How To Know If A House Is Expensive Or Cheap

When it comes to buying a property, it is essential to know its value. However, buying to live in and buying to invest are two different things, which is why we want to distinguish between market value and investment value. Investment value will indicate whether we are buying expensive or cheaply from the point of view of a professional investor, while the market value will be the price we will have to pay if we want to buy a specific property.

In the first case, when we buy a house to live in, whether it is a primary or secondary residence, we must bear in mind that if we want to choose our home based on our preferences and tastes (which are usually personal and subjective reasons), we will have to accept a price adjusted to its market value, which is the price at which both buyer and seller agree to close the sale.

In the second case, if we want to buy a real estate property at a profitable price, we will have to calculate its investment value. Investment value is the maximum that a well-informed investor would pay for that property based solely on objective criteria based on its economic profitability.

Therefore, regardless of the reason for the purchase, if we want to know if we are buying expensively or cheaply, we will have to calculate the investment value and buy it with the market value; if it is lower, then we will be buying expensively.

How do we calculate the investment value?

The expected profitability of a home should be at least 7% for its purchase to be interesting from an economic point of view. This reference index would be the sum of the profitability of a low-risk investment over 10 or 20 years, such as Spanish state obligations, which currently stand at 3%, and a risk premium, which given current laws on rentals and market legal insecurity, we like to place above 4%.

The most common way to calculate this value is based on rental profitability. To do this, we have to study at least 10 rental properties, with the same characteristics as ours, and apply a 10% discount to the offered rent, as there is always room for negotiation.

To calculate the investment value, it is necessary to capitalize rental income. The goal of the operation is to answer this question: at what maximum price would I have to buy this property so that the investment provides me with an estimated annual return of X, taking into account the rental income paid for equivalent apartments and the inherent expenses of the purchase? In addition to this price, we must add 10% in taxes and expenses to calculate the total investment.

In addition, to calculate a value adjusted to reality, we must apply the occupancy coefficient since there is always a period when the property is vacant, and we place it at 0.85 (although this value will depend a lot on the area where the property is located).

Therefore, if we want to know the investment value of a property whose real rental price would be around €1,750, we will have to multiply that rent by 12 months, by 0.85 occupancy, and divide it by 0.7 (expected profitability) and subtract 10% of the amount obtained, in the concept of purchase expenses and taxes, to know its true investment value. In summary, a professional investor would not pay more than €230,000 for that property.

In the current real estate market, especially on the Costa del Sol, it is very uncommon to find properties for sale whose market value approximates the investment value if we apply these criteria. It is a market where demand, especially foreign demand, is pushing prices up, and sellers are taking advantage of the moment to push the price of their properties up.

In addition, this is an area with a high tourism rate, which leads many owners to put their homes on the tourist rental market, taking them off the long-term rental market in order to seek higher profitability.

In conclusion, although a professional investor would carry out a more complex study, including cash flows, analyzing profitability always considering their highest and best use (in the case of the Costa del Sol, and depending on the area and asset, it would be tourist rental) and analyzing other expenses such as an investment in renovation or improvement of the asset, this is still an easy and quick way to quickly know if we are buying expensive or cheap.

In any case, if you want to carry out the purchase of your home with tranquillity and security, we always recommend having a professional team such as Valido Home to advise you at all times and take care of the entire process for you so that you don't have to worry about anything. Contact us now and buy with confidence!