# Intrinsic value of residential property



## wayneL (11 September 2008)

There is a bit of a discussion on this on a UK forum - what is the intrinsic value of a property.

First let's assume that the property is a standard sort of residential property with no unique and rare features such as views, beachfront, subdivision potential etc. In other words a commodity type shelter.

When a company is valued, it is on the basis of current and future earnings basically. A residential property can be compared to a mature, steady blue chip company as earnings (rent) is stable and is extremely unlikely to exceed inflation over the long term. It is also unlikely to underperform inflation as well.

What would be a fair PE ratio for such a company? The assumption on the UK forum is about 16 times, so net earnings of about 6.25%.

As a residential properties only earnings (not capital gain - earnings) are from derived from rent, we must use actually realizable rent on the open market (this figure is also imputed in OO property as well).

An estimate of costs to subtract range fro 20-25% of gross rent, so net rent is assumed to be 75-80% of gross rent.

The property I was renting in Geraldton before I came over here was $250 dollars per week which comes out at a valuation as per follows:

_substitute $ where £ is_




Yet would have sold all day long at $350,000

Typically of the UK, there are new houses in the development where I am selling (infrequently) at a reduced price of about £200,000 for which the realizable rent is £775pcm;








I mentioned on another thread, a friend just bought a flat in Basingstoke for £120,000 with a realizable rent of £800pcm. This is how the valuation comes out:




NOT A BAD DEAL! These were selling for £180,000 or more last year. 

This is closer to where the property market should be and I believe is the shape of things to come.

That is, commodity property will return to a more intrinsic valuation.

Discuss.........


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## Sean K (11 September 2008)

This is purely investment property valuation?

If it is to own and live in what do you add as the psychological measure of home ownership? Maybe call this speculative factor. 

Might have to add 10-20% on to the fair value above. Or more. Maybe that is one of the additional factors having driven up Australian house prices and why they are still expensive compared to the rest of the world. Australians need to own a front and back yard for some reason.

Or, am I off track here?

PS, Maybe the Ã­ntrinsic ´aspect of the title wipes this concept out, along with any other speculative nature of potential growth.


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## prawn_86 (11 September 2008)

I not a property buff by any means, but i have always had a fairly simple view of that earnings/rent should exceed costs, if not the property is overvalued. Its much like borrowing at 8% to invest in a stock yeilding 2%.

Obviously you do need to think about cap gains, but you cannot quantify that on intrinsic values. Also neg gearing can have an effect, which i havnt totally got my head around yet...


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## wayneL (11 September 2008)

prawn_86 said:


> I not a property buff by any means, but i have always had a fairly simple view of that earnings/rent should exceed costs, if not the property is overvalued. Its much like borrowing at 8% to invest in a stock yeilding 2%.
> 
> Obviously you do need to think about cap gains, but you cannot quantify that on intrinsic values. Also neg gearing can have an effect, which i havnt totally got my head around yet...




Cap gains are not earnings... and there may also be a cap loss.

Also future increase in earnings is reflected by PE ratio, otherwise it would be 12-14


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## gfresh (11 September 2008)

*$291k* presently 

I am thinking it would be appropriate to determine people's capacity to pay, to decide the average property price. Maybe this is getting away from 'intrinsic' value here (land/construction/holding cost), however for comparison: 

ABS avg weekly wage: $1183.10 (ABS May 2008)

(full time - assuming 2x fulltime wages are required for property purchase, part timers, singles will have to rent, etc)

Couple: 2 x $1183.10 = $2366.2 x 52 = $123042.4 p/a 

Each taxed @ middle bracket 30%: $86130 p/a

Net/wk: $1656.35

Here we get back to the "affordability" measure, the proportion of wages that are required to service an average mortgage, allowing the rest for other living expenses, children, etc. If we take 30% of the above:

Serviceability for "average" home on "average" earnings: $496.90/wk

If we take a longer-term average of 7.5% financing.. 

Loan @ 7.5% over 25 years: $291k = $496/wk (using a quick mortgage calculator)

That 30% could be adjusted to fit, e.g. 40% = $389k.. getting closer to actual average prices. 

There are many extra costs, and 'what ifs' that maybe should be included, and as Kennas pointed out, desirability, distance to city centres, etc are important. Just another attempt anyhow.


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## Glen48 (11 September 2008)

one  way is to take the Monthly rent ( assuming you get 52 weeks rent  most times its only about 48) x by 150 and that should be what the house is worth.
Houses only go up in value due to replacement costs , Shares out preform Real Estate over the long term.
As house prices come down here there is a  chance prices could over shoot the mark and then it would be a good time to buy.
The best investment you can make is to live in a dump and own shares staying married is the best tip for any long term success and also try and put a bit aside some where and don't tell ANY body if the marriage works ( they can fall apart after 40 yrs) you have nest egg if not it can help you survive the divorce.
Is it cheating on your partner yes but with a 60% chance of the marriage failing and 80% chance the Wife will walk out call it insurance.


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## freddy2 (11 September 2008)

I'm sure smarter minds than me have tackled the property valuation problem. However I would have thought that it was best to split the valuation into land and building.

The land should rise in value at about the inflation rate after costs (eg land tax) if it is in an area such as capital cities that are expected to be around in 100+ years. Note this assumption could be questionable in areas such as country towns. Therefore the land after any period of holding could be sold for approximately what it is worth in today's dollars.

Also I'm not sure what the lifespan of a typical home is but this would be a large factor in the calculation. Also consider that the rent should be put up at regular intevals in-line with inflation. I am suprised that when I have rented the owners have never put in a clause adjusting the rent say yearly for inflation.

I'm very interested in what others have to say, because this is an area I could learn much about and much of the above could be wrong.


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## pepperoni (11 September 2008)

Strangely I was thinking about this very topic whilst trying to sleep last night.

There has to be a pretty close correlation between what people are prepared to pay to rent a property and its intrinsic value.

You would also expect that in a normal market what would be prepared to pay to rent would correlate with what they would pay to buy as its so strongly dictated by perception and psychology (ignoring the the fundamental "why buy at 3% rental return when I can rent and easily invest for 4+% after tax")

The variable would be how much capital gain you expect to get.

But in all normal circumstances Id expect intrinsic value lies in the 2% (high CG or development potential) - 8% (no CG) rental return range.


6.25% is a bit too bearish ... it was 5% ish back in the 80s and 90s (ie add 3 zeros to the end of your rent) and I expect it will tend to that in the med-long term.

Gotta remember that unlike deposits bonds and shares property can pretty much NEVER go to zero value ... so it is very low PRICE risk and has some gold like properties as an investment.


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## pepperoni (11 September 2008)

As a separate post, the sheeple have started to assume 10%+ cg every year due to property propaganda by vested interests (including govt) and have started to value just about any property they like by reference to how much they can borrow.

This is peculiar to property and is a function of the fact banks offer 10X or more as much money on home loans as they do for investment loans . And this is very well known by the sheeple who see these borrowings as nothing more than "free money"

The simple thinking is "rates will always be less than 10% and whatever I pay will increase and 10% or more so even at max borrowings I cant lose".

Someone said to me yest if banks offered money like they did in our parents days (ie they would only lend you money if you had so much you didnt need it) property values would drop quickly to about 30% of where they are.


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## Mofra (11 September 2008)

It is an interesting concept, although the valuation calculations appear to be a broad stroke calculation that could be applied to almost any form of income-producing investment irrespective of asset class. 
Yields are traditionally lower in what are regarded as safer o) asset classes (be it bonds, equities or the different property markets) which is often cited as an explanation for commercial yields being higher then residential property yields.

The only real problem with the valuation is that more claculations are required to calculate the true costs and advantages of holding - a commercial property may appear to be yielding much closer to ASX-type PERs however the ability to access cheaper credit is sacrificed in comparison to residential property (strangely not a factor for many property investors ), however the leases on commercial property are genreally longer, have more stringent exit conditions and are often supported by ratchet clauses that guarantee year on year yield increases in excess of CPI/market rates.


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