How To Value A Rental Property

In this article we discuss how to value a property intended to generate rental income. Using a very simple example, we intro how to go about thinking of return on investment (ROI) if you are considering investing in property.
This article is for educational purposed only.


Return of a Rental Property vs Primary Residence

One of our subscribers recently asked how we value residential property used to generate rental income, given our recent study of the S&P 500 versus real estate, as they were considering investing in property for this purpose.

Unfortunately, our real estate analysis only examined housing price appreciation data, not factoring in rental yields. It is a fair question, however, and one we discuss in detail below:


How to Value a Rental Property

We find it easiest to learn through an example, so let’s set up our scenario:

  • Imagine owning a US property valued at $320,000, representing the average US house price before the pandemic.
  • The intention is to rent out the property at $2,000 per month, with
  • Monthly operating expenses totalling $538.
  • After 10 years of renting, we decide to sell.


What would be our return on investment (ROI) after 10 years?

To calculate ROI for a rental property, we need to consider two key components:

  1. Appreciation of the Property Value during ownership
  2. Total Profit from Rental Income over the same period


1) Property Value Appreciation

Given our property is an average-priced home in the US, we’ll apply a 5.4% annual appreciation rate, as we concluded in our study.

So, after a decade, we expect to sell the property, valued today at $320,000, for approximately $541,477.


Table showing how a property's value appreciates over time if we assume it appreciates at 5.4% per year, the average US housing price growth rate per year for the previous 50 years (1973 to 2023)


2) Total Profit from Rental Income

Calculating rental profit involves considering both rental income and operating expenses. But they are not fixed as costs increase annually, so we need to adjust what we earn, too.

We’ll assume operating expenses increase in line with inflation each year, but we should be able to increase our rental rate more than the operating expenses, say inflation +1%.

Using these assumptions, we expect to earn a total profit of $217,490 after renting out for 10 years.


Table showing how rental income and rental operating expenses grow per year if we assume operating expenses grow at inflation and rental income grows at inflation + 1%


Return on Investment (ROI)

We are now in a position to calculate our ROI!

By the end of Year 10 (start of Year 11), combining the property sale of $541,477 and rental income of $217,490, the total return amounts to $758,967.

Therefore, considering our initial investment of $320,000, the ROI will be >137% over a decade, yielding an annualised return of approximately 9%.




This example provides insight into how to value a property generating rental income.

While we employed broad assumptions, real-world scenarios demand region-specific property prices, expected rental yields analysis, and a thorough breakdown of operating costs.

The attractiveness of a 9% return in long-term property rental must be weighed against alternatives. For instance, our study of S&P 500 returns since 1973 suggests an expected annualised return of over 11%. Investing the initial $320,000 in the S&P index for a decade could potentially grow the investment to over $900,000.

Of course, the risks between investing in the stock market and property differ significantly. Still, factors such as liquidity (ease of buying and selling) and the effort involved in managing your investment should also be considered.

Ultimately, individuals must analyse their situations and risk tolerance to determine the most appropriate investment.



Additional Considerations

Our example doesn’t consider factors such as purchasing a property using a mortgage, where debt can be used to increase returns significantly but with added risk.

Additionally, short-term rentals in high tourist traffic areas may offer higher yields, albeit with increased risk, such as unforeseen events like the COVID-19 pandemic impacting occupancy.


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