The perils of property valuation

Property is considered a staid asset class, with returns linked broadly to inflation. That's mostly true. But property purchases are typically financed with debt, meaning that equity owners tend to have a much less stable rise. In addition to this, the standard property valuation technique of capitalising net income can alter reported valuations by far more than the changes in underlying income suggest as capitalisation, or 'cap', rates tend to rise when income is falling, creating a magnifying effect.Let me explain with a simple example.Table 1200520072009Income$6.00$6.30$5.35Cap rate7.50%6.00%9.00%Property value (Income/Cap Rate)$80$105$59Debt$60$60$60Net Asset Value$20$45$-1Table 1 outlines the impact of a simple boom-bust cycle....

Property is considered a staid asset class, with returns linked broadly to inflation. That's mostly true. But property purchases are typically financed with debt, meaning that equity owners tend to have a much less stable rise. In addition to this, the standard property valuation technique of capitalising net income can alter reported valuations by far more than the changes in underlying income suggest as capitalisation, or 'cap', rates tend to rise when income is falling, creating a magnifying effect.

Let me explain with a simple example.

2005

2007

2009

$6.00

$6.30

$5.35

7.50%

6.00%

9.00%

$80

$105

$59

$60

$60

$60

$20

$45

$-1

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