Key Takeaways

  • The comparable sales method estimates value by averaging the per-square-foot prices of recently sold nearby properties, then applying that figure to the subject property’s square footage.
  • The income method uses the capitalization rate (NOI divided by property value) to back into a valuation. Once you know your market’s average cap rate, you can solve for what a property should be worth.
  • The cost method factors in what it would cost to rebuild the structure from scratch, subtracts depreciation based on the property’s age, and adds the land value separately.
  • The Gross Rent Multiplier (GRM) method is a quick way to estimate value using projected gross rental income, though it doesn’t account for operating expenses.
  • No single valuation method is foolproof. Using multiple approaches together gives investors a more accurate picture and helps avoid overpaying. 

As an investor, you know that the key to scalable success is knowing which opportunities to skip and which to pursue. Because if you’re not careful, you could waste a lot of time chasing after deals that ultimately won’t pencil.

At Asset Based Lending (ABL), we’ve underwritten countless deals for investors nationwide, so we know a thing or two about how to evaluate a rental property. Explore our DSCR rental loan program, or read on to learn the four most common ways to estimate a rental property’s worth. 

What Is Property Value?

In real estate, property value is simply the price a buyer and seller agree on in a fair and open market, i.e., what a property is worth at any given time.

But unlike stocks or bonds, real estate is relatively illiquid: transactions are slower, less frequent, and highly localized. This can make it hard to estimate value. That’s why we’ve broken down four proven methods investors use to determine property value with confidence quickly.

4 Ways to Evaluate Rental Property

Comparable Sales Method

The comparable sales method involves comparing the subject property to similar properties nearby that recently sold (aka “comps”). By averaging the sales prices of these comps (and accounting for any differences), you can estimate the rental property’s value.

For instance, imagine you find three properties in the same neighborhood as the subject property that all sold within the last 90 days. Since the properties are different sizes, you calculate a per-square-foot (PSF) price for each to make them more comparable. From there, you average the three PSF prices. Finally, you multiply this average PSF price by the subject property’s square footage to estimate its value.

Here’s what the math looks like with example figures:

  • Comp 1: $350,000 sales price / 2,000 SF = $175 PSF
  • Comp 2: $430,000 sales price / 2,500 SF = $172 PSF
  • Comp 3: $310,000 sales price / 1,900 SF = $163 PSF
  • Comp Average: ($175 + $172 + 163) / 3 = $170 PSF
  • Subject Property Value: $170 PSF x 3,000 SF = $510,000

In this case, the estimated property value is $510,000. Of course, when running your comp analysis, you should also account for differences in property age, condition, number of bedrooms/bathrooms, etc.

Income Method

The income method for estimating property value relies on the capitalization rate (or cap rate) formula, which measures a property’s annual return at a property level:

Cap Rate = Net Operating Income (NOI) / Property Value

For instance, say you bought a property for $300,000 that brings in an annual NOI of $15,000. Then your cap rate would be 5% ($15,000 / $300,000).

The income method for evaluating rental property simply uses the average cap rate for a given market and rearranges the cap rate formula to solve for property value:

Property value = Net Operating Income (NOI) / Cap Rate

Let’s say your rental market’s average cap rate is 6%. If you project a rental property will generate an annual NOI of $20,000, you should value it at about $333,000 ($20,000 / 0.06). 

Note: To find your market’s average cap rate, contact your local ABL loan expert, average the cap rates of nearby properties if you have the necessary data, or use tools like CapRateIndex.com for a rough estimate. 

Cost Method

The cost method for estimating property value is based on the cost to build a property from scratch. Here’s the formula:

Property Value = (Replacement Cost – Depreciation) + Land Value

Let’s break it down step by step.

Replacement cost is what it would cost to build the physical structure, including labor and materials. You can estimate this by getting actual quotes from real contractors and suppliers. 

Of course, since the building already exists, some of its value has depreciated due to regular wear and tear. To account for this, subtract an amount for depreciation. This could be based on an annual depreciation rate (e.g., the IRS depreciates residential properties over 27.5 years, which is about 3.63% per year). Finally, you must add the value of the land, which is separate from the building itself and can be estimated with the comp method.

For instance, imagine a rental property would cost $300,000 to build new. Since the property is 5 years old, you subtract $54,450 for depreciation, leaving you with a value of $245,550. Finally, you estimate the land is worth $100,000, so you add it: $245,550 + $100,000 = $345,000.

Gross Rent Multiplier (GRM) Method

The Gross Rent Multiplier (GRM) method is similar to the income method in that it relies on rearranging an existing return formula, the GRM formula: 

Gross Rent Multiplier (GRM) = Property Value / Annual Gross Rental Income

For instance, if you buy a $500,000 property that generates $30,000 in annual gross rental income, its GRM would be about 16.66. In other words, it would take 16.66 years to make your money back with gross rent (if you paid with cash).

Now, let’s say you have a target GRM of 10 based on your past investments or the performance of comp properties. Furthermore, you project the subject property will generate $35,000 in annual gross rental income. By rearranging the GRM formula, you can solve for property value:

Property Value = Gross Rent Multiplier (GRM) x Annual Gross Rental Income

In this case, the estimated property value would be $350,000 (10 x $35,000). 

Keep in mind that the GRM method is a quick but blunt method for estimating property value since it doesn’t account for operating expenses and other market factors. 

Finance Your Next Rental Property with Asset Based Lending

Ultimately, no method for estimating rental property value is failproof. However, by understanding a few different approaches, you can make relatively accurate estimates, and at the very least, avoid dramatically overpaying for a rental property.

If you have your eye on a rental property and want to secure financing to make a serious offer, you’ve come to the right place. With an Asset Based Lending loan, you can qualify for a rental loan faster than you could with a traditional lender. Pre-qualify today to find out how much you can borrow.

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