With the price of housing skyrocketing in many areas of the country, wages not keeping pace with the cost of living and high student loan debt among Millenials; not everyone can afford to get into the real estate market at all let alone purchase a rental property. For those who can afford to purchase a property for rental purposes, there is the potential to earn a healthy monthly income because of the high demand for rental housing. Still, choosing the right rental property to purchase is important. It is advisable to perform a valuation analysis of real estate rental properties before making a purchase.
How to value rental property
The sales comparison approach
Known as “SCA”, the sales comparison approach to valuing a rental property is based on comparing similar properties that have rented or sold in a specific time period. It is best to study SCA across an extensive period of time in order to identify truly insightful patterns. An investor must examine specific property attributes to determine a relative price value with the SCA approach.
As an example, price per square foot is an easily quantifiable metric that investors can use to evaluate how a property should be valued. When requesting a comparative market analysis, investors should hire a real estate agent or certified appraiser to lower the odds of a fraudulent appraisal.
The income approach to real estate investing
The income approach to real estate investing keys into the potential income that can be generated from a rental property in comparison to the up-front investment. This model is commonly used when analyzing commercial real estate investments. A prospective property’s yearly capitalization rate is determined by estimating yearly revenue via the gross rent multiplier and dividing it by the property’s present-day value. Mortgage interest expenses must be accounted for and one must also consider the fact that rental income can increase or decrease over time.
The capital asset pricing model
Often referred to with the acronym of “CAPM”, this approach to valuing a rental property is more broad based. It accounts for risk as well as opportunity cost in the context of real estate investing. The focus is on how much return on investment the property can generate through rental revenue. This return is then compared to no-risk investments like real estate investment trusts. If the anticipated return on such a guaranteed investment is higher than the potential return from a rental property, the property is not worth the investment.
The cost approach
The cost approach to valuing a potential real estate investment is based on the fact that a property’s worth is mainly determined by what it can be used for. This value is determined by summing the property’s land value and the depreciated value of upgrades. Those who use this approach argue that the highest possible value use must be taken into consideration to determine a property’s true value.
The cost approach is regularly employed to asses the value of a vacant plot of land. As an example, a real estate developer might look for four acres of land in a low-traffic area that can be developed into an apartment complex. He can determine the value of a prospective plot of land according to its best use. If people live and work far away from the site and it is surrounded by manufacturing plants, the best use of the property is not to convert it into an apartment complex but to garner interest from nearby manufacturing plant owners.
The bottom line is that a good rental property will generate regular income. Whatever method you use to evaluate a rental property’s value, make sure that you are making a wise choice before buying.
Son-Rise Property Management is a full service property management company located in Bellingham, WA. Contact us today to see how we can help you find the perfect home to rent or manage your property.