Valuing investment property: what you should know

Valuing investment property: market value, profitability and capitalisation rate

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05.09.2023 | 6 Minuten

There are many reasons to value a property or have it appraised. For example, if you want to invest in an investment property, it makes sense to assess the purchase price before you do. The value of the property is also relevant for mortgage financing. In any case, we recommend dealing with the topic of real estate valuation carefully and at an early stage.

For investment properties, the market value is usually determined using either the capitalized income or the discounted cash flow method. But what do both these values mean and how are they calculated? And is hiring a specialist to appraise a property worth it? Find the answers to these and other questions in this article.

The market value of a property

The market value or fair value is the value that is determined in a real estate valuation. Both terms are used synonymously. The market value corresponds to the presumed, most probable current selling price on the open market. According to the definition of the Swiss Valuation Standard (SVS), the market value is the estimated amount for which a real estate asset should be exchanged on the date of valuation between a seller willing to sell and a buyer willing to buy, after a reasonable marketing period, in a transaction in the ordinary course of business, whereby each party acts with expertise, prudence and without coercion.

These factors influence the market value

Various factors are taken into consideration when valuing a property. Above all, location is decisive. Properties in well-developed, central locations are sometimes worth up to 40 percent more than comparable properties in peripheral locations. How sought-after a location is can be seen, for example, in the standard land value. This standard value can be defined for every plot of land in Switzerland. However, it should only serve as an indication, as it is derived from other land sales. When assessing the location, the surroundings of the property – for example, the view and immissions such as noise – as well as the tax multiplier of the municipality are also taken into account.

In addition to the land value, the value of the building or the potential use of the building is also a relevant factor for appraising the market value. The year of construction, number of rooms, living and usable area, floor plan, standard of construction and expansion possibilities as well as the condition of the property play an important role here.

For owners of investment properties, the potential return on investment is of course also of great importance. Find out what you need to pay attention to when calculating returns in our article.

Valuation methods: how the market value is determined

There is no general formula or approach to appraising the market value. The calculation is based on the above-mentioned value-determining factors, the current situation on the real estate market and the valuation method used, which in turn depends on the type of property. In addition to the capitalized income method for investment properties, there are two other common methods: the comparative value method or hedonic method, and the real value method, also known as the replacement cost or asset value method. The latter is often used to check the plausibility of the earning power or the value given by the DCF method (discounted cashflow method). In this valuation method, the property value is made up of the new value of the property – minus age depreciation – and the value of the land.

Find out more about the comparative value method and the real value method, which are especially relevant for the valuation of residential property, in our article.

A view of a desk. A man determines the market value of a property using a tablet.
© Getty Images

The value of income properties: the capitalized income method

The capitalized income method is often used when valuing investment properties. With this method, the focus is on the rental income that can be sustainably achieved.

Capitalization rate

When calculating profitability, the capitalization interest rate, a real estate-specific interest rate, comes into play. This rate takes into account expenses associated with the property, such as capital costs, administrative costs, fees, insurance premiums, maintenance and repair costs, operating costs, depreciation of the building and the risk of lost rent. Ultimately, it indicates what running costs, expressed as a percentage of the value, can be expected for a property. As the capitalization rate depends on many factors, it must be determined individually for each property. To avoid a loss on an investment property, it must be at least as high as the returns used to cover the costs. The assumed rate of interest can also be provided with a risk premium.

Determining the capitalization rate requires not only expertise, but also access to appropriate software. For laypeople, we therefore recommend getting a professional real estate valuation. With UBS key4 mortgages you only need a few details to receive a free online property valuation for an initial estimate of the house’s value.

Calculating profitability: examples

The simplified profitability calculation, also known as the mean value method, is based on constant and sustainable rental income. The annual net rental income is divided by the capitalization interest rate:

Profitability = (annual net rental income / capitalization rate) * 100

In our example, we assume an annual net rental income of CHF 150,000 and a capitalization rate of 3.5 percent:

(150,000 / 3.5) * 100 = 4,285,714

If the capitalization rate is 5 percent with the same net rental income, profitability decreases:

(150,000 / 5) * 100 = 3,000,000

Therefore, the lower the capitalization interest rate, the higher the profitability.

Alternative to the capitalized income method: the DCF method

The discounted cashflow (DCF) method is an internationally recognized procedure for valuing real estate. Like the capitalized income method, it is used to value investment properties. In the DCF method, the net income expected in the future is discounted on the valuation date. This yields the present value, which corresponds to the market value. Discounting is carried out for each property in line with the market and is risk-adjusted, i.e., taking into account the individual opportunities and risks. This is a dynamic calculation method.

As part of the valuation, the individual income and cost items are analyzed and evaluated in detail. As a basis, the valuation specialist has access to the settlement values per property for recent years, the current rental situation and extensive market information. This basis is used to estimate the expected future cashflows and determines the discount rate.

DCF vs. capitalized income method

The main difference between the two methods is that the capitalized income method is based on a constant, sustainable income and cost structure. The DCF method, on the other hand, is particularly well suited to showing changes in rents – for example, a rent increase in the event of a change of tenant or after a renovation.

Overall, the discounted cashflow method is more comprehensive and allows for more precise valuation of investment properties. It can also be seen as an expanded capitalized income method. Nevertheless, the capitalized income method is also very accurate, as many different factors are already taken into account in the capitalization rate. It can also be conducted with less data and takes less time and has therefore become widely used, especially by banks.

For a well-founded valuation, it can also be useful to carry out the capitalized income method to get a second opinion.

Questions about how to finance an investment property?

Our advisory team will be happy to help you.

Getting a property professionally appraised: yes or no?

As shown, there are many different factors to consider in both valuation methods, which is not an easy task for a layperson. It is therefore recommended to get a professional valuation. Of course there is one central question for potential buyers of an investment property. How much does a professional real estate valuation cost?

The cost of having the value of a house or apartment appraised by a certified appraiser depends heavily on the size and complexity of the property. It is also crucial whether the property has been inspected – which is usually the case – or whether the estimate is only made on the basis of the property documents. The scope of the documents to be procured also plays a role.

The decision on how a property is valued also depends on what the appraisal is needed for. In the event of an inheritance or divorce, for example, a short assessment is sufficient. If the property is to be sold as an investment property, a comprehensive assessment makes sense.

Conclusion: it’s worth having an investment property appraised

The costs of a professional estimate are worthwhile. Especially if you want to take out a mortgage for an investment property, a good property valuation is essential. Because the higher the value of the property, the more equity you have to contribute. The requirements regarding affordability and the level of mortgage interest also increase. This one-off investment will pay off in the long term. In addition, it may be useful to have two independent expert opinions prepared in order to have comparative values. We’ll be happy to advise you.


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