calculating how much a house should be worth…

[enriquecoronado]

OK …. So I am avid reader of this wonderful blog, but as of tonight I have never been a participator. My question should be simple, especially for all the incredibly knowledgeable housing economics experts who contribute to this board.

Lets say I have a couple parameters- one, how much a house rents for, and two, previous sale(s) of the house during the last 10 years or so. Using these parameters I would like to calculate what this house should sell for, assuming a normal rate of appreciation over the last few housing cycles (lets say 30 years)

I know that in commercial real estate I’ve read about cap rates, which as I understand, will basically allow you to estimate a sales value, by dividing the yearly lease income by the cap rate. What is the Cap Rate for San Diego residential real estate? As to previous sales prices, is there a way to use methodology used in the Case-Shiller index to estimate a value based on previous sales of the same home?

Heres a specific example: I currently rent a house in North Park for $2150… It last sold in 2000 for about 325K… How much should it sell for today based on these parameters and based on normal appreciation/inflation over the last few housing cycles?

[temeculaguy]

The flaw in this question is that you are trying to apply logic and history to develop a real estate valuation method based on rental price. This can be done but you’ve chosen a house in San Diego to apply it to, this cannot be done.

Here’s my best guess, take your 2150 rent. I don’t know what it includes besides rent (gardner, trash, hoa, pest control service, etc.) add those things up and subtract from your rent. My guess is affordable for most would be 15-20% more than rent for principle and interest. The tax and insurance will be offset by the new deduction plus a little more and that will cover repairs and maint.

If you can afford to rent for 2150 you would buy for 2500 to 2800 (principal and interest). The extra 350 to 650 a month would hurt for a few years but would be offset over time because your payment would be protected. Your actual payment will be higher but the tax break will bring you back around your P&I as your true outlay. You don’t need a downpayment to rent so you can’t compare it to a loan with a downpayment in this scenario, but you should have one in reality. You also need to use 30 yr fixed to get your numbers. 400k at 6% 30 yr, $2400 P&I

my guess is 425 to 450 and it’s inline with fundamentals for for a 2150 renter, 400k it’s a no brainer, more than 475, keep renting. Now’s the part where you tell me the owner wants to sell it for 850K because he forgot to take his crazy pills.

[4plexowner]

As an investor, the property is worth its rental value – period

IMO the San Diego RE market will bottom when rental houses in rental neighborhoods reach their rental value (what a sentence!)

That means rental-quality SFRs in Clairemont and North Park for $275K

Because 40% of the RE market activity in San Diego during 2004/2005 was pure speculation, I believe there is a glut of housing available in San Diego given the current demand – IMO, without the speculative buyers, basic houses are worth their rental value

[Bugs]

I believe the tool that would work best for you is a gross rent multiplier (GRM). The reason I say that is because working with a GRM is a lot easier to do than trying to work with an overall rate – aka “cap rate”. In order to even use an overall rate, you have to analyze the income stream down to its net income level, which means coming up with fixed and variable expense ratios.

A GRM only requires you to figure out the market rents for a property, which for a single family residence is hard enough.

At the bottom of the last cycle, GRMs were running as low as 120, meaning the properties were selling for 120 times their monthly rent; or 10x their annual gross. The typical range was about 140-150 or so, depending on the area. Now the bottom of the last cycle represented an extreme low point at which the pricing trends were undervalued relative to the long term trendlines for population, wages and pricing.

At peak, pricing resulted in GRMs topping out in the 350 -370 (!!) ranges for those residential properties that would typically be rented. That’s obviously more than double the low point, and is yet another indication why the relationship between rents/prices will eventually correct.

I think that if you can wait until prices drop to result in a GRM of 175 or below you’ll be a lot closer to what a property will be worth relative to the long term trend that will extend beyond any individual cycle. BTW, the difference between 150 and 175 is substantial: $2,000/month x 150 = $300,000; $2,000/month x 175 = $350,000.

It’ll be interesting to see if rents contract at the same time prices are correcting. So far they haven’t.

[an]

Bugs, do you have the GRM data on the last 2 cycles (peak and valley)? I just want to know if the GRM is consistent at the bottom. With a 120 GRM, a $3500 rent = $420k. That’s a pretty typical rent price for a million dollar house these days. Even at 150 GRM, it’s equate to $525k and 175 GRM, it’s $612k. So, even with a 175 GRM, we still have a long way to fall.

[gn]

“It’ll be interesting to see if rents contract at the same time prices are correcting. So far they haven’t.”

Are you suggesting that there’s a decent chance that rent will contract b/c there is a surplus of SFH & condos ?

[Reality]

“The flaw in this question is that you are trying to apply logic and history to develop a real estate valuation method based on rental price. This can be done but you’ve chosen a house in San Diego to apply it to, this cannot be done.”

Why not exactly?

[blahblahblah]

Also, do not forget the opportunity cost of the lost down payment. For example, 20% of 400K is 80K which will return $4K in interest when invested in no-risk 6-month CDs in the first year alone; that number grows of course as the interest compounds. This can offset some of the tax break (the interest is taxable) and effectively lowers the current rent. Shares or bonds could return even more of course. My guess is that the true cost of the property assuming a normal lending environment (20% down, 6.5% interest) is more like $330K and maybe less.

[Ash Housewares]

I wouldn’t hesitate to purchase with a GRM of even 200. This number is the “rule of thumb” for fairly valued homes. It comes from the 6% return you can get with relatively little risk in bonds. 1/.06=16.67, 16.67*12months = 200.

Using this rule, $430,000 is the upper limit of “fair value” based on $2150 monthly rent.

[23109VC]

rents seem to be going up here in temecula.

when i was looking for a hoseu to rent about one year ago, a nice 3 BD or 4 BD home was in the 1600-1800 range. now the same house is 1800-2100.

the house i currently rent is on the “small” side for temecual,, it’s “only” 1900 sq ft.. and it was listed at 1400… now for $1400 you might get a 2 bedroom aprt. to rent an equivalent house now, i’d expect to pay 1800 minimum.

i’ve looked hard lately in this area and most houses athat re unde 1800/month are what i would consider “stripped” homes…lineleum, no appliances, crummier areas. if you find a well optioned home, loaded wtih upgrades… tile, granite, appliances, nice location, landscaping – you’re looking at 1800-2000/month minimum.

using a 200x rent at 1800/month you wind up with many of these SFR houses in temecula area selling at 360000.

right now, many of these hoems ar elisting at 450-500.

on a side – there are two houses for sale near me – they are on the same street – exact same house – almost identical in terms of upgrades….you would take one or the other – neither is any better than the other.

one listing for $475k.
the other is a short sale advertised on MLS at $399. bet the guy selling at 475k is PISSED….

i think pricing in temecula for thse homes will bottom out near 300-350k….

i don’t see these ultra fixed up himes in nice parts of temecula selling for 200-250 or even 275k…

to be that cheap they would need to rent out at 1300/month or something…and apartmetns are more than that right now.

[blahblahblah]

Those are asking rents. Temecula is FB central. Actual rents may vary.

[Bugs]

My personal experience only dates back one complete cycle prior to this one, so I have no information regarding the GRMs back in the early 1980s. Sorry.

Applying GRMs to single family residences is not normally considered a reliable or accurate method of valuation. Part of this is due to the variations of rationality involved at different times, and part is due to the difficulty in really pinning down the rental rates. The only reason I brought it up is because our original question involved trying to figure out how to establish a reasonable baseline.

Exploiting the relationships between income and sales price works quite well when the property types are typically rental-driven. Inasmuch as the commercial property types have generally followed the same trends as the residential, albeit at somewhat of a lag, the trends that are showing in the commercial markets can be compared to the residential trends as a secondary indicator. Commercial income multipliers have increased in the same way, and those increases are attributed to investor agressiveness and the expectations for continued price appreciation. Why else would an investor buy a property that doesn’t currently cash flow, if not for the expectation of making those losses up at the time of sale as a result of price increases?

[temeculaguy]

23109, I disagree with the rent trend here in Temecula. I’ve been following pretty closely and it has come down since August 2006 when I started watching. Here’s a harveston for you I found on craigs

http://inlandempire.craigslist.org/apa/322993663.html

One of the things is that most rentals aren’t dialed in with granite and top end applinaces and expensive flooring, so your selection is limited for now but it’s growing every day. Some of the landlords are having cash flow issues, many are for sale and rent and a lot of the brown lawners aren’t for rent during foreclosure. By late summer when the listings that are growing every day fail to sell, many will choose to rent them out.

Another thing is the shortage of rentals, in 92592 (so. temecula) pop. 56,000 there aren’t any apartment buildings and as of a year ago only one small townhome complex. Now, 92592 has four major projects under construction with more than a thousand units of condos most will be completed by years end, none are rented as apartments (even though half look like them) but many will end up as rentals or first time purchases for current renters. You can’t increase a product a few thousand percent without putting downward pressure on pricing.

To the poster that asked why you can’t apply a rent multiplier in San Diego, I should have qualified it by saying “you can’t apply it now” since it has never been this silly.

I used Bugs’ formula and it was spot on for the last down cycle. In 1996 I was faced with renting out or selling a property. It sold for about 140x rent. I chose to sell because investors were buying the massive forclosures and renting them out, finding a renter was difficult at the time and price wars and incentives for renters were commonplace. But, history never repeats itself, right?

[23109VC]

temecula guy-

are you familiar with harveston? these homes in harveston, that now list for $400-500k..

where do you see them selling at the “bottom” of this decline?

do you see rents going down or staying flat?

i’ve still got the chance to buy that 1900 sq ft one story home, totally loaded with upgrades, sweet location – for $350k. i have yet to see anything – anything – in harveston for that price except attached condos. this is a free standing house – loaded with granite, flooring, high end shutters, ceiling fans, landscaping, stamped concrete…appliances… it’s only a 3BD/2BA…but it’s a one story…which i like…

maybe in 3 years these homes will be selling for $200??

the house is in the sausalito tract. streets are edenton, oak park, sarasota… in 92591.

[PerryChase]

23109VC for a lawyer working fro Homeland Security (if i remember well) you’re very indecisive.

Market psychology and Real Estate bubble history should tell you that we’re only at the beginning of the down cycle. There’ll be plenty of opportunities to buy later. It’s not going to be “different” this time. The only thing we don’t know is how low it’ll go.

When people say it’s different, it never is.

[Author]

Posts