It pains me to see so many people over-paying for property.
The problem lies in over-zealous calculation/valuation of property, or simply the lack of such valuation.
Instead of relying on past transactions, which tends to feed on itself, one should value the property based on cashflow - cashflow from rental, even if it is for your own stay. Because, you never know when you might choose to rent it out and stay in another place. So, don't cut off your options.
Valuation
So, how to value the property? A simply formulae is:
(Rental Income - Expenses) / Required Returns
Eg. Suppose a property is able to fetch $2,500 rental per month (thus $30,000 p.a), and expenses is $500 per month (thus $6,000 p.a), and you desire a return of 5% p.a, then the value of the property would be:
(30,000 - 6,000) / 0.05 = $480,000
Expenses
These are some expenses that one should factor in:
- Property Tax
- Insurance
- Repairs and Maintenance
What about Capital Appreciation?
Yes, there might be capital appreciation. However, it is not easy to determine the upside. You can project growth in the rental income, but you will be taking on this upside risk.
Also, our calculation did not factor in months where there are no rental (vacancy rate), as well as we are projecting the rental income as perpectual (and not 20 years or some other fix time duration).
As such, the calculations offered would be a good trade-off for potential capital appreciation.
Of course, if you are a speculator (or a fanciful so-called invesculator), then you probably won't be interested in all these calculations, as you are feeding off sentiments.
.JPG)
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