Simplistic Models for House Valuation

D

danb

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I understand that there are many factors driving people decision to buy a certain house at a certain price.

However, I am keen to explore models for doing valuation on houses in estabhlished areas where recent transactions have been few and far between.

Is it fair to look at rental yield and assume this is equivalent to a deposit interest yield i.e rent of a house is 2,000 per month = 24,000 per annun.

To earn 24,000 per annun interest @ current average deposit rate of 5% I would need to place 480,000 on deposit.

This would suggest to me that the 1st order value of the house is 480K.

I understand that I have not factored in tax on rental earning but am interested to hear other views or about any other model.

Thanks,
Dan B
 
5% deposit interest is a 'risk free' return. It is also hassle free and your capital is secure.

Buying a house/apartment for investment purposes does not tick any of those boxes at the moment - especially the third box.

For that reason I would be seeking a much higher return on a property investment to compensate me for the income risk (voids), grief potential (tenant issues) and capital risk (price collapse).

I would not pay more than 300k for the 24k pa income stream you described.
 
I'd suggest three further parameters

1. Expected long term growth in rental income.
2. Excess return required over the risk free rate
3. Tax and expenses (including your time)

Your model can be expressed as follows:

24,000 / 5% = 480,000

I'd go a little further

Rental income (net of taxes and expenses)
divided by
risk free return plus excess return required for risk less long term rental growth

Unfortunately taxes on rental income will vary widely from person to person. Just keep in mind that an assumption of zero gives the highest possible valuation. An investor with no mortgage paying a marginal rate of 41% tax is the opposite end of the scale.

Long term risk free returns are about 5%.

Long term rental growth in line with expected inflation (2-3%) might be expected so long as rents were not significantly over or under valued at the moment.

Expenses might include the average annual cost of maintenance, furnishings, management fees, etc

The excess return required for risk is difficult to quantify but should allow for the following risks amongst others
1 That you won't command your expected rental
2 A change in taxation
3 Higher expenses

PS This looks at the value in terms of what it's worth to an investor. I don't see it as a property investment question though, just an objective means for a home buyer to arrive at a valuation
 
You're completely ignoring the emotional aspect, in particular of you're talking about "houses in estabhlished areas where recent transactions have been few and far between". If you're talking about a dream house or a prestige location, and 2 or more parties are seriously interested then any model will go out the window.
 
95% of homes are generic 2 bed apartments, 3 bed semi d's etc. I think as a nation we lost the run of ourselves a little with the notion of dream houses
 
Agreed that the notion of dream houses is over used, however the OP is specifically asking about established areas & where transactions are few & far between.
Perhaps the question is flawed, in that because there doesn't exist a dynamic market (& hence easy entry/exit strategy), such properties are not suitable as investments to begin with.
 
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