Proven ways to value a rental property

Proven ways to value a rental property
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Property management companies in Atlanta are reporting that real estate in the area is fast approaching and in some locales even surpassing record-setting valuations. Individuals who are current property owners are earning increased equity on an almost daily basis.

Additionally, Investors are flocking to the market and looking to profit due to the current market status. The value of property is steadily increasing. The amount of rent you can charge is also climbing at a fairly substantial and consistent pace. Despite the favorable market, investors still need to be prudent and wary of overpriced assets that are still somewhat abundant. If you fail to ensure accurate valuations prior to purchasing a property, you can significantly damage your portfolio and put yourself in a bind.

In this blog post, we’re going to go over some methods you can use to ensure you’re properly valuing a potential addition to your portfolio before purchasing the property.

The income approach

The income approach determines the value of a property by calculating the annual capitalization rate. Just take the annual projected income and divide it by the current value of the property. So, if a property costs $200,000, and the annual rent collected is $18,000 ($1,500 per month x 12 months) the annual capitalization rate would be 9%.

In most geographic areas, a property with anywhere between an 6-10% cap rate is considered to be a solid and sound investment. It’s important to remember that the higher the demand is in the area, the lower the cap rate will be. Desirable metropolitan areas like Atlanta can yield a cap rate of closer to 5%, yet still be considered a very good value. The income approach is very straightforward and easy to calculate, so it’s important to take potential additional expenses like mortgage interest into consideration when looking at the potential purchase as a whole.

The sales comparison approach

The sales comparison method is the most widely utilized valuation model in residential real estate. Real estate agents and real estate appraisers both use this method as a default. The sales comparison approach is based on having very similar properties in the surrounding geographic area that have been recently rented or sold outright.

When looking for an investment property to purchase, investors often ask to see the sales comparison approach factored out for the last few years. They will look at a predictive forecast for the next few years as well so that they can run an analysis that looks for any positive or negative trends that may be occurring.

This method relies on comparing apples to apples-type properties. Things like square footage, number of bedrooms, and lot size all factor in when making these types of value comparisons. Most appraisers and real estate agents will also calculate a price per square foot. Once you have determined the cost per square foot, you can expect a similar value in similar properties in the area.

Gross rent multiplier

Gross Rent Multiplier is based on estimating the amount of rent that a property owner can expect to collect from the property each year. This number is calculated prior to factoring in things like utilities, taxes, and insurance expenses. This method is extremely similar to the income approach but does not figure out the capitalization rate. This method isolates the gross rents that are going to be collected.

To figure out the GRM, divide the cost of the property by the amount of rent you expect to collect annually. For example, if a property is priced at $450,000 and you think you will receive $36,000 in annual rent ($3000 per month) the gross rent multiplier would be equal to 12.5. With GRM, you are hoping to get a low number.

A good range to look for is a Gross Rent Multiplier of somewhere between 4 and 7. If the number comes in higher than that, it doesn’t necessarily mean that the investment is a bad one. It just means that the asset might take somewhat longer to pay for itself than one with a lower GRM.

You can use any or all of these methods to accurately calculate the worth of specific properties. Be sure to look for a future blog post where we will continue this discussion. As always, please contact PMI Perimeter with any Atlanta area property management questions or inquiries.