Rental properties are valued differently by investors than the average homeowner. Investors acquire rental properties for the future monthly rental income and long-term appreciation in the value of the properties. In this post, we will explore the ways to value a real estate rental property and a new method for investors to obtain monthly property value updates.
How to Value a Rental Property in Real Estate
The Sales Comparison Approach
A sales comparison approach (SCA) is among the most used methods for appraising residential properties. Appraisers and real estate brokers utilize it the most often when evaluating homes. This method is based on a simple analysis of comparable properties recently sold or leased in the area. To see any developing patterns, most investors want to view an SCA that covers a significant amount of time.
The SCA assigns a relative pricing value based on traits or features. A home's value may depend on various factors, including the number of rooms and bathrooms, the presence of a garage or driveway, a pool, a deck, a fireplace, or any other distinguishing features.
Using the price per square foot as a guide, investors may determine how much their property is worth. That is to say, investors should anticipate revenue in the neighborhood of $1/square foot, assuming similar townhouses in the vicinity rent for the same price.
Income Approach
Investing in a rental property is a significant factor in a person's buying decision. As a result, it may be a sensible business decision to consider both present and future revenue when assessing a rental property. The income technique sometimes referred to as the capitalization rate or cap rate approach, is most frequently utilized in commercial real estate transactions. To begin, deduct running costs from the rental revenue to arrive at the property's net operating income, known as NOI.
A property's rental revenue comprises any money it generates, including the monthly rent and any additional income generated by items like appliances or pet rent. Expenses associated with running a business include paying for property management and leasing, upkeep and repairs, property insurance and taxes, and fees charged by homeowner's associations.
Gross Rent Multiplier (GRM) Method
The GRM method estimates the value of the rental property by evaluating it on the total amount of annual rent that an investor is likely to obtain from the property. Using this method, you can quickly determine if a property is worth your time and money. Since this does not include related costs such as property taxes, security, utilities, and the like, it should be regarded with caution.
The gross rent multiplier technique is similar to that same income approach, except it utilizes gross rent instead of net operating income as its cap rate. The income approach's cap rate is a percentage, while the gross rent multipliers are more significant than one. Compare the GRMs and rental revenue of comparable properties to the one you're considering to ensure that your comparisons are accurate.
Capital Asset Pricing Model
By far, the most challenging way to estimate the rental property's income value is using a capital asset pricing model (CAPM). This model illustrates the link between the anticipated return and the risk of investing in an asset, per the Corporate Finance Institute. Expected returns are calculated by multiplying a risk-free return (besides a 10-year U.S. Treasury bond's yield) by a premium for more risk.
The capital asset pricing model is used to figure out how much a rental property is worth. It considers things like the property's age, condition, location, neighborhood rating, operating costs, potential rental income, and net cash flow. Real estate investors, according to CAPM, can only earn more if they take more risk in return for a more significant gain. The reality is that a rental property with a good combination of risk and profit may be found in the real world, according to several real estate investors.
Conclusion
A rental property's worth can't be determined with accuracy. Before making investment choices concerning rental properties, most serious investors consider all of the components of these valuation methodologies. To get started in real estate investing, it's a good idea to familiarize yourself with these basic valuation ideas. The next step is to use a mortgage calculator to get a reasonable interest rate on a home that will bring in a good quantity of money for you. You'll have more data to work with if you use this tool to assess a potential rental property.
