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Martin

Is It Possible To Work Out The Cost Of A House By Rental Income?

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AS we already know properties in the Uk and for that a good section of the World are over valued, but the question remains by how much?

The whole property market has gone speculative, but the ray of light I see is from the rents, rents I feel truly reflect the true cost of property this is because they operate in a none speculative market.

The challenge is to work out the true value of a house from the cost of rents. The below is an example of what I mean, this is took from a real World example.

House cost to buy: £120,000

Rental income: £380

IO mortgage £500 at 5% (worked out on the BBC mortgage calculator)

Right are you lot still with me, for a landlord to make some money on this property he would have to pay an interest only mortgage of:

£280

The £100 includes profit and general other out goings to do with letting a property out.

So what would what would £280 amount to a mortgage, using the BBC mortgage calculator its £50,000.

All these figures are very rough and your welcome to pick them to pieces.

Regards

Martin

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Give the man a cigar :)

As it happens, using the rental income as measure of the 'real' value of a property is fairly standard, but it's nice to see someone indepedently think "hang on a minute!!!...." I wish a few more people would have this 'The emperor has no clothes' revelation.

To use an example from my neck of the woods - 2 bed flat....purchase price £167K. So a repayment mortgage of about £1050, or IO of £800. An identical flat can be rented for £675.

This suggests that a more realistic value should be circa £110K

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I agree - to a point.

To simplify the equation, if a house had a rental value of £5,000 pa and you required a 5% yield then:

100/5 = 20 (multiplier).

20 x £5,000 = £100,000 capital value.

HOWEVER, this is the initial yield. You then need to factor in future growth or downside risk. Its known as the All Risks Yield which reflects the investors prediction of future risk and reward / growth. You can also do a discounted cash flow analysis. The investor who is most bullish in their predictions will be able to pay the most for the property.

I think most investors see an under supply of housing and thus see growth prospects over the long terms as good.

Alternatively, someone falls "in love" with the house and pays stoopid money, or jumps into the market in fear of not being able to afford it in the future (which is a self fulfilling prophecy in its effect on prices).

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Its is not as straightforward as that.

You have to work out the rental income and RELATE IT to your risk free alternatives - the interest rate for capital.

Although people assume the alternative rate is the risk free BOE rate - it is not.

The rate prices rise through massaged RPI is 4.4%. http://www.statistics.gov.uk/cci/nugget.asp?id=19

(The real rate including bills, council tax rises is plainly higher)

(1) Low income, hard working, saving workers: 6.2% interest rate after 20% savings tax = 4.96%, Above RPI rate rate = 0.36% (varies around zero).

Hardworking savers scrabbling from insecure job to job, your savings are taxed at 20% depending on your varying income.

So, for all the bother of opening numeroius accounts and keeping upto date to get the top rate, at 6.2% AER your actual in your trouser pocket income receives has to multiplied by 0.80 to lop off 20% - (6.2% x 0.80 = 4.96%). As RPI inflation is 4.4%, you are at near zero after inflation or losing purchasing power.

(2) High income workers: 6.2% Interest rate after 40% savings tax = 3.72%, Above RPI rate = -0.68% (negative)

(A range of tax breaks are available for these workers to invest in property)

So now the picture is a little different from merely comparing the rental income to the riskfree BOE rate. The truth is for many people the 'Riskless' BOE rate is a sure way of losing money over time even on the governments figures thanks to interest being taxed.

It is plain that if a discounting formula is used and you are in catagory (2), a rents only have to reach 3.72% to match what you get in real return from the BOE, not 5.75%. The reason for this is that all the tax breaks - numeroius scehmes - that operate on property mean its a better shelter than savings!

This tax situation vs savings pushes up the valuation of property way, way above what the poor fella (1) can work out makes sense either through rental income or mortgage costs, or affordability.

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Give the man a cigar :)

As it happens, using the rental income as measure of the 'real' value of a property is fairly standard, but it's nice to see someone indepedently think "hang on a minute!!!...." I wish a few more people would have this 'The emperor has no clothes' revelation.

To use an example from my neck of the woods - 2 bed flat....purchase price £167K. So a repayment mortgage of about £1050, or IO of £800. An identical flat can be rented for £675.

This suggests that a more realistic value should be circa £110K

Lets take that example -

£675 pm = about £8100 rent pa

After tax return BOE savings to match for 40% tax payer = 3.74% so thats worth circa £216,577 to a 40% taxpayer who can totally avoid tax on savings.

(If the 40% taxpayer totally escapes the 40% tax on rental income via range of tax breaks).

2000 MIRAS - a tax break for first time buyers, Scrapped.

since then, a huge range of tax breaks for the rich over property ever since.

Since most cannot fully ultilise the huge range of breaks, you get a figure of between £110,000 and £216,000 - circa £167k - making perfect investment sense (at your expense).

Edited by brainclamp

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Lets take that example -

£675 pm = about £8100 rent pa

After tax return BOE savings to match for 40% tax payer = 3.74% so thats worth circa £216,577 to a 40% taxpayer who can totally avoid tax on savings.

(If the 40% taxpayer totally escapes the 40% tax on rental income via range of tax breaks).

2000 MIRAS - a tax break for first time buyers, Scrapped.

since then, a huge range of tax breaks for the rich over property ever since.

Since most cannot fully ultilise the huge range of breaks, you get a figure of between £110,000 and £216,000 - circa £167k - making perfect investment sense (at your expense).

Yep!

I'd look at the dividend yield on the FTSE also before I made the decision.

Rents are not static either, like dividends. The initial yield will increase with time on quality stocks and property. Personally I'd be in stocks, wrapped in a SIPP, claiming back the income tax. You don't have to deal with people or fix the roof. The gains are better too.

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I think it is difficult to compare one directly with another.

If you are buying a home then you will in most cases be happy to pay that bit more per month knowing you will have something to show for it in the end, its just human nature. People feel that by buying a home they are somehow getting better value for money.

Its the security thing and this will be very hard to change, Freedom to do what you want, knock down walls, change the deco etc.

On the otherhand a LL will be happy to sub a rental income if he knows that property is going to increase (or even decrease) over the long term, he starts with nothing, borows the max and suddenly ends up with £XXXX in the bank all from borrowed and somebody elses hard earned cash.

Example

£100k house

25 year repay =£591 IO = £416 @ 5%

Now if I was a nobody with very little savings I could have a repayment mortgage on that house for £591pm and rent it out for £391pm.

In 15 years that house maybe worth more or less than £100k but at least 70% will have been paid by the tenant so myself with nothing to start with suddenly has a property that I have paid only 30% for and maybe some equity to boot as well.

In that time it will be more likely that rent will increase and not decrease so it may come a time that the tenant is paying 100% of the mortgage.

Edited by Jonnybegood

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Lets take that example -

£675 pm = about £8100 rent pa

After tax return BOE savings to match for 40% tax payer = 3.74% so thats worth circa £216,577 to a 40% taxpayer who can totally avoid tax on savings.

(If the 40% taxpayer totally escapes the 40% tax on rental income via range of tax breaks).

2000 MIRAS - a tax break for first time buyers, Scrapped.

since then, a huge range of tax breaks for the rich over property ever since.

Since most cannot fully ultilise the huge range of breaks, you get a figure of between £110,000 and £216,000 - circa £167k - making perfect investment sense (at your expense).

Makes no sense whatsoever.

If you are investing in a risk asset such as property, you need a significantly higher rate of return than you'd get in a savings account, otherwise why are you bothering? You made an excellent case in your previous post for increasing interest rates, there needs to be an incentive to save above inflation, which is one reason why there are endless threads berating the BOE for not increasing rates further. What happens to property prices if they do go up or there's a recession (even a small one)? Increasing rates also blows your comparison out of the water.

Index-linked gilts can provide a real yield of around 2%, conventional gilts should give more (3%-ish) as they are riskier, property quite a bit more (I'd argue 5%, I don't think anything below 4% could have a credible argument) for this reason.

Incidentally, you appear to have ignored voids (2 months a year), management fees (£1600 pa at 2 bed flats near me), letting agency fees, non-stop flat building increasing competition & reducing rent, not to mention ars*y tenants. Investing to avoid tax often backfires, I think it will here too.

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I think it is difficult to compare one directly with another.

If you are buying a home then you will in most cases be happy to pay that bit more per month knowing you will have something to show for it in the end, its just human nature. People feel that by buying a home they are somehow getting better value for money.

Its the security thing and this will be very hard to change, Freedom to do what you want, knock down walls, change the deco etc.

On the otherhand a LL will be happy to sub a rental income if he knows that property is going to increase (or even decrease) over the long term, he starts with nothing, borows the max and suddenly ends up with £XXXX in the bank all from borrowed and somebody elses hard earned cash.

Example

£100k house

25 year repay =£591 IO = £416 @ 5%

Now if I was a nobody with very little savings I could have a repayment mortgage on that house for £591pm and rent it out for £391pm.

In 15 years that house maybe worth more or less than £100k but at least 70% will have been paid by the tenant so myself with nothing to start with suddenly has a property that I have paid only 30% for and maybe some equity to boot as well.

In that time it will be more likely that rent will increase and not decrease so it may come a time that the tenant is paying 100% of the mortgage.

Another piece of doomed BTL logic.

You are paying a market rate of interest, the tenant is paying the market rent. Nobody is getting any subsidy. It's an investment. If interest rates go up, or there is a recession, you are up sh1t creek with other BTLs & there's a big paddle shortage.

Don't confuse BTL investment with OO where you get the benefit of living in a house. If you buy shares in Amstrad, you can't move in with Alan Sugar instead of getting a dividend!

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Another piece of doomed BTL logic.

You are paying a market rate of interest, the tenant is paying the market rent. Nobody is getting any subsidy. It's an investment. If interest rates go up, or there is a recession, you are up sh1t creek with other BTLs & there's a big paddle shortage.

Don't confuse BTL investment with OO where you get the benefit of living in a house. If you buy shares in Amstrad, you can't move in with Alan Sugar instead of getting a dividend!

If there was a recession or HPC then rentals will increase or at least demand for rental property would increase.

You can now fix a mortgage (OO or BTL) for long periods, you cannot do thesame with rental, Over the next 15 years it is almost certain that rental will be higher than it is today, however on a fixed rate the LL may be paying the same mortgage.

If the LL is subbing the tenant £200pm to cover the mortgage then over a hypothetical 25 years he would of paid £60k for a property worth around £200k with the tenant making up the difference.

Not bad from where I am sitting and this is why it will continue if not on the scale it is now.

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After tax return BOE savings to match for 40% tax payer = 3.74% so thats worth circa £216,577 to a 40% taxpayer who can totally avoid tax on savings.

(If the 40% taxpayer totally escapes the 40% tax on rental income via range of tax breaks).

Help me out here as I'm a 40% tax payer and I'm not sure what tax breaks I'm missing out on. What tax breaks are you talking about? A BTL landlord can offset basic maintainance, loan interest and management fees but has to pay income tax on the profit part of his rental income. If he makes a capital gain and wants to cash in in the short term he has to pay CGT. Taper relief doesn't kick in until three years and you are I believe you are still liable to pay tax on 60% of the gain after as long as ten years of holding the asset.

Add to this that to liquidise the investment and to obtain it in the first place the BTL has to pay solicitors fees and stamp duty. This isn't sounding much like a tax avoidance scheme to me.

Can you elaborate on why you think I'd be better off putting my money into property rather froma tax point of view than something like and ISA or a pension?

Thanks,

Bertie

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AS we already know properties in the Uk and for that a good section of the World are over valued, but the question remains by how much?

The whole property market has gone speculative, but the ray of light I see is from the rents, rents I feel truly reflect the true cost of property this is because they operate in a none speculative market.

The challenge is to work out the true value of a house from the cost of rents. The below is an example of what I mean, this is took from a real World example.

House cost to buy: £120,000

Rental income: £380

IO mortgage £500 at 5% (worked out on the BBC mortgage calculator)

Right are you lot still with me, for a landlord to make some money on this property he would have to pay an interest only mortgage of:

£280

The £100 includes profit and general other out goings to do with letting a property out.

So what would what would £280 amount to a mortgage, using the BBC mortgage calculator its £50,000.

All these figures are very rough and your welcome to pick them to pieces.

Regards

Martin

5% mortgage? Not any more.

This argument does ignore the fact that rents are likely to go up in line with earnings over time, whereas the mortgage repayments should be fixed. In 25 years time, you would expect both the price of the house to be more than it is today and the rent to be about twice as much as the mortgage.

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Help me out here as I'm a 40% tax payer and I'm not sure what tax breaks I'm missing out on. What tax breaks are you talking about? A BTL landlord can offset basic maintainance, loan interest and management fees but has to pay income tax on the profit part of his rental income. If he makes a capital gain and wants to cash in in the short term he has to pay CGT. Taper relief doesn't kick in until three years and you are I believe you are still liable to pay tax on 60% of the gain after as long as ten years of holding the asset.

Add to this that to liquidise the investment and to obtain it in the first place the BTL has to pay solicitors fees and stamp duty. This isn't sounding much like a tax avoidance scheme to me.

Can you elaborate on why you think I'd be better off putting my money into property rather froma tax point of view than something like and ISA or a pension?

Thanks,

Bertie

ISA is rather limited isn't it. A pension means you cannot touch the cash for decades.

Tax relief on capital used for BTL mortages against rental income is a massive relief.

The tax breaks for investors depend where you are in the pecking order, from rich and well connected to a 40% earner.

There are many schemes and breaks out there for the savvy operator.

Do you really think all the buyers out there are not using them?

"Would a tougher tax regime reduce the ability of private equity partners to afford Notting Hill properties, and so suppress the metropolitan market’s exuberance? Hardly anyone thinks so. Yolande Barnes, Savills’ head of research, points to the series of broken promises to end top earners’ tax breaks. Instead these pledges have been the subject of endless consultation papers, a much-used official delaying tactic. The Central London frenzy is abating – but only somewhat. "

http://property.timesonline.co.uk/tol/life...icle1898537.ece

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ISA is rather limited isn't it. A pension means you cannot touch the cash for decades.

Tax relief on capital used for BTL mortages against rental income is a massive relief.

The tax breaks for investors depend where you are in the pecking order, from rich and well connected to a 40% earner.

There are many schemes and breaks out there for the savvy operator.

Do you really think all the buyers out there are not using them?

"Would a tougher tax regime reduce the ability of private equity partners to afford Notting Hill properties, and so suppress the metropolitan market’s exuberance? Hardly anyone thinks so. Yolande Barnes, Savills’ head of research, points to the series of broken promises to end top earners’ tax breaks. Instead these pledges have been the subject of endless consultation papers, a much-used official delaying tactic. The Central London frenzy is abating – but only somewhat. "

http://property.timesonline.co.uk/tol/life...icle1898537.ece

I read the article you linked to. The tax breaks referred to are primarily when the person earns the money. These relate to breaks given in the realms of private equity and relate really to the super rich who participate in this arena. So I'm still unclear what the schemes and breaks are for the BTL operator who is now in possession of a series of properties.

The money may have originally been earned in a tax efficient manor but once in possession of the BTL, the tax regime would appear to offer only a few special cases where you can escape the tax. One of these is to invest in commercial property. You can then use the business asset tax relief, but you'd not get away with this on a house or flat. The other is to try and claim the property as one of two primary residences by living in the property for at least some of the year. This is intended to help with holiday homes but could not be applied to a portfolio.

There's an ongoing belief that the BTL landlord gets some kind of tax benefit versus the first time buyer. This isn't true long term. The BTL gets tax relief a little bit each month and the interest payments whereas the OO gets the relief on the capital gains. With the recent rises we've been seeing, I'd rather the relief on the gains than on the interest so isn't the OO actually doing better overall tax wise?

The real issue remains that BTL speculation has under called risk and over called potential future gains. Prices are out of step with future returns and an adjustment will be required at some point. Market momentum is slowing and capital returns are now apparent in most of the UK and in some areas of London.

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If there was a recession or HPC then rentals will increase or at least demand for rental property would increase.

You can now fix a mortgage (OO or BTL) for long periods, you cannot do thesame with rental, Over the next 15 years it is almost certain that rental will be higher than it is today, however on a fixed rate the LL may be paying the same mortgage.

If the LL is subbing the tenant £200pm to cover the mortgage then over a hypothetical 25 years he would of paid £60k for a property worth around £200k with the tenant making up the difference.

Not bad from where I am sitting and this is why it will continue if not on the scale it is now.

It will be a strange recession in which people pay more rent. Higher unemployment and negative growth will result in less money being available. Rents will fall, properties will be sold at whatever rate prevails, which could become very low depending on severity and duration of negative growth. Rental growth won't be stimulated in this situation, people become much poorer, which is why the BOE is trying to avoid increasing rates, but it's between a rock & a hard place.

The LL isn't "subbing the tenant" to buy a property which he then keeps himself, anymore than if you borrowed money to buy shares (usually regarded as foolish) the dividend subs you to pay back the borrowed capital. All you've done is accept a large interest rate related liability in exchange for an asset which produces an unknown return through rent and taxable capital appreciation. If anything goes wrong with either side of the equation, you're right back up sh1t creek again. How long can unsustainable capital growth bail BTLs out for? (There's a hint in the word "unsustainable" BTW.) No-one knows for sure, but the longer it persists, the greater the risks for everyone and the worse the potential outcome.

I suspect many BTLs are using the same logic to carry on with half-baked, loss making schemes. There's going to be wailing & gnashing of teeth when the penny drops.

You may want to think about sitting somewhere safer.

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We discussed this here some years ago.

The simplest method is:

Take the weekly rental (Pds.380 / 4 = Pds.95) and multiply by 1,000

- so Pds.95 x 1,000 = Pds. 95,000

That's a reasonable price when interest rates are around 5%

Using your method my property is actually worth 30 thousand more than I thought it was and I only bought it a year and a half ago. It's not worth 30 thousand more in reality so I think your equation is flawed.

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Guest d23
It will be a strange recession in which people pay more rent.

rents went up during the last crash / recession (above inflation); presumably it'll be different this time?

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rents went up during the last crash / recession (above inflation); presumably it'll be different this time?

If you're willing to risk your cash flow and solvency on rents increasing & hold a depreciating asset, that's your choice.

I've heard a rumour that a few flats have been built recently, BTW, have you noticed any?

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Guest d23
If you're willing to risk your cash flow and solvency on rents increasing & hold a depreciating asset, that's your choice.

I've heard a rumour that a few flats have been built recently, BTW, have you noticed any?

:blink: I'm not willing to risk anything on owning a house / depreciatingn asset; I rent and have an interest in rental rates tho and am trying to be realistic about their future prospects.

I've heard a rumour that the UK population has increased by 3 million people in the last 10 years, BTW, have you noticed that? :rolleyes:

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I've heard a rumour that the UK population has increased by 3 million people in the last 10 years, BTW, have you noticed that? :rolleyes:

Yes and I've noticed that in many of regional town and cities many of the flats are still empty. Maybe they are building them in the wrong area's?

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Anyone who has any experience in pricing financial products would notice that what you are calculating is "intrinsic value".

Take an equity option for example - a larger portion of its present value is attributed to "theta" - or time value - which takes into account volatility surfaces, the risk free rate etc.... In the property context, projected house price inflation is a significant contributor to its total present value.

A lot of property investors aren't buying solely for the increase it intrinsic value which of course, may be negative at T0.

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:blink: I'm not willing to risk anything on owning a house / depreciatingn asset; I rent and have an interest in rental rates tho and am trying to be realistic about their future prospects.

I've heard a rumour that the UK population has increased by 3 million people in the last 10 years, BTW, have you noticed that? :rolleyes:

I'm glad to hear it, BTL is very high risk; but like everyone else I don't know what's going to happen. There's always a possibility of something unexpected, but there's some evidence that recent BTLs are forking out cash every month to cover the rent/interest gap, own flats which are reducing in value & may not even be let.

What happens next? I'm sure you'll decide for yourself.

Population growth or not, like many others here I think that recent high property inflation is speculation-based and has little support either as an investment or home buying proposition. Earnings aren't high enough, interest rates probably have to rise to suppress inflation, economic growth seems to be dependent on easy credit & cheap imports.

There's plenty of people wanting to rent property I'm sure, but is the number of people who can afford current asking prices at a time of rapid flat building enough to meet the supply?

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Anyone who has any experience in pricing financial products would notice that what you are calculating is "intrinsic value".

Take an equity option for example - a larger portion of its present value is attributed to "theta" - or time value - which takes into account volatility surfaces, the risk free rate etc.... In the property context, projected house price inflation is a significant contributor to its total present value.

A lot of property investors aren't buying solely for the increase it intrinsic value which of course, may be negative at T0.

Not entirely sure who you're addressing, but presumably you're saying, depending on assumptions made, if intrinsic value is negative at T0 there's no point in buying, & if it's positive go ahead? Sounds as though you don't take a view yourself though.

Edited by somethingfishy

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