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.
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