If you have read any guide on real estate investing or attended seminars or training you will have heard the following:
“Buy below market value”.
Let’s explore what this statement actually means.
What Does Below Market Value Mean?
Sometimes you will see a property that is below market value called an “undervalued property”. What this means is that the property will sell for less than its true worth or value in the market place.
A below market value property has a price tag that is lower than its real value in its current condition.
Another way to look at below market value is from a value-add perspective. A property that is in need of significant repairs and rehabbing is likely to be available for a substantial discount on current market prices.
Once the repairs and rehab work are completed, the property can be sold for its real market price.
If a property is for sale for $200,000 and you put in an offer for $190,000 and this is accepted does that mean that you bought below market value?
No, it doesn’t.
A lot of people think that this is the case, and if you are one of them then let me explain why this isn’t (or not likely to be) below market value.
Why would someone sell a House Below Market Value?
Why are houses listed below market value sometimes? There can be a number of reasons why a vendor will sell their house below market value. Here are some common reasons:
- The owner of the property does not know the current market value and is selling the house at the price that they believe it is worth
- The house is in need of repairs and / or rehabbing work
- The owner of the house needs to sell the property very fast because they are in some kind of distress. They are willing to accept a below market value price for their property to close quickly
- A rental property may not be providing the returns that the market suggests it should and the owner is running in to cash flow problems
One of the best ways to find below market value properties is to specifically target the “distressed” market. Examples of properties in the distressed market include:
- Bank foreclosures
- Zombie properties – these are properties that are vacant
- Properties that are in poor condition
Unless the seller of a property has seriously underestimated its true value, every property that you invest in is very likely to have a degree of distress about it which justifies the below market price.
People ask me a lot “can I buy a property for less than market value?” The answer to this is a resounding “YES”.
Asking Prices for Properties
In an example above, I talked about buying a property below the asking price of $200,000 and that paying a bit less does not necessarily mean that you have purchased below market value. The first question to ask is how was the asking price of S200,000 determined?
Did the realtor recommend this price?
Did the seller instruct the realtor to list the property at this price?
These two scenarios are common and happen a lot. Often a realtor will tell a vendor that they can sell their property for a high asking price so that they can secure the exclusive selling rights to it.
When the property doesn’t sell at this higher price, they will ask the vendor to consider reducing the price. Yes, these are sneaky tactics but this does happen often.
The other side of this coin is that the realtor recommends that the vendor list the property at a price that is close to the true market value, but the vendor insists that they want it listed at a higher price.
So, the bottom line here is that you should never accept the asking price of a property to be the true market value. You need to do your homework here to establish what the true value of the property really is and not just take the word of a seller or realtor.
Real Estate Investors Obsessed with Buying Below Market Value
A lot of new real estate investors and some experienced ones are totally obsessed with the concept of buying below market value. They spend a great deal of time calculating bids they should make for specific properties while paying little attention to finding out the real market value of a property.
So, what they can end up doing is buying a property below the asking price rather than below market value. As asking prices tend to be inflated then they might have actually purchased the property at its true market value or even above it.
Here is another problem.
If you believe that the true market value of a property is S180,000 for example, and you are looking to buy at a minimum of 20% below market value then you would need to submit a bid of $144,000. If the asking price of the property is $200,000 your bid will be almost 30% below the asking price which the vendor is unlikely to accept.
Do you have the confidence to make a bid of around 30% lower than the asking price? Some people will and some won’t. The thing is that the vendor will probably see this as a dramatically low bid and reject it out of site.
So, what do you do?
Well, you need to know the approximate market value of the property so that you can base your decisions on this.
How to know if a house is Underpriced?
The secret here is knowing how the Professionals assess the market value of a property.
Please bear in mind that coming up with the true market value of a property is almost impossible to do. Even if two properties look identical it is very likely that they will be different in a number of ways.
So, it is rarely just a question of comparing “like with like”.
When you want to purchase a property and need to obtain a mortgage for it, any potential lender is going to want to arrange a professional appraisal.
If the lender appraisal professional reports back that the value of the property is higher than the price the seller wants, this property would be underpriced (or undervalued).
If the transaction was successfully concluded at the original price that the seller wanted then this would be a below market value purchase.
Of course, it can go the other way and the professional appraiser may determine that the property is not worth what the seller is asking for it.
Did you know that there are two different types of valuers? Well, there are those professional valuers that work for financial institutions and perform valuations to support a mortgage application.
Then there are different valuers that work with realtors and recommend asking prices for properties.
It is actually very likely that both of these valuers are highly qualified, but the methods used to come up with the final valuation are different. A valuer that works with a realtor is going to take recent house sale transactions into account.
The prices these properties sold for will have an impact. A mortgage valuer will not do this.
What happens when the market is slow and there hasn’t been a lot of house sale transactions to compare with? In this case the valuer will need to rely on their own experience and judgement to recommend a true valuation.
Hardly an exact science, is it? It is easy to define how professionals should calculate the market value of a property but it is a lot tougher in practice. Mortgage valuers are usually more conservative in their valuations than realtor valuers.
At the end of the day, if a valuer gets the market value right to within 10% then they have done pretty well.
The problem with this is that 10% is a lot of money when purchasing a property. If the true value of a property is S200,000 then a realtor may list it anywhere between S180,000 and S220,000. That’s a $40,000 spread. And a lot of valuations have a wider margin of error such as 15% – 20%.
So how can you Assess the Approximate Market Value?
The first thing to say here is that you need to do this. Never just accept an evaluation. Do your homework and your due diligence. Find out what similar properties are selling for now and what they sold for in the recent past.
If the market is fairly slow then you may need to go back a bit with your research.
If you see that some properties sold for less than they should have done there may be a number of reasons for this. Some people are under pressure to sell their properties fast because they need to relocate or they may be going through a divorce for example.
If a house has been repossessed it may have sold at auction way below its true value.
Here are some proven ways that you can identify the approximate market value of a property:
If you go to Google or one of the other search engines and enter “what is my house worth” then you will find numerous online tools that will help you to determine the approximate market value.
Almost a quarter of property owners in the United States use these online tools. Large real estate sites such as Redfin and Zillow have these online estimator tools available.
The way that these online tools work is that they take into account deeds of ownership, property transfers, tax assessments and other public records. They use math models to estimate the value of a property based on recent listings and sales in the local area.
How accurate are these online tools for identifying the approximate market value of a property? Well, it really depends on the data that they have available to calculate the estimate.
My opinion is that these valuations are always going to be somewhat inaccurate.
Mortgage lenders will often have access to similar tools for estimating the value of a property. The difference between these tools and those offered online by realtors is that they have a “confidence score” built in to them. If there is a high confidence score, the more accurate the valuation should be.
These tools tend to be more accurate than those used by realtors.
The Price Index Calculator from FHFA
If you prefer to use a more scientific approach with your property valuations then you should use the HPI (house prices index) tool provided by the FHFA (federal housing financing agency.
There is a repeat sales methodology employed with this tool and it is able to reference millions of mortgage records going back to the 1970s.
The HPI calculator is definitely worth using but you need to bear in mind that there is no inflation seasonal adjustment. You are unlikely to be able to access the tools used by the lending professionals so this really is the next best thing.
Ask your Realtor for a CMA (Comparative Market Analysis)
Your realtor can arrange for you to have a CMA performed on a property. This is different to a full professional appraisal, but it will give you a realtor’s opinion on the value of a property. They use this for creating new property listings.
If you have a good relationship with a realtor (which I would always recommend) then you may be able to get a CMA for free. The realtor will expect you to use them for the purchase of the property if things turn out as you want them to.
Get a Professional Appraisal
You are able to hire a professional appraiser to provide you with an approximate market value of a property whenever you need this. This will probably cost you a few hundred dollars but it can certainly be worth it.
When you are talking to a potential appraiser, make sure that their appraisal will take into account the following:
- The local market
- The condition of the property and the land that comes with it
- Similar properties to assess recent sales, depreciation (if applicable), listings and other local market factors
A professional appraiser will provide you with a detailed report of their findings. This is not going to be 100% accurate, but if you use an experienced appraiser then you will have a better chance of the appraisal being more accurate.
Take a look at as much recent data as you can for similar house prices in your area. You can then calculate an approximate price by taking the highest prices and taking an average. Don’t include low selling prices in your calculations as this is going to skew the results.
You can check MLS listings to find similar properties and also find out what prices houses of sold for in the area from a realtor for example.
When you have identified similar properties, you will need to closely compare them to identify differences which will have an impact on the value. This can include the number of rooms and the condition of the similar properties.
Is Below Market Value a Myth?
Now that you know it is virtually impossible to know the true market value of a property, you might be thinking that being able to purchase a house at below market value is nothing more than a myth.
The best you can do is to be aware of the approximate market value of a property using the methods I have outlined in this post. If you assume an accuracy factor of plus and minus 5% then it should still be possible to identify and purchase a property that is underpriced.
I would love to hear your thoughts or experiences. Please add them to the comments section below.
Thank you and have a great day.