Investment Approach is one of the three methods used in estimating the market value of real estate. The other two methods are: Sales Comparison Approach and Cost Approach. In this article, I discuss the investment approach. Investment Approach is also referred to as the Income Capitalization Approach. You arrive at the value of real estate by multiplying the rent by a factor. The logic here is that the value of real estate is determined by how much rent you can get from it. It follows therefore that the higher the rent, the higher the value. There are three steps in investment approach method of valuation.
Steps in Investment Approach
Step 1: Ascertaining the market rent
The first step under the investment approach method of valuation is to ascertain the market rent of the real estate. So how do you estimate the market rent? You do this by finding out what similar properties have been let at. You will need to make adjustments for the differences if any. Like in the sales comparison approach you will exclude properties let under force, coercion, ignorance, desperation, or involving special relations e.g. brothers or business associates. The reason for excluding these sales is that they do not reflect the market.
Step 2 Obtaining the multiplier
The second step in investment approach is to obtain the multiplier. The multiplier is simply the factor by which rent is multiplied to give market value. In valuation, we call this multiplier years purchase, or simply YP. You obtain the multiplier by dividing sale price of real estate by the market rent per annum. For example if a property has been sold for 12,000,000 and its market rent is 50,000 per month, the multiplier will be 12,000,000÷(50,000×12) = 20. The level of accuracy will improve with the number of sales analyzed in this manner. As a precaution, only use multiplier from the same sub-market e.g. high income apartments, town houses, middle income apartments, maisonettes, industrial property, apartment blocks etc.
Step 3 Applying the multiplier
The final step in the investment approach is to apply the multiplier to the rent established in step 1. If your property can be let at a market rent of 65,000, applying the multiplier as above, the value would be 65,000x12x20 = 15,600,000.
Stephen Omengo
Registered Valuer, Registered Estate Agent & Registered EIA Expert
Real Estate Consultant at Tysons Limited, Nairobi-Kenya
Personal blog: www.StephenOmengo.com
Personal email: stephen@StephenOmengo.com
thanks, i always value your articles because it helps me along the way as a trainee valuer.This is rather a comment but our market data are always unreliable thus making these approach difficult to use or apply.
Thanks Andrew,
As a valuer you will need to analyse a lot of data. This will help you to detect the ones that are misleading (not market) so that you can leave them out. The final value judgement will then be reliable and you will feel happy with your valuation
Hello There. I found your blog using msn. This is a really well written article. I’ll be sure to bookmark it and return to read more of your useful information. Thanks for the post. I will definitely return.
Thank you Steve, your blogs are really helpful, it has helped me answer some question on valuations and new land laws
Hi Mary,
Thanks for the complements.
Regards.
Simple, brief , accurate, concise and straight to the point. Thanks.
Thanks and much appreciated.
Thanks , it’s been helpful
Welcome Tracy
What would be your approach in obtaining the YP in instances where there is little or no records of sales?
Dear Marcel,
Where there are no sales at all, it will be pretty hard to compute Years Purchase (YP) given that YP is the result of the division of Sale by Rent per annum. Few sales may be a good pointer to the YP. You may consider listings but exercise a lot of care to confirm their reasonableness. It may be prudent to consider comparable markets. For instance, you may compare Nairobi South B vs. Nairobi South C; Langata Estate vs. Golfcouse Estate; Runda vs. Spring Valley; Middle Income Estate in Kisumu vs. Middle Income Estate in Nakuru. If the markets are comparable, YPs must also be comparable.
Have a pleasant career.