So What Is A Reasonable Price?

[Guest X-QUORK]

How do you decide what a house is worth? Obviously, one would ignore the hyper-inflated price that the vendor and EA have given, but just how should we decide on a reasonable price for a property?

Is it as simple as deciding how much you think the current market as a whole is over-valued (say 30%) and subtract that from the asking price? Or, as is my preference, try and work out the price of the house as it would've been circa 1995 (easy if the property was sold around that time, just look up the details of the transaction on-line), and then add annual inflation of approx 2.5%...there's your price.

How do you do it?

[MrB]

How do you decide what a house is worth? Obviously, one would ignore the hyper-inflated price that the vendor and EA have given, but just how should we decide on a reasonable price for a property?

Is it as simple as deciding how much you think the current market as a whole is over-valued (say 30%) and subtract that from the asking price? Or, as is my preference, try and work out the price of the house as it would've been circa 1995 (easy if the property was sold around that time, just look up the details of the transaction on-line), and then add annual inflation of approx 2.5%...there's your price.

How do you do it?

An average house historically has been 3 to 4 times an average income. When they approach this kind of level again the time to buy might be near, even though there is a likleyhood of prices undershooting these norms.

By this standard a small terraced house might cost £80-£90K at a push, rather than £140k, if an average wage was somewhere between 20 and 25k.

So, empirically speaking, an average person earning an average wage should be able to buy an average house, without bankrupting himself.

Now only existing homeowners with equity, and suicidal FTB's borrowing 6x income can buy.

[iLegallyBlonde]

I look at nethouseprices.co.uk and look at the last time the house sold and add 5% per year and that would be what the house is worth IMO.

One I have my eye on at the moment was bought for £189k in 2003, they are asking £365k but will take an offer I have about £210k in mind !!!!

[Guest]

In a funny sort of way, we don't actually know the answer to this question.

The 1970s is a period from which most of our present day ...er... myths / expectations of the property market are derived. Mortgage debt was wiped out by large wage increases. (Yes I know there was lots of shit hitting the fan in the 1970s too, even though I was born in 1975). This enabled the great big "move ups" and thus the property ladder was born.

Bear with me.

If we are now in a permanently low-wage-increase environment, then those people currently sitting in mid-level or upper levels of the housing market will never see this move-up again. This is significant. How do you value their houses, if someone at their peak earnings have only just stretched to afford a (possibly nice) but nevertheless basic-ish starter house?

This is uncharted territory but the British people haven't realised it yet.

EDIT: Elaboration: Estate Agents frequently point out the average age of a first time buyer as 35ish. People on this web site have, several times, pointed out that this age is statistically your "peak earnings" age.

Edited February 19, 2006 by megaflop

[right_freds_dead]

what i tend to do is approach the property from the side, using a pencill like an artist i try to guage the price by composition. i also sketch in a few local properties for scale.

if it rains - simple. i just put my brolly out and declare myself to be eccentric landscape artist j.wheeler.

then i trash the local art cafe like the who.

works a treat. i tell you this comrades. the chicks really dig it.

PLUS. you can record your own upbeeat covers for bernard cribbins songs.

[Guest X-QUORK]

Terrified,

I find your 5% a year odd, that's at least twice standard inflation over the last few years! And what if the house was last bought in 2004, would you accept the price paid at the absolute peak as reasonable?

Edited February 20, 2006 by X-QUORK

[Given Up]

A reasonable price is what someone is prepared to pay in their opinion. That is the issue. Properties are not all the same and people fall in love with a place and offer more than they would if they had not fallen in love with it.

[FreeFall]

Don't think there's any such thing as a "reasonable" price. Housing is a commodity - if someone is prepared to pay more than you then you're not going to own one. I've pretty much resigned myself to not owning a house or flat unless something dramtic happens to either my salary, or the housing market. Both have a degree of uncertainty in them unfortunately.

[Goat]

Value the house as an investment. This means that it is worth the present value of all future rents less all expenses, ie the sum of the net future income stream discounted so that income further in the future is worth less.

A good proxy for this is to look at the required yield of a property as an investment. If you are BTLing you should be looking for a gross yield of roughly 8 to 12%, say 10% for this example. My house costs me rent of £6,600 per year, to get a 10% yield this means that you can't pay more than £66,000 for the house. The house is therefore worth £66,000, and not the £130,000 + that my landlord thinks it's worth.

So if you want a good idea what a house is really worth multiply the annual rent it would generate by 10.

[ShirtyTheSlightlyAggresiveBear]

There was the 12-20 approach mentioned here ages ago. It kinda makes sense as a very "rough" guide to where in the range of prices the property is sitting historically.

Take the est. rental price of the property and multiple it by 12 (or whatever to get it to an annual figure). This is the annual cost to rent.

Annual rental cost * 12. This is the lower range of "undervalued".

Annual rental cost * 20. This is the upper range of "overvalued".

For example.

Rental cost is £600pcm. Annual rental cost is £7200

-> 12 * 7200 = £86,400

-> 20 * 7200 = £144,000

If the property was for sale at 150k, its almost 21 times the annual rent cost, hence overvalued/overpriced.

If the property was for sale at 108k, its reasonably(average) priced at 15 times the annual rent cost.

When the property price is towards the 20 figure or higher its overpriced. Your looking at 20 years to get a return or pay the loan off.

Likewise towards the lower value or lower, its a bargain.

From ancedotal figures I have done, this stands up fairly well. We currenly seem to be at about 19-20 on the scale, some properties much higher.

Note, that this ignores inflation, IR, and anything else that makes it more complex to factor it. Its only a rough guide after all.

[theChuz]

My simple calculation for a box standard 2 up 2 down is....

100K - one f*ckin idiot = 75K - 80K , unfortunatly someone forgot to minus the idiot and they are priced at 120K and rising.

about 5 years ago the same 2 up 2 down for about 50K so i think im even being generous to put it at 75K

[ShirtyTheSlightlyAggresiveBear]

for 120k, do you get the idiot thrown in as well?

[2005]

I look at house prices in 2000/1 and add inflation for 5 years and that is what I consider to be a good price. This method also matches the anual rent x 12/20 method.

Both bring me out with a price of £115-120k for a three bed semi in my area and I would be happy paying that.

Unfortunately asking prices are £200-225

[FreeFall]

for 120k, do you get the idiot thrown in as well?

For 120k I'd throw the idiot in a well....

[Guest Winners and Losers]

For 120k I'd throw the idiot in a well....

Would that be Fanny Magnet????

[We've gone]

Value the house as an investment. This means that it is worth the present value of all future rents less all expenses, ie the sum of the net future income stream discounted so that income further in the future is worth less.

A good proxy for this is to look at the required yield of a property as an investment. If you are BTLing you should be looking for a gross yield of roughly 8 to 12%, say 10% for this example. My house costs me rent of £6,600 per year, to get a 10% yield this means that you can't pay more than £66,000 for the house. The house is therefore worth £66,000, and not the £130,000 + that my landlord thinks it's worth.

So if you want a good idea what a house is really worth multiply the annual rent it would generate by 10.

That would value Tony Blair's house at just over £1 million, a loss of £2.5 million. I think you are right in principle, but if typically the type of propery being valued is owner occupied, you may have to allow a higher multiple - say 20. Still leaves Tony with a £1.5 million loss.

[Goat]

That would value Tony Blair's house at just over £1 million, a loss of £2.5 million. I think you are right in principle, but if typically the type of propery being valued is owner occupied, you may have to allow a higher multiple - say 20. Still leaves Tony with a £1.5 million loss.

I stand by about 8 to 10% gross yield, a multiple of 20 gives a 5% gross yield, below the interest on the mortgage, never mind agents fees/repairs/voids. 20 times is about what houses are going for at the moment (ignoring ridiculously overpriced PM properties), not sustainable in the long run.

I don't accept that people are willing to pay more to OO, if they were then there wouldn't be any rental properties, the landlords would end up being outbid every time.

It should be cheaper to own rather than rent, at the moment we have the reverse situation.

[Magpie]

I stand by about 8 to 10% gross yield, a multiple of 20 gives a 5% gross yield, below the interest on the mortgage, never mind agents fees/repairs/voids. 20 times is about what houses are going for at the moment (ignoring ridiculously overpriced PM properties), not sustainable in the long run.

I don't accept that people are willing to pay more to OO, if they were then there wouldn't be any rental properties, the landlords would end up being outbid every time.

It should be cheaper to own rather than rent, at the moment we have the reverse situation.

It used to be the case that a lot of rental properties were the ones that weren't too exciting to OOs so landlords filled a gap in the market. Plus there are always people who simply don't want to put down roots - want to be flexible, move etc. So that's why there were rental properties even though most people would pay a bit more to buy than to rent.

I don't see any earthly reason why it should necessarily be cheaper to own than rent though. Most people buying a home don't give a damn about notional yield, just about whether or not they can afford the mortgage for a house they want to live in. Unfortunately many can't now, which is the problem, but it's only a STR or BTL mentality that makes yield the primary issue.

[Goat]

I don't see any earthly reason why it should necessarily be cheaper to own than rent though. Most people buying a home don't give a damn about notional yield, just about whether or not they can afford the mortgage for a house they want to live in. Unfortunately many can't now, which is the problem, but it's only a STR or BTL mentality that makes yield the primary issue.

Several reasons why renting should be more expensive:

1. A landlord is taking a risk and a premium should be payable for this.

2. Renting is a shorter term comittment and as such should be expected to be more expensive.

3. We're not necesarilly comparing like with like. The mortgage cost is only part of the overall property cost, rent is the all in cost including repairs, redecoration and insurance.

Most people may not give a damn about the yield however that is a result more of financial illiteracy rather than sensible investing.

To recap, the value of a house (OO or rental) is the present value of the future housing services provided by that asset, net of associated costs.

The best proxy for the value of the housing services is the annual rental. If you really want to you can estimate the monetary value of the future costs and benefits of a house and then discount them at an appropriate rate, but you are going to end up with the same figure as if you work on a required yield basis.

People may be just able to afford the mortgages on their dream properties but there are a number of things to remember:

1. In a low inflation age the loan is being repaid much more slowly, if your stretching yourself today then you will not be able to move up the ladder unless your income goes up very rapidly. (Especially important for FTB's)

2. 40% + of takehome pay is a very large proportion. It may be just affordable in the short run but with the end of final salary pension schemes, ever rising fuel & services bills etc it is just too much to be maintained in the longer run. That is before you even think about having kids, so, advice to FTB's, have a vascetomy first.

3. People may be able to afford the mortgages however the properties do seem to be of a much lower standard than should be expected. At my age my parents could afford a 3 bedroom house, now I would struggle to buy a studio flat. That was with a non-working wife and new child to pay for as well!

[non-FTBer]

1) look at the ceiling price for the street/streets that you are looking at

2) See whether the house you are looking at is smaller/larger

3) Adjust ceiling price to take into account:

• Idiots
  
• Size/Location etc
  
• negative HPI (in my area) of last 15 months
  
• Anything else you want a discount for
  

4) This is a fair market value at which people could expect to sell today (IMHO).

I'd be looking for at least 10-15% below that valuation myself.

Example:

Went to look at a house last week.

Asking price of £189,950

Ceiling for road: £161K (early 2005)

Size/locaiton: almost same as ceiling price house

Taking the ceiling price and lopping off £5K for depreciation over the last year to give £156K would give them a price that would enable them to sell fairly quickly IMO. They have been on the market since October with no offers.

I would not pay more than about £140K for the place, but I think they could easily sell it for £156K if they are quick - don't want to be chasing the market down.

If you apply the 12/20 rule to this then:

Rental (approx): £650pcm, £7800pa.

Low: £7800 * 12 = £93600

High: £7800 * 20 = £156000

So they are actually asking well in excess of 20x possible rental income.

Applying that valuation has just convinced me to stay well clear

[Goat]

If you apply the 12/20 rule to this then:

Rental (approx): £650pcm, £7800pa.

Low: £7800 * 12 = £93600

High: £7800 * 20 = £156000

So they are actually asking well in excess of 20x possible rental income.

Applying that valuation has just convinced me to stay well clear

And remember 20x is the absolute maximum, sell now point! A sensible valuation would be 12x and even that IMO is a bit high, 12x being the do not buy beyond this multiple point.

Looking at prices this way you can see how far out some of them are. I used to think in terms of a 20% drop, now I've got to say I thinking in terms of 50%!

[Magpie]

Most people may not give a damn about the yield however that is a result more of financial illiteracy rather than sensible investing.

To recap, the value of a house (OO or rental) is the present value of the future housing services provided by that asset, net of associated costs.

The best proxy for the value of the housing services is the annual rental.

Hi,

Sorry if I sounded crabby earlier - most of what you're saying makes sense. But I don't think most people judge whether or not to buy on a yield basis, and I don't think that necessarily makes them financially illiterate (plenty of people are financially illiterate, but not for this reason...). You're making that comparison at this stage of the cycle because 1) many people are looking sceptically at BTL calculations and 2) STRs are using the same sums for their own different purposes.

When there is more sanity in house prices this is not how people judge the situation at all. The sums you are talking about are essentially sums used by landlords to decide whether or not a property is paying its way. That is a completely different calculation to the one people use to decide whether or not to buy somewhere, even if you exclude the emotional factors associated with owning your own home.

Historically I think it has mostly been the case that people would pay more to buy than they would to rent. We're at the peak of a bubble, but thinking about more normal times, if you weren't looking at a market expecting a fall, then you would make the decision on the simple assumption that paying a mortgage will mean you end up owning, whereas renting won't, and that outweighs the extra costs incurred by owning over renting. It is only the fact that the market is currently overpriced that makes one doubt the fact that most people would pay more to own than to rent. Of course they would, because a mortgage ends up with you as owner. That is not the same as saying that rent is dead money, because I recognise the danger of paying a long-term mortgage on an overpriced property, but I think the comparison needs to be made over the long-term, with a reasonable set of parameters for where the market might go to allow for possible falls in prices (and possible long term rent increases too). In other words the calculation I would make to decide between renting and buying would be this: will the extra amount I pay for a mortgage plus all the extra costs of maintenance etc justify the fact I end up as owner - and I'd want to do this sum over 2, 5, 10, 25 years etc, alowing for possible interest rate variations It's not such a gratifyingly simple sum, but it's more relevant.

I'm not trying to say that property isn't overpriced. Of course it is. But I don't think this calculation (12/20) is, or should be, the one that normal buyers would use. For a start, the "Sell now" point only applies if 1) you are a landlord looking at properties other than your main residence or 2) you are looking at sell to rent with a high confidence that the market will fall in the short term.

Also, and here I'm agreeing with you, the decision to buy also involves extra negative factors, like possible future interest rate rises, which aren't accomodated by the 12/20 rule. Doing the sums on current yield ignores some of the possible long term negatives as well.

And finally, if using this rule even momentarily convinces you that you shouldn't buy till property falls 50% then maybe that just shows that it's not a very good rule. Say property falls 30% and you're still there renting and waiting for it to get down to your ideal point? Mightn't that be a bit of a mistake?

Edited February 20, 2006 by Magpie

[Elizabeth]

How do you decide what a house is worth? Obviously, one would ignore the hyper-inflated price that the vendor and EA have given, but just how should we decide on a reasonable price for a property?

Is it as simple as deciding how much you think the current market as a whole is over-valued (say 30%) and subtract that from the asking price? Or, as is my preference, try and work out the price of the house as it would've been circa 1995 (easy if the property was sold around that time, just look up the details of the transaction on-line), and then add annual inflation of approx 2.5%...there's your price.

How do you do it?

This seems like a very theoretical question. They are not going to accept your offer... till every last FTB has dropped out of the market in despair (or contempt?!)