- Don’t pay too much for the earth.
- Don’t pay too much for the business.
As a good real estate investment rule of thumb, net rents in real estate (by “net,” I mean after expenses) have averaged about 1% above Treasury bonds (that’s the way it’s been with real estate stocks since 1990). The Treasury bond is at 5.15% as I write, so we might guess that the nationwide average net rent is 6.15%. (6.15% is the “earnings-to-price” ratio, so we need to find the inverse of it for the P/E of your house.)
The second value rule regarding real estate investment advice is also simple: Don’t pay too much for the “business.” Just like a stock, look at the P/E ratio… a.k.a. the rent. While real estate prices can fluctuate in the short run, in the long run, property prices are significantly driven by rental values. If you look at the “Price-to-earnings” ratio of your property, you can learn about your home’s true “intrinsic” value.
How can you figure the P/E for your property? Forbes suggests the only real way to know: “To get rental data for homes comparable to the one you’re buying or selling, check with the relocation department of big real estate agencies.” You’ve got to know what the comparable net rents are to your property.
The tricky thing about selling real estate is that real estate is not liquid. Unlike stocks, where we have the luxury of being able to sell whenever we want and the luxury of trailing stops to get us out exactly when we want out, in real estate, it’s not so easy. You unfortunately need to be a good guesser, because you actually need to sell into an “up” market, and buy in a down market.
This is all a very rough guide. Once you’ve figured your P/E, it may be very different from the current nationwide fair value P/E guess of 16. If your P/E is low, you may have gotten a good deal, or you could collect high rents from your place. If your P/E is twice as high as 16, my advice is that you ought to consider selling.
While this can’t be done successfully on a regular basis, you can improve your chances considerably by doing what works in the stock market as well. The P/E ratio is our value indicator in our 1-2-3 Model in the stock market – and I found that you NEVER make money in stocks over the long run when the P/E of the market is above 17. While I don’t have the data on homes, the number may be very similar.
