Value in a valueless world?

Value in a valueless world?

It doesn't have to be difficult to work out the value of a property

Something we hear continuously in every arena is that you can’t place a value on a property because there are not enough transactions. In short this is a mistake, in fact, MyHome published a report on different methods for doing this only a few months ago.

In Ireland we tend to rely on market interpretations of value by considering comparable properties, but when transactions fall so do the points of reference – it’s like navigating without a compass when that happens.

In a shameless plug I’ll let you know in advance that I’m covering the Sunday Business Show on Today FM from 10-11 this week and we’ll have a heavy hitting panel talking about property and whether there are opportunities or not – don’t miss that if you like the topic!

There are alternative ways, one is called ‘the investment method’ and to do it you typically need to have an idea of the gross rental yield. Gross rental yield is calculated as follows:

(Monthly rent) x (12) / Property price, x 100

Multiply the monthly rent in to an annual figure then divide it by the capital cost and multiply by 100 to make a percentage. Here’s an example.

Rent of €950 per month

Property price: €120,000

950×12/120,000 = 0.095 x 100 = 9.5%.

But you can also substitute for figures you don’t have, so imagine you only have an idea of the rent and no clue of the ‘value’ because there are no comparable properties. Instead you can look to a yield as the solution.

If you wanted to ensure you are getting a higher return than deposits then you could pick a figure like 7% as a return which is worth the risk of the investment. Personally I think it should be a bit higher because you can buy government bonds that aren’t far below that – but a historical ‘decent’ return on property was 7% a year.

Now we need to turn that into something we can calculate a value from, if you wanted to use the rent in order to determine the price you would pay to get a 7% yield you do the following:

100/ rental yield expected (7%) = multiplier.

The ‘multiplier’ means how many times you multiply annual rent to get the capital value. So we’ll do that again with the property above.

100/7 = 14.3 then you multiply annual rent by that figure.

14.3 x €11,400 (which is 950 per month by twelve months) = €163,020

And this shows that you at €120,000 you are getting a better deal than a 7% yield – we already calculated that this has a 9.5% return.

Prospective buyers of homes can also use this as a way of gauging value because you always have the alternative of renting in the area you want to live in. But buyer beware, because there is a hitch in this system which is the ‘owners premium’. People who want to live in a desirable area are often willing to pay a premium to locate there, this is reflected in rents that are not as high as the capital values would imply they should be and also by a price that is higher than a reasonable yield.

Let’s look at some Allsop guide prices to demonstrate this, see the table below. The figures in the second last column represent the difference from a ‘fair valuation’ using the investment method. If you want to understand the whole table read the report (download it from this link).

What it shows is that even at an auction where everything is ‘priced to sell’ that the bottom three properties start off in the red (for instance the last property has a -€3,467 figure, meaning that you would have to deduct that amount from the reserve price to be at ‘fair value’ or a 7% yield).

 

 

 

 

 

Why does that anomaly occur? Simply put it exists because people are willing to pay more to live there and they compete with investors and everybody else, think of a nice neighbourhood near you and chances are you will find that this ‘owners premium’ exists there, in Dublin at least, it appears to occur regularly in Blackrock, Co. Dublin.

The main thing to take from this is that you don’t need valuations in the traditional form to understand the market, there are other options. And if you use yields and spot something that looks good then you have reason to look further, if the rental yield is genuine and in the double digits then no matter what the market noise is saying, it is likely a good investment.

And that my friends is the trick, to be able to cut through the cloud of market noise and headlines to find deals that make sense. I hope this helps you make more informed decisions!

@karldeeter

Irish Mortgage Brokers

 

 

There are 11 comments for this article
  1. Geraldine at 2:18 pm

    HI.
    I’m a prospective buyer and I have been using the yield calculation to assess asking prices. I find that, in many cases, asking prices are still far above a fair level that would give a minimum expected yield of 7%.
    But using the yield calculation the % yield can change along with fluctuations in the rental market. In the current market – with potential cutbacks in rental allowances (I recently read this currently makes up 40% of the rental market) and with large increases in household taxes expected – this would all have an impact on the yield. So, for example, I could buy a house this year with an expected yield of 7% but find that next year my yield reduces. In my opinion the yield calculation is a good estimate of value but it is really just an ‘estimate’ rather than a guarantee in todays market.

  2. Philip, London at 12:22 am

    The figures ignore the effects of tax. Any gross yield has to be reduced (by most investors) by around 50% and this will only increase in the future. I would like to invest in a Dublin property now to prepare for a move there in the next 5 years but really don’t think it is worth it. Saw a house recently where the tenants were paying €2,000 per month but realised I would be lucky to be left with €800 after maintenance and taxes. And this is before we even know what the property taxes will be.

    The figures above do not take the increasing levels of taxation into account.

  3. Peter at 9:16 pm

    I should also have added the cost of depreciation and repairs which can be material as a landlord. A landlord should factor in the cost of replacing carpets, repainting, replacing electrical appliances etc every 7-10 years. Kitchens and bathrooms should have about a 20 year life. There will also be ongoing repair costs. Any prudent investor should be considering an ownership term at least 20 years in this market. It would be interesting to see you calculate and share with readers the net yield after all the costs of ownership as I suspect it will suggest that most properties are still over priced. Just because a property looks lowly priced in absolute terms doesn’t mean that it represents good value.

  4. Peter at 8:47 pm

    The reference to gross yield is completely misleading. Net yield should be used ie after deducting all costs (insurance, management fees, agents fees, accountants fees, property taxes, council charges, factoring in empty periods between letting, income tax etc). Net yield will pay your mortgage not gross yield. The net yield should be compared with the cost of the mortgage to determine if the property is profit or loss making at any given price.

  5. Tony Murray. at 2:41 pm

    1) does expected yield calculate as collected annual rent? For me this is the issue unknown!
    There is currently a 10% vacancy rate in rental accommodation. U.K is experiencing a rent default situation due to personal over-indebtedness.
    Moreover, once the market levels out and reflects what people can afford to repay then demand will likely decrease for rental properties in certain areas; forcing some investors to put these properties onto the market: increasing supply further. Most start out professional incomes has fallen and is at 35k and less. Ability to leverage =?
    One further point – if you could agree that Nama, Banks and other vested interests act as a barrier currently to properties coming to the market then you to must consider that supply is not true.
    Should market forces apply – if they do when Nama is subjected to Freedom of Information next year – and this alters the market dynamic then the formula is good in theory only! No rent collected = 0% rental yield + the loss of the monthly payments and likely you 20%+ deposit.
    I’ll try to find a formula to fit that scenario and send it to: mysocialspidersphere.blogspot.ie. There is a good blog there referring to the Nama Delusion! It’s worth reading.
    Further, is there a bulk of properties soon to come onto the market all together in Blackrock area? I think I recall something being said recently, perhaps… To my mind Blackrock area has reduced in ‘premium’ terms in recent years since property developers case their investment lens in that direction. Take a drive and see if you agree.

    Please don’t censor!
    Corrections, Criticisms and Comments welcome.

  6. Tony Murray. at 2:34 pm

    Hi,
    I does expected yield calculate as collected annual rent? For me this is the issue unknown!

    There is currently a 10% vacancy rate in rental accommodation.U.K is experiencing a rent default situation due to personal over-indebtedness.

    Moreover, once the market levels out and reflects what people can afford to repay then demand will likely decrease for rental properties in certain areas; forcing some investors to put these properties onto the market. Increasing supply further.

    One further point – if you could agree that Nama, Banks, vested interests act as a barrier currently to properties coming to the market then you to must consider that supply is not true.

    Should market forces apply – if they do when Nama is subjected to Freedom of Information – and this changes the market dynamic then the formula is good in theory only! No rent collected = 0% rental yield + the loss of the monthly payments.

    I’ll try to find a formula to fit that scenario and send it to: mysocialspidertap.blogspot.ie. There is a blog there referring to the Nama Delusion!

    Is there a bulk of properties soon to come onto the market together in Blackrock – to my mind this area has reduced in ‘premium’ terms in recent years since property developers case their investment lens in that direction.

    Please don’t censor!

    Corrections, Criticisms and Comments welcome.

  7. Karl Deeter Author at 1:05 pm

    @Trish it may seem counter to what we hear, but a few estate agents have told me that realistically priced houses in areas where people want to live (regular housing stock in city suburbs) are experiencing this with some regularity. I wonder what kind of price they got if you used the yield calculations?

    @Sean hard to say, we certainly haven’t seen repo’s in the expected numbers (compared to other countries). With the expected bank solutions being offered it seems that for most they will be able to stay in their home which could mean this won’t be the case.

  8. Paddy the Prophet at 12:58 pm

    Good article Karl, RoI is the best way to value property.

    If you can oblige sellers to include BER ratings in adds we will really be making progress!

  9. Ed Murphy at 12:58 pm

    I fully agree that other valuation methods have to be adopted now to gauge whether the price of a particular property is good value or not as you rightly point out the comparative method is no longer adequate due to the low level of transactions occurring.

    The above method seems to make sense in the current market.

    Good article.

  10. Sean not so prudent at 12:53 pm

    Hi Karl, do you think the glut of buy to let properties in arrears will be reposessed by the banks and if so will this drive the value of property down even further?

    Thanks

    Sean

  11. trish Mahon at 12:49 pm

    Just sold my house in Rathfarnham in two weeks after 3 sessions of viewing for above asking price!! I put a whole day of preparation in each day of viewing. All personal clutter removed, bathroom emptied. I packed up my car with 2 dogs, 1 cat, laundery basket, dish drainer. Anyone selling has to do the hard graft, am seeing some really badly presented homes on sites.
    I hope the buyers lender accept the offered price on the house as its above asking.

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