How to know if a property is expensive or cheap

22 Apr How to know if a property is expensive or cheap

When we buy or rent a house there is always the question of whether the price is high or low. This happens whether we are the owner, the purchaser, the leaseholder or the tenant.
There is an easy method to know if the price is right, it’s called PER (Price Earnings Ratio) and it is based on the relationship that exists between the sale and the rental prices of a property.
The first thing we have to know is the Gross Return of the property, that is the percentage we get by dividing the annual rental price between the purchase price of the house. For example, a € 240.000 house that we could rent for € 1.000/month would have a 5% return.
(€ 12.000 / € 240.000) x 100 = 5%

If we divide the purchase price of the house between the annual rent we obtain the number of years we would need to pay the house’s value. This value is the PER, universally accepted as a reference in property valuations and official data is provided by the Bank of Spain (22 years or 264 months at the end of 2014). In our example it would be 20 years.

To find out if the sale or rental price is correctly established we need to know two of the three factors that conform the PER equation.

Knowing the PER, to find out if a sale price is correct we would need to know a rental price of reference in the same type of property. Multiplying the estimated rental price of the property by the PER we obtain the adequate sale or purchase price.

In the same way, if we have a house that could be sold for € 300.000 it would be enough to divide that amount between 264 to find out that its rental price should be around € 1.135/month.

In short, the lower the PER of a house regarding the Spanish average (22 times) the better it is to buy it, whereas the higher the PER the better it is to live in it as a tenant.