You may have heard of the term below market value when discussing property investing. This concept is an investment strategy used by investors when purchasing a property. In certain market conditions, an investor may be able to purchase a property below market value. But what is below market value, how does it work and should you employ this within your own investing strategy?
What is below market value
Below market value simply refers to purchasing a property at a price lower than what its perceived value is. Purchasing an asset below market can enable the investor to make money on the way in. By finding properties that are listed below their perceived value or negotiating like a pro an investor can build in equity from the get go.
Why do these properties exist?
Within any market, a good or service will have a perceived value that dictates its price in the market. The same applies to property and in most cases, this perceived value is met during the purchase of a property. However, the true value of a property may not always be reflective of the purchase price despite what it may be listed for sale as. In many circumstances, a property can be sold above or below its true value. If a buyer falls in love with a property, it may be sold higher than its true value. Likewise, if a property needs to be sold quickly a seller may decide to accept a low-ball offer. Therefore, the conditions of the properties sale may impact the price and this may not represent the norm.
How to determine below market value?
There are numerous property price estimates available that an investor could use. These estimates give the average price for a type of property in any given suburb. Though these price calculations should be taken with a grain of salt. Why? because they only give the average sale price and don’t represent an individual’s property value. A more accurate way to determine the property’s value is to look at comparable sales. Comparable sales are properties with a similar location, configuration, and conditions. This will more accurately gauge the market and determine an individual property’s true value.
How do you find these properties?
The easiest way to find these properties is to identify properties that need to be sold urgently. In some circumstances, a property may be listed cheaper than its comparable sales and this could be an opportunity to purchase something below its market value. By taking this approach the investor can potentially make money on the way in.
Most of these properties are usually referred to as “distressed sales”. Sometimes, distressed sales can arise where sellers need to get out of a property quickly for a range of reasons. This may be advertised as “Mortgagee in possession”, “distressed property”, “quick sale” or even “owner wants out”. Understanding the rationale behind the sale of the property can aid in being able to drive a hard bargain and get the best value investment. It is important to note, finding these distressed properties can be quite time-consuming and short-supplied but they are most definitely possible if purchasing in a buyer’s market.
Cheaper doesn’t mean better
It is important to note, that just because a property is cheap does not mean it is below true market value. In many cases, cheap properties are cheap for a reason and personal due diligence should apply to determine why the property may be listed below the median of an area. Understanding how to differentiate between cheap and below market is extremely important. Failing to do so may means the investor may purchase a poor asset assuming it is below market.
The problem with buying below market
The problem with purchasing below market is that it can impact performance. When you focus on below market value you are usually drawn towards areas with less desirability. This is because it is easier to find properties below market value in locations of less demand. Though, if every buyer purchases a property in this area at a 10% discount it isn’t truly below market, is it? To focus on growth an investor should focus on demand. If you focus on demand, it means properties in high-demand areas are unlikely to be below market value. This is because even if it is a distressed sale, other buyers are likely to pay the market price. So, the investor is left in a conundrum as they want to purchase below market but also want to buy in a high-demand area. The likelihood of both of these criteria aligning is a rarity.
Similarly, market conditions may impact the likelihood of being able to purchase below market. If property prices are soaring and there is minimal supply the market is usually a seller’s market. This means the sellers hold the power as there are numerous buyers in the market with a minimal supply of properties. That makes it extremely difficult for investors to purchase below market as the seller is usually spoilt for choice. So, it becomes extremely difficult to find a needle in a haystack. Moreover, waiting to find a below-market property can take months. So, the investor could be missing out on potential equity gain that would supersede the money that might have been saved by finding something below the market.
Should I focus on below-market properties?
Whether you focus on below-market value properties is ultimately up to you, the investor. In certain market conditions, it can be a viable investment option to building in equity. Although, if the investor only focuses on this how will they succeed when market conditions change? A more comprehensive approach could be to focus on demand and identify strong demand suburbs. Then look within these suburbs to identify good deals which show strong value. That way you purchase in a strong demand area but also ensure you don’t overpay for a property and get the most value for money.
Below-market value properties can be a great way to accelerate the growth of your property portfolio. In order to find these properties an investor needs to be truly in tune with the market, they are investing in. Utilising comparable sales can help guide an investor in determining the value of a listed property. Noting that cheaper doesn’t mean below market value! Though, this approach can be effective an investor should still prioritise demand if they are wanting to focus on capital growth.