The 2016 Santa rally saw the FTSE 100 hit new highs, the price to earnings ratio of shares hit 33. The average norm for P/E on the FTSE100 is approximately 15. Obviously this would suggest shares in the FTSE 100 are overpriced. This got me thinking, what is the price to earnings ratio of the UK buy to let housing market?
A quick fact check online reveals the following data.
The average UK house price as of June 2016 was £214,000
The average house rental per annum in the UK as of May 2016 was £10,788
So lets do a quick calculation of P/E for buy to let.
£214,000 ÷ £10,788 = 19.83
A P/E of 19.83 does not seem to suggest that the UK buy to let housing market is exceptionally overpriced.
However many buy to let landlords have taken out interest only mortgage on these investments. What happens to P/E when mortgage interest repayments are deducted from rental earnings?
The average mortgage interest repayment on £214,000 per annum at 3% is £6,420.
If we deduct the average interest repayment from average rental income.
£10,788 – £ 6,420= £4,368
So the real income for a £214,000 risk is £4,368.
Now let’s do another P/E calculation using these figures.
£214,000 ÷ £4,368= 48.99
So the real P/E of the average UK buy to let is 48.99
These P/E calculations do not include landlords cost for maintenance of properties, commission paid to rental collection agencies or insurance premiums.
An interest rate rise of just 1% would wipe out earnings from the average UK buy to let and send the P/E through the roof of the average buy to let property. No wonder the bank of England wants to kerb lending to the UK buy to let market, it is obviously just speculative. Given that it can take months or years to sell/ liquidate a property, UK buy to let landlords are taking massive long term risk for next to zero real earnings gain.
I know I assumed a lot in these calculations but it does give some perspective to the risk reward involved in buy to let.
Author Paul Fear 01/01/2017.