Smart investing decisions come after a long time of study and practice. They’re necessary to determine the value of your rental property. Because real estate transactions are not as frequent as transactions in the stock market, for example, it’s going property valuation becomes a difficult task, especially if you’re not familiar with the process. Property valuation, though, will tell you the accurate price of your property so you can make a reasonable offer and avoid overpaying.
That’s why it is crucial that you do a proper valuation before you decide to sell it off. There are several ways that can help you determine your rental property value. If you want to know more about these methods, continue reading this guide.
Why You Need to Determine Property Value
When it comes to the rent payment, you’ll need to be more careful when determining how much your tenants should pay for you. Rent payments are usually determined by property value. Usually, rent is estimated to be 0.8% to 1.1% of the property value. So, for example, your tenants will have to pay about $2,000 or $2,750 per month if your property value is around $250,000. Make sure those rent payments should cover at least mortgage bills and don’t forget to factor things like maintenance, taxes, and other repair costs into the rent payments as well.
The second reason you need to know your property value is, of course, to sell it whenever you want to. It can also help you sell your property below the market value whenever that opportunity presents itself. With that said, here are various methods to calculate your rental property value.
Sales Comparison Approach
One of the easiest and most popular methods used to determine the value of rental properties is the sales comparison approach. Simply put, real estate investors will look through the sales prices of properties similar to the one in their possession and they would get an approximate value of their rental property. Note, however, that the properties that you’re going to evaluate the prices should be within close range of your rental property to ensure that you get an accurate estimate.
Taking that into consideration, you can start implementing this method by viewing the prices of 3-5 properties that are as similar as possible to your property, and that were the latest, as older sales won’t give you accurate results as new property sales would. Make sure that you view properties that are as close as possible to your property (in the same neighborhood and housing market).
Gross Rental Multiplier Approach
This method helps you determine a rental property value by calculating the rental income that the property garners in the span of one year. The Gross Rental Multiplier method (GRM) can be calculated by dividing the purchase price by the annual gross rental income. This calculation will tell you how big the purchase price compared to the annual income this property generates. So, if you get a GRM of 4, for example, that means that the purchase price of your property is 4 times larger than the annual income it generates.
The real estate specialists at socalhomebuyers.com explain that investors will look for properties with a low GRM (4-7), as that means it will take much less time to pay off the price than it would with a high GRM. This will give you an idea of what to expect when you sell your rental property and whether or not you should sell it in the first place. If you don’t like to do these calculations on your own for fear of making errors, you can use an online GRM calculator, which will do this automatically for you.
Cap Rate Approach
Cap, or capitalization, is one method used to determine the return on investment of your property irrespective of the financing method. You can calculate the cap rate the Net Operating Income (NOI) by the property price. This method is efficient, as it will give you a quick estimate of your rental property value. The cap rate is considered to be a more inclusive calculation than the GRM, as it includes expenses as well.
You can calculate the cap rate by adding the yearly rent of your property and subtracting expenses like operating expenses, repairs, management, property taxes, and vacancy factor. What will come out will be the Net Operating Income (NOI), which you can then divide by the purchase price. Like GRM, there are calculators that can automatically do cap rate calculations for you to avoid errors.
Note the Cash Flow
Usually, the cash flow is calculated either on a monthly or yearly basis. How much cash flow you get is important to know whether or not you’ll be able to cover all expenses for your property and is going to affect your property valuation calculations. After you get mortgage bills and other expenses out of the way, you can calculate your cash flow. If you get a positive number, then you’ll have a remaining balance that can cover your own expenses for that property.
On the other hand, if you have negative cash flow, then your rental income is probably not high enough to cover these expenses. Usually, investors tend to avoid properties with negative cash flow, so knowing this factor can help you determine how much to charge your tenants and find the right investor to buy your property.
There are a few things to take into consideration aside from the cash flow. All valuation models are effective and accurate. When you choose one, however, make sure that it will provide you with the highest value possible. Use GRM or cap rates to evaluate your property if investors intend to buy your property. Traditional buyers prefer traditional methods, so make sure to look those up as well. In any case, make sure to consult a real estate agent, as they will be more familiar with the favored pricing models among potential buyers.
Taking these factors into consideration, you shouldn’t face any problems as you evaluate your property value. Remember that there are property value calculators that can help you do the valuation process without much hassle. Though your valuation model will depend on investors who want your property, be sure that you get the highest value possible for your unit.