Rental Valuation: Determining Property Value and ROI

Rental Valuation: Determining Property Value and ROI

You can make a good income from rental properties, but you want to make sure you're maximizing that income at all times.

Rental valuation is a practice that will allow you to find the most suitable amount to charge for rent. If you charge too much, people won't be interested, and if you charge too little, you won't be getting the best ROI. It can also help with your purchase decisions when looking at a new rental property investment.

Let's take a look at some of the best ways you can value your rental property.

Sales Comparison Approach

This is one of the most common property valuation approaches among appraisers and property managers. It involves looking at other similar properties in the area that have recently sold.

This will usually involve at at least three comparable properties sold in about the last 30 days. You want to consider homes with similar characteristics. Factors to think about are the property size, age, number of bedrooms/bathrooms, etc.

Capital Asset Pricing Model

CAPM considers the potential ROI from a property investment compared that of low-risk (or zero-risk) investments. For example, you could consider the potential returns of investing in US treasury bonds or real estate investment trusts (REITs), both of which carry much less risk than a rental property.

If the return from the low-risk investment is higher, then you can consider it to be a better investment. It would make less sense to take on risk if there's not a higher reward potential.

Income Approach

This involves looking at the potential yield from a property in relation to the initial investment and is most commonly used for commercial real estate. It starts by determining the annual capitalization rate. This is the projected income and is found by dividing the gross rent multiplier by the current property value.

For example, a property at $100,000 with a monthly income of $1,200 ($14,400 per year) would be:

14,400 ÷ 100,000 = 0.144 or 14.4%

This example doesn't include any assumptions so it's generally more complicated.

Gross Rent Multiplier Approach

The GRM method looks at how much rent you can collect each year. It's a simple approach to work out if an investment is worthwhile and is common for new investors. Note that it doesn't factor in taxes or other expenses, so isn't entirely accurate.

It's similar to the income approach but uses gross rent instead of the net operating income. You should look at the GRMs and rental income of other comparable properties to find the most suitable investment.

Cost Approach

This is an estimate that you can get by combining the land value and depreciation value of improvements. It's done based on what the best use of that land will be. The cost approach is typically used for commercial real estate, so you may want to use one of the other methods for rental properties.

Performing a Rental Valuation

Rental valuation is essential for investors to help them make the best decisions. It can also help you set a suitable rental price for properties that you own. The sales comparison approach is perhaps the most common choice, but depending on the specific situation you're in, you might want to use a different method.

PMI Fine Properties has been assisting investors with a range of property management services for almost 20 years. Get your free rental analysis from us today.