I think I enjoy scouting and hunting for a new deal even more now that I did when I started with property investment. I like to tell myself that it is just because I now have more experience working with agents and doing numbers in my head so less pressure when I’m out there, but secretly I just love looking at houses and finding the diamond where everyone else is seeing a mess….That moment you when it hits you (normally as a very stinky smell straight in the nose) and you realise that this is the real deal, is just like no other feeling on this planet!
However when I just started this process caused me lots of sleepless nights and stress over mulling over the questions floating in my head…. Is it really as good as I think it is? Is it really a great buy? Will it give me the profits I need in the time frame I need it in? What if I don’t get tenants? What if I can’t sell the property for the money I put into it? What if what if…. And so it went on.
This is exactly where new investors get stuck, they love the property “window shopping” part but can never get themselves to the point of actually buying anything at all. It was only after I learned to master the 4 main steps of a property investment that I was able to put in an offer confidently. And here they are….
WHAT IS IT WORTH?
Calculating the market value of the property is the first step. But before getting into that, we need to take a brief detour…
UNDERSTANDING BELOW MARKET VALUE
If you've spent any time researching property online, you'll have come across the term “BMV” – standing for Below Market Value. Every company selling property claims that they offer “BMV” deals. And everyone looking for deals has BMV as one of their requirements. But what does it really mean?
Well, some people will tell you there's no such thing. And technically, they're right. You could define “market value” as:
The price agreed between a willing seller and a willing buyer
Meaning that whenever you buy, you create the market value – so by definition, it's impossible to buy below market value. So I rather prefer to think of it as buying at a discount. And yes I love buying anything on sale, houses included!
So how do you buy a house at a discount? When will a house be sold at a discount and how do you identify it? It is not like the estate agent will put a tag on their for sale board saying “for sale – 40% discount….!!” So….just imagine a situation where two houses are for sale. They're absolutely identical in every way – same size, same condition, and next door to each other. The only difference is the situation of the person selling:
You'd imagine that house #2 would sell for less, wouldn't you? The seller doesn't have time to wait for the best offer – and they'll probably need to sell to a “cash buyer” (not using a bond from a bank) for reasons of speed as bonds could take long to be approved.
Purely due to the situation of the seller, you can buy at a better price than might have been possible under other circumstances. That's – in my opinion – what most people really mean when they say Below market value.
For another slightly more complicated example, imagine a situation with another two houses. Again they're identical in every respect, except:
If you had lots of construction experience, you might know that the structural problem isn't as serious as it appears and would only cost R10,000 to be fixed. You'd therefore expect house #1 to sell for R10,000 less than house #2. (Maybe with a bit more of a discount to reflect the work involved in fixing it.)
But most people do not have construction experience, and won't consider buying house #1 at all: they don't know if it will cost R10,000, R50,000 or R200,000 to fix it.
As a result, there will be only a few interested buyers taking much longer to sell the property and as a result the seller might reduce his price to get more interested buyers.
So as a buyer with experience, you might be able to buy house #1 for R150,000 less than house #2. After spending R50,000 fixing the structural problem, you've effectively bought it for R100,000 discount.
This discount amount is all up to you and your negotiating abilities so make sure that you sharpen these up by reading some books on negotiations if it is not something that comes naturally to you. (like I was absolutely crap at it…).
But how do you know that you really did get a discount…the seller might have overpriced his property to start with and you might end up paying more than market value even if you received a discount on the ASKING Price….
HOW TO ASSESS MARKET VALUE
How do you work out market value? By comparing it to other similar properties i.e. “comparables”.
Comparables are what the banks and professional valuers use to work out what a property is worth. A “comparable” is a property that's:
The more similar, more nearby and more recent the sale, the more accurate the comparable.
It’s no good if the other properties are far away or double the size, and you can’t tell anything from a property that sold two years ago or is still on the market and just has an “asking price” (which might be totally disconnected from reality).
But if an identical property across the road sold for R1,500,000 a few months ago, that's a good comparable. From there, to work out the value of the property that's being sold now, the valuer would take the R1,500,000 and:
When you’re assessing a deal, it makes sense for you to calculate market value in exactly the same way: using similar properties, that are very nearby, and have sold recently.
HOW TO VALUE A PROPERTY YOURSELF
Let's imagine that an estate agent is marketing a property for R1,500,000. How do you work out what that property is really worth?
To see a demo of this you can have a look at the video "How to determine what price you can offer on a property"
This 4-step process isn't scientific, but gives you your “best guess” of what the property is worth.
OTHER WAYS OF FINDING A PROPERTY'S VALUE
If you're willing to spend some money, you can pay for a valuation report. There are many professional companies that work for the bank that will also do this for you at a fee.
You can also call local estate agents and ask if they've recently sold any properties similar to the one you're looking at. This is helpful for getting up-to-date information: it takes a few months for sales to filter through to Property24, so an estate agent might tell you about a sale last month that you wouldn't find online.
HOW CONFIDENT CAN YOU BE?
You can never be 100% confident so don't expect to be. There are some obvious other things you need to look out for – like the condition of the property. If the property you're looking at needs renovation work, you should deduct at least the renovation cost from the value of perfect condition comparables. But of course, it's hard to exactly calculate what a renovation would cost.
Another factor is the number of good comparables. If there's a row of identical houses (which you could find in an estate or complex) and two of them have sold within the last year, you can be pretty sure about what another house in that row would sell for today. But if there aren't many comparables and the types of property are very variable (like in a suburb or mixed use area), it'll be much harder to be confident.
Just remember: be conservative in your estimation, and always look for anything you might have missed. Nobody gives a property away cheaply because they're feeling generous: if you think a property is worth much more than the asking price it might be a bargain, but there's more likely another hidden factor that's causing the price to be lower.
WHAT WILL IT RENT FOR?
For properties you intend to keep (buy-to-let) rather than sell on (flip), when assessing a deal you'll need to answer two extra questions:
(If you're flipping the property, you could ignore this whole section but I would highly recommend against that! It's a good idea to understand the rental aspect too – so you can have it as a “Plan B” if you're not able to sell it for some reason.)
Rental markets change over time and often move cyclically throughout the year (especially in towns with a large student population), but they don’t change that much or that fast. With a bit of research, you should be able to estimate the monthly rent you’ll achieve to within R500.
Doing this research is important – because if you need to rent the property out for R1000 per month more than other rentals in the area to cover your costs, you'll find yourself with an empty property. Rental prices are set by the tenants, not landlords – so you need to be confident that you'll find a tenant at a price that works for you. On this all I can say is be conservative. VERY conservative.
DOES THE PROPERTY WORK FOR YOU?
By this point, you know:
These calculations are critical in working out whether the property will work for you.
Because knowing you're not overpaying for a property is great, but there's no point even slightly underpaying if owning the property won't make sense for you.
If you're flipping this is less of a concern: as long as you've calculated a healthy profit when you re-sell, you don't need to worry too much about anything else.
This is where the essential property calculations come in – You can watch the video on how to calculate a rental property on this link How I calculate income from my rental investment property
If you work out that a property is worth R1,500,000 and you can get it for R1,400,000 that sounds good…but what if it gives you an ROI of 4% and your target is 8%? Then you could argue that it's not worth buying it at all – so now you can work backwards and calculate how much to actually buy it for.
ARE THERE ANY ISSUES?
Once you've got a good understanding of the numbers, the situation and whether it makes sense for you, there's just one more question…
Is there some kind of hidden issue with the property that you don't know about?
And unfortunately, that can be a tricky question to answer without investing some cash and time.
If you don't have a background in construction or valuation, it's easy to miss major issues that could turn a property from must-buy to can't-run-away-fast-enough. I've seen buyers miss:
And a whole lot more. Unless you're an expert yourself, the only way to have some degree of certainty is to pay one – in the form of a property inspector survey.
Inspectors will be able to do a report for you, which give a general look at the condition of every aspect of the property, or a full structural survey which goes into more detail about the structure if you've got a particular reason to be concerned (and is more expensive).
There are also potential issues with a property that you couldn't see even if you were an expert. These are related to the legal side, and could include:
And so, so much more.
Again, you won't know about these in advance: they'll only come to light once you've committed to the purchase and incurred legal fees. It's against the law for estate agents or sellers to withhold information that could have a material impact on the buyer's decision…but often, nobody will know until the attorneys are far down the process.
By the end of this process, you've analysed the property enough to know:
It sounds time-consuming, but with practice you can do a “desktop analysis” in under 10 minutes.
So run the numbers, look at the facts, check with your coach if you have one. If everything comes back looking and feeling good…go make your offer.
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