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Valuation of any house. NPV.
harbinger13
Posts: 138 Forumite
This is not my original idea - but I have had a read around. I am sure most financial experts here calculate these day in and day out - it is NPV (net present value) of your investment.
So what determines the house price - the same way you would determine the price of a stock - the cash flow; the amount of money you expect from the asset you own.
When you a buy stock - you price in the margin of safety - imagine buying a $1 at 50cents (sorry I have a US keyboard); next price in the expected dividends across the life time of ownership; third how under valued is the stock.
So lets apply to the house that you may buy.
Income earned by House rent you save (which you would have paid, if you were renting) - calculated by year
Expense - mortgage you pay, calculate by year
House expenses (bills only)- applies in both cases - renting and owning, but it is still an expense when you own the house
Expense - tax which our council will never fail to collect and which is bound to rise irrespective of any party in power
Unfortunately as in US, one does not get a tax break for the interest you pay on your mortgage - sorry UK sucks in this matter - but
Then expenses of repair or minor upgrades.
So what you get generally is Income - Expenses. This is the cash flow of the house for the year only.
But there is one more factor we long for in a house, appreciation. Generally it is accepted norm to count in 5% appreciation y-o-y. This is an average over the life time of your house - say 25 years. But it depends on your luck as well, whether you enter in a downtrend or uptrend. So a safe measure is 5% - ofcourse you can suitably amend.
So after a certain period you decide to sell - you would then repay your loan, early repayment penalty if any, and your broker fees 4%-6%.
At this point you are left with Selling Price - (Mortgage+expenses).
Now there is one initial investment which you ideally you would have done, downpayment - generally 20% is good but of course over the past years we know the trend. Lets be safe 20% downpayment.
Now you have 3 figures to remember -
- cash flow
- selling balance (profit hopefully) (SB)
- initial downpayment.
Ok at this point you require one more number, the expected rate of return (Rx). This is the rate of return what you ideally want. What is the best bank rate you can get - if you plunked your downpayment to a bank with the resolve to not withdraw the money for its term. Right now I see around 7%. Of what I know generally the mortgage rates (the interest rate you lock for your repayment) are equal long term savings rate - so if at best you get 6.5% int rate for mortgage, go conservative and assume you intend a return of investment of 7%. Varies by your choice.
Finally NPV of your house =
(- downpayment)
+ Cashflow1
(1+Rx)^1
......
......
+ CashflowN
(1+Rx)^N
+ SB
(1+Rx)^N
N is the year you sell - 5 or 7 or 10 or 15 yrs etc.
Cashflow for year 1 (CF1) = Income-yr-1 - Expenses-yr-1
Cashflow for year 2 (CF2) = (CF1) + Income-yr-2 - Expenses-yr-2
Cashflow for year 3 (CF3) = (CF1+CF2) + Income-yr-3 - Expenses-yr-3
....
....
....
Generally what is the factor which is going to get your cashflow +ve over the years. Initially - generally the cashflows are negative, but get better over time. So what is the factor which will make cashflow +ve. It is the rising rent expected over time and the constant mortgage expense you will bear over time. In US it is common for 30 yrs Fixed Rate Repayment Mortgages - not so in UK
- but if you can get one then try taking it, you can always pay some amount of penalty switch to a lower rate when things are good. Expecting this type of appreciation is investors way - but expecting appreciation via the rapid jump in the valuation of the house is the trader/gamblers way (my opinion only) - but if you gain via both of the above it is jackpot.
All in all if you can calculate this elusive NPV, which is supposed to be +ve, then you have a better sense of your investment. In one way you can assume this is equivalent to compounding of interest over the years of your initial downpayment at the specified rate Rx - though in actual calculation it does not work out exactly if you apply the numbers - because of several adjustment factors such as expenses, tax, broker fee etc.
One of the earliest estimates required on your behalf is - HOW MUCH OF RENT WOULD YOU PAY FOR THE HOUSE YOU WANT TO BUY. From there on it is just plugging in numbers. Next time you visit a home for persual, ask the broker how much would they rent it out for - if they did. Ask and look for rents of similar properties in the area or building. Remember you dont need an exact figure, a good estimate is enough - and you can then let the rent appreciate y-o-y by a conservative percentage margin, say 3% in line with the inflation.
I am trying to get an xls ready and will try to post it here via the help of the moderators.
Hopefully the finance experts lurking around will correct me if they find anything wrong.
So what determines the house price - the same way you would determine the price of a stock - the cash flow; the amount of money you expect from the asset you own.
When you a buy stock - you price in the margin of safety - imagine buying a $1 at 50cents (sorry I have a US keyboard); next price in the expected dividends across the life time of ownership; third how under valued is the stock.
So lets apply to the house that you may buy.
Income earned by House rent you save (which you would have paid, if you were renting) - calculated by year
Expense - mortgage you pay, calculate by year
House expenses (bills only)- applies in both cases - renting and owning, but it is still an expense when you own the house
Expense - tax which our council will never fail to collect and which is bound to rise irrespective of any party in power
Unfortunately as in US, one does not get a tax break for the interest you pay on your mortgage - sorry UK sucks in this matter - but
Then expenses of repair or minor upgrades.
So what you get generally is Income - Expenses. This is the cash flow of the house for the year only.
But there is one more factor we long for in a house, appreciation. Generally it is accepted norm to count in 5% appreciation y-o-y. This is an average over the life time of your house - say 25 years. But it depends on your luck as well, whether you enter in a downtrend or uptrend. So a safe measure is 5% - ofcourse you can suitably amend.
So after a certain period you decide to sell - you would then repay your loan, early repayment penalty if any, and your broker fees 4%-6%.
At this point you are left with Selling Price - (Mortgage+expenses).
Now there is one initial investment which you ideally you would have done, downpayment - generally 20% is good but of course over the past years we know the trend. Lets be safe 20% downpayment.
Now you have 3 figures to remember -
- cash flow
- selling balance (profit hopefully) (SB)
- initial downpayment.
Ok at this point you require one more number, the expected rate of return (Rx). This is the rate of return what you ideally want. What is the best bank rate you can get - if you plunked your downpayment to a bank with the resolve to not withdraw the money for its term. Right now I see around 7%. Of what I know generally the mortgage rates (the interest rate you lock for your repayment) are equal long term savings rate - so if at best you get 6.5% int rate for mortgage, go conservative and assume you intend a return of investment of 7%. Varies by your choice.
Finally NPV of your house =
(- downpayment)
+ Cashflow1
(1+Rx)^1
......
......
+ CashflowN
(1+Rx)^N
+ SB
(1+Rx)^N
N is the year you sell - 5 or 7 or 10 or 15 yrs etc.
Cashflow for year 1 (CF1) = Income-yr-1 - Expenses-yr-1
Cashflow for year 2 (CF2) = (CF1) + Income-yr-2 - Expenses-yr-2
Cashflow for year 3 (CF3) = (CF1+CF2) + Income-yr-3 - Expenses-yr-3
....
....
....
Generally what is the factor which is going to get your cashflow +ve over the years. Initially - generally the cashflows are negative, but get better over time. So what is the factor which will make cashflow +ve. It is the rising rent expected over time and the constant mortgage expense you will bear over time. In US it is common for 30 yrs Fixed Rate Repayment Mortgages - not so in UK
- but if you can get one then try taking it, you can always pay some amount of penalty switch to a lower rate when things are good. Expecting this type of appreciation is investors way - but expecting appreciation via the rapid jump in the valuation of the house is the trader/gamblers way (my opinion only) - but if you gain via both of the above it is jackpot.All in all if you can calculate this elusive NPV, which is supposed to be +ve, then you have a better sense of your investment. In one way you can assume this is equivalent to compounding of interest over the years of your initial downpayment at the specified rate Rx - though in actual calculation it does not work out exactly if you apply the numbers - because of several adjustment factors such as expenses, tax, broker fee etc.
One of the earliest estimates required on your behalf is - HOW MUCH OF RENT WOULD YOU PAY FOR THE HOUSE YOU WANT TO BUY. From there on it is just plugging in numbers. Next time you visit a home for persual, ask the broker how much would they rent it out for - if they did. Ask and look for rents of similar properties in the area or building. Remember you dont need an exact figure, a good estimate is enough - and you can then let the rent appreciate y-o-y by a conservative percentage margin, say 3% in line with the inflation.
I am trying to get an xls ready and will try to post it here via the help of the moderators.
Hopefully the finance experts lurking around will correct me if they find anything wrong.
Recession - if you are forced to drink beer at your home.
Depression - if you have no beer to drink at all!
I don't see any of the above - so where is it (recession)?
Depression - if you have no beer to drink at all!
I don't see any of the above - so where is it (recession)?
0
Comments
-
harbinger13 wrote: »
.... ..... .....
(1+Rx)^1 (1+Rx)^N (1+Rx)^N
....
= 70% overvalued.0
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