable is $5,000. It’s a positive number, which means that the property you are considering is high by $5,000.

Determining Comparables

Two-Bedroom Property vs. Three-Bedroom Property

The number of bedrooms can also be used to determine property value.

Consider another two properties. The one difference is your potential property has three bedrooms and the comparable has two bedrooms.  Take the average price for two bedrooms, then take an average price for three bedrooms. Your research of two, three-bedroom properties, shows the average price is $500,000. A sample of two-bedrooms results in an average price of $475,000. This is how to determine the effect that the extra bedroom has on the estimated value of your property.

To summarize, first find the difference in value between the average three-bedroom and the average two-bedroom price:

Average Price Difference Between 1 and 2 Bedrooms
Number of Bedrooms Average Selling Price
3 bedroom $520,000.00
2 bedroom $475,000.00
Difference $45,000.00

Then divide that difference of the price of the two-bedroom property to determine how the extra bedroom impacts the purchase price.

Percentage Price Difference
Price difference, 2 to 3 bedroom $45,000.00
Price of 2 bedroom $475,000.00
Divide price difference by price of 2 bedroom (as percentage) 9.47%

From your research, you have determined that the price difference of a 2-bedroom to a 3- bedroom property is 9.4737 %.

Now,  imagine that you are looking at a three-bedroom property that you can buy for $500,000.

There is a virtually identical two-bedroom property in the same neighbourhood, except it has 2-bedrooms and sold for $450,000.

Here is the math:

Adjusted Value of Property
Price of 2 bedroom $475,000.00
Percentage impact of extra bedroom 9.47%
Dollar value of extra bedroom $44982.50
Add this to the 2 bedroom property $519982.50

The estimate of the price of a three-bedroom property is close to $519,982. This means that the property you are considering purchasing for $500,000 is underpriced by approximately $20,000.

Follow the same process for any other factors that appear on the list. For example, if you determine, by comparing properties in a different neighbourhood, that one neighbourhood is more or less expensive, work out the difference between the two neighbourhoods. Adjust the purchase price of the comparable accordingly to know if you are getting a deal. It’s possible to mix comparables. If the potential property has a garage and two bedrooms, while the comparable has no garage and one bedroom, perform the calculations to come up with a comparable. However, similar to making photocopies of photocopies, the integrity of the calculation is diminished with each additional variable.

Being able to identify good deals on property will help with the first business decision you will make as a property investor – should you buy the property? The more you understand and research the market by properly examining comparables, the more accurate your pricing research will be. The better you will be able to make informed decisions. Real estate involves a lot of decision-making; having the know-how to identify reasonably priced properties will set you ahead.

Stay tuned for the next article – how to determine an appropriate rent.

Author:  Gil Donkersgoed

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