Hat tip to stephen for sending this over, from zero hedge – check the comments at this link too:
http://www.zerohedge.com/article/what%E2%80%99s-your-home-worth
This is a vexing question for millions of Americans. There was a time when most people had a reasonably good idea of what they could sell a property for. There were enough purchases and sales to create comps. Not any longer. Homes that have been foreclosed on come to the market at distressed prices. This is happening in every neighborhood across the country. When one property sells at a distressed price it influences all the properties around it.
So what is residential real estate worth today? The answer to that question is, “About 15 times the annual rent”.
RE professionals are going to write me and say that this simple calculation is wrong. They will say that the number is lower. Possibly as low as 12 times rent. They might be right. However in areas of the country that I watch the 15 times rent number is a pretty good indication of value.
Based on this calculation the following rent/price guidelines can be determined:
|
HOME PRICE |
MONTHLY RENTAL |
|
$200,000 |
$1,100 |
|
$350,000 |
$1,950 |
|
$500,000 |
$2,800 |
|
$750,000 |
$4,200 |
|
$1,000,000 |
$5,600 |
|
$2,000,000 |
$11,000 |
It is still difficult for a homeowner to make a reasonable estimate on what the rental value of a property will be. But I have found that most people have a better handle on this number than they do on what their home can be successfully marketed for. There are regional considerations for rental values, by and large this formula works well for metro versus rural properties as a valuation tool.
This analysis creates a tremendous problem. There are very few homes for sale at 15 times rent. The only ones that come up for sale in that price range are those that are in foreclosure and are being sold by bank lenders. We know that there is demand for properties when those conditions are met. That has been proven in just about every area of the country.
Again, they are calling a bottom in SD???
http://realestate.yahoo.com/promo/where-home-prices-are-hitting-bottom.html
Moody’s Economy.com forecasts that five years from now, home prices in San Diego will have risen by 25.41%
No supporting evidence provided, just a wild guess?
Mellor Roos and HOA deduct from rental amount?
Again, they are calling a bottom in SD???
Local Boy, you don’t understand. That’s this months bottom. Next month there will be a new bottom, and the month after that, and the month after that…..
I get 1100.00 times 15 equals 165,000!
So that means that the house I rent here in Solana Beach, which Zillow values at just under $1M, is actually worth just over $550,000.
I’ll wait, but it may be a while! (By the way, I do think home values have that far to fall…or inflation has that far to rise to catch up with it.)
-Erica
What you mean a 300k house doesn’t rent for $2700 a month? That’s not what the television told me. I’d better better get an estimater in to tell me my house is worth more to justify a higher rental price. Im a homeowner I deserve it.
Erica, I’m in a similar situation. But I’m kinda tempted to take the FHA zero-down option and buy a place so I can lock in 5% forever as inflation goes nuts. And then if inflation doesn’t materialize, you can walk away happy as you never put anything down.
If all these sellers at $800k – $1m would just cut to $700k, they would all be snapped up right away by FHA put-option players like me. I’m waiting for the first really nice house inside FHA limits.
OK based on this formula, here’s a real world exercise: currently renting a single level 3,100 sf. in CV, gated, high elevation with good view, small lot with pool. Current owner,(now mid 70s) purchased in 3/94 for bit over 600k and everything original except a couple of appliances.Before renting was on market at $1,395ml. DOM over 450 days. Based on 15 times rent valuation method, stands at 657k. Was approached by owner if interested in private sale…assuming there’s a interest on my part of 6, on a scale of 1 to 10, any thoughts of an opening offer?
(most attractive feature of the property is location… very quiet, great view,no power lines,etc… downside is quirky floor plan, small lot, and all original condition circa 80s).
–“So that means that the house I rent here in Solana Beach, which Zillow values at just under $1M, is actually worth just over $550,000.”
Yes, that’s the idea. You’re better off renting at $3k a month than tying $1M of capital on a house.
–“I do think home values have that far to fall…or inflation has that far to rise to catch up with it”
Everyone thinks we are going to get huge inflation, but it’s the opposite. We are in for very little inflation or deflation. Everyone is leveraged and has no money to spend to create inflation. Even if the government throws money from helicopters, people are just going to use it to pay off debt.
That would put the house I rent here in Del Mar (we’re almost neighbors Erica) at $396k, or $264/sqft. Sounds about right, assuming a rational market. If my landlord would hand it over for $450k I would buy it this very second.
The house 2 doors down is for sale at $1.45M. 3000 sqft, ocean view, built in 2004 but fairly plain. Then a block away a brand new house is on the market, also with an ocean view, but this one is 5500 sqft and on twice the lot… listed at $1.75M and not selling.
OK,
ZeroHedge is WAAAAAAAY overvaluing real estate.
When I bought my house in 2000, I paid 10.5 rental equivalent. That was in Southern California, in a fairly hot area. And, that was 4 years after the “last bottom”.
Either rents have a long way to go up (which means significant inflation, and we need serious job growth to drive that) or we are historically somewhere off the charts right now. I just checked my old neighborhood last sold same model and it is going for 16.5X annual rent.
I can think of a lot of better ways to spend money right now.
Chuck
Who wants to be a renter?Dont tell you guys are going to start glorifying renting.When everyone hates real estate that is the time to buy.
Boy, would it be great for my house to be worth 15x annual rent (interestingly that’s what the Zestimate is). I paid about 4.5x rent for it.
As a homeowner and landlord I find the rent to value factor to be at least 16.5X in good areas. And, lower in bad areas. Obviously it’s much, much easier to rent than own in a really nice area like Del Mar or Solana Beach. I wouldn’t count on your landlord selling at anything near even a factor of 16X in those areas.
Don’t believe me? Do the math.
Cap rates express the same thing when determining values and vary by location.
hug a realtor. Who wants to rent? I do!
I sold at the peak in 2005, just so I could rent. It’s the best value for your money.
I don’t see a lot of realtors out there right now buying? If property is such a steal, why not leverage yourself to the hilt to get one of these great deals.
Bottom line – when interest rates are low, values will soar. Bubblenerd is exactly right – in San Diego, we have deflation, lack of job growth, and over valued prices; and there are more defaults coming.
This metric, while useful, and perhaps accurate, is of less use in the higher end. There really isn’t a vibrant market for 2M dollar houses on a rental basis, and to the extent there is, its easily skewed.
This basic rule (15* annual rent) gets you in the right ballpark, but there are many local variation. One of the most obvious one is condition of the property: a property in great location but in bad shape can command a good price (good teardown or remodel value), but not much rent. A lot of the old rental properties in La Jolla/Del Mar/etc fall into this category. Speaking for myself, I would buy a fixer-upper in a nice area, but I would never rent one.
As a general rule of thumb I think the 15*annual rent number would be a good estimate of the bottom if the government intervention stopped and the market was allowed to sort itself out. For the 92024 zip I saw house prices climb to about 25*annual rent at the peak and now hovering around 18*annual rent. Hard to say what will happen now with all the intervention FHA expanded role.
Location, Location, Location
You CANNOT compare areas like the midwest to Southern CA on such a simple valuation calculation. The 2 areas are simply on different scales and it has ALWAYS been that way. If you believe 15x is accurate then you are either a simpleton or still renting.
I’m renting a 2 level 4br 3bth for $24k per year. At the 15x rule that puts the price at $360k. The foreclosures of the same model are selling in the high 400’s stop. So this means it’s got about another $100k to fall? Sounds plausible especially since we’re not done with the recession yet.
Mike,
As a native Californian whose parents were RE investors and brokers, I can assure you that these numbers are right on target.
Prices here will always be higher than equivalent places in Ohio or Kentucky, but there is a limit here, too. Historically, California prices have been ~2-3X the price of an equivalent home in “flyover country,” and we will see those same ratios again. The 12-15X rent target is exactly what I’m looking for when looking to buy.
BTW, prices are still artificially inflated almost everywhere. What do you think would happen to housing prices if the govt stopped backstopping housing via taxpayer give-aways and buying mortgage debt and related securities? What happens if the Fed lets interest rates float?
We are nowhere near a “normal” market. The housing market is being supported almost entirely by govt interference.
I cant take anymore, I might comsider making an offer on a house in compton.
Paid Off @ #5- Check your math, annualize the rent= (1100×12)= 13,200×15=$198K
Bahooey all this none sense. I’ve moved on with my life – because it is short. Aspen, CO is really nice this time of year. The trees leaves are turning yellow, orange and gold and the weather is great. Back to reality in another week however.
Aspen is beautiful any time of the year, as is Vail and pretty much anything from the front range to Utah. The only things I really miss about Colorado are the mountains and the skiing. The only thing as pretty as Vail with a 100″ base is Del Mar (or any local beach for that matter) at 6′ and hollow.
I see prices falling all around me. God help this city once I’m a permanent resident.
Since the govt cant seem to create any jobs here all we can do is artificially increase asset prices.Houses for all so people can get free money to buy new cars and flat screens.
Sold my last April 2006 for 23x. Currently good for probably 16x for whatever sucker bought it the second time since then. No thanks. It isn’t good areas, it is the Cold Equations and while gross multiples are simplifications I still know I’m not interested in this market until they get under 12x before i even bring out my pencil. California used to command a premium because of a relative certainty in future expenses in comparison to other places. you knew what the taxes were going to be, utility and maintenance costs were small compared to other areas, demand (vacancy factors) were favorable, etc. Sorry to say those are more questionable for California not less due to the now permanent state of fiscal crisis at all levels of misgovernance.
I’m an OD (Original Doomer), and still renting even though I’m older than time itself.
But I think we really need to consider the possibility that we’re wrong, and we could go the way of Zimbabwe rather than Japan. Zimbabwe Ben is printing like a mofo, and it’s at least possible that he prints enough to create inflation even in a Depression.
If Zimbabwe Ben gets his way, 30-year fixed at 5% is going to be the best bet ever at any price.
Surprisingly, that 15x formula works for my current rental in Montreal. I’ll have to remember that when I go shopping for a new place next year.
To buy or not to buy? That is the question. 🙂
I lease some houses in Portland, OR and I keep a close eye on houses for sale as well. The formula is off here by a considerable amount. I reckon 20x would be a better estimate in the neighborhood I work in. Of course, Portland didn’t have the bubble San Diego had (about half the increase, I think), and the upscale neighborhoods didn’t drop more than 10% or so, so that makes a difference.
Another huge factor: RENTS. Areas with mostly single family homes, and not much multifamily tend to get much higher rents. It’s supply and demand. There’s an apartment glut in my city.
SO… once again, Real Estate is local. Generalizations with ratios rarely mean much.
One house I have rented is probably close to a 23x annual rent ratio.
Go to Craigslist and compare house rents to the price of the same house on Zillow (just for a very crude measure), and you’ll see 15x isn’t close in many many cities.
15x net cash flow is a number that I would accept as reasonable on a financial basis in a stable market and economy. Anything higher is driven by the assumption that there will be growth in the net cash flow, or possibly by non-economic factors. The same reasoning applies as to dividend paying stocks, or bonds. As in investment, rental properties need to produce a return competitive to other investments with similar risk.
The buildings that I have an interest in were all purchased before (some long before) the last boom for 8x to 11x scheduled rent and rehabed. Rents and valuations are higher now, but not by much after adjusting for inflation. Of course, none of my stuff is on the high end of the market where prices are high and returns are low.
If buying a house to live in, the price is whatever it takes. I believe that ‘what it takes’ is too high and falling, so I’m a renter.
15x rent seems to be an oversimplification. It completely ignores interest rates. Did the 15x rules still hold 18 months ago when 30-year fixed rates were 125bps higher (even more on jumbos)? Will it still hold if and when interest go up to 7%, 8%?
It seems like a better metric would be PITI/rent. Using this method, I would guess fair value would be at around 1.2, maybe 1.3 (always greater than 1.0 so long as the mortgage interest tax deduction is with us).
I realize PITI doesn’t take into account maintenance costs… But I figure this is offset by the value placed on home ownership in our society (which is still VERY high, even post-crash).
What do you all feel is good target for PITI/rent?
I’ll add my real world example… I recently refi’d so I have that appraisal. I also know what comparable rents are because houses in my ‘hood are for rent. It’s a bit of an unusal property because we have a very nice granny flat – but I’ have a good idea of what that would rent for also…
The formula comes in about $10k higher than the appraisal we got a few months ago. (The appraisal seemed low… but not unreasonable. It was very hard to value the companion unit because there is nothing similar in our area.)
FWIW – since I live in an older hood – University City – no mello roos, no HOAs.
The math works if you’re not dreaming an asking price.
That said – high end homes tend to rent for less than the sale price would warrant… A friend has an ocean view house in Del Mar that he rents for 3k/month… It’s definitely worth more than a million – so that case the rent/own math works in favor of the renter.
I just bought a house for $190,000 in Fallbrook and am renting it out for $1175 a month. So the 15X is pretty much right on.
Hmmm. My house in Riverside cost $150,000. I believe I could rent it out for $1,500 a month, so the purchase price was only 8 1/3 times annual rent.
But then go to a place like Irvine, and the math is reversed-a house that costs a million bucks might rent for $2,750 a month, for a purchase price of 30 times annual rent.
That is, this is way too simplistic.