Tuesday, April 13, 2010

P/E ratio for the UK house market doesn’t compare well to shares or German property

Tempted by Buy-to-let in the UK? Don't Be!

To value any investment, it’s essential to look at the price earnings ratio (P/E). And I’m not talking about the ‘price to earnings’ figure quoted in the media. When the media talk about property, the price to earnings figure you’ll hear about is a so-called ‘affordability indicator’. That is simply a ratio of average house price to average earnings (wages). When we’re looking at buy to let, the P/E that we want is the house price (“price” or P) divided by the after-tax rental income (the “earnings”, or E). As my friend told me, a BTL rental yield is about 5%. But after tax, rental voids (the time lost while you’re looking for tenants) and maintenance, that 5% yield drops down to nearer 3%. And a 3% yield gives us a P/E of 33 times...

Posted by damien @ 09:58 AM (2825 views)
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3 thoughts on “P/E ratio for the UK house market doesn’t compare well to shares or German property

  • mark wadsworth says:

    Exactly. When I got into BTL in the late 1990s, my rule of thumb was a p/e of about 8, i.e. price = 100 months’ rent (which made the maths very easy e.g. if flat costs £50,000 and monthly rent £500 or more, it was worth buying).

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  • But to get to a P/E of 33 the whole price of the property is being used.

    Surely the correct figure is to use is the capital invested or deposit (ie 25% of the value of the property). This would reduce the P/E to 8.25 wouldn’t it ?

    Just buyig shares and useing the P/E doesn’t take into account the leverage gained by property investment.

    Now I know that leverage in reverse will quickly wipe out a 25% deposit but that’s irrelevant because prices only go up if you own property !

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  • Str 2007 – you are kidding right?

    Of course you cant just use the deposit if you are calculating the P/E!!! How you finance the purchase of an asset is irrelevant to the P/E ratio. By implying that you don’t need to include the debt part, you seem to assume that you are not on the hook for the mortgage amount – you are liable for the entire amount regardless what happens to the property!

    You can of course just borrow money and use it to buy shares, if you want leverage, provided you can find a counter party who will eat your credit risk.

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