Wondering how to value a rental property? Here’s how!
There are few different techniques for deciding just how much your rental unit is worth.
In this article, we will explain how each strategy works and how it could benefit you both logistically and financially. We’ve even included a rental value price calculator to make your life just THAT much easier.
Different Ways to Value a Rental Property
Here is everything you need to know about how to value a rental property:
Sales Comparison Approach
This is one of the most common types of ways to calculate the value of a rental property. Those in the industry sometimes call it SCA.
It is similar to using comparable sales (comps) when determining the fair market value of a home for sale. When you use the SCA method, you simply look for what other homes are selling and renting for in your property’s immediate area.
Most investors use the metric of dollars per square foot complete the comparison.
Gross Rent Multiplier
Developers typically use the gross rent multiplier approach to determine how much commercial income a multi-unit real estate development could make.
First, the developer takes the price of the entire building. Then, he divides this number by the gross rents of each unit. The number he creates is a ratio that he can use to compare his building to over similar ones in the local real estate market.
Investors also sometimes call this method the gross income multiplier method. Developers might use this name when their evaluation of the property also considers things like the coin operated laundry machines or paid parking.
It is important to remember that this calculation is not an appraisal tool. It is merely a way for investors to investigate a property’s potential worth before making an offer on it.
Basically, the gross rent multiplier method is a selection tool. It helps investors to decide to accept, reject, or negotiate on a property.
The Capital Asset Pricing Model
The next way to determine the price of your rental is to use the capital asset pricing model approach. This is a bit of a more comprehensive way to evaluate worth. It is sometimes called CAPM.
This evaluation method seriously considers the potential for return on investment in a property. It then takes this amount and compares it to investments that carry absolutely no risk, like real estate trust funds or United States Treasury bonds.
Essentially, if the perceived potential for return on investment is greater than that of the rental property, then it doesn’t make sense to take a financial risk on it.
With this in mind, it is important to remember that this method of pricing takes all potential risks into consideration, like the crime rate in the area or the potential for costly repairs on an older house.
The Income Approach
This might seem like the most straightforward way to calculate the value of a rental property. Using the income approach, you simply need to discover how much money you stand to make from a particular rental unit. This is the process used most frequently by commercial real estate developers.
To use this method, you need to know the annual capitalization rate for the property. It is easy to find out what this is. All you have to do is take the projected income for the annual gross rent and divide it by the current value of the property.
This is a very simple model and does not account for many variables, like the potential for interest rates on a mortgage. Another variable is the net present value of money. In real estate terms, this means that the worth of any money received in the future could be both inflated or deflated. Because of this, you have to account for this risk when making your calculations.
The Cost Approach
The final way to value your rental property is the cost approach. In this method, you determine the value of a property by deciding how to reasonably use it. This means that you cannot best use land hundreds of miles from the nearest town for new condos. Rather, a developer should probably use the land for something like farming or ranching instead. Because of this, its rental value would be lower.
If the land is in a city, then it must already be zoned “residential” to be cost effective. If it is not, the developer who wants to build homes, apartments, or condos on it will incur sizeable expenses to rezone it.