I have some rental property which a friend has inquired about purchasing from me. I’m not sure how to price it. Is there some generally accepted formula based on rental income for determining an appropriate sale price for a rental property? (Residential, not commercial.)
I tried googling for this information and only wound up with sales pitches.
The purpose shouldn’t matter, right? I’d get an appraisal- especially because it’s a friend of yours- a third-party authority is easier to rest on than your say-so in this sort of thing.
It’s entirely possible that the rental price underrepresents the real value of the property.
I’ll back Stolichnaya’s opinion here. Typical appraisals where you aren’t demanding to affix a value to the near-unique that will stand up in court are not onerously expensive, and it’s a very good way to destroy a friendship to try to arrive at a “fair price” by simply the good guesses of two laymen friends. What if some hidden defect, totally unbeknownst to you, shows up in a few years? What if real estate prices in the area shift rapidly – in either direction? Get an objective figure from a professional, and you’re both comfortable with it and insulated from the relationship-straining possibilities simply because you have agreed on an objective fair-market price set by a third party.
Good advice, but at the same time, I wonder if there’s some rule of thumb, such as spoke- alludes to, that assesses a house according to the value of the rental income (understanding, of course, that such a rule would only be a guide, and that condition of the building plus other intangibles would enter in). After all, considering a rental property as a business, aren’t businesses usually valued at X times the net income, or some such, plus the usual tangigbles/intangibles?
in addition you can always knock off a bit of that for your friend that way or to assist with financing. For example say this house appraises for $300K, you originally purchased for $50K 20 years ago you stand to make a hefty chunk of change. If you sold it to your buddy for $240K he could get an 80% loan with no down at better rates than the whole $300K, especially if he has less than stellar credit.
Absolutely. For a house, the most common way of doing this is a “Gross Income Multiplier.” It’s really easy: you take the total amount of money it could hypothetically generate over a year (you could also do a monthly multiplier if you prefer), and multiply it by the multiplier.
The first part is easy: it’s whatever the monthly market rent is, times twelve (or by itself if you’re using a monthly multiplier).
The second part is harder: appraisers know what a reasonable GIM is in their area, because that’s what they do for a living. Typically they’ll extract GIMs from sales, it’s pretty easy if you’ve got five sales of rental homes, since all you have to ask a related party is “how much does it rent for.” I have no idea what a reasonable GIM is in your area, hell I don’t even really know what one is in my area for a house (for largish multifamily properties it can range area from 4.5X to 8X depending on its age, condition, expense structure and plenty of other factors, but a 500 unit apartment complex isn’t a house, and that just applies to my area which has nothing to do with yours).
This is of course a highly simple way of valuing an income producing property. There are others, but they’re probably overkill for a single family rental home, though I don’t know that for certain since I don’t appraise the silly things.
I appreciate the advice to get an appraisal. On the other hand, an appraisal can be pretty subjective in my experience, particularly when you get into the question of what properties are “comparable.” It is also my experience that appraisers (in this area anyway) can be subject to influence by one party or another. I was hoping to avoid that potential source of conflict by trying to find an objective approach based on income. Looking at desdinova’s last post, though, I see that there may be too many variables to make that practical.
Well you could always look at what the city has the property assessed at. It will probably be a little low but it’s a starting point.
In markets where there’s been a lot of appreciation, the city assessment is often way off because it’s often a couple of years old. Plus, there’s sometimes political pressure to keep assessments lower than market, just because property taxes are based on the assessment.
Weird…my house I bought happened to be a rental property for about 20 years before I bought it. But really it’s just a single-family dwelling that was bequeathed to the owners when their dad died - they already had a house so they just rented this one out. As far as I could tell, the assessment was just for the property as if I was going to be living in it, not renting it out (it was no different than the rest of the houses in the neighborhood).
The only “catch” when I bought, regarding the fact that it was a rental, was that the sellers were ready to deny my bid because they figured they could keep it and keep renting it out and make more money that way. They, of course, ended up selling.
Is the difference in your scenario the fact that your friend is planning to rent it out, or is the friend planning to live there? And is it a duplex or single-family?
A friend of mine who is pretty heavily into rentals uses $100 monthly rent per $10K of purchase price. For example he would need $1500/month total rent for a place that cost him $150K. He is worried that if interest rates rise much more, this rule of thumb will no longer work. YMMV.
As a guideline to estimate the rental price of single family homes I’ve usually started with 1.0% of the value per month, so that a $100,000 home would rent for $1000/month. If I multiplied the monthly rent by 100 I’d be in the ballpark, but housing values can fluctuate wildly, and I’m so darn old that half the stuff I know is worse than useless, it’s actually harmful, so take that as you will.
I thought I had heard that rule-of-thumb formula tossed around in this neck of the woods, but I wasn’t sure. That’s the number I had in the back of my mind. I didn’t want to mention it in the OP for fear of influencing the discussion.
But you make a good point. I can see how changing interest rates would affect the numbers.
And ZipperJJ, it is strictly a rental property from my friend’s perspective.
If we’re talking about a single-family or duplex in a neighborhood, the resale price of the property will pretty much be equivilent to owner-occupied homes in the neighborhood. The 1% rule can tell you if the property is a good investment for immediate cash-flow from your rental. 1% is right around the PITI payments for a 30 year mortgage with little down. It’s not necessarily the correct price for a sale - the 800 sq foot house in the close-in neighborhood might rent for $1500/mo, but it might sell for $300K. In these circumstances, I presume the buyer is planning to make a large down payment and make a profit from appreciation, and not from cash flow from rent.