22 Oct More Value Than You Think: How to Avoid the Value Trap When Buying
In this week’s episode, we’re looking at how to value, specifically property but we touch on shares and bonds too. We go through overall how to best not destroy your investments, we’ll be talking about valuations overall, the biggest mistakes most people make and paying too much.
In this episode:
- We’ll go through some examples
- What is the actual value?
- How to actually value properties
- Information on valuing
Let’s talk about how to value, whether its property, shares or bonds.
When it comes to buying any investment it’s going to cost you something, what’s generally considered the value?
So how do you actually avoid the value trap and not pay too much for an investment? You make your money on the buy-in, Kevin Turner says it. The cost of paying too much, what does it look like?
If you’re buying a $500k property and overpay by 5% (so about $25,000), as a first home buyer this happens a lot. New developments usually have referral costs built into the price.
In this scenario, if you had of invested that elsewhere for 10 years earning 8% that $25,000 would now be $54,000. The risk is not only are you foregoing investing those funds elsewhere, it will be harder for the investment to grow in value.
Getting the right price increases your capital growth overall.
What is Value?
There are two different types, market value or underlying/fundamental value.
Market value is what you pay for it – it’s not necessarily what it’s worth. Shares are a buyers recommendation.
Whats that drive from? It’s driven by the fundamentals. If someone is giving recommendations on an asset it’s from looking at the business model and how well the company will do in the future. If a share is $1.10 and they say don’t buy it, but the market value is 50c and they value it at a $1 then they will give you a buyer recommendation and say definitely get some.
Property is a bit different it’s more subjective.
What is Fundamental Value?
It’s simply going through due diligence, doing some comparisons, you’ll never be purchasing fundamental value its always market value. Being aware of this before you buy helps you not overpay.
For example with shares, Dominos shares went up massively in share price over a short period, it went about 80 times price earning, which means that the price was 80 times the earning. The banks at the moment actually have 13 price earnings, it was overvalued quite a bit and that’s an instant where people overpay.
In property, you could look at a yield basis, where if you’re buying an investment property at 0.5% yield and just speculating on capital gains it a similar thing where you can get caught out.
Property is harder to put an actual valuation on it.
What is market value and how is it derived?
For example, say Jim’s house is valued at $500,000 how do I work out the value?
Look at what it last sold for, working back to how much you bought it for, how much the market has gone up – looking at Domain for the median price statistics.
Median value overall takes an aggregated view of the market and it depends on the sample size. It can be very bias and very skewed.
You can work out relatively easy if you have an existing property if the median house price rise has been 9% you can figure out the value that way, otherwise, banks use another methodology through looking at recent house sales and similar profiles within the last 6 months. That’s broadly how the valuers look at it.
Online as well, it’s a similar methodology. Bedrooms, land size, what the property is comparable to, etc.
The other way is you can get a real estate agent to do it for you, they have access to RP data which is the paid version of those free sites.
They will always happily come out and give you a market appraisal.
If you’re looking at buying you should be doing this, looking at property history and sales history. Just because your agent says its worth a certain amount doesn’t mean it is, make sure you don’t overpay by only looking at their price.
Future value, how do we work that out?
Again it’s very hard. With future value, the best way to predict is a through strong trend of demand verse supply. DSR Data actually gives a rough estimate of the supply verse demand of suburbs.
Low supply – high demand prices will grow, why Sydney is growing so well.
Over time if there’s strong demand for a suburb the price should go up. To get an idea of what the value might be in the future it’s a good idea to look around and look at potential factors that might increase the demand. Gentrification might happen in some suburbs so always look around. Use a variety of sources to make your decision and don’t just rely on one. Every time you do research still be the one making the decision don’t let it bias you too much, look at a few different sources.
What is the best way to get a valuation?
Domain has good property profiles, and you can look up the individual property.
They’re all not super accurate so it might be worth paying for RP data if you want really accurate info.
- Don’t pay too much – opportunity cost for future potential growth will be missed out on. If you pay too much upfront, your property won’t grow as much.
- Fundamental value – this is the best guess of what something should be worth. Market value – the price people are willing to pay for it. If you took a look at different areas of Sydney and worked out the fundamental around that, the additional demand for that is a massive price disparity compared to the actual fundamental value.
- It’s worth remembering that generally the bank and those valuations do it on the basis that you can sell a property fairly quickly. Which is why the value may be different because the on market value is more aggressive especially if it’s trending up so there can be a gap.
- Know what else is selling in the neighbourhood and do your research.
- Work out what it costs at the beginning.
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