This is part of a series of articles from the book: The ABC of REAL ESTATE investment in Kenya.
Whether you want to buy a house as an investment or to occupy it, it is important to know whether it is overpriced. This article will teach you how to do this. There may be some math, but the method is actually quite simple so read on.
1. Income method.
If you want to buy a house to get rental income, take the rent you can derive from the house every month, say Ksh. 20 000 then multiply that by 12 to know the total rent you will get in one year.
Calculating yearly rent collected:
20 000 * 12 = 240 000 shillings
Then reduce this amount by 10% if it’s a residential house or 15-20% if it’s a commercial building. This are called outgoings; i.e. the expenses that are incurred by the building e.g. payment of rates, repair and maintenance, management fee, voids (the time that the building might not have a tenant) etc. Let’s assume that our building is residential and therefore assume an outgoing rate of 10% meaning that we can multiply the annual rent by 90% i.e. 0.9 to get the net rent.
Calculating the net rent:
So 240 000 * 0.9 = 216 000 shillings
Then multiply this by a factor called YP (Years Purchase) or Present value (PV) of an annuity calculated as 1-PV.
To make our lives easier, let’s apply the YP Method to our house above.
The YP factor varies based on where a property is located. For properties in a moderately growing area like Athi River, Rongai etc Let’s assume a YP (multiplying factor) of 14 and a YP of 16 for properties within fast growing areas e.g. Eastleigh and a YP of 12 for properties in slow growing areas like Murang’a, Machakos and other such small towns.
Let’s assume that the house we want to buy is in Rongai and therefore use a YP of 14.
Multiplying our net annual rent with the YP factor:
216 000 * 14 = 3,024,000 shillings
Say 3 million. This means that the Open Market Value (willing buyer, willing seller) of this house should be 3 million shillings.
If the seller sells you the house at 3.5 million, that would be fair since the seller might have considered the cost of selling the house i.e. (legal fees, agency fees, profit margin, and other fees). It would not make economic sense to buy the said house for a price higher than this.
There are other factors that are put in place before you can finally decide to buy a house but this is an easy way to check whether a house is overpriced. So, tomorrow when you read the advertisements in the papers with houses for sale or your colleague at work wants to sell you his house, you can do these simple calculations.
Important to note that the value derived in this way incorporates the values of land and developments (house) combined.
In summary,
Rent per month * 12 (months in a year) = Gross annual rent.
Gross Annual Rent * 0.9 (after subtracting 10% outgoings) = Net Annual Rent
Net Annual Rent * 14 (YP) = Value of house or property
The above article is an extract from the book :
The ABC of REAL ESTATE investment in Kenya “The Law, The Logic, The Math”
Click here to get your copy of the book.
Written by: Kariuki Waweru. BA (Land Econ) Hons, UoN, G.M.I.S.K (VEMS)
@kariukiwaweru www.kariukiwaweru.com