Calculating the value of a rental property can be a little confusing and complicated. For a property owner there are three different methods of calculating a rental property’s overall value. The three methods of calculation are Sales Comps and Price per Square Foot, Gross Rental Multiplier and Cap Rate. Each method uses different data sets for calculation and therefore produces different results. Below is a brief overview of these three property value calculation methods, how they work and which method is the best for calculating the value of a rental property.
How to value my rental property
Sales Comps and Price per Square Foot:
Sales Comps and Price per Square Foot is a quick and simple method of calculating a property’s value. This calculation method takes note of what’s occurring in the local market. Houses, condos, apartments, and buildings in the same general location (or market) will be valued on a scale based on that market’s attributes including desirability of location, cost of living, rental vacancy rate and more. For example, if you look at several houses in a subdivision you will find that houses with similar attributes such as square footage, size of yard, and quality of finishes will be valued about the same amount. Houses with less or more square footage and other desirable features will be priced on a scale above or beneath the average house in the neighborhood. To calculate a property’s value using this method find the selling price of comparable homes in the area. Then divide the selling price by the square footage of the property. Next multiply the per square foot monetary value by the square footage of the unknown property to get a standard value.
Example: if 2,100 square foot homes are selling for $350,000, the price per square foot is $166.67. To calculate the value of a 2,500 square foot property multiple 2,500 by $166.67 to get a market value of $416,667.
Gross Rental Multiplier:
The Gross Rental Multiplier (GRM) uses yearly rent totals to determine the value of a property. A rental home with a selling price of $300,000 renting for $1,700 per month has a GRM of 14.7 ($300,000 selling price divided by $20,400 yearly rent total). The calculation can also be reversed as well. For example, a home renting for $24,000 per year ($2,000 per month) in an area with a GRM of 14.6 has a property value of $350,000.
Cap Rate is a more advanced version of GRM. What makes it useful is that it takes business operating expenses such as repairs and upkeep into consideration when calculating a property’s value. To calculate the Cap Rate a Net Operating Income (NOI) figure is required. To calculate NOI take the property’s yearly rental total and subtract expenses such as repair, property taxes, vacancy and other costs related to property upkeep. Then divide the NOI by the property’s value. A $300,000 property with $21,000 per year in rental income and $7,000 in overall annual expenses has an NOI of $14,000 per year. This is a cap rate of 4.7 percent. The calculation also works backward and this can be done by dividing the annual NOI expense by the overall market’s cap rate. To correctly calculate a percentage use a decimal (i.e. 4.6 percent becomes 0.046).
When selecting a calculation method for rental property value there are two factors to consider:
What type of buyer is looking at the property?
Which calculation method produces the highest overall value for the type of buyer?
For an investor, use a GRM calculation to get the highest value. If the investor pushes for average expenses, Cap Rate can be employed. If the buyers are traditional homeowners a simple Sales Comps and Price per Square Foot calculation will provide a fair market value. In summation there are several ways to calculate a property’s value and the method used will depend on the types of buyers or the market in which a property is located.
Son-Rise Property Management has been serving the property management needs of Bellingham and Whatcom County since 1996. Contact us today to see how we can help you find a rental property for your family or manage your rental properties.