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4 things to analyse before you buy your first investment property

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….

  1. What's it worth?
  2. What will can you rent it for?
  3. Does it make sense for me?
  4. Are there any hidden issues?

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:

  • The seller of house #1 is in no rush to sell: they'll leave it on the market for as long as it takes to get the best price
  • The seller of house #2 absolutely must sell the property within 30 days to avoid being repossessed, or they might be going through a divorce and want to be rid of their offending spouse as soon as possible or even someone immigrating and wanting to move as soon as possible before their VISA expires…. There are many reasons people might want to sell fast, it is up to you to understand the real reason for the owner wanting to sell.

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:

  • House #1 has some kind of unidentified structural problem that's causing cracks in the wall
  • House #2 is structurally absolutely fine

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:

  • Similar ie also a 3 bed, 2 bath, double garage property
  • Nearby
  • Has sold recently

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:

  • Increase or reduce it depending on the property's condition. Marks on the ceiling, water damage on the walls, kitchens, bathrooms, swimming pool condition and a lot more gets taken into consideration.
  • Increase or reduce it depending on whether the property market in general has picked up or slowed down since the comparable has sold.

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?

  • Step 1: Completely ignore the agent's asking price. Pretend you don't even know it: it has no relevance at all.
  • Step 2: Generate a list of recent sales:
    • Go to Property24
    • On the right panel click the “see more property trends” button
    • Scroll right to the bottom and Click on “Sold prices in….” button
    • Find the street and even the actual property you are looking for to see what the properties last sold for and in what year

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"

  • Step 3: Go through the list, using the photos and number of bedrooms to find properties that are most similar to the one you want to know the value of
  • Step 4: From your list of similar properties, work out the range of sold prices. There will usually be some strange outliers too, which sold at a particularly high or low price for no obvious reason. Give the most weight to properties that sold recently. If the sale was more than a year ago, be careful because the market in general might have gone up or down since then.

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:

  • Will tenants want to stay there?
  • If so, how much for?

(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.

  1. You can easily get comparable rental prices on TPN. Not only for houses or flats but even also for room rentals. Always get the investors report off the TPN shop for your suburb. You can see typical rental prices per size of property, whether it is a good rental area – more renters than owners, whether tenants pay well and even whether the tenants pay better as compared to other areas in South Africa. ( you can also do other funky rental stuff on TPN but that is a topic for another day)
  2. If you can’t find anything useful for you area, you can always post an advertisement on Gumtree or Facebook Marketplace with some random photos at different price points and see how many calls you get per ad. No calls – your price is too high, phone can’t stop ringing – your price is too low. Remember you can always tell people that the place has already been taken….so don’t be scared to try this when all else fails!
  3. And lastly you can always call a rental agent in the area and get their advice. Always look for someone that are advertising lots of properties to rent on Property24 with little or no sales. You want a local rental expert.

DOES THE PROPERTY WORK FOR YOU?

By this point, you know:

  • How much the property is actually worth – so you won't overpay
  • How easily it will rent – so you know it won't sit empty
  • What it will rent for – allowing you to run some calculations…

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.

STRUCTURAL ISSUES

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:

  • Cracks and slopes suggesting that the foundations are crumbling
  • Layouts that would make it un-bondable
  • Incorrect zoning that would make your strategy impossible

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).

LEGAL ISSUES

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:

  • Restrictive items on the title deed that prevent you from doing certain things. As an example a few hundred years ago some towns in Cape Town had restrictions that couldn’t allow any property in the whole town to sell alcohol.
  • An issue with the title, which makes it hard to prove legal ownership
  • An extension or alteration that was done without permission
  • A dispute over the property's boundaries
  • Arrears in the rates and taxes

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.

and finally

By the end of this process, you've analysed the property enough to know:

  • How much it's worth
  • What it will rent for
  • Whether it works for you, based on your goals
  • How much you should be paying for it
  • Whether there are any structural issues
  • (And later, if there are any legal issues)

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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