Property Investment

Finding Value in Real Estate Markets

Value Criteria

There are two concepts to understand value criteria. First, and though 'value' is an often used word, it is incorrectly equated with the price. These are two very different ideas. The price of the property is the amount a buyer is prepared to pay a seller. We are all familiar with the price. But what about value?

The value of a property can be above or below its price, in other words above what the property is really worth. For example, if the price of a property is $500k, but its value is $600k, then you can say that you have found good value. However, if you paid $500k and it is only worth $400k, you have lost value.

So our goal is to always buy properties where the price is lower than its value, and this can be done during good and bad times in the market.

The second concept, and each person has their own individual formula, is what determines value? We can measure price by what we paid, but how do we calculate value?

At Finwell, we believe that value is determined by how much banks are prepared to lend to households when they make a purchase. The amount they lend is driven by how much income purchasers have. And they are in the business of trying to lend as much as possible.

Think of it this way. Two stores, exact same size in a shopping centre. Yet one is a jewellery store and the other, a news agency. The landlord knows that the jewellery store can afford more than the news agency so it knows it can charge more. Both owners have the same size, but the news agency pays less at least for the moment. If the landlord could fill the entire shopping centre with stores like jewellery stores, it would. The value of the store — the one next to the jewellery store, is the valuable one.

And that is what happens in the suburbs. For example, if the banks discover that in a particular suburb the average family (news agency) only uses 30% of a single income to pay for their home mortgage, where an average family can afford to pay 50% of their combined income to pay for a mortgage (jewellery store), then clearly families in this suburb can still pay more. To increase the mortgage payments for all homeowners in this suburb (like the landlord getting all jewellery stores) the banks can’t just increase the interest rates for this suburb and not for others; so what do they do?

The banks lend more, up to a maximum of how much households can afford. This pushes up the price of these properties. We see this often in Greenfield areas, where migrants who have higher incomes (and the banks know this of course) move into suburbs and with their higher incomes, drive up prices.

At Finwell we understand these two concepts and apply these to identify suburbs and properties using extensive research so that we make sound value purchases for our clients.

 

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