How to Quickly Estimate a Rental Property's Value
Sometimes it helps to be able to calculate a rental income property's estimated value just as a quick first-glance look to determine whether its in line with similar properties in the local market area.
In other words, not to provide a true picture of a property's profitability, but just to help decide whether or not it even comes close to being a good real estate investment opportunity.
Well, there is a way.
Gross Rent Multiplier and Capitalization Rate are both popular real estate investing measures regularly used by real estate investors, realtors, and other real estate analysts just for that purpose.
In this article we'll look at both measures along with the appropriate formulation you can use to arrive at a property's market value the next time you're working with rental income property.
1. Gross Rent Multiplier
Gross rent multiplier (or GRM) measures the ratio between a rental property's gross scheduled income and its stated price.
- Gross scheduled income = the number of units times their annual rent based on 100% occupancy. Apply a market rent for any vacant units.
- Price = the stated price for the property
= Gross Rent Multiplier
How to Use to Estimate Property Value
- First, use a GRM that reflects the average for other similar rental properties in your local market area. Check with a local real estate professional or appraiser if you need help.
- Then, apply the following formulation when you want to calculate an estimated value for a rental property.
= Market Value
You're considering the purchase of a 5-unit apartment building with a gross rent of $64,000 and you want to compute the property's estmated market value based on the neighborhood's average GRM of 5.0.
RESULT: 64,000 x .05 = $320,000
2. Capitalization Rate
Capitalization rate (or, cap rate) expresses the relationship between a property's value and its net operating income (NOI) for the current or coming year.
- Net Operating Income = all the property's rental and other income less its operating expenses.
- Market Value = the stated price for the rental property
= Cap Rate
How to Use Cap Rate to Estimate Property Value
- Select a capitalization rate that reflects the average for other similar rental properties in your local market area. Check with a local real estate professional or appraiser if you need help.
- Apply the following formulation when you want to estimate the value for a particular property.
= Market Value
Let's say that you're trying to establish a reasonable sale price on small office complex with a net operating income of $40,600, and based upon your research the average cap rate for similar properties is 8.5%.
RESULT: 40,600 ÷ .085 = $477,647
Rule of Thumb
The advantage to using both methods is that they are relatively easy to compute. But bear in mind that they are just a precursor to a serious real estate analysis of the property.
So don't rely upon either method to make your final real estate investment decision without computing (and validating) all the property's rents, operating expenses and other financial data yourself.
Here's to your real estate investing success.
So You Know
ProAPOD's Agent 6 and Executive 10 real estate analysis software solutions and Pro RE Calculator each compute gross rent multiplier and cap rate automatically based upon your data entries.