Seattle Bubble Forum Archive

A house I am watching on Refin is Listing for $594,000. On another RE site, the same house is listed for Rent at $2,250 per month.

My math says the "P/E" of this house is 22.

Is 22 a "reasonable" ratio? If not, what would be "reasonable?"

i'm looking at this from the perspective of an owner-occupied house, not as a landlord.

(Sorry if this has been covered in previous posts. Just point me in the right direction and I'll check those posts out.)

In stocks, a P/E of 14 is supposed to be "fair". I think you can generalize this number to most investments. The goal is to figure out what rate of return on investment is good or bad, and a P/E of 14 returns around 7% a year. In stocks, you might not get that 7% back in dividends, because the company is reinvesting your cash in the business.

Because you mortgage a house, you must consider mortgage interest rates as well as the risk of leveraged deflation. If interest rates were over 10% for instance, you'd need a P/E below 10 just to cover the interest.

Also the maintenance costs for stocks are quite different than houses. In each, you may pay a tax when selling the asset, but in housing you pay an annual tax and have annual maintenance costs. Add it all up, and it seems to me like a good rule of thumb is that a house should return at least the mortgage interest rate plus 2-3%.

At 6% rates, my guess is a P/E of about 12 would be considered a good investment, maybe even in a falling market.

14, Huh? Hmmm. 22 sounds a bit high, then.

I used The Tim's post from yesterday as an example, and put in this Listing's numbers and got:

Renting Buying
Rent/Mortgage: $2,250 $2,278
Insurance: $20 $167
Property Tax: - $569
Tax Savings*: - ($486)
Maintenance: - $495
Total: $2,270 $3,023
*: (year 1 only, less standard deduction)

yielding a monthly savings in renting of $753. Again, hmmm.

I'm not convinced that purchasing this property would be wise, at this price.

(I wish I could get the formatting correct to line up the numbers columns above...)

Take the inverse of the PE and you have the cap rate. That is a measure that is commonly used by property investors and you can pretty easily find what people are buying at today.

They hit 7.5% in 2001 (13x) Maybe they will go lower this dowwnturn but I suspect at 7-8% you will see lots of people entering the market.

http://en.wikipedia.org/wiki/Cap_rate