To Those Who Rent, Please Work Out What The House

[threetimesdead]

Do you not do a discounted cashflow analysis ?

You don't really need a DCF for a back of the envelope calculation

The only fair comparison is rent vs I/O mortgage (or what is also seen as the opportunity cost of not investing that cash into alternative safe investments)

Take your annual rent and divide it by the average BoE historical interest rate - get the estimate value of the house

The only problem is what do you take for an "average" interest rate

BoE data here - http://www.bankofengland.co.uk/statistics/rates/baserate.pdf - last 10 years 5%, last 25 years 8% (roughly)

My own situation - Annual rental 10,200 @5% - house is worth 204k, @8% house is worth 127.5k

It is on the market for 355k+10k stamp duty+5k expenses = 370k

At best (for the LL) it has to fall from 370k to 200k

[threetimesdead]

You don't really need a DCF for a back of the envelope calculation

The only fair comparison is rent vs I/O mortgage (or what is also seen as the opportunity cost of not investing that cash into alternative safe investments)

Take your annual rent and divide it by the average BoE historical interest rate - get the estimate value of the house

The only problem is what do you take for an "average" interest rate

BoE data here - http://www.bankofengland.co.uk/statistics/rates/baserate.pdf - last 10 years 5%, last 25 years 8% (roughly)

My own situation - Annual rental 10,200 @5% - house is worth 204k, @8% house is worth 127.5k

It is on the market for 355k+10k stamp duty+5k expenses = 370k

At best (for the LL) it has to fall from 370k to 200k

The other way of looking at it is the interest on 200k in the bank pays my rent

If I were to buy @ 370k i would not only lose the interest on my 200k in the bank but will also have to pay interest on a 170k bridge loan

Should be taught to kids before they leave the school

[andykn]

Renting for 800, identical place was bought for 205,000 mid 2007. Dunno what that means just in case that helps

It means someone is earning over 4%, index linked, on their savings and their capital will almost certainly be preserved long term.

[andykn]

The other way of looking at it is the interest on 200k in the bank pays my rent

If I were to buy @ 370k i would not only lose the interest on my 200k in the bank but will also have to pay interest on a 170k bridge loan

Should be taught to kids before they leave the school

But the interest on your 200k won't rise with inflation, unlike your rent.

[threetimesdead]

Which is why Buy to Let is so popular. I borrow 550k, buy the place and in 25 years you've paid off my loan and I've one flat which has cost me virtually nothing. It wouldn't matter to me much where it went in the next few years.

What a lot of rubbish!

550k on a 25 years mortgage is more than 1mln and he only paid 390k, so you dish out another 650k out of your own pocket and hope not to be in negative equity, i.e. - above 1.05mln

[threetimesdead]

But the interest on your 200k won't rise with inflation, unlike your rent.

Only an estate agents can be so poor at maths as you are

Let alone understanding real and nominal rates

Edited May 26, 2009 by threetimesdead

[spud]

ours was 3 bed 1 reception front and back yard mid terrace.

Rent was £400 mth

so (400/6.14)*1000 = £65146.58p

last year the end terrace sold for £112500

non in street for sale at the moment but next street over has similar house (pavement fronted) for £105000

so round 60% fall to go, but here they have shot up a lot in 2001 you could have picked one up for average £25000.

[betterToDo]

It means someone is earning over 4%, index linked, on their savings and their capital will almost certainly be preserved long term.

Good for him. Hes a nice chap, and this is a lovely place.

[loafer]

1. we are agreed on!

2. my point was that i didn't think a 50 year old would want to buy a big family house - surely more likely to be trading down? i would make the point that houses are too expensive if even well paid 40 year olds can't afford them.

3. see point 2 - surely after 25 years owning propery you are ready to start trading down not taking on a new 25 year mortgage at 3 times salary. hence surely family houses should be affordable to younger people?

4. judgement/arbitary - those living in London, and who can move to home counties might have made significantly more "magic money" that that, I have anyway and i'm 34, - but see 2/3 above - the point i am trying to make is that if there houses are only affordable to 50 year olds with £250k equity, prepared to take on a 3x salary mortgage then they are not really affordable!

Certainly this is prime South East, commuting into the City, so your last point is true, subject to the proviso that it is all about affordability for the buyer of that type of property that is the key.

Moving on to your main point, I chose 50 as an age because it felt about right, but I concede that 45 might be more like it. Many people nowadays who are 45 have kids sub-10 years old around where I live, so a family house is right, and downsizing only really kicks in post retirement in my view.

In any event, the key issue is that even with my assumptions, the house I rent is still c.25% overvalued, and will probably fall 40% p2t.

[andykn]

I wouldn't go near BTL at the moment. You seem to be ignoring rapidly falling values and once they have stopped falling, substantial interest rate increases. I'd want to see 10% yield on an 8% fix to contemplate BTL again. I guess you're already in BTL and probably unable to get out of it again! What are your LTVs?

I'm talking about people who have built up substantial retirement savings and are seeing deposit yields of 1-2%. If they BTL now they will see improved income and long term (10 years +) capital security.

And their income will be index linked long term too, that is extraodinarily valuable.

I'm personally looking to trade up from my modest 2 bed flat and can wait to see what prices will do.

[andykn]

What a lot of rubbish!

550k on a 25 years mortgage is more than 1mln and he only paid 390k, so you dish out another 650k out of your own pocket and hope not to be in negative equity, i.e. - above 1.05mln

Sorry, you're the one spouting rubbish. The 390K was only for the first 15 years (and ignored inflationary rises in rent).

Back of the class.

[andykn]

Only an estate agents can be so poor at maths as you are

Let alone understanding real and nominal rates

Well it was kind of you to explain where I was going wrong, or is your maths as poor as all the other Bears?

If you have 200k to invest, in the bank your interest income will remain largely static over 25 years, if you buy to let a 200k property, the rental income will rise broadly with inflation.

Look at the difference between flat and rising annuity costs to see exactly how valuable that is.

[Soul Reaver]

To those who rent, if you know the current value of the house you rent please use the figure below to work out what the rent would be if you could get a 100% mortgage (bears - I know I'm being ultra fair to the bulls by allowing 100% mortgages).

Now I'm going to be ultra fair again and choose 5.5% as a fixed rate for the mortgage. Now 5.5% over 25 years on a repayment mortgage is £6.14 per £1,000 of mortgage.

My family currently rent a 3-bed semi at a cost of £725. So if we were paying a similar amount on a mortgage the property would have to be £118,000 to buy currently. i.e. (725/6.14) * 1000

Next door is a carbon copy and is on for £167,500. So a further fall of 30% is required.

(And yes, you Bulls could argue that renting means you don't end up with the property at the end of the 25 years, but conversely you also don't have an asset that is falling by ~£3k each month either. And this is only working out why we shouldn't buy for the next few years, while house prices are falling. Of course it is logical to own you own home eventually if your circumstances match).

So anyone else? We're currently on 30% further falls on my example!

The house I rent in peterborough (5 bed detached) was on for 320 at peak and is now around 230. He offered me it for 240. We pay 950 a month and I have two mates there while I am away so it costs me 316 for my UK base I have no intention of buying unless I can get it for say 175 as then my two mates will be giving me 633 a month to live in my house. I will stay renting for the next couple of years methinks.

[denna]

my house is the same as op,

(725/6.14)*1000 = £118078

3 bed 2 reception rooms, medium garden.

thing is the lady next door was lamenting her house is not selling, so she has dropped the price from £220,000 to £180,000 and still it has not shifted.

Our house has been extended and is in far better shape, so am guessing it would be valued at a fair amount higher.

Even so I still can't belive she quoted such astronomical figures with a straight face. As though she earn't this money and was utterly entitled to it just by gettting old and smelly in a shabby house for 50 years.

[gimble]

in the bank your interest income will remain largely static over 25 years

fail.

Interest earnt on a savings account is compound! If I stick 200K in a savings account earning 5% and leave it there for 25 years, in the first year I will earn 10K interest and in the 25th year I will earn 31K interest and have 645K.

edit: removed unnecessary insult. sorry.

Edited May 27, 2009 by gimble

[tahoma]

rent/owning comparisons should be done with an I/O mortgage as the repayment part of a mortgage is equiv to saving an amount each month...

Not in a falling market - it is more equivalent to p*ssing money up the wall. Having slightly less negative equity than you would have done with an IO mortgage is not equivalent to 'saving'.

Saved money can be spent.

[50%deposit]

been meaning to contribute but just no time

house value ranges from£180k asking to Zoopla estimate of £120k. rent is £625. can someone do the maths for me?

[grizzly bear]

Certainly this is prime South East, commuting into the City, so your last point is true, subject to the proviso that it is all about affordability for the buyer of that type of property that is the key.

Moving on to your main point, I chose 50 as an age because it felt about right, but I concede that 45 might be more like it. Many people nowadays who are 45 have kids sub-10 years old around where I live, so a family house is right, and downsizing only really kicks in post retirement in my view.

In any event, the key issue is that even with my assumptions, the house I rent is still c.25% overvalued, and will probably fall 40% p2t.

So we are both agreed that bigger houses in the SE still overvalued - by around 25%, and that the % would be more than 25% if it wasn't that there are older families who have built up equity because of HPI who can buy them.

re: downsizing, my parents friends all had kids in their late 20s, and by the time they were 50 (around 5 years ago) the kids had all left home and they downsized, many of them now retired early eg at 55/60 - hence I was taken aback by the comment about buying the big house at 50.

[bear_or_bull]

Is not just about whether the rent is greater than or less than the mortgage. Sure, that's important, but the principal (and you're debt exposure) is important both for you and the macro economy. If mortgage interest rates were 0.5% you could borrow I/O 2.4 million for 1000 quid a month. That's rational, right? But you are still on the hock for the cosy 2.4million. In a low inflation world you are never gonna pay it back. Not only that, even if you are on a repayment mortgage it will be a) expensive, and leave you VERY exposed.

And that's without raising the issue of real vs nominal rates. In this case you might be happy paying IRs of 15% if inflation is 20%. Even though the initial monthly payments may be much more than the rent (aka 1970s) it is rational to buy. You're being given money to do so.

The presses myopic fixation on "affordability" is not something that should be repeated here. It's just focusing on a single metric, of many, that ignores either the rationality of buying (dubious) and/or the consequences of everyone doing so (disaster down the tracks). We should all know the difference.

[bear_or_bull]

So we are both agreed that bigger houses in the SE still overvalued - by around 25%, and that the % would be more than 25% if it wasn't that there are older families who have built up equity because of HPI who can buy them.

re: downsizing, my parents friends all had kids in their late 20s, and by the time they were 50 (around 5 years ago) the kids had all left home and they downsized, many of them now retired early eg at 55/60 - hence I was taken aback by the comment about buying the big house at 50.

Times have changed. With the debt around young people's necks these days many are forced to put it off until their mid 30s. Especially if that involves housing. I know people who have put off children because they feel they can't afford to give them the same start they had. That and they were either priced out and in rental (which people don't like for nesting) or had bought a 1bed that they couldn't trade up from. In fact, most of the people I do know that have bred have done so outside of the country. Sad (& I know some will disagree so don't want to start the "dear god, don't put your life on hold for x" argument) but true. Such is the cost of the boom.

[Goat]

fail.

Interest earnt on a savings account is compound! If I stick 200K in a savings account earning 5% and leave it there for 25 years, in the first year I will earn 10K interest and in the 25th year I will earn 31K interest and have 645K.

edit: removed unnecessary insult. sorry.

Except that the net rent can be placed in a savings account in the same way so that doesn't really work.

One problem with the EA's logic is that he's ignoring costs of owning the property (voids; agents fees & repairs) so the actual net yield is closer to 3%.

The other problem is that a 3% return is terrible by historical standards.

I should also say that using 5.5% as a discount rate is wrong. Rents paid also factor in the expenses mentioned above, for a homeowner you need to adjust the rate to (IMO) 8% minimum and I would argue that 10% is more appropriate.

So £800 pcm = £96,000 - £120,000.

[gimble]

Is not just about whether the rent is greater than or less than the mortgage. Sure, that's important, but the principal (and you're debt exposure) is important both for you and the macro economy. If mortgage interest rates were 0.5% you could borrow I/O 2.4 million for 1000 quid a month. That's rational, right? But you are still on the hock for the cosy 2.4million. In a low inflation world you are never gonna pay it back. Not only that, even if you are on a repayment mortgage it will be a) expensive, and leave you VERY exposed.

And that's without raising the issue of real vs nominal rates. In this case you might be happy paying IRs of 15% if inflation is 20%. Even though the initial monthly payments may be much more than the rent (aka 1970s) it is rational to buy. You're being given money to do so.

The presses myopic fixation on "affordability" is not something that should be repeated here. It's just focusing on a single metric, of many, that ignores either the rationality of buying (dubious) and/or the consequences of everyone doing so (disaster down the tracks). We should all know the difference.

Spot on. The up-front 'affordability' of a brand new 25 year mortgage is a terrible way of measuring the cost of housing. The total cost of servicing the debt over the lifetime of the loan varies dramatically depending on the inflation rate and interest rate. Borrowing a high capital sum in a low inflation and low interest rate scenario is more costly than borrwing a smaller amount at a higher rate in a high inflation environment.

[ScaredEitherWay]

The studio room I rent would go on the market right now at £55k, the OP's original calculation would give it a value of £57k.

So not far off.

At the peak, this property would have gone up for sale at £75k, one achieved £74,000 in January 2007, another achieved £73,000 in June 2007.

[gimble]

Except that the net rent can be placed in a savings account in the same way so that doesn't really work.

One problem with the EA's logic is that he's ignoring costs of owning the property (voids; agents fees & repairs) so the actual net yield is closer to 3%.

The other problem is that a 3% return is terrible by historical standards.

I should also say that using 5.5% as a discount rate is wrong. Rents paid also factor in the expenses mentioned above, for a homeowner you need to adjust the rate to (IMO) 8% minimum and I would argue that 10% is more appropriate.

So £800 pcm = £96,000 - £120,000.

Of course, you're right that the return on a rented property can be reinvested too, I wasn't suggesting that cash in the bank is necessarily better than buying a place and letting it out. My point was that 'andykin' seemed to think that if you stick some cash in savings then the amount of interest that it earns does not rise over time. As long as your interest rate at least matches inflation then your return will indeed match or grow faster than inflation as the sum grows with the interest compounding. I guess he's right that at the moment, if you're looking for some yeild that beats savings rates, buying property and letting it out is an option. But doing so would be taking a big punt on the idea that interest rates will stay as low as they are for a long time.

[andykn]

fail.

Interest earnt on a savings account is compound! If I stick 200K in a savings account earning 5% and leave it there for 25 years, in the first year I will earn 10K interest and in the 25th year I will earn 31K interest and have 645K.

edit: removed unnecessary insult. sorry.

Just as well you did, your thinking is faulty.

There are many people with cash who wish to invest for income and find current savings rates poor. A buy to let will give them an index linked income, a deposit account won't. All the examples given here show that current house and rental prices give a good index linked return for a capital sum at today's prices.

Even if you invest for growth and reinvest all the interest or rental income (which will then compund itself) which do you think will do better over 25 years? Given that, over 25 years, even if property falls to early 90s levels and stays there relative to earning/prices, you will still have some capital appreciation over 25 years.