The investment method of property valuations.

I recently enjoyed the company of IPAV lecturer Frank Quinn and during our time together we discussed the Irish property market and more importantly that of valuations, he explained that while the investment method of valuations is virtually unused in Irish property that it is relevant, not only for investment properties but also for residential housing.

First it is important to realise that there are two broad ways of valuing a property, the first is where you value at the ‘market’ price, in an upward market this can have the issue of pushing values higher as bidders vie to outdo each other on comparable properties, in a downward market it can be equally distorting, but in a fairly stagnant market the absence of transactions is, of itself a distortion, estate agents can’t look at their own back book of sales for information if that back book is empty.

It is therefore desirable at times, to use the valuation method, it is a simple way of viewing property valuations,  it does tend to strip some of the natural premium you might see existing in certain geographic areas, however, the basics of it are as follows:-

value of property = annual income x multiplier. you arrive at your multiplier by dividing 100 by your desired rate of return (so if you said 6.5% is what you need as a risk premium – which isn’t too far over the highest deposit rates which are virtually risk free) then M=100/6.5 = 15.38

Thus, if a property was renting at €1,300 per month then the value of it should be (according to this method)

1,300 x 12 (to get your annual rent) = €15,600 and then using the same ‘M’ as above, the valuation would be

15,600 x 15.38 = €239,928

Many estate agents feel that this doesn’t hold true for primary homes because they are not bought for the same reasons as investment property, but substitutions would naturally be part of any decision making process. If you could buy a house in neighbourhood X for €600,000 or rent it for €1,200 (and this kind of disconnect in prices versus yields is really common in the Irish market – South Dublin, D2, D4, D6 specifically) then you have to ask yourself, what is the ownership premium worth? By using the valuation method a property that is getting €1,200 a month is worth (using the same M as above) about €220,000 so it would make sense not to buy.

In the example above funding a mortgage would (at an LTV of 80%) cost [600k x 80% = 480k, over 25yrs @ 5%]  €2,700 p.m. If you could rent a comparable property for €1,200 then it makes absolute sense to do do, substitution based on prices would apply. If you really really really loved the place you could likely ask your landlord for a multi-year lease, so security of tenure would be in place and you save a lot of money.

The issue with the Irish market is that everybody ignores the idea that you you ‘don’t have to buy’, treating the two markets as totally separate entities and this is a mistake, it would be akin to  saying ‘you would always eat at home even if it was more expensive to do so than eating out’, home might be where the heart is, but the cheque book generally lies firmly in the head.

However, prices are only one element of the property market and that is why waiting to find an absolute bottom is task that will likely end in frustration. The other factors that affect cost are that of funding (we tend to assume that at least in the first time buyer market the majority of buyers are not cash buyer), stamp duty, legal fees, mortgage interest relief and taxation laws/changes.

When you talk to estate agents about the investment method in property valuations most of them tend to disagree with using it, even though in the current market, with its absence of hard data, marginal transaction data and unclear outlook it would be the most appropriate. Actual selling prices are unknown, and it is impossible to know (across the market) what is really happening, thus you have people discounting the PTsb/ESRI figures, and others saying that despite anecdotal evidence that it’s the only actual true dataset.

So, if you are considering a property, be it for investment or for personal use, the investment method of valuations is perfectly acceptable (unfortunately it won’t be to the majority of vendors), but it won’t be embraced because of its current implications, falling rents actually impact heavily on asking prices using this method whereas interest rates don’t and that is why there is a heavy focus on ‘affordability’ instead.

Comments

  1. It won’t be embraced because, in Ireland, property valuations are, by cultural “law”, to be kept permanently divorced from reality.

  2. To make your calculation more accurate, you should factor in the tax incentives inherent in ownership in Ireland. It won’t change the overall message you are trying to convey but the comparison would be a lot more meaningful and I think you’d find that the gap in valuation methods is less than you originally thought.

  3. @Fergus: great to see ya dropped by! I always know I did a decent job when it warrants a comment from you! Having said that, I’m sure you have a few ideas on how we could get 1. selling prices into the public domain and 2. ensure that prices are reflective of asset values closer to actual rather than inferred values?

    @John: do you mean like S23 allowances or the ability to write off partial amounts of mortgage interest? I can see where this might work out (partly) on homeownership but what about investments?

Leave a Comment

Awesome! You've decided to leave a comment. Please keep in mind that comments are moderated.