Know How You Can Determine Your Rental Property Value

Often investors, while investing in real estate, ask themselves, how much will be the rental property value? And what does it cost in investing?

Though this is important when you consider purchasing a rental property, yet, you need to know that rents offer an increasing source of revenue and a steady way to make money. But, above all you forget to note before getting into the game of real estate rentals, how will one go about making the evaluations of the rental property.

Because without knowing the value of the property, neither you would be able to charge the rent effectively, nor you will know how much property tax is to be paid. Thus, looking at this, I initiated to write on the top ways for the estimation of your rental property as property value not only teaches you how to estimate rate payable, but also property taxes laid upon.

The Tops Ways on How to Value Your Rental Property

The Income Approach 

The income approach is a popular method for the valuation of the rental property. This approach is frequently used for rental spaces while investing in commercial real estate. 

The method mainly focuses on the potential income for the rental property and relies mostly on the determination of the annual capitalization rate of an investment. This rate is the projected annual income and is calculated by dividing the current value of the property from the gross rent multiplier. 

For example, if a building cost Rs 20 lakhs while purchasing and the expected monthly income from the rentals is Rs 40,000, then the expected annual capitalization rate will be –

                                        =( 40,000*12 months ) / 20,00,000

                                        = 4,80,000/20,00,000

                                        = 0.24 or 24%

This is a very simplified model, and if applied in real estate, the concept can also be known as discounted cash flow. 

Gross Rent Multiplier Approach 

This approach is also one of the common approaches used for the valuation of the rental property. However, this approach is based on the amount of rent an investor can collect each year from the tenants. 

It is a quick and easy way of measuring whether a property is worth investing. This approach, therefore, considers any taxes, insurance, utilities, and any other expenses associated with the property. 

Though the gross rent multiplier model seems similar to the income approach, yet it doesn’t use net operating income as its cap rate, instead uses gross rent. 

For example, say a commercial property is sold in the neighbourhood for Rs 25 lakhs with an annual income of Rs 5,30,000. Thus, for the calculation of GRM or Gross Rent Multiplier, you need to divide the sale price from the annual rental income like-

                                            = 25,00,000 / 5,30,000

                                            = 4.72

Thereby, you can now calculate this figure to the one you are looking for, as long as you know the annual rental income of the latter. Further, for the prospective property, you can find out its market value by multiplying the GRM by its annual income.

However, if you find the value of the property to be higher than the one that was sold recently, i.e. Rs 25 lakhs, then it might not be a prospective property, and instead move on. 

Researching by the Comparable Units

Under this method, you need to research the rental prices for units similar to yours. And for this, you need to find out how much rent others are charging for the comparable units. You can also look around your neighbourhood to find the current rate prevailing for the rental properties.

Further, you will be required to look for the units that match yours in comparison to the number of bedrooms, bathrooms, amenities, and location. At this moment, you can make a list of properties that are similar to yours and write down how much rent the owners are charging, and know the occupancy rates. Then, you can assess and know whether you can also ask for the same, or either more or less depending on the situations and the interpretations of your property to others.

However, for an acceptable valuation of your rental property, you can also find out how much it would cost to build a replica of the property at hand. Answering this question is very much related to the valuation of your rental property. Finding out the rental value in this way is known as the ‘replacement cost method’.

Under this, you need to include the purchase price of land, the cost of the labour and materials, excluding any depreciation. This method is beneficial when it becomes challenging to identify the value of the property with the help of comparable properties.

Contacting the Property Managers for Setting Rental Price

For determination of the rental value of the property, you can hire a property management team to oversee, and set out a reasonable rent that you can charge from the tenants. 

Even if you have any financial problems, still, you can contact any local property managers and consult them about the rental prices. This is so because they often deal with the property showings, and thereby know what the tenant likes and doesn’t like. Also, they can tell you all about what the tenants will be willing to pay based on the location, size, and amenities provided in your property.

Further, you can connect to some well-known real estate agents who deal with the rentals, as they have a keen understanding of the local rental price. Also, they are familiar with all the rental properties in your area. Thus, it makes them a qualified expert for the assessment of the positive and negative values of your rental property and helps in setting the appropriate rental price.

Determination of the Property by Square Footage

Seeing from a real estate perspective, rental property is no different than any other surrounding owner-occupied houses, such as condos or co-operatives. Taking this in mind, you can value your rental property on the same basis as other homes.

For this, you need to consider the selling price and later divide it by the property’s size to calculate the price of the property in per square foot. For instance, if 2,000 square foot property is sold out at Rs 30,00,000 in your area, and the price per square foot is Rs 1500. So, if your property is 2,050 square foot, then its value would be Rs 30,75,000, which is figured out by multiplying the 2,050 square feet by price per square feet, i.e. Rs 1500.

Housing Price-to-Rent Ratio 

Further, the Price-to-Rent Ratio is also critical. It is somewhat similar to the income approach. To find the price to rent ratio, you need to divide the median home price by the average annual rent in a given area. For example, if the average price of the property in your housing market is Rs 20 lakhs and the property rent Rs 20,000 a month. In that case, the price-to-rent ratio will be-

                                    = Rs 20,00,000/ Rs 2,40,000 ( i.e. 20,000*12)

                                    = 8.33

The ratio measures the relative affordability of renting versus buying out a given housing market. Likewise, if the ratio is-

Fifteen or below, it suggests that it’s better to buy a house than to rent it out.

If it’s between 16-20, it suggests that it’s better to rent than to buy a house.

And, if it’s 21 and above, it suggests it’s better for renting than buying the house.

What can be a good ROI for a Rental Property?

For determining whether you’ve found a good deal or not, you need to divide the net annual income by the initial investment, and at this moment, express the result in the percentage form. According to the recent reports on the rental properties, the returns between 4-10 per cent are reasonable for the rental property.

However, a rental property of ROI under 4% is not typically worth investment, and an ROI of over 10% is considered a good deal, indeed. Using realistic and conservative numbers in your calculation will give you a more reasonable view of your ROI on the rental property.

Further, you should be aware of the lower-end properties, which often look more promising on the paper rather than the mid-range and the high-range properties, but can have more frequent tenant turnovers, and high repair costs. The key here is to estimate the rate of high vacancies at a later time, and the repair costs, so that you can get an accurate picture of your estimated ROI and thus, don’t land up in disappointment when your initial investments don’t pan up.

The Final Words

To conclude is to say, no one can predict the rental value of the property accurately. Yet, investors can overlook the components from all these methods of valuation, before making any investment decisions on the rental property. 

So, learning these introductory valuation concepts can be seen as a first step to get into the real estate investment game. Further, on finding out a property that yields the right amount of income, try to include, and co-ordinate these steps in the proper estimation of the value of the rental property.