… and the dreaded white elephant in the room: Below Market Value.
So the start of my last article began with an intro about how my wife claims she writes my articles – but I claim she merely edits them! It’s a shame she edits this stuff out as I would like to start with a story about my wife again…
The RICS invited us to a fantastic seminar entitled ‘RICS Business Valuation Breakfast Seminar 2013’. You can imagine how excited I was! [Editor’s note: Sad but true.]
I arrived at the pre-ordained starting time as my wife was just finishing her pre-seminar tea and sticky buns. With the RICS press-pack under arm, she walked out the door! Fair enough. That’s probably most people’s reaction to a seminar on valuation.
Anyway, I missed the sticky buns but did listen to some great speakers. There were many different valuation methodologies discussed:
- Market Approach: Comparing recent transactions
- Income Approach: Based on the aggregation of expected income generation
- Cost Approach: The cost to create or replace
- Asset-based Approach: Valuing the sum of individual assets
Now of course these are relating to business, not a ‘simple’ residential property. But all valuation comes down to a basis of Market Value, which, according to the RICS, goes something like this: ‘The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and willing seller in an arm’s length transaction after proper marketing where the parties had each acted knowledgeably, prudently and without compulsion.’
The IFRS (International Financial Reporting Standards) tell us that Fair Value, on the other hand, is ‘the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date’.
Okay, well, hmm. None of these definitions use inordinately long or byzantine phrases…
While they both agree that the date carries true for assets and liabilities, I think we can agree that a willing buyer and seller, acting knowledgeably, etc., can be equated with an orderly transaction between market participants. Interestingly, the RICS uses the word estimated and specify proper marketing, although I think that truly proper marketing could be seen as covered by the orderly transaction of the IFRS.
To me, the estimate is quite important, though. If the ‘price’ was not an estimation, then surely there would never be super profits on property deals or market crashes.
Your next property purchase So when you are looking into your next property purchase, be it for your own habitation or as an investment (or looking to renovate/refurbish your pad), how can you check that you are paying the right price?
- Remove all of your emotion from the analysis. ‘But I like it!’ doesn’t have a box on the valuation/survey form.
- Know your market. Look at comparable property prices, not just at the sales prices, to try and find out the actual market value.
- Have a think about the market in which you are operating. Are both sides of the transaction willing, or is the economy putting pressure on one side or the other?
- What happens in the future if you are not a willing seller? Will you still be able to get a ‘fair’ price?
Well that’s not so complicated, was it? Check the prices of comparable property sales, check the market and expected market conditions, and try to stay rational. Of course, rationale may go out of the window when a certain someone starts gushing over the curtains (which the owner is taking anyway). [Editor’s note: In my own defense they were beautiful, silk curtains.]
And speaking of the foibles of our loved ones when looking for a nest, as an aside I just have to say that the cost of repainting a whole house as a percentage of the cost of buying a house can often be negligible. And truthfully, I would rather walk into a house smelling of fresh paint than whatever the last owner had for their goodbye dinner. I’m not certain how my valuation lecturer for three years at Cirencester, or all the qualified and certified valuation experts worldwide, will feel about this glib look at valuation. But the truth of the matter is, that with enough truly comparable data, you should be able to get a fair estimation of market value.
One last caveat, and a very important one – that dreaded acronym used by property marketers, BMV (Below Market Value) – if we take the price/value as being willing and educated participants, then why are these selling at BMV? Does that mean that either their estimate of market value is not realistic or that they are actually not a willing seller? And if they are not a willing seller, should you buy what they are selling? Are you sure you want to buy into a possible white elephant that has already charged down at least one developer?
That’s more questions than I am willing to answer in this space, so until next time.