I have heard that a formula of 100 times one month rent is a reasonable way to determine value of a residential property for rental purposes. Does anyone know if that is correct? I spoke with a banker and he said that lenders today will use a number as high as 120 times one month rent. But then I talked with an older investor who said he never purchases above 70 times one month rent. I assume that each formula generates a ROI. What multiple are other investors of rental property using and why?
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It's a good question, but the answer will depend entirely on where in the world you are, and on the area the property is in.
To give you an idea, I'm in the southeast of the UK, where property is expensive. A one-bedroom flat in this area (ignoring retirement flats, which are cheap but have all kinds of restrictions and strings attached) will bring in a rental income of around £900, but you'll be lucky to find one selling for under £150,000 unless it's in need of full refurbishment and in a grotty part of town.
So the answer is to look locally to see what property sells for, and what kind of rental income it will deliver. Talk to your bank or mortgage broker to see how much of a deposit they need, and whether it's needed in cash or secured on other assets (risky !), as well as the interest rate (often much higher for buy-to-let mortgages, at least here in the UK).
Then do some serious maths.
It's the rental income minus everything else; mortgage payments, insurance, tax, maintenance, cost of meeting safety regulations, cost of redecoration every time a tenant leaves, etc. Also, what happens if a tenant stops paying rent - do you have the reserves to cover that plus legal costs of eviction ?
For many smaller landlords here in the UK, things are getting tougher due to increased regulation. But they buy investment properties not to make a profit, but because the rental income covers the cost of holding an expensive asset, which they hope will increase in value to sell when they retire to provide a pension.
Thanks! I guess the two factors that are hard for me to determine are the return on investment and the appreciation of the asset. ROI is something I can determine by figuring the costs of operating and owning the rental minus the rent, then dividing that into the purchase price. But the appreciation of the asset is really hard for me to determine. Since I can take depreciation on the rental, that should help me with income taxes, but when I go to sell the property, then I will need to worry about the taxes on the gain after the depreciation. I really enjoy seeing the UK perspective on rentals. I am US based but I think a lot of what you say fits into my situation.
From what I've heard, I think there are differences between the US and UK property markets. The impression I get is that in the UK, houses are built to last for many decades or even a century+, so the house is where the value is. In the US, I get the feeling that unless you're in a city centre, the value is in the land with houses being of much lighter construction and expected to last a few decades.
The reality is that none of us can see into the future to know how much appreciation you'll get, and some of it will depend on when in the market cycle you sell, but generally real estate tends to be one of the best performing asset classes in the long term. As long as you can afford to keep up with the running costs and regulatory changes, it's probably a safer bet than most other assets !
I want to visit UK sometime because I think it's very cool that many of the houses that people live in daily are older than the existence of the US. The way we treat everything as a throw-away is pretty depressing in this country. I drive a 25 year old car because it works fine, but most folks would never consider driving something that old in the US. Real estate does seem like a good long-term solution. The entry point might be wrong at this time due to the run-up in prices in the US.
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