The headlines are full of conflicting property price figures – warning they are going up, down or nowhere, so how do you know whether the price you pay for a home as a landlord is fair?
The short answer is ignore the rest and rely on your own calculation of what the property is worth to you, according to Simon Thompson, managing director of Accommodation For Students, the leading student accommodation search engine accommodationforstudents.com
Pay too much, and you risk sliding in to negative equity or failing to raise enough rental income to cover the bills.
The key calculation is residual value.
Surveyors, developers and experienced property investors base their projects on calculating the residual value and reject any homes that fail to meet this benchmark.
Residual value is a back calculation of the value after working out the yield.
Calculating residual value
For example, if a shared home generates £7,500 a year in rents as an average 6.5% yield, the value of the property is:
• Rental income divided by yield x 100
• £7,500 divided by 6.5 x 100 = £115,385 in our example
If the owner is asking for more than £115, 385, the rental yield will not support the extra value, so as an investor you will be paying over the odds for the home.
Conversely, if the residual value is less than asking price, then you have a potential bargain in your sights.
Sensible property investors will set a conservative yield – for instance 100% occupation is unlikely, so set the annual rent you are likely to receive at a more reasonable figure – say 80% – 85% of the potential maximum rent.
This way, if you have someone in arrears or voids, the property is still likely to wash its face as an investment.
Similarly, include a 10% – 15% contingency in your yield calculation for repairs as a percentage of annual rent.
Sellers overvalue homes
Several property pundits are challenging property sellers to offer more realistic prices for their homes,
“Despite tough lending restrictions and a stuttering economy, sellers want to cash in on their main financial asset – as a buy to let landlord and property investor, you must consider the long term financial prospects of an investment for you,” said Thompson.
“Interest rates have nowhere to go but up, so if you max out your residual values and buy top dollar for a property that’s not worth the money you are paying, your pocket will suffer in the long run at the expense of everyone else gaining what they want out of the deal.”
“Pay too much and the likelihood is the property will slip in to negative equity as prices drop, leaving the landlord to bail out the investment by injecting cash from elsewhere.”
The reason most property investors get in to financial trouble is gearing too highly against properties with an over-inflated price tag, he added, calculating residual value is a valuable tool to keep property costs in perspective.
Find out more at the Accommodation For Students web site