This post first appeared in the June edition of: Cirios Trends: Finding Real Estate Opportunities.

“Mow much should I pay?” is about the most common question we get here at Cirios. Unfortunately (or fortunately), the answer to this question is never black and white. Depending on a buyer’s desired use for a property, there are many ways to determine value and what the right price to pay is.

An investor looking to rehab and sell a home quickly may put a different value on it than an investor looking to buy and rent for several years. Since each investor has different profit targets and time horizons, formulas that determine what price the investor would pay nearly always differ.

Still different is the price a regular home buyer would be willing to pay after accounting for mortgage payments, tax breaks, upkeep expenses, etc.

This piece covers a couple different methods for valuing a property, and is at best a cursory examination of these topics. Each one contains many further levels of complexities and nuance.

Many investors that purchase and hold income generating properties use the Income Method of valuation to determine an attractive purchase price. If an investor wants to earn, say 6% on his money, he would use the annual operating cash flow generated by the property to calculate what purchase price would achieve that level of return.

This type of investor often uses the concept of a “Cap Rate” to figure out how much properties are worth. A Cap Rate (short for Capitalization Rate) is the rate of return generated by net cash flows – that is, rental income minus all operating expenses associated with owning the property. For example, if a 6-unit apartment building bought for $400,000 generated $30,000 in net operating income, the Cap Rate would be 7.5% ($30,000 / $400,000).

If a nearby 6-unit building generated $45,000 of income, applying the same Cap Rate you would arrive at a value of $600,000 ($45,000 / .075). In general, as markets improve and property values go up, Cap Rates go down. This makes sense: When times are good, there are usually more buyers than sellers, so sellers can demand high prices which push down rates of return.

The reverse is true when prices fall and markets tighten up. Investors demand a higher rate of return for taking the risk of buying a property in a hard environment, which drives down the prices they are willing to pay and thus pushes the Cap Rate up.

For home buyers, the decision of what price to pay is determined by two primary factors. First, the buyer’s ability and willingness to pay. Monthly income and savings will often dictate how much a buyer can pay, then more emotional factors kick in to determine how much he or she is willing to pay. The confluence of hard numbers and soft feelings creates a price range where the buyer can be satisfied both economically and emotionally.

Second, recent sales, other listings and general market conditions will determine what a fair price for a given home is. Subjectivity plays a huge factor in comparing like properties, so valuing single family homes is much more an art than a science.

Often, relative affordability between different cities is evaluated using a “Rent Ratio.” A Rent Ratio is exactly what it sounds like, a ratio between the cost to buy and the cost to rent. If a $200,000 home would cost around $16,000 per year to rent, the Rent Ratio is 12.5 ($200,000 / $16,000). According to Rent.com, which compiles rental data nationwide, a Rent Ratio around 15 means the buying and renting are roughly equivalent options. Below 15 and buying may be the best route, while above 15 and it may be best to hold off.

According to the most recent data, San Francisco is actually ranked as the best city to rent, with a whopping Rent Ratio of 37. That’s higher than New York at 21 and Honolulu at 24.

So, does that mean it’s a terrible idea to buy a home in San Francisco? Far from it. There may be plenty of valid reasons not to buy in San Francisco, but a broad metric like this doesn’t tell the story of individual neighborhoods.

What this high ratio does tell you, is that if you are lucky enough to find a property in San Francisco where buying and renting cost roughly the same, you are probably getting a pretty good deal.

This post first appeared in the March edition of: Cirios Trends: In Search of Real Estate Opportunities.

San Francisco Building Owners Sell Winners, Keep Sinners
(San Francisco Business Times)
There’s an old saying on Wall Street that you shouldn’t sell your winners to finance your sinners. Landlords in San Francisco, apparently, didn’t get the message. 303 Second St., just blocks from the freshly constructed One Rincon Tower, was just listed and is expected to fetch north of $200 million. Along with another new listing at 333 Market St., which is a few blocks from the Embarcadero and 100% leased to Wells Fargo, the activity supports the view that building owners are looking to raise capital by selling strong performing assets. SF landlords are likely hoping they don’t end up like former brokerages like Bear Stearns and Lehman Brothers, which shed high quality assets to stave off a cash crunch. Oops.

(Read more here: http://tinyurl.com/ciriostrendsmar1)

Bay Area Home Sales Slip in January
(San Francisco Chronicle)
It’s not unusual for home sales to fall from December to January; the holidays are a notoriously sleepy time in the housing market. But this January was abnormally slow, as transactions in the Bay Area fell 4% from a year ago, marking the first year-over-year drop in sales in 17 months. Some chalked up the slowdown to the dearth of listings on the market, while others raised the possibility of a hiccup in the housing market’s recent strength. At least within the San Francisco city limits, we at Cirios have noticed a meaningful pickup in new listings in the past month (supported by the data presented on the first page). Opportunistic buyers should be licking their chops, but, as always, picking their spots.

(Read more here: http://tinyurl.com/ciriostrendsmar2)

Hotels Slash Prices to Keep Occupancy Up
(San Francisco Business Times)
Sure, you’re broke, but it’s never been a better time to visit San Francisco. Hotels, smarting from an excessively weak tourism market, are slashing rates to keep their rooms full. Northern California as a whole saw room rates slip 13.2% from last year, while San Francisco’s decline approached 16%. Meanwhile, occupancy in San Francisco held relatively steady, off only 4.3% from 2009. Contrast this with apartment buildings, where landlords let units sit vacant rather than dropping rents. This is especially true in San Francisco, where tenant-friendly rent control laws means it can take years for landlords to recoup lost rental income.

(Read more here: http://tinyurl.com/ciriostrendsmar3)

Santa Clara Residents Undecided on 49ers Fate
(San Jose Business Journal)
Less than a month after the Santa Clara city council paved the way for a June vote on a nearly $1 billion stadium for the San Francisco 49ers, voters aren’t so sure. In a recent poll, Santa Clara voters are split right down the middle on the subject, with 45% favoring the plans and an equal portion opposed. This contrasts another poll done last month which shows just 40% of Santa Clara voters in favor of the stadium, with 54% opposed. San Francisco is still holding out hope that they’ll get a shot at keeping the team, but only time, and votes, will tell.

(Read more here: http://tinyurl.com/ciriostrendsmar4 )