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If you’re looking to learn more about property value on rental properties, then check out our Ultimate Guide to Property Value on Rental Properties.
It is not necessarily the Purchase Price of a property. Sometimes we will buy a property at a discount and sometimes—especially for an exceptional property—we might pay more than the property value to acquire the property.
Doesn’t Purchase Price = Property Value?
Some folks automatically assume, incorrectly, that if a willing buyer and willing seller agree in an arms-length transaction agree to a price that means that property is worth that. That’s not true. Sometimes the terms of the purchase make the property more/less valuable than the purchase price.
As just one example, let’s say there is a property worth $400,000. But, the seller is willing to finance the entire purchase at 0% interest. Even though the property is still worth $400,000 a buyer may agree to pay the seller $500,000 to purchase the property if it comes with an interest-free loan.
How to Determine Property Value Using Comparable Sales
I taught an entire class on how to use comparable sales to determine the value of a property. You can watch the video below.
Calculating Appreciation
When calculating appreciation, we often use the property value as the base for multiplying by the Appreciation Rate.
Here’s a sample appreciation calculation:
Appreciation
| Organic Appreciation | $7,834 | |||
| + | Forced Appreciation | + | $0 | |
| Total Appreciation | = | $7,834 |
Let's walk through calculating Appreciation for 
Typical 25% Down Payment Gainesville, Florida Rental Property.
First, there's organic appreciation and forced appreciation.
Organic Appreciation
Organic appreciation is the tendency that properties become more expensive over time. Some would argue that, at least part of it, is from inflation.
Ultimately, to calculate the organic appreciation we will need the current value of the property and Appreciation Rate.
Both the current value of a property and the appreciation rate are easy since they both are primary inputs that do not require any real calculation.
Organic Appreciation
| Property Value | $261,142 | |||
| × | Appreciation Rate | × | 3% | |
| Appreciation | = | $7,834 |
That means that we're estimating Typical 25% Down Payment Gainesville, Florida Rental Property will naturally and organically appreciate $7,834.26 over a full year.
Forced Appreciation
Forced appreciation from buying a property at a discount and/or improving the property to add value.
To calculate forced appreciation—especially on a new purchase—we will take the difference between the Purchase Price and the After Repair Value of the property.
Forced Appreciation
| After Repair Value | $261,142 | |||
| - | Purchase Price | - | $261,142 | |
| Forced Appreciation | = | $0 |
That means that we're estimating Typical 25% Down Payment Gainesville, Florida Rental Property was forced to appreciate $0 by buying at a discount and/or improving the property in the next year.
It is not uncommon to have zero or even negative forced appreciation on a property when acquiring it. In fact, sometimes we deliberately trade the short-term benefit of buying a property at a discount to select a property that is likely to see better than average organic appreciation in the long-term. Think of this as: selecting a high quality, in-demand property that is likely to continue to increase in demand in the future and grow faster than inflation and other properties in different areas or with different characteristics.
Total Appreciation
The total appreciation is the sum of the estimated organic appreciation and the estimated forced appreciation over the next year.
Total Appreciation
| Organic Appreciation | $7,834 | |||
| + | Forced Appreciation | + | $0 | |
| Total Appreciation | = | $7,834 |
For Typical 25% Down Payment Gainesville, Florida Rental Property we're estimating the organic appreciation of $7,834.26 plus the forced appreciation of $0 gives us an estimated total appreciation of $7,834.26 in the next year.
Calculating Cap Rate
We also use property value when calculating Cap Rate.
Here’s a sample cap rate calculation:
Cap Rate
| Annual Net Operating Income | $16,791 | |||
| ÷ | Purchase Price | ÷ | $261,142 | |
| Cap Rate | = | 6.43% |
Let's walk through calculating Cap Rate for Typical 25% Down Payment Gainesville, Florida Rental Property.
Ultimately, we will need Net Operating Income and Purchase Price.
Purchase Price is easy since it is a primary input that does not require any real calculation.
So, let's focus on How to Calculate Net Operating Income.
To calculate Net Operating Income (often abbreviated NOI), we need to know the Gross Operating Income for the property and the Operating Expenses.
We'll start with the Gross Operating Income.
Gross Operating Income is really just the total Gross Potential Income for the property minus the vacancy allowance for the property.
That means we'll need to start with calculating Gross Potential Income based on all the income sources for the property: rent and anything else you might be getting income from on the property.
Annual Gross Potential Income
| Annual Rent | $27,720 | |||
| + | Annual Other Income | + | $0 | |
| Annual Gross Potential Income | = | $27,720 |
Gross Potential Income is how much total income the property could possibly produce from all sources.
For Typical 25% Down Payment Gainesville, Florida Rental Property we take the total amount of rent they could collect and any additional income they might also get from the property.
The rent for Typical 25% Down Payment Gainesville, Florida Rental Property is estimated to be $2,310 per month or $27,720 per year. We'll use the annual amount of $27,720 for our calculation and we will, for now, ignore vacancies... we'll deal with vacancy when calculating Gross Operating Income.
We're estimating $0 in other income from the property.
Some common examples of other income might be: profits from on-site laundry (especially in multi-family), pet rent, renting out extra spaces on the property (like an extra garage or storage unit) or things like that.
That means that Typical 25% Down Payment Gainesville, Florida Rental Property has a Gross Potential Income of $27,720 per year.
But that does not consider the impact of vacancy. To do that, we'll look at Gross Operating Income next.
Annual Gross Operating Income
| Annual Gross Potential Income | $27,720 | |||
| - | Annual Vacancy Dollar | - | $832 | |
| Annual Gross Operating Income | = | $26,888 |
Gross Operating Income unlike Gross Potential Income does take into account the impact of vacancy on the property.
For Typical 25% Down Payment Gainesville, Florida Rental Property, we're estimating that the property is vacant 3% of the time. That means that we're not seeing $831.60 of the $27,720 that we thought we might get from the property.
Annual Gross Operating Income
| Annual Gross Potential Income | $27,720 | |||
| - | Annual Vacancy Dollar | - | $832 | |
| Annual Gross Operating Income | = | $26,888 |
But, what about all the other expenses? Well, those are called Operating Expenses.
Annual Operating Expenses
| Annual Property Taxes | $0 | |||
| Annual Property Insurance | $4,007 | |||
| Annual Homeowner's Association Fees | $0 | |||
| Annual Landlord-Paid Utilities | $0 | |||
| Annual Other Expenses 1 | $0 | |||
| Annual Other Expenses 2 | $0 | |||
| Annual Property Maintenance | $2,689 | |||
| Annual Property Management | $0 | |||
| Annual Operating Expenses | = | $10,097 |
Operating Expenses are all the expenses of operating the property except vacancy and financing of the property.
For Typical 25% Down Payment Gainesville, Florida Rental Property we used the following:
- Property Taxes - These are the property taxes paid for the property. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated they are $0 per year.
- Property Insurance - This is the insurance policy to cover the property from perils like fires and liability from injuries on the property. Your specific policy will define what hazards you're covered for. This policy typically does not cover the personal property of tenants; they should get their own renter's insurance policy to cover that. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the cost of this insurance policy to be $4,007.22 per year.
- Homeowner's Association Fees - This is usually the cost for the homeowner's association (HOA) where the property is located. What the HOA coverages varies widely between different HOAs so be sure to check with the HOA to find out what is included for your HOA fee. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the cost of the homeowner's association fees to be $0 per year.
- Landlord-Paid Utilities - With many single family homes... and to a slightly lesser extend... duplexes, triplexes adn fourplexes... the tenants all pay individually metered utilities. However, in some cases... especially for larger multi-family properties... the landlord is responsbile for some shared (or in some cases... all) utilities. This is just for the utilities that the landlord is responsbile for paying. Tenant-paid utilities should not be included here. It is not uncommon to have this be equal to zero especially for smaller properties. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the cost of the landlord-paid utilities to be $0 per year.
- Other Expenses - Sometimes a property will have an extra expenses associated with it. Some examples might include lawn service, snow removal, common area cleaning, etc. For smaller properties, it is not uncommon to have these extra expenses be equal to zero. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the annual cost of these extra expenses to be:
- Other Expenses 1: $0
- Other Expenses 2: $0
- Maintenance - With many properties... especially residential properties... the landlord will be responsible for maintaining the properties and should set aside money to pay for on-going maintenance. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the cost of maintenance, on average, to be $2,688.84 per year.
- There is some debate over whether you should include some or all of the Capital Expenses in the Operating Expenses or if they should be capital improvements to the property and not including in Operating Expenses. You can choose to include them by increasing the maintenance percentage or choose to include them elsewhere by excluding them from Maintenance.
- Property Management - With most properties, there will be an expense to managing the properties either in the form a professional property management fee or the... much lower hard costs... of managing the property yourself. For Typical 25% Down Payment Gainesville, Florida Rental Property, we've estimated the cost of property management to be 0% of the rent or $0 per year.
If we add up all of these expenses for Typical 25% Down Payment Gainesville, Florida Rental Property, we're estimating the Annual Operating Expenses to be $10,097.44.
Annual Operating Expenses
| Annual Property Taxes | $0 | |||
| Annual Property Insurance | $4,007 | |||
| Annual Homeowner's Association Fees | $0 | |||
| Annual Landlord-Paid Utilities | $0 | |||
| Annual Other Expenses 1 | $0 | |||
| Annual Other Expenses 2 | $0 | |||
| Annual Property Maintenance | $2,689 | |||
| Annual Property Management | $0 | |||
| Annual Operating Expenses | = | $10,097 |
Now that we know the Gross Potential Income and the Operating Expenses for the property, we can calculate the Net Operating Income.
Annual Net Operating Income
| Annual Gross Operating Income | $26,888 | |||
| - | Annual Operating Expenses | - | $10,097 | |
| Annual Net Operating Income | = | $16,791 |
Net Operating Income is how much money you're making from the property after vacancy and all the Operating Expenses except for the financing expenses on the property (like the mortgage payment and, if applicable, private mortgage insurance).
For Typical 25% Down Payment Gainesville, Florida Rental Property we would use the Gross Operating Income of $26,888.40 per year and subtract out all the Operating Expenses of $10,097.44 for the year.
That would result in a Net Operating Income of $16,790.96 per year or $1,399.25 per month.
Annual Net Operating Income
| Annual Gross Operating Income | $26,888 | |||
| - | Annual Operating Expenses | - | $10,097 | |
| Annual Net Operating Income | = | $16,791 |
And, finally, with a Net Operating Income of $16,790.96 per year and a Purchase Price of $261,142, we can calculate the Cap Rate.
Cap Rate
| Annual Net Operating Income | $16,791 | |||
| ÷ | Purchase Price | ÷ | $261,142 | |
| Cap Rate | = | 6.43% |
That means that Typical 25% Down Payment Gainesville, Florida Rental Property has a Cap Rate of 6.43%.
Property Value When Analyzing Deals
When analyzing deals using The World’s Greatest Real Estate Deal Analysis Spreadsheet™, you enter in what your estimate of property value is in the input field labeled After Repair Value (ARV).
This can be different than the purchase price.
Primary Input
Property value Primary is considered a primary input in the Hierarchy of Real Estate Metrics.
It is used as an input to Calculate Appreciation or to Calculate Cap Rate.
