Knowing the rental value of your investment property allows you to make informed decisions when conducting business. By determining the property value and the potential rental income of a rental property, you can decide whether it's worth investing in. There are several methods to perform a rental property valuation, all of which are used in real estate investing.
Valuation Methods You Can Use
Gross Rent Multiplier Approach
Through the GRM approach, real estate investors can determine the rental property's value based on the gross annual rental income. The metric doesn't include other expenses like property taxes, insurance costs, or operating expenses, but it provides a good estimate of the property's value.
The formula is GRM = Property Price ÷ Annual Gross Rent. For example, if the property value is $1.2 million and it generates $240,000 per year in rent, then the GRM is 5.
A GRM between 4 and 7 is generally considered a good investment, but this can vary based on market and property type.
Income Approach
Unlike the GRM method, the income approach uses the net operating income (NOI) as its cap rate instead of gross rent. Commonly used for commercial real estate investing, it calculates the potential income of a rental property based on the initial investment.
The income approach may not be as reliable since it doesn't consider interests on mortgage payments, and rental income will depend on current market conditions.
The formula is Expected Capitalization Rate = (Monthly Income x 12 Months) ÷ Purchase Price.
Capital Asset Pricing Model (CAPM)
Also used to determine the expected returns of an investment, it gives you insight into the risks that come with acquiring the property such as maintenance expenses for older properties, or security costs of buildings in high-crime neighborhoods. It is ideal for investors with lower risk tolerance.
The formula for this model is Expected Return on Security = Risk-Free Rate + [Beta of Security] x (Expected Return of the Market - Risk-Free Rate)]
Sales Comparison Approach
The sales comparison approach is mostly for residential properties like single-family rental homes by real estate agents and appraisers when attempting to value a rental property. It uses basic factors like the square foot of the building, the number of rooms, and other features that contribute to its property value. It's also the easiest way to evaluate comparable properties.
The formula is Value of Subject Property = Sale Price of Comparable Property +/- Adjustments.
Factors That Influence Rental Value
Rental Property Size
The larger the units are, the higher the landlord can charge for rent, directly affecting the gross rental income of the investment. Even the layout of the rental property can be a factor. For instance, more renters might prefer an open floor plan.
Condition
Rental value can depend on the state of the building during purchase. On top of the fair market value, you also have to account for the maintenance or renovation costs you have to spend to get it in the best shape.
Renovations
Recent renovations to a rental property can easily improve its rental value. Prospective tenants would prefer a rental unit with modern features in the kitchen, bathroom, living room, and other areas of the real estate property.
Amenities
Having amenities that provide convenience to tenants also increases rental property value. In some cases, these are also considered to calculate the net operating income since certain utilities add to the overall operating expenses.
Location
Acknowledging the location is important in assessing the value of a rental property. For instance, a rental unit might fare better if it's in proximity to amenities like public transportation or supermarkets.
Local Market Conditions
Your rental income will depend on various factors concerning local market conditions. A rental business cannot thrive when the area has low demand, much less if there are high vacancy rates among the competition.
Property Type
Some property types can perform better in certain circumstances. Beach houses, for instance, will likely earn more rental income when it is located in tropical locations, while single-family rental properties will be preferred when they are near schools.
Tools You Can Use
Zillow Zestimate
With a median error rate of 2.4% for on-market homes and 7.49% for off-market homes, Zestimate is an accessible tool you can use to estimate the market value of a property. It uses public data, MLS, and user-submitted data, which provides you with data-driven results.
Stessa Valuations
Stessa Valuations also offers various real-time valuation methods for your rental property. There are three methods you can explore, as well as the integration of Zestimate within the system of the company.
Property Management Company Tools
Several companies offer tools without having to pay for property management fees. Harland Property Management, for instance, has a free rental analysis tool as well as an ROI Calculator, both of which provide insights that can influence your investment decisions.
Rental Value FAQs
What is the most accurate way to calculate rental value?
The most accurate way is not just using the provided formulas and methods, but also taking into account accurate variables like the property's gross rental income, square footage, market conditions, and more. If you're unsure, you might benefit from hiring a professional to make the calculations.
What happens if I overprice a rental property?
You'll risk your business having longer vacancy periods since prospective tenants would prefer similar properties with lower rent prices. It reduces your tenant pool and significantly affects your rental income.
How often should I re-evaluate my property's rental value?
You should at least do it at least once a year to stay on top of things. However, the frequency can still depend on several factors like major changes in the rental market or economic conditions.
How do I stay updated on rental market changes?
You can monitor local news and real estate publications to catch the latest news in the industry. Having a network with other landlords may also help. You can always hire professional property management as it is part of their job to stay informed about market changes to manage the rental business accordingly.
Hiring a Property Manager for a Positive Change
Calculating your property's rental value is not a one-time thing since everything that affects it constantly changes. Hiring a property management company like Harland Property Management takes this responsibility off your hands, along with the tedious tasks that come with being a landlord. By contacting us, you can be stress-free and earn passive income in no time!
