Real Estate Value

[rwesty]

How much is a condo worth that would rent for $1000/mth ($125/mth in association dues and taxes of $800/yr)? At what price would this property be worth it as an investment? At what price would this property be worth it as a primary residence? What other factors besides what a place can rent for can change the value of a property?

If my plan is to keep the property for 20 years, initially to live in and then rent when I move, is the worry of a nationwide real estate crash reason enough to hold off on buying if the price is right? I plan on doing 10% down, 10% home equity loan and a 15-year fixed mortgage. This is in Minneapolis/St. Paul.

[shark6]

As I understand it, rental property is traditionally valued based on the cash flow it generates.

You need to write down all of your income and all of your expenses for the year, including maintenance, mortgage payments, taxes and association dues.

Then, figure out what return on investment you would want on this type of investment. Divide the cash flow by the ROI and you'll have the worth as an investment.

[yellowbastard]

The condo would be worth the expected future cash flows divided by the required rate of return you would expect to receive from investments of a similar risk profile.

In your case it looks like annual cash flows of $9700 for 20 years. If your required rate of return was 8% for instance the price of the property would be.

($9700/1.08)+($9700/1.08^2)+($9700/1.08^4)...+...($9700/1.08^20) ~ $95,236

You can read about the discounted cash flow model here.

[Scorpion Man]

[ QUOTE ]
The condo would be worth the expected future cash flows divided by the required rate of return you would expect to receive from investments of a similar risk profile.

In your case it looks like annual cash flows of $9700 for 20 years. If your required rate of return was 8% for instance the price of the property would be.

($9700/1.08)+($9700/1.08^2)+($9700/1.08^4)...+...($9700/1.08^20) ~ $95,236

You can read about the discounted cash flow model here.

[/ QUOTE ]


There are elements of truth here, but it is not correct. Poster is basically describing the value of a $9700 perpetuity (almost...) and assuming the condo is blown up by terrorists in year 20 and is worthless. The post also assumes you pay 100% cash for the property.

The post ignores the impact of 2 major factors: leverage and price appreciation.

You have to make assumptions for what you sell the property for (and use those proceeds as a flow in the final period).

You also have to adjust free cash flow for interest payments. In terms of what you can pay for this, the relevant return numbers are related to your equity given your specific cost of leverage, not the overall unlevered asset cost (although there are ways to start with the unlevered asset and adjust for leverage, it is simpler to use the actual cash flows and your equity down).

That said, when you are only putting 10% down, you will be able to justify very high prices if you assume price appreciation to the unit and you have low cost of borrow.

If you don't understand finance, though, the easiest thing to do is to ask around about "cap rates" for condos in your area and simply take the unleveraged $9700/cap rate. I.e. 10% cap rate = $97,000. This rate implicitly adjusts for future expected appreciation and the interest rate environment and is a shorthand for what the market is currently bearing for rental property.

Whether you live in the property or not does not change its value. When you go to sell it the buyers will not say "oh, you lived in it? well that changes our perception of its value".

[haakee]

Your cash flow analysis does not take inflation into account. Nominal income in year 20 is likely to be much more than $9700.

[Thremp]

[ QUOTE ]
Your cash flow analysis does not take inflation into account. Nominal income in year 20 is likely to be much more than $9700.

[/ QUOTE ]

This shouldn't matter at all. And normal models don't account for this.