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Essential Rental Valuation Tips for Landlords & Property Investors in San Diego

Knowing how to estimate rental property value in San Diego is both an art and a science. Although these calculations can be complicated and overwhelming, rental property valuation is critical because it helps you understand fair market value of your dwelling. If you know its potential net income, it will be easier for you to figure out whether you need to adjust the rental price, refinance, buy or sell. It is also helpful for taxation purposes, transferring real estate, and compulsory acquisition.

A Quick Guide on How To Determine Rental Property Value & Why Hire Professionals To Appraise Your Real Estate

In this article, we have summarized all you need to know about rental valuation – why it is important, how to calculate it, which factors influence the value, and how to increase the value. We will briefly analyze 5 different calculation methods, including sales comparison, capital asset pricing model, income approach, gross rent multiplier, and cost approach.

Whether you already own a rental home or are still looking to invest in one, you will find useful tips on approximating property value. The information provided here will help you make the best decision for your rental business. For those investors who need help with this task, we will provide information on how to find real estate agents or property managers who will calculate the value for you and help you generate substantial rental income by providing their professional services and advice.

What Is Rental Property Valuation?

Rental property valuation is the process of calculating current value, or economic worth, of investment property. It serves to show you the potential cash flow you might earn from renting it out.

Valuation of long-term and vacation rental homes is different from valuation of primary residences. In order to determine the worth of a rental property, you have to take numerous factors into consideration, such as dwelling’s age, location, size, current market trends, amenities, and so on.

Why Is Fair Rental Value Important?

There are numerous reasons why it is vital to know the exact worth of your rental real estate and they include successful property portfolio, property insurance, rent price, financing, sales, purchase, taxation, and so on. Below are just some of the ways how fair buying or selling price is used:

  • It helps landlords assess whether their rental rate is acceptable or needs to be adjusted
  • It helps sellers know whether the price is adequate, while buyers use this information to decide if they are making a profitable investment.
  • Mortgage lenders use estimated value to establish if purchase price coordinates with fair market value to make sure they are not overfinancing.
  • County auditors use assessed value to calculate taxes you have to pay.
  • Individuals looking to transfer property to a relative also need to know the value, as the new owner may have to pay additional taxes.
  • In cases of compulsory acquisition, the government uses estimated value to justly compensate the previous owner.

What Are The Factors That Influence The Amount Of Rental Value

Listed below are the most common factors that affect rental property value:

  • Local market trends – Larger markets typically have higher priced properties, while smaller markets have more affordable properties.
  • Location – Commercial real estate investors should opt for properties on busier streets, while residential investors should look for quieter areas with quality amenities.
  • Number of bedrooms – The more bedrooms you have, the higher the rent rate and income you will collect.
  • Furniture – Every tenant prefers high-quality furniture. Although it calls for more spending initially, it does raise the overall value and you can also justify higher rent price.
  • Amenities – Access to on-site laundry, parking, swimming pool, or fitness center will make you competitive in the market and significantly increase the value of your real estate.
  • Property condition – Newer properties are more appealing as they need less upkeep.

How To Estimate Rental Property Value: 5 Valuation Methods

There is more than way to calculate the value of a rental property. In fact, there are five different concepts of properly determining the worth, and each one has its own use. In general, appraisers combine three methods (sales comparison, income approach, and the cost approach), but serious investors analyze components from each one, before making an investment decision.

Sales comparison

One of the most popular concepts of assessing residential properties is sales comparison. Also known as “comps”, this approach is based on comparing similar properties in the area over a specific period of time. It is typically used by real estate agents and appraisers who use various features (e.g., number of bedrooms, fireplaces, garages) to assign a relative price value. The metric used in this approach, ‘price per square foot’, is easily understandable and the least confusing for the majority of investors.  

How to calculate: If comparable homes in the area have sold for $500,000, this can be a starting point for the calculation. Unique factors, special amenities, and type of property is then taken into consideration and analyzed to determine the value.

It is worth noting that every property has something unique that cannot be quantifiable. Because of this, the sales comparison concept is meant to be used only as a baseline, and not as the exact valuation tool. Remember to use certified experts for comparative analysis to avoid fraudulent appraisals and be confident that the estimate is valid.

Example comparison:

Target Property Comparison 1 Comparison 2 Comparison 3
Price $350,00 $353,00 $347,00 $360,00
Square Feet 3,150 3,100 3,100 3,200
Bedrooms/Baths 4/4 4/3.5 4/3.5 3/4
Bath Improvement $0 $6,000 $6,000 -$5,000
Garage No Yes (-$2,000) No No
Adjusted value $350,000 $359,000 $353,000 $355,000
Price per sq foot $111 / sq ft $115 / sq ft $113 / sq ft $110 / sq ft

Capital asset pricing model

Capital asset pricing model is the most complicated concept of all. It takes into account various aspects (condition, age, location, operating expenses, cash flow, etc.) to describe the connection between estimated return and the risk of investing. Theoretically, CAPM approach implies that higher profits are only possible when higher levels of risks are taken.

Risk factors include things like property age or safety. For example, if your property is located in area of high-crime rate, you will need to invest more in safety precautionary measures than an owner who has property in a gated neighborhood.  

How to calculate: This approach comparespotential ROI (return on investment) to other non-risk investment (e.g. real estate investment trusts). If the calculation shows that return on risk-free (guaranteed) investment is higher than potential profit from your rental property, then stay clear of purchasing the property.

Income/cap rate method

Income approach focuses on what the potential income would yield in relation to initial investment amount. This is a very simple concept that is based on identifying the annual capitalization rate. Typically, an investor may determine operating expenses based on a specific property’s historical and anticipated future expenses can be appraised either by specific historic and future expenses or by using the 50% Rule for properties that have not been rented before. According to this approach, you can estimate operating expenses when you multiply adjusted gross rental income by 50%. For example, if adjusted gross rental income is $16,000, operating expenses are estimated at $8,000.

How to calculate: Capitalization rate is calculated when Net operating income (NOI) is divided by purchase price. The adjusted gross rental income is income from all rental units, as well as parking spaces, pet rent, and other on-site services. Below we have an example of how to calculate property value assuming similar properties in the area have 7% cap rate.

STEP 1:

Subtract operating expenses from adjusted gross rental income to get net operating income (NOI):

Adjusted gross rental income – operating expenses = Net operating income (NOI)

$40,000 – $8,000 = $32,000

STEP 2:

Calculate cap rate using the following formula:

Net operating income / Purchase price = Capitalization rate

$32,000 / $450,000 = 0.07 (7%)

STEP 3:

Finally, calculate property value by dividing NOI by cap rate percentage:

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

$32,000 NOI / 7% cap rate = $457,143 property value

Note: NOI does not include mortgage payment, capital expense contributions, or the non-cash expense of depreciation.

Gross rent multiplier

Similar to income method, the Gross Rent Multiplier (GRM) approach estimates rental property value based on annual rental income and the purchase price of comparable property. However, this is rougher calculation, as it does not take into consideration expenses such as taxes, mortgage payments, maintenance, professional service fees, and so on. Rental value estimation appraised by this approach may not hold true as other concepts. This method is generally used for residential investment properties, both single family dwellings and multifamily properties.

How to calculate:

STEP 1:

To calculate Gross rent multiplier, divide purchase price by gross annual rental income

Property purchase price / Gross annual rental income = Gross rent Multiplier (GRM)

$500,000 / $50,000 = 10

STEP 2:

Now that you know the GRM, calculate property value by multiplying Gross annual income and GRM.

If your target property has annual income of $50,000, here’s the calculation:

Gross annual rental income * Gross rent multiplier (GRM) = Property value

$50,000 * 10 = $500,000

Cost approach

Cost approach is calculated by identifying the replacement cost minus physical depreciation, external depreciation, and functional obsolescence. It is typically used to determine the value of newly built objects, as it can be too hard to determine the value of older homes using this cost approach.

  • Physical depreciation is age-related wear and tear.
  • Functional obsolescence is the expense of updating and modernizing the property.
  • External obsolesce represents off-sitechanges inenvironmental or economic conditions that negatively impact the value. For instance, a new built train tracks nearby, newly built nightclubs, or industrial installations, and so on.

How to calculate: Follow these simple steps to appraise the value of a rental property using the cost approach:

STEP 1: Estimate land value by analyzing comparables.

STEP 2: Determine what the cost of new property and replacement cost, including materials, labor, permits, insurance, etc.

STEP 3: Calculate accumulated depreciation.

STEP 4: Calculate property value using this formula:

Land Cost + Cost New (Replacement Cost) – Accumulated Depreciation (Physical depreciation + Functional obsolesce + External obsolesce) = Property Value

$70,000 + $200,000 – ($20,000 + $15,000 + $15,000) = $220,000

How To Increase Your Property’s Value

There are a lot of rental property upgrades you can do to boost the value and increase cash flow, and we will mention the most effective ones:

  • Remodel the kitchen
  • Renovate the bathroom
  • Modernize the layout
  • Energy-efficient upgrades
  • Install new floorsa
  • Build additions (extra bedroom, sunroom, office)
  • Add popular amenities
  • Update curb appeal and landscaping

Professional Assistance From Real Estate Advisors

If you feel uncomfortable about assessing property value yourself, it is wise to hire a professional to get an official and accurate value estimation. It would lift a lot off load off your back, and you would be confident that valuation is done right. Expert appraisers possess a deep understanding of local market trends, pricing, and how to create fair estimates, which is why it is crucial to work with specialists.

Who can appraise the property?

Rental property can be appraised by licensed or certified appraisers, also known as property valuers or land valuers. They are responsible for providing objective, third-party opinion without prejudices. Every jurisdiction has different regulations about who can valuate a property.

Property managers and real estate agents usually have ample experience in providing expert guidance and determining accurate rental valuation. Their knowledge is irreplaceable in helping you make important investment decisions. You will get the best results and best advice regarding your rental business.

How to choose a good real estate appraiser?

In order to find a reputable and qualified appraiser, consider the following:

  • Review past reputation and clients’ testimonials to see what other people’s impressions are
  • Get local real estate agent or lender referral
  • Check pricing before moving forward
  • Verify credentials and licenses

Disclosure

This material is intended for informational purposes only and should not be used for any other purposes. It is meant solely to inform, and not to give advice or instructions on how to move forward. The information presented here does not constitute legal advice, it does not represent professional advice and is not guaranteed to be accurate, complete, current, or error-free. The content is subject to change without notice. Laws, rules, and regulations may vary by location, city, or state. If you have questions about your rental property, consult a professional property manager.

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About the Author

David Miller is Real Estate Advisor at Swell Property. Whether you’re eyeing a new home, an investment property, securing the best mortgage, or aiming to enhance your property’s value, my focus is on providing personalized guidance and strategy for your success. I listen to your needs attentively, ensuring that my expertise aligns perfectly with your real estate goals. My clients’ satisfaction and referrals are the true measure of my success in San Diego’s dynamic real estate market. If you’re searching for a real estate professional who’s deeply committed to your success, I’m eager to demonstrate my expertise and win your trust. Let’s connect and start this journey together.

David Miller Real Estate Advisor

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