If the rent ten years rather than the total amount invested in a house is recovered, it is expensive
Housing is the most important investment made by most people throughout their lives. Right or wrong at the right price can mean long years of hardships to pay off the floor, with a greater risk if one stays unemployed, or, on the contrary, repay earlier letters without entailing an effort stifling to the family economy. But is it possible to find out what is the right price for a house? It is possible, from the value of rents and in a very simple technique known as 'cap rate', or capitalization rate, which is used by professional investors to find out whether the price of a real estate asset is right, is is undervalued or overvalued.
The capitalization rate applied to housing, is the ratio of the annual rent, net of expenses of community, more than that paid by the floor. For example, if a house is purchased for 300,000 euros and is rented for 2,500 euros a month, the landlord gets an annual income of 30,000 euros. Its capitalization rate would then be 10% and that in ten years would recover the investment in the property. If, however, perceived the rent is 1,250 euros per month, the annual income would be 15,000 euros and a capitalization rate of 5%, which would take twenty years to recover the investment.
The homeowner could have done something else with the money, for example, to acquire public debt to ten years at an interest rate of 3%. Public debt is investment assets considered safer because it is assumed that the State always pays what he owes, at least in the advanced countries. The capitalization rate of real estate assets should obviously be higher than the interest rate on the public debt because investment in them is much more risky. The house will always be there, but while the public debt can be sold in the market instantly, if necessary, the housing can take months, or even years, to be alienated because the real estate market is much less liquid than the debt. In addition, during the time elapsed since the house is put on sale until it, the real estate market conditions may have changed substantially and obtained less money than was originally thought materializes. For this reason, housing investment is riskier than government debt.
This fact follows that if the interest rate on assets such as government bonds to ten years is between 3% and 5%, the capitalization rate of investment in real estate assets should be between 10% and 15 %. Consequently, any cost involving investment in housing, whether rented, can not be recovered within a maximum period of ten years means that housing is overvalued.
Why renting is used as a benchmark to calculate the capitalization rate and thus whether or not a home is overvalued? Because, when renting an apartment, a person or a family you consider your monthly income and you need to spend to eat, dress, go to work, pay for college kids, etc. From there, calculate how much you can pay rent, so that it adapts to real economic possibilities of the family. That rent is the rent you get the homeowner on their investment. Therefore, if you are thinking about buying a home, learn first of the rents of similar dwellings and then calculate the capitalization rate. You will know if you are overvalued or if the price is right.
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