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

[the end is a bit nigher]

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'll take your word that rents went up but equally, prices came down until the long-term equilibrium was restored

the phrase 'renting is dead money' came from the day when it was cheaper to buy than to rent - at the moment this isn't the case and plenty of people seem to have forgotton this - this needs to be corrected before property is worth buying again

in terms of how to value a property by rent charged, in the good old days a genreal rule of thimb for a landlord was to buy at 125x rent and sell at 200x - in my case I pay £750 rent and the property is valued around £350 = 467x - of course some of this can be offset by the historically low IRs argument etc. but en masse borrowing to rent out a property is a relatively new concept

[Trixta]

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.

Sorry - my post was a bit unclear. I was trying to say that a lot of people who buy property (and know what theyre doing) also consider the time value when working out how much a property is worth.

The projected future growth in value of a property (it's time value) is also priced into the cost of a particular property (assuming the buyer is a logical buyer).

When I said "you" earlier - I was addressing the people who are trying to attribute the market price of a property solely to the equivalent in rental income that can be obtained from it.

[JustYield]

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.

I've read some pretentious twaddle on this site, but this takes the biscuit. Volatility surfaces - my ****. Future growth of what exactly? Rents of course (imputed or actual). What else is there?

Someone send it in to Private Eye, pseud's corner.

[somethingfishy]

Sorry - my post was a bit unclear. I was trying to say that a lot of people who buy property (and know what theyre doing) also consider the time value when working out how much a property is worth.

The projected future growth in value of a property (it's time value) is also priced into the cost of a particular property (assuming the buyer is a logical buyer).

When I said "you" earlier - I was addressing the people who are trying to attribute the market price of a property solely to the equivalent in rental income that can be obtained from it.

I agree with the principle, but I’m not sure explicitly valuing future capital growth helps much. Using discounted cash flow you just have to place a value on future rent. Modelling volatility surfaces sounds interesting if you can find someone willing to pay you to do it, but I think the difficult bit is making reasonable assumptions. Discounted cash flow also has the advantage that you can do the calculation on the back of a fag packet, or Justyield’s ars*. I had go on another thread, which makes me currently think that prices are about 50% overvalued (ie a 33% fall is needed). What do you think?

For Sale

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Room for up to 20 residents.

Roof terrace.

Fliptop conservatory

An excellent opportunity to buy an empty fag packet while you can still afford one.

An outstanding development opportunity into 2 ashtrays

Offers invited over £150,000

[CrashConnoisseur]

Taxation of housing.

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? [bertie]

Even in the short-term the tax advantage is with the first time buyer / owner occupier since they pay no tax on their imputed rent -- the rent they are effectively paying themselves for living in their own property. Where a property is let by its owner to another occupier then rental profits are subject to tax. If the owner and occupier happen to be the same person -- an owner occupier -- then no tax is payable. If the property is the owner's principal private residence then they are also exempt from any capital gains.

Owner occupied property is grossly undertaxed compared to most other investments. Consider a tenant who rents a house for £500 per month while having £100K of savings in the bank on which they receive £500 interest per month (6% per annum). They pay tax on that £500 per month interest and their landlord pays tax on any profit from the rent. Now, if the tenant was to use their £100K of capital to buy the house (post crash) from their landlord and become an owner occupier they would cease to pay tax on the £100K and pay no tax on their imputed rent either -- HMRC loses the tax on both the tenant's savings and rent.

[gfromls]

A simple metric, like 1,000 times the weekly rental is best.

If the selling price is higher, it means:

+ Rates are below 5% (not true presently)

+ There is too much speculative pressure, as people bet on capital gains,

since a 5% yield assumes not capital gain

Start there, and understand why the market is different from that

that can't be right, it would mean the house that I currently rent (which has gone up in price by 300% - in 6 years)

....is still 20% undervalued.

[bertie]

Taxation of housing.

Owner occupied property is grossly undertaxed compared to most other investments. Consider a tenant who rents a house for £500 per month while having £100K of savings in the bank on which they receive £500 interest per month (6% per annum). They pay tax on that £500 per month interest and their landlord pays tax on any profit from the rent. Now, if the tenant was to use their £100K of capital to buy the house (post crash) from their landlord and become an owner occupier they would cease to pay tax on the £100K and pay no tax on their imputed rent either -- HMRC loses the tax on both the tenant's savings and rent.

I believe you've just rediscovered the benefits of the offset mortgage where you pay no tax as long as you are net in debt (i.e. most people!). I'm a big fan of saving this way rather than using cash based savings. Comparison with equities is a little more difficult as I believe that historically these ought to outperform the mortgage offset returns over time. Despite the possibility of a long term win, I've just pulled all my stock market based savings to plough into the mortgage and reduce my exposure to what might be a bumpy period of high IR's and stock market fluctuations. Time will tell if this was a good move or not.

[somethingfishy]

A simple metric, like 1,000 times the weekly rental is best.

If the selling price is higher, it means:

+ Rates are below 5% (not true presently)

+ There is too much speculative pressure, as people bet on capital gains,

since a 5% yield assumes not capital gain

Start there, and understand why the market is different from that

TEIN's rule of thimb earlier in the thread is effectively buy at 9.6% yield, sell at 6%, I think, which looks as though it's based on long experience of old style BTLs. I don't get the impression that many people are getting more than 3 point something% if you take out all the expenses and make an allowance for voids, although I've only really been looking at new build flats in Basingstoke TBH. Maybe 5% (cash in the bank) is enough to make it worthwhile, but it doesn't seem to enter current BTL thinking which remains firmly locked on 'property only goes up' with a nonsensical post hoc justification, which looks like a crash warning to me.

Edited July 22, 2007 by somethingfishy

[brainclamp]

Taxation of housing.

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? [bertie]

Even in the short-term the tax advantage is with the first time buyer / owner occupier since they pay no tax on their imputed rent -- the rent they are effectively paying themselves for living in their own property. Where a property is let by its owner to another occupier then rental profits are subject to tax. If the owner and occupier happen to be the same person -- an owner occupier -- then no tax is payable. If the property is the owner's principal private residence then they are also exempt from any capital gains.

Owner occupied property is grossly undertaxed compared to most other investments. Consider a tenant who rents a house for £500 per month while having £100K of savings in the bank on which they receive £500 interest per month (6% per annum). They pay tax on that £500 per month interest and their landlord pays tax on any profit from the rent. Now, if the tenant was to use their £100K of capital to buy the house (post crash) from their landlord and become an owner occupier they would cease to pay tax on the £100K and pay no tax on their imputed rent either -- HMRC loses the tax on both the tenant's savings and rent.

Your benefit argument is nonsense - it's just that - imputed - an artificial construct, because the FTBers are owners and are not subject to rent through a trade or business. The FTBer has to look at this housing cost and finds to own, he has to bid higher than the landlord with tax breaks which is very difficult or impossible. His imaginary tax break from owing doesn't figure.

The reality is the landlord would not pay much tax if any at all after his deductions, which are taken from gross income (sales) - he only pays income tax on what is left spare after mortgage deductions and perhaps rolling loss allowances. FTBers lose the after tax interest income from the cash they use to buy the property, and have to evaluate these losses against the alternative costs of housing (renting), which will always be cheaper than a FTBer mortgage because of the tax breaks for landlords.

The landlord uses a mortgage on a property and pays no taxes due to tax relief on source income.

The FTber has no tax relief from his source income - he cannot afford to to pay the equlivalent.

Both are in reality, in business - both are economic agents who have to sell thier services and receive income from thier activities. On form of income is called a wage, the other, rent.

One is passive income, involving little labour which gets tax breaks.

One is active income which is all labour, and forms the basis of society, family creation, and gets none.

(I also cease to pay tax on the savings/money I spend to buy a banana, that money goes to the seller - HMRC do not 'lose' the tax value of the money, it is transferred into other activities.)

Of course, if MIRAS is now brought back, to bring the playing field both in line again.

HPI will go up further, because fo the supply problem, and savings will be even more worthless as a real store of wealth through such inflation. This would probabily led to more dissaving and blow out the trade deficit and consumer inflation IMO!

Edited July 22, 2007 by brainclamp

[Martin]

Sorry it’s taken a while to reply, I knew the replies, would consist of people trying to justify the investment in property at this time as an excellent investment.

However I really do feel that subsidising a tenant is a crazy situation to be in, a typical argument goes something like:

Rental will increase over time

Fixed rate mortgage do not increase, (a 25 year fixed mortgage I’m talking about here).

Inflation erodes the debt.

With an IO after 10 years on a mortgage you will have a house that is worth twice as much as you paid for it.

But the very REAL problem is if you cannot afford to keep subsidising them, with a pension fund or any investment scheme I can take a break.

A very REAL problem could be:

Illness

Redundancy

Any other number of things can affect household income.

The bulls answer would be something like:

“Well I could always sell the property”

But looking around my area, a lot of houses have been up for sale for more than 6 months, that will also include 6 months of no rent from a tenant and then you will have to pay for estate agents fees etc etc etc. Remember what ever you do you have to do it quickly.

I just love the crazy bull tax avoidance scheme, and then they point out leverage, that’s fantastic leverage brilliant, was that not one of the problems that helped create the Great Depression, idiots borrowing money to make money on a very speculative asset, which made no real dividend.

I personally have been watching this bubble for a long time, its been really interesting, with hindsight I should have got into property in 2000, but for certain I would be out of it by now, my God yes I would, but having said that I would have to pay CGT and alsorts of legal stuff. But getting out is what I would have done no matter what price it cost.

But hey I felt that stock were under valued in 2003 and have doubled my money since then (I now liquid), I would have made more money from property mainly because of “leverage”. But like any good gambler I know when to quit.

My conclusion to this property mess is that I would have sleepless nights if I were a BLT landlord subsidising my tenants and my advice would be to GET OUT!

[bertie]

The landlord uses a mortgage on a property and pays no taxes due to tax relief on source income.

The FTber has no tax relief from his source income - he cannot afford to to pay the equivalent.

There are certainly landlords who are paying no interest on the rental income. These are the ones who are making a loss. Where the management and interest costs equal the IO payments, you are liable for no tax at all. A guaranteed tax avoidance scheme. This type of landlord is on the increase.