Posted by: davidgarnerconsulting | September 10, 2009

Property Investing Advice – How to Value Property

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Property Investing Advice – How to Value Property

By David Garner – Managing Partner at David Garner Consulting and Senior Portfolio Manager with BRIC Group

There are two very valuable rules to consider when assessing the true value of a real estate holding, be that commercial property, residential, or a real estate stock:

Don’t pay too much for the underlying asset and,

Don’t pay too much for the business element.

Don’t pay too much underlying asset. For a property stock, you shouldn’t pay more than a 10% premium to the actual market value of the underlying properties. And when it comes to buying an actual property the same applies, you had better have a really good reason before paying a 10% premium to market value. The best property investing advice you will ever hear, is to buy property at a 20% discount. If you’re able to put aside your own personal like and dislikes      and not be too picky, it’s really not that hard to achieve.

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My second rule and piece of advice for property investing is also very simple: Don’t pay too much for the business element. It’s the same as valuing a share; you need to look at the Price-to-Earnings ratio, or P/E ratio. Here’s what I mean; all (or at least most) property has generates revenue (earnings), in the form of rent. While property prices will fluctuate in the short-term, in the long-term, property prices are significantly driven by rental values. If you look at the Price-to-earnings ratio of your property, you can learn about your home’s true real value.

In property investment, to find the price-to-earnings ratio we first need to know the NET annual rent for the property you are valuing as a percentage of the property price, say a NET annual yield of 3.9%.

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We then divide 100 by 3.9 and that gives us a P/E of 26. That means that the property’s price is about 22 times the annual NET rent.

This means this property sells for 26 times the NET rent – the lower the figure the better.

a Property Value

£150,000.00

b Annual Rent

£7,000.00

c Annual Costs

£1,200.00

d NET Annual Rent (b-c)

£5,800.00

   

 

e NET Rental Yield (d/a)

3.9%

   

 

f P/E Ratio (100/e)

26

What we need to do now is figure out if 26 is good or bad, remember the lower your P/E is the better. The way we do that is to work out the P/E for the area so you need the following:

Average rent for similar properties in the area, (simply ring round as many rental agents as you can).

Average price for similar properties in the area. (Estate agents, the internet).

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Once you have these numbers simply follow the same process as before:

a Avg. Property Value

£165,000.00

b Avg. Annual Rent

£6,500.00

c Avg. Annual Costs

£1,200.00

d NET Annual Rent (b-c)

£5,300.00

   

 

e NET Rental Yield (d/a)

3.2%

   

 

f P/E Ratio (100/e)

31

This means that your property, with a P/E of 26 is represents a good buy. If your P/E is low, you could collect a high rental yield from your property. On the other hand If your P/E is twice as high as the local average my advice is that you ought to consider selling.

The scary thing is that from experience you NEVER make money in the long-run buying stocks if the P/E ratio is above 17. I don’t have enough data for property investing to say whether the giure is the same, but something tells me it’s going to be similar.

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