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Valuation By Rental Yield


dr ray
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OK

Rental or lease yields on most capital goods is around 8.5%

Yields on property would need to be over 8% actual IMO

Some time ago, when I rented a property, I had a net yield of 16% based on actual cost or when using up to date value around 10% or less.

Both methods of assessing yield are important.

Using actual cost gives you the real profitability of that particular property and factors to consider are simply the initial capital or mortgage if leveraged and all other costs set against the return or revenue.

This one is more important for pure business and profitability as it gives your profit and loss.

Using up to date valuation before adding other costs is useful when capital appreciation/depreciation is an important factor as it influences the balance sheet figure of the particular property and could possibly influence if "opportunity" value of capital is good or even the total value of the "asset" set against revenue/loss.

I would suggest that a landlord with properties over 30 years old, even if he did let at slightly below current market rate would be very profitable as his actual costs against revenue would be very low with very high yield.

But if yield was calculated on a current market valuation for the property it could look very poor. This would only really be useful to see opportunity cost of capital. Extreme example would be if property valuation raised so much possibly due to massive HPI or finding oil under property etc that yield went to say 1% or less and it could be reasonably assumed that a yield of 10% was available from a safe bank deposite it may well be worth "selling up". This is exactly the same dilema facing many businesses every day, "Is it worth it".

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You may be right but that would be a huge drop as I am already taking 10-15% off peak.

I'm not looking at investing at these prices - I am just trying to get opinion on fair value based on rent. I posted a while back that I had looked at BTL in Hereford in the early 90s and even then I couldn't make the figures add up and I never did it. Prices went up more than 3 fold after that (although rents hardly changed).

yep. bubbles do change things.

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No the value of a house is what the markets highest bidder is willing/able to pay.

Commercial property is valued by yield, so why not res property "when considering as an investment"?

If OO's are paying up, the investor has to choices:

1/ Stand aside

2/ Take a punt on capital gain

But if the Cap gain doesn't materialize (conceivable/probable for the medium term) a reasonable yield is certainly a cushion.

Yield must come into it IMO.

Otherwise pick up some shares with cheap multiples and decent yield (after guessing recession impact on earnings). There are plenty of ways to lever shares contrary to what the property gurus erroneously ascertain... and ways to scrounge additional income from them.

I reckon the 10 times income is a reasonable rule of thumb for BTL. That's where I bought my couple at (a few years ago now) and I couldn't give a feck about cap gain in the medium term. Without that 10x income, I ain't interested.

Edited by wayneL
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No the value of a house is what the markets highest bidder is willing/able to pay.

The price of the house is the what the highest bidder will pay (or probably more accurately the price the second highest bidder will pay); the value is different.

The value of a house is the amount that a rational investor (or owner) would pay in a normal market, you can make a reasonable estimate of this from historic norms and current rents. The difference between price and value is a measure of the size of the bubble.

Flats in Leeds city centre were priced at £200,000+ but quite clearly the value was much lower.

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The mystery to me is why more landlords were not selling up when current yields dropped well below 5%. Did they not notice this sign? Sure some stopped adding, but few seemed to have sold.

Anyone?

And if they didn't sell into this peak, what exactly is the BTL exit strategy?

Anyone?

Having spent many years on BTL sites, I would say that on the whole they didn't do it for the same reasons most people who have bought into the bubble do not sell - they were convinced it is going up pretty much forever. The market has fallen now and they are in denial - they genuinely believe that a falling market gives them buying opportunities. What I have seen mostly is a desire not to sell and repay money but a desire to borrow more money and buy more property, which of course they can't do any more. What they don't seem to realise is that they are over-leveraged already - they are relying on rents which, they mysteriously think will rise in the recession. But rents won't rise until house prices are near the bottom, and they will fall until then. However, I am speaking about the kind of people on SP, I'm sure there are plenty out there who are marter than that. I have a friend who was pretty big in BTL - often spoke at conferences wtc. He sold the last property in his portfolio last year. He did very well for himself really because he understood that BTL was not a money-printing machine. The same could not be said of people on SP.

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I know it has been discussed before but the rules of thumb I have seen for working out the value of a rental property give figures which differ by up to 100%

What system do the folk on here favour when working out how much a property is worth from its rental value.

What is considered an acceptable long term rental yield by professional landlords?

I aim for 12.5% equating to 8 years purchase.

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Commercial property is valued by yield, so why not res property "when considering as an investment"?

If OO's are paying up, the investor has to choices:

1/ Stand aside

2/ Take a punt on capital gain

If you think about it carefully, rental yield also allows for a normal capital gain so taking a punt is pure speculation that the bubble will grow bigger.

There's also a point here about why rental yield is important, even if OOs don't use it.

Rational investors will use the yield method; if OO's use an alternative (higher value) method then all sales will go to OO's, existing investors will sell up and rents on the remaining stock will rise until the yield method matches the alternative.

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This is the formula I have seen before.

In Hereford a 3 bed house in a decent area would rent for £600 or less and currently costs around 170-200k. Although I think Hereford is overpriced even the most pessimistic bear cannot really believe that they would drop to 72K or that rents would go up (down more likely as jobs are lost).

This would suggest that either there should be no rentals in Hereford or the figures are wrong

Why not? Prior to 2001 how much were these £170-£200k houses selling for? Closer to £72k than £200k? I don't see why once the bubble has well and truly deflated why many many properties will be worth much more than a sensible multiple of salary, or the average monthly rent x 12 x 10. This was the norm pre bubble and I expect a similar equilibrium to be roughly reached again. The new paradigm is dead, long live the new paradigm.

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Why not? Prior to 2001 how much were these £170-£200k houses selling for? Closer to £72k than £200k? I don't see why once the bubble has well and truly deflated why many many properties will be worth much more than a sensible multiple of salary, or the average monthly rent x 12 x 10. This was the norm pre bubble and I expect a similar equilibrium to be roughly reached again. The new paradigm is dead, long live the new paradigm.

Long term trend line graph on the home page of this site would suggest they will fall to around 150K with an unquantifiable overshoot first. Prices probably were around 75-100k in 2001 but you have to allow for inflation. My wages have probably gone up 1/3 since then

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Lets take the 10% yield ‘rule’ and have a bit of fun. Here’s a house in an area popular with landlords, they tend to buy these bigger houses and let the rooms separately (£50 pppw)

http://www.rightmove.co.uk/viewdetails-167...p;mam_disp=true

4 x £50 x 52 = £10,400. So with our 10% yield ‘rule’ this house would be worth £104,000. However, it looks as though they’re struggling to sell it for 75k.

Look what it sold for in 2002, look what houses were selling for in this street in 2000 and then explain what rental yields have got to do with house prices.

http://www.nethouseprices.com/index.php?co...0&curPage=3

Obviously I’ve used a fairly extreme example here but all you need to do is check prices v yields in your own area and you’ll see.

Btw, the only reason I’m banging on about this is because I fear some could get burnt, if they were to use yields as a way of valuing houses.

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Long term trend line graph on the home page of this site would suggest they will fall to around 150K with an unquantifiable overshoot first. Prices probably were around 75-100k in 2001 but you have to allow for inflation. My wages have probably gone up 1/3 since then

Couple of points

  1. The long term trend line has been skewed by the current bubble, it should be lower.

  2. A fall from £180,000 to £150,000 would be 16%, we've had that already.

  3. The graph on the front page is for average houses, I would suggest that the rent for the average house is closer to £1,000 pcm rather than £600 (in my area £600 is 1 bedroom flat if your lucky).

Ok that's 3

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Btw, the only reason I’m banging on about this is because I fear some could get burnt, if they were to use yields as a way of valuing houses.

As opposed to the people who have definately been burnt by not using yields and are now seeing their investments being sold off for 1/2 what they paid for them

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Lets take the 10% yield ‘rule’ and have a bit of fun. Here’s a house in an area popular with landlords, they tend to buy these bigger houses and let the rooms separately (£50 pppw)

http://www.rightmove.co.uk/viewdetails-167...p;mam_disp=true

4 x £50 x 52 = £10,400. So with our 10% yield ‘rule’ this house would be worth £104,000. However, it looks as though they’re struggling to sell it for 75k.

Look what it sold for in 2002, look what houses were selling for in this street in 2000 and then explain what rental yields have got to do with house prices.

http://www.nethouseprices.com/index.php?co...0&curPage=3

Obviously I’ve used a fairly extreme example here but all you need to do is check prices v yields in your own area and you’ll see.

Btw, the only reason I’m banging on about this is because I fear some could get burnt, if they were to use yields as a way of valuing houses.

This is in Holbeck which suffers from the excessive number of new builds in Leeds but is too far from the university to attract students so is getting a double whammy.

It would probably sell in Hereford for 100K and attract that sort of rental.

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Lets take the 10% yield 'rule' and have a bit of fun. Here's a house in an area popular with landlords, they tend to buy these bigger houses and let the rooms separately (£50 pppw)

http://www.rightmove.co.uk/viewdetails-167...p;mam_disp=true

4 x £50 x 52 = £10,400. So with our 10% yield 'rule' this house would be worth £104,000. However, it looks as though they're struggling to sell it for 75k.

Look what it sold for in 2002, look what houses were selling for in this street in 2000 and then explain what rental yields have got to do with house prices.

http://www.nethouseprices.com/index.php?co...0&curPage=3

Obviously I've used a fairly extreme example here but all you need to do is check prices v yields in your own area and you'll see.

Btw, the only reason I'm banging on about this is because I fear some could get burnt, if they were to use yields as a way of valuing houses.

Yep gross yield doesn't cut it in all cases. It's just a rule of thumb to see whether further numbers are justified.

Nett yield is more to the point, plus a risk premium for this type of setup. Here you are going to get defaults and damage, plus all the usual expenses.

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This is in Holbeck which suffers from the excessive number of new builds in Leeds but is too far from the university to attract students so is getting a double whammy.

It would probably sell in Hereford for 100K and attract that sort of rental.

Ah, so this yield rule varies from place to place?

next you’ll be telling me it varies depending on the type of property ;)

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Yep gross yield doesn't cut it in all cases. It's just a rule of thumb to see whether further numbers are justified.

Nett yield is more to the point, plus a risk premium for this type of setup. Here you are going to get defaults and damage, plus all the usual expenses.

However the costs involved tend to move in line with the rents (agents fees, void periods) or the value of the property (repairs/redecoration) so the gross yield remains a powerful tool.

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4 x £50 x 52 = £10,400. So with our 10% yield ‘rule’ this house would be worth £104,000. However, it looks as though they’re struggling to sell it for 75k.

Have you been to the property in question to make sure that it doesn't need tens of thousands of repairs to get it up to inhabitable standard.

Also these HMO's necessarily involve much more work on the part of the landlord so you would reasoably expect a much higher yield than for a normal property.

Single examples of "that looks very cheap" don't help.

Of course I agree that most amateur BTLers haven't a clue about discounted cash flows and rental yields; all they see is prices going up and jump in to the "sure fire moneymaker". This is why we have a huge property bubble at the moment which is now deflating at an unprecedented rate.

That does not meant that the yield can not be used to estimate a "true" value of the property as opposed to the current market price.

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I worked out a fair value for rental yields of about 8%. Of course, none of the "professional landlords" on HouseMouse or Singing Pig at the time agreed, because they were only getting 3% (they thought they were getting more because they were, moronically, comparing rentals to their original purchase price, not the current market price, of their properties).

I can only see one issue with them using purchase price when discussing yield, & that is it wouldn't allow comparison with other possible investments at this point in time (if they wanted to switch). However, don't see anything wrong with using it as a figure for yield.

Heck, using running yield as you suggest, if the value of the property went down then their yield would go up even though this isn't realisable to them.

Wouldn't the best yield for them to use be what would be realised if the asset were disposed of now at current market price?

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Have you been to the property in question to make sure that it doesn't need tens of thousands of repairs to get it up to inhabitable standard.

Also these HMO's necessarily involve much more work on the part of the landlord so you would reasoably expect a much higher yield than for a normal property.

Well, the agent says its been ‘Improved’, but no, I’ve not viewed it personally. I can assure you that its not a one off though. The thing is, even at 75k they’re asking far too much for it, it sold for 22k in 2002. Whereas the yield looks attractive there’s a lot more to it than meets the eye.

Single examples of "that looks very cheap" don't help.

I’ll resist the obvious comment.

Of course I agree that most amateur BTLers haven't a clue about discounted cash flows and rental yields; all they see is prices going up and jump in to the "sure fire moneymaker". This is why we have a huge property bubble at the moment which is now deflating at an unprecedented rate.

I wouldn’t be surprised if a few of these novice btl’ers have ended up needing counselling, following their stint as a ‘professional investor’.

That does not meant that the yield can not be used to estimate a "true" value of the property as opposed to the current market price.

Some property’s are in areas with huge rental demand, some are not.

Some property’s are in areas which are safe from vandals or squatters during void periods, some are not.

Some property’s are in areas where tenants can be expected to keep the property clean and get on with the neighbours, some are not.

Within any given area there are all types of property, some will better suited to renting than others and will therefore spend less time void.

that’s why the OP found such variations (imho).

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"Some property’s are in areas with huge rental demand, some are not.

Some property’s are in areas which are safe from vandals or squatters during void periods, some are not.

Some property’s are in areas where tenants can be expected to keep the property clean and get on with the neighbours, some are not.

Within any given area there are all types of property, some will better suited to renting than others and will therefore spend less time void.

that’s why the OP found such variations (imho)."

Generally speaking if a property is not attractive to rent it will not be attractive to owner occupiers so the rental yield method is still valid.

There will be some variation. Yields on city centre 1 bed flats will be higher than rural detached 4 bed houses because there is more rental demand from students etc. So you might need to adjust the equation for the different catagories but generally I think it is still a useful way to value the property. The other way using £/sq metre is just comparing one possibly overinflated house price with another and doesn't give you the true value-only the relative value.

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A curious thread for HPC, wouldn't it better if this was on singingpig or one of the other sites popular with BTL'ers, for example citizens advice?

Forgetting yields, are people assuming that when this bust is over house prices will rise again above wage inflation? Can anyone name one other bubble that burst and then reinflated again? Dot com stocks are still floundering 8 years after the event, Tulip bulbs are way down in price and that bubble was years ago, the south seas company never recovered...

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First post, seen a lot of good stuff on here over the last 12 months or so hence rather surprised that for a board of educated house price types the answers on this topic are quite so wooly. I'm an ex-landlord, out a few years, and was a landlord in a neighbourhood of what you might describe as professional landlords ie it was a student area and probably the majority of properties were rental. The following is a list of observations that show the market at work as assets find their correct value, just think about it this way rather than there being any single rule.

Circa 1996/97 there was no significant BTL mortgage market which meant that you paid cash, used a personal loan or went to one of the few specialist providers for a mortgage. In the neighbourhood I operated in a 4-5 bed large victorian house was around £60k, a lot were owned by local businessmen, particularly those from cultures where capital and investment growth was entrenched and encouraged. You would let for £35 per room per week for 50 weeks of the year meaning a rental income of 35 x 5 x 50 = 8750 on an investment of 60k. This gave a yield of 14.5% (assuming no debt on the property, see below) and was attractive but not ridiculously so when typical mortgage rates were 9-10% when you could borrow to BTL. Money still came in but it was a niche market as it was just not possible to get funding for such a venture on a larger scale.

Over the next 2-3 years interest rates came down significantly, the BTL mortgage market was born and the ability to raise money seemed to become significantly easier. Now you could borrow 90% of the value of the property which meant putting down 6k or so and borrowing the rest at 6% or so. So the sum became, invest 6k, borrow 54k at 6% meaning £3,250 interest payments per year (capital payments are irrelevant). So, on an investment of 6k you would make £8,750 - £3,250 = £5,500 per annum = 92% yield. Honestly no-one cared about repair costs etc on such figures so I am not including them here, they only become relevant when your return is marginal compared to other investments.

Now, it sounds obv but the way the market works is that accessible investment opportunities yielding 90%+ do not sit around for long and what happened was a massive flow of money into these markets, for anyone that said they needed a 90% return someone else would accept 80%, someone else 70% etc etc until the yield reached that of other comparable investments for the money + any sector specific risk margin. So interest rates stayed low (and got effectively lower) as the mortgage market became ever more competitive. Over a few years (that's all it took), the same property worked it's way up to a valuation around £230k and rental values were approx £70pppw x 52 weeks (if you had a decent house). So as a cash investment the yield was now 8.4% compared to maybe the 5% you would get in the bank. Without such a large margin cushion the stamp duty, repairs, voids, local authority registration fees etc that were introduced, gas + elec certs etc became much more relevant and if you looked at the investment over 5 years (stamp duty on entry, EA fees on exit and everything else in between) the return simply was not enough to make it an attractive investment. With leverage and say a 10% deposit the maths were £23k down, 207 borrowed @ 6% =£12.5k interest, 70 x 5 x 52 = £18.2k income = a return of £5.7k on investment of £23k = 24% return. Which sounds great, however, you have to leverage yourself 9 times to achieve this (= more risk), stamp duty on entry = £2.3k meaning year 1 return is almost halved, EA fees of 2% on exits means almost the entire final year return is gone and repairs etc begin to have a significant effect on margin. So the yield is poor if the investment is safe and better (but not great) if highly geared. This probably sounds familiar by now, it's the same in other markets too, all caused by the same cheap tidal wave of money.

Anyway, prices reached that level in 2003 and have pretty much stuck there. They dipped slightly as interest rates went up but basically they have stuck whilst sentiment has changed such that there is not a competition to get in.

Basically the valuation depends on the return on the investment compared to what you could do with the money elsewhere and the type of risk profile you want for your investment. More leverage = better returns, high gearing on the way up makes sense but is devastating on the way down as a small drop in price wipes out the thin veneer of equity. Yield should of course always be measured against current market value as that is how much you have invested in that particular investment be it debt or equity. Assumed capital growth should also be irrelevant to a yield calculation as that is not investment, it is speculation on capital values. Despite what a lot of people think there is still a legitimate BTL market out there, there may not be many good investments currently but there have been landlords for 100s of years and always will be. As I said, I am out and will wait out this downturn before getting back in because history is my friend it will all come around again as it always has done before.

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A curious thread for HPC, wouldn't it better if this was on singingpig or one of the other sites popular with BTL'ers, for example citizens advice?

Forgetting yields, are people assuming that when this bust is over house prices will rise again above wage inflation? Can anyone name one other bubble that burst and then reinflated again? Dot com stocks are still floundering 8 years after the event, Tulip bulbs are way down in price and that bubble was years ago, the south seas company never recovered...

What? you mean that a thread about house prices is inappropriate for this site?

Shouldn't we be able to have a sensible discussion about the correct value of a property? If this was discussed on SP the argu ment would be bias one way, on this site perhaps bias the other way - both equally wrong.

There are some on this site who believe that houses will just carry on getting cheaper. If you have an open mind it seems obvious that house prices will overshoot on the way down, languish for a few years and then overshoot on the way up again. It happened before and it will happen again.

The tulip bubble never recovered because of technological advances which allowed growers to propagate tulips from seed. Unless you are foreseeing that technological advances will mean that people will not need houses to live in the prices will recover, sooner or later. If you don't realise this you will still be renting at the top of the next property boom. There is a time to rent and a time to buy. The smart thing is knowing when. That is what I am trying to find out.

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A curious thread for HPC, wouldn't it better if this was on singingpig or one of the other sites popular with BTL'ers, for example citizens advice?

Forgetting yields, are people assuming that when this bust is over house prices will rise again above wage inflation? Can anyone name one other bubble that burst and then reinflated again? Dot com stocks are still floundering 8 years after the event, Tulip bulbs are way down in price and that bubble was years ago, the south seas company never recovered...

Not this little black duck, hence why yields are important.

With a decent yield and rent covering mortgage, house prices need only track inflation to make an adequate inflation hedged, and leveraged investment.

The caveat is buying at correct value and not at bubblicious prices. When I buy, I don't give a ****** about the medium term cap gain. That's why I bought in the mid-late 90's and have bought nothing since.

Shares are much better for playing price movements because of liquidity, divisibility etc. If the greater fool turns out to be you, you can exit with the press of a button... fast. However in the housing market, the greatest fool is stuck with an illiquid piece of shit nobody will buy (except at the "right price").

But if you can get housing "at value", there is no better "set and forget" investment. But we are still a long way from that value at present.

And no, it's not about hoping for another bubble at all, that's speculating not investing.

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