As a real estate investor, it's important to understand how to use and conduct a real estate market analysis when buying and selling an investment property, whether it be commercial real estate or in the residential market. Real estate markets are fluid. Changing economic conditions, adjustments in supply and demand, or property income and revenues will all affect the value of a property at any given moment.
Rather than having to rely on real estate professionals every time you look at a potential investment opportunity or want to determine your property's market value, learn how to conduct your own market analysis to help you make more informed decisions when investing in real estate.
What is a real estate market analysis?
A real estate market analysis is an in-depth property analysis that helps identify a commercial or residential property value. A market analysis, which can also be referred to as a comparative market analysis, identifies market trends such as average rental rate, vacancy rate, and supply and demand in the market area and looks at comparable property (comps) using sales data from properties similar in features, location, and property type to derive a price range or likely sales price.
When is market analysis used in real estate?
Market analysis is typically used when a property is being purchased or sold. Real estate investors may use a real estate market analysis when considering an investment to determine its current as-is market value or gain a snapshot into the market as a whole in the property's area.
Additionally, property owners may want to have a market analysis completed when it comes time to sell. This can help them gain a better understanding of where the market stands and what a realistic list price is at the given time.
How to conduct a residential real estate market analysis
If you're conducting your own residential market analysis, start by assessing the market area. Determine the sales activity for the area, how many homes are for sale there, average days on market, and general supply and demand.
Most of the time, this information can be found online for free from industry websites like Zillow (NASDAQ: ZG) (NASDAQ: Z), Redfin (NASDAQ: RDFN), or Realtor.com. However, if you can't find this information yourself, you can also call a local real estate firm in the area.
From there, you'll want to dive into the nitty gritty. Consider the crime rate and supply and demand. Look for new developments underway or other projects that might be in the process of being rehabbed. The county or city permitting department can often provide data on this. In bigger cities, these reports are often regularly provided by the city or county.
Next, look at the neighborhood features that may add or deter from the overall value of the property. Nearby shopping centers, restaurants, and quality or ratings of local schools can help or hurt a property's value. Again, this information is typically provided for free from industry websites. You can also use Google (NASDAQ: GOOGL) Maps Street View to walk the streets if you aren't local.
Also, dive deep into the numbers deriving the property's value. I personally like to use the property map on Zillow or Redfin that shows recently sold comparable properties. This is not the website's automated valuation but the actual map on the website that shows properties similar in size and area that have recently sold. Zillow even allows you to filter results to certain criteria, which can include square footage, number of bedrooms or bathrooms, lot size, age of home, and days sold.
I look for properties similar in property style, such as ranch, colonial, one-story versus two-story, and similar in condition and features, such as pool versus no pool. Ideally, you'll identify three properties that sold in 90 days or less, as well as three properties for sale and pending sale in the area. Using the average price per square foot from the comparable properties, you can find market value of the subject property.
Negative market features, such as lower demand now compared to 90 days or more, and negative property or neighborhood features, such as being close to a railroad, in a less-desirable location, or on a busy street, for example, should be factored in by deducting a small percentage (2% to 5%) per negative feature from the total market value.
How to conduct a commercial real estate market analysis
Commercial real estate market analysis is a bit more complex. Unlike in residential real estate, values for commercial property are determined by the income produced or potentially produced in the given market, not necessarily by using comparable properties alone.
Just as with a residential market analysis, start your report by determining market conditions and looking at market trends. What is the current supply and demand for the specific property type, and how many projects are under construction or awaiting permitting approval? What are the average rental rates, occupancy, and vacancy rates for that sector in the market, and what is the average cap rate?
Next, confirm property features, including the number of rental units in the property, square footage, lot size, zoning, and property features. Then you'll want to run an income and expense report to determine the property's net operating income (NOI). If a property is underperforming or has high vacancy or isn't performing at all, look at average income and expenses in the market and run a pro forma income and expense report, which shows what the property could earn if it were improved.
The net operating income is multiplied by the average cap rate to find the likely sales price of the property. Most professional market analysis will include comparable properties for reference, but here, the value or sale price of the comparable property isn't the helpful information, but rather the cap rate at which it sold for.
The Millionacres bottom line
Conducting your own real estate market analysis is actually a lot easier than you might think. Once you find trusted resources for the data you're seeking, you'll be able to confidently analyze a property or market at any given moment and trust your valuation is on par with real estate professionals.
If you're diving into a new market or if the data just isn't there, don't be afraid to get a professional market analysis or seek help from a pro. They may be able to provide further insights into the market you might have missed.