Does Zillow really work?
Zillow is a computer program that analyses “closed sales data” and “tax assessments records” which are pulled from public tax records from the local county or city in which the property is located. A Tax Assessment is the value the city or county places on the property for tax purposes. That value rarely reflects the market value of the property. In rising markets, this value can often lag the market value, but in falling markets, this value is usually inflated. The problem with Tax Assessments is that the city or county, has a vested interest in valuing the property for a higher amount, because they get the additional taxes from the property. So Tax Assessment is not a good indicator of market value.
The other problem with Zillow is that it does not nessesarily understand what kind of property it is dealing with. For example, Zillow may use a standard method of value, like price per square foot to calculate value. But when dealing with multi-family properties, for instance, this method is generally not reliable. So, Zillow may list a property as a multi-family property, but it uses an incorrect metric to calculate the value.
When dealing with multi-family properties especially in the Richmond, Virginia market, the only metric that really counts, is the income vs. cost approach. Buyers and investors of multi-family properties in the Richmond, Virginia area are looking for a specific ROI or Return On Investment. They want to purchase a property at a given price and have that property generate income. So those buyers determine the value of a property based on its expected income minus its expected expenses. This is called NOI or Net Operating Income. NOI is calculated simply as Income minus Expenses.
So, to determine the value of a multi-family property you should take the total income minus the total expenses and use a multiple based on the level of activity or intensity of buyer or investor interest in a particular market. The formula for this is Income – Expenses x Multiple = Market Value. The “multiple” depends on many how intense demand is for a given market or how scarce the supply is. Right now in the Richmond, Virginia area its my opinion that buyers are willing to pay a multiple between 6 and 12. For example, if a property generates $2500 per month in income minus $200 in expenses X 12 months, X 12, then the value of the property is $331,000 for example. Every investor has a different multiple they are looking to generate. Another widely used metric is called the Cap Rate. Or Capitalization Rate. This is the ratio of Income a property generates to its Sales Price. Different property types have different Cap Rates depending on what investors are willing to pay for a certain return. Commercial Office Property has a different Cap Rate than Residential Multi-Family Property. And different sub-markets within the a metro area have different Cap Rates. A Multi-family property in the Fan District/VCU sub-market might have a different Cap Rate than a Multi-Family property in Chesterfield or Henrico County. The Investor Sales Team at Snipes Properties recently analysed the last 12 months of Sales of Multi-Family properties for the Fan District/VCU sub-market and discovered that the average Cap Rate that investors are willing to pay was between 5-9% with an average Cap Rate of 6.5%. You can read the synopsis here. This represents a fairly tight range, which means that investors are willing to pay a slight premium for this type of asset and that the supply of this type of property is limited.