Given the growth of the real estate market and gradual stabilization of values as we approach the top of the market, it’s more important than ever to evaluate the equity position in our portfolios and make educated and informed decisions to keep holding or pursue an exit strategy. Appraisal plays a critical role in the investment process and can lend considerable insight to your approach.
Direction of the Market
The tenuous lending environment forces us to consider what strategy will allow us to continue receiving the greatest economic benefit from our holdings. In recent months, moves by the Fed have shown its concern that economic growth, while needing the temper of slight interest rake hikes, also needs to be encouraged to ensure strong lending activity. Over the last year, refinance volume has dropped significantly due to the interest rate increases, while purchase mortgage volume has exhibited marginal growth since last year. The availability of capital and still relatively low rates is allowing continued stability and appreciation in most markets.
Determining Value
You can easily gather an estimate of the value of real property held for income purposes using cap rate calculations based on the net income of the property. If you know the net operating income (NOI) of your asset and the prevailing rate of return demanded by local investors for your property type, location, and perceived risk, you can get an estimate of value by dividing the NOI by the cap rate. As an example, if your 4-unit multi-family generates an NOI of $124,000 and investors are seeking a 9.5% rate of return for the subject property class, the cap rate calculation would yield a value of $1,305,263.16. This is the basis on the income approach to valuation.
For strictly single-family property, the use of AVMs or automated valuation models can be of some aid. Examples include the ‘estimated’ values offered by so many public real estate listing sites. AVMs are essentially applying the substitution or comparison method of appraisal using data drawn from public sources such as market databases, tax records, and MLS data. The best approach is to request a formal appraisal to get a more precise valuation of your property based on all the available data and the experience of market experts.
Viable Exit Strategies
So how does it look? Is the value what you were expecting? How has the value of the property changed over the last 5 years, and during the term of your ownership?
If your cash flow isn’t improving or it’s at a point of stagnancy, it might be time to consider selling and reinvesting in a project with more upside. Alternatively, if you’re not ready to let it go, but see value-add potential and are willing to put in some effort and invest some cash, you can improve condition, decrease vacancy, increase rents, and pursue auxiliary revenue generation strategies.
Time to exit? You have few options: do you want to continue to earn a passive cash flow or are you ready to cash out?
If you see the market for your property improving and significant appreciation on the horizon, or if you see a value-add strategy that fits with your goals, it may be best to hold the property and make the needed improvements while the market takes its course. On the other hand, if it’s too much hassle or you see an eminent decline in value approaching, you can either fully cash out or sell and hold a note. The first may be best if you have better opportunities with higher rates of return, and the latter if you’re looking for tax deferral benefits and continued cash flow without management responsibilities. Either way, get an appraisal to know the specific market for your property and to proceed with certainty. A quality valuation can also give you an advantage in negotiations.
Following the Most Profitable Path
When considering how to move forward your investment strategy or entering negotiations with buyers and potential partners, knowing the marketing direction and your equity position gives you a distinct advantage and improves your long-term profit potential. Equipped with detailed market research, a thoughtful review of your investment strategy, and an expertly-prepared valuation, you’re in an excellent position to reap the maximum value from your property whether you choose to continue holding or pursue an exit strategy.
