To say that the property market is uncertain would be the understatement of the century. Are we near the bottom, or are we expecting more significant declines? We now see properties for sale with advertisements touting 10%, 20%, 30% or more below market. But what is the market, and how can we possibly determine fair market value?
There is a common thread that runs through all investment markets, be it the stock market, bond market, commodities market and real estate market. All markets fear uncertainty. What can an investor do? Do you buy now? What if the market drops another 20% or more? If you wait, the market may go up. Everyone has an opinion, but nobody really knows.
The pundits all have their forecasts and predictions. The “market is about to turn”, “the market is going to “continue to decline”, “inventory is too high”, “days of supply is shrinking”. On and on it goes. You can find a theory that supports whatever your view might be. I learned not to have faith in all of these predictions after learning about the18-year property cycle. If you are interested you can check out here . There is a saying in the financial markets that states, “economists have predicted nine of the last three recessions.” Think about it.
Market uncertainty leads to fear that paralyzes markets. Most people know that you should try to buy when markets are near their low. Human nature, however, keeps people from investing because they fear they will make a mistake. What then should the investor do?
Minimizing Risk
All investment requires that you take risk. Even in a “safest” investment like FDs, you have the risk that inflation may outpace the interest that you earn. Risk cannot be avoided, but it can be minimized or managed. In the stock market you may minimize risk by buying when a stock is selling below its “book value”, which is simply the value of that particular company’s assets. The theory being that the stock could not fall very far below that or the company could become a takeover target.
What if you could apply this theory to real estate? If you knew you were getting value, would you buy?
Book Value
Simply put, the book value of a house would be its replacement cost. If existing properties is selling for more than it would cost to build new properties, you will see developers stepping in to take advantage of the situation. On the other hand, if new properties cost less than existing houses, you will see buyers purchasing the new properties. Both situations will cause a market correction.
This correction does not happen overnight. Existing supply needs to return to a balanced situation. Developer inventory, foreclosures and oversupply must be absorbed by the market. The fact is that it will correct because that is what markets do. Market forces in action. For a long-term investor in a growing market, this can be to your advantage. While the market is adjusting you will be able to find bargains.
If you look for property that is selling at a significant discount to book value with good rental returns you should do very well. You just need to be patient while the market goes through its adjustments. If you are in a market with a declining population, the book value theory is no sure thing. If you are a speculator who is looking to flip properties, the book value theory probably won’t work fast enough.
In life you can’t have everything, where would you put it? – Steven Wright
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