iProperty value is an obvious concern for rental property investors. That said, there are different methods of rental property valuation. Each can be useful, but they can also tell you different things about a rental property’s value.
This post is part two of a series looking at different methods of rental property valuation. If you didn’t see part one, you can find it here. Part one covered the sales comparison approach and gross rent multiplier.
3 More Approaches to Rental Property Valuation
Income Approach
With the income approach, you have another method that looks at a property’s income potential. It is similar to GRM in that way. However, it uses the net operating income instead of looking at it through gross rental income.
It is a look at the property’s cap rate. You divide your net operating income by the property’s purchase price to calculate your cap rate.
You can multiply the result by 100 to get the cap rate percentage.
For example, let’s say you have a property that sells at $250,000 and has $20,000 in NOI. The cap rate for that property is 8%. In general, higher cap rates are better. However, it might not tell the complete story of the property’s profitability.
Cost Approach
The cost approach is more complex than other valuation methods. It operates under the assumption that a property should not cost more than it would build a new identical property. Also, it accounts for the structure, its age, depreciation, and the value of the land. It can be especially useful if the property is unique or there are no appraisal comps.
This type of valuation starts with the cost to replace or reproduce the property. You subtract the structure’s depreciation and add the land’s estimated value. The resulting figure is the property’s value according to the cost approach. Under this approach, you should only pay that figure.
Capital Asset Pricing
Capital asset pricing is complex, but it provides a more comprehensive view of an investment’s value. Going beyond the view of a real estate investment, it looks at the relationship between risk and return. Investors commonly use it to value stocks, but it can work for other investments.
With this method, you need to calculate your expected return and compare it to investments with no risk. Along with that, you look at various factors to calculate the risk level of the investment property. The idea is that the expected return should increase as risk increases.
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