A very simple indicator of the value of a property is the amount it or similar properties rent for. It makes sense that houses that cost more to rent should cost more to buy. If we could figure out how the relationship between renting and buying should look, then we'd be well on our way to determining a good price to pay for a particular house.

A lot of work has gone into figuring out what the relationship should be, and although we don't have a hard and fast rule, there are enough generally accepted guidelines for the technique to be useful.

A good rule of thumb for an investor is: 11 months rent divided by the interest rate.

So if 11 months rent equals €10,000, and your mortgage rate is 6%,
you divide 10,000 by 6 to get 1666.
Now multiply 100 by the 1666 to get €166,600.

If a property rents for €900.00 then it is worth €165,000.
If a property rents for €1200.00 then it is worth €220,000.
If a property rents for €1500.00 then it is worth €275,000.
If a property rents for €2000.00 then it is worth €366,666.
Source the rental property prices on www.daft.ie or a similar web site.

If you are buying to live in the property add in maximum 10% of the price calculated

These figures don't make comfortable reading in the Irish context because they suggest house prices may still have a very long way to fall. This was recently highlighted by Kathleen Barrington in the Sunday Business Post.

In her article "Approach property deals with care" she examined the Grange in Stillorgan, Co. Dublin.

She notes that developer Ray Grehan announced that he was selling 2 bed apartments for 2005 prices. This amounted to a reduction of €60,000 - from €585,000 to €525,000.

In addition, Grehan also offered buyers a complicated interest-free loan for 15% of the value of the property for up to seven years.

The conclusions she reaches spell out the disconnect between what people think a property is worth to own, and what people are willing to pay to rent it.

The buyer would have to shoulder mortgage repayments of €2,814 a month if the mortgage was repaid over the traditional 20 years, though this could be reduced to €2,499 if paid over 25 years and €2,173 a month over 35 years. The figures assume a mortgage interest rate of 5.20 per cent. At the end of year seven, the buyer would still have to pay Grehan back his €78,750 either from savings, from remortgaging the property or from the proceeds of any sale. It is not clear what the cost of a mortgage might be in seven years’ time or even whether a mortgage will be available - just one of the things that make this deal hard to assess.

Calculations supplied to us by a leading bank suggest you would need to save €769.70 a month to have €78,750 seven years from now. The figure assumes you save in a deposit account offering a 7 per cent interest rate.
All these saving and borrowing costs have to be weighed against the cost of renting the apartment for as little as €1,400 a month, according to figures supplied by property website Daft.ie which tracks rents in the property market.

Indeed, Naoise McNally of Daft calculated the yield on an investment in the Grange at just 2.9 per cent (the yield is calculated by taking 11 x months average rent and expressing it as a percentage of the purchase price). Even assuming a higher rental income of €1,600 a month, the yield works out at just 3.3 per cent.

Given that these yields are lower than the borrowing costs of 5.20 per cent, given that inflation is running at 4 per cent and given that many banks will pay 6 or 7 per cent for deposits, the idea of settling for a yield of just 2.9 or 3.3 per cent appears ludicrous - all the more so when few observers consider capital appreciation to be likely in the next few years.

One of the key conclusions she reaches using the unemotional way of valuing a property - rental yield - puts the value of the property at 1/2 its asking price.

Based on rental assumptions in the €1,400 to €1,600 a month range, the Insider reckons property would need to be priced in the €250,000 to €300,000 range to deliver an even minimally acceptable yield of 6 per cent. That is a long way off the €525,000 at which the apartment is currently on offer.

It is rare to see it spelled out so clearly. This apartment is overpriced by 100%, or in other words, needs a price cut of 50% to make it even minimally attractive as an investment. Even at this price, all things being equal, money on deposit on a bank is earning the same, without the work involved in being a landlord. Obviously this does not take capital appreciation into account. This has been the real money-maker for investors over the past decade. We are highly unlikely to see a return of 10%+ annual increases in the value of property in Ireland any time soon. A more modest rate of capital appreciation will probably return to the market when the bottom has been reached. Traditionally this rate of increase barely outperforms the rate of inflation meaning that there is no great attraction in capital appreciation due to the increase in value being swallowed up by the corresponding decrease of the worth of the currency.