#### Mike

Estimating buy price - Part 1

How to estimate what price to pay for a house.

The following example illustrates how a house in a suburban street of identical properties is valued.

Four houses in the same street have been bought with vacant possession within the last 12 months. The values of each property are affected by three items:
• the market is judged to be rising at 0.25% per month;
• the even numbers in the street are more popular because they back onto a park;
• the lower numbers in the street are always thought to be the better end of the street.
The prices paid and repair costs for each house were:

House No.-- Date bought-- Price Paid-----Repair Costs
No.20--------January-------\$200,000-----\$30,000
No.66--------March----------\$190,000----\$12,000
No.85--------June-----------\$140,000----\$35,000
No.46--------September-----\$174,500----\$40,000

What price should be paid for No. 54 in December where repair costs are \$60,000?

I'd like you to have a crack at working it out before I give the answer. Anyone who gets it right deserves the title of guru.

Regards, Mike

PS: Sim, is there a better way to insert tables?

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Here Goes

Without putting all my Calculations in how does \$161,593.33 sound.

Fingers Crossed.

\$156,500.00

Originally posted by Mike
How to estimate what price to pay for a house.

The following example illustrates how a house in a suburban street of identical properties is valued.
What price should be paid for No. 54 in December where repair costs are \$60,000?

Regards, Mike

Mike,

The estimate of the price to be paid for the house should be more than mathematics of the market movement and comparable sales in the street. It brings together a whole range of other variables which will be almost impossible to reflect in a spreadsheet, things like:

- Weekly Rent
- Vacancy Factors
- Ongoing Maintenance
- Capital Growth Potential
- Planned infrastructure developments
- X Factor (subdivisions etc)..

This could see you paying more than what a first glance would suggest you might pay or it might see you deciding the whole street is just way overvalued and walking away.

And further on from the data surrounding the actual house it would also need to factor in the individuals portfolio and the makeup they're looking for in it..

Duncan.

Hi Mike,

I would have to agree with Duncan:

Firstly it seems all the sales occurred this year, at a time when interest rates are low and market sentiment is high.

On a comparative sales basis then one would probably end up paying way too much for a property.

WHAT MARKET RENTAL COULD SUCH A PROPERTY ACHIEVE???

The current ANNUAL MARKET RENT achievable divided by the 5 year rental yield percentage will indicate the realistic value.

Regards,

Steve

Mike,

I love puzzles - I say \$151,829

Ok, I'll go the lowball...

\$147,500

asy

What's the prize?

\$152,980

Say cheese ,

Lotana

Rough calculation \$149.5k

Joe D

Thanks for the replies everyone. Most of you did very well, however, since no-one described how they arrived at their figure I can hardly bestow the guru title on someone who may have had a lucky guess. So I will post the answer in this post but not the workout solution. Since this is a discussion forum, for the benefit of all the newbies I think we should see your rationale or workout. After you post your workout I will post the workout which gave the answer. Whoever comes closest with the correct rationale or workout will be henceforth known as The Guru. That answer, BTW, is \$152,843.75 or rounded up is \$153,000.

Here are your bids or offers in ascending order with the highest offer on top:
1. Lee Jackson \$161,593.33 - 5.6% over
2. WillG \$156,500
4. Lotana \$152,980
5. Les \$151,829
6. Joe D \$149,500
7. Asy \$147,500
[/list=1] Well, Lee was very brave to answer first and would have bought the property at auction as the highest bidder. And, by comparison to the ANSWER he overpaid by 5.6%. Since none of the comparison properties were rentals and No. 54 was vacant no comparison rental info could assist with the valuation.

I think the range of answers show that valuing a property is not an exact science but the more comparables that can be gathered will help to get close as Lotana and Les showed. So here is a simplified valuer's checklist to help you find as many comparables as possible:

1. Obtain as much preliminary information about the property as possible, in particular:

* tenure of site;
* any tenancies;
* size and extent of accomodation and site;
* any peculiarities of the district or situation;
* recent sales, purchases or lettings of the building.

2. Thoroughly inspect the property inside and out.

3 Ascertain outstanding defects and deficiencies that need remedying to bring the property up to normal standards.

4. Make a provisional estimate of the costs of curing those defects and deficiencies.

5. Judge the effect of those costs on the mind of a hypothetical buyer.

6. Obtain as many recent transactions concerning comparable properties as possible.

7. Adjust those transactions for any rise or fall in the market over the period in which they have taken place.

8. Compare and adjust the information from the 'comparables' so that it relates as closely as possible to the property being valued.

9. For vacant properties use as far as possible transactions of vacant 'comparables'.

10. For investment properties, consider rental levels as well as yields of 'comparables'. (Refer to Steve Navra's method in post 5)

11. Allow for differing states of repair with particular reference to step 3 above.

12. Come to a conclusion in the light of your analysis which you hope will equal that of a would-be-buyer.

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Buying a property \$20.00 below valuation.

Hey Mike,

If you call it a miss - I am confused . Anyway, here is my work out:

1. Since we are valuing an even number and our stats contain just one odd number we dismiss it. Then capitalise repairs:

House No.-- Date bought-- Price + Repairs
No.20--------January-------\$230,000
No.46--------September-----\$214,500
No.66--------March----------\$202,000

2. Knowing property appreiation rate, we standardise historical prices to the month of December (e.i. how much would a property be in December). This results in the following:

House No.-- Months to December-- Rate -- Future Value
No.20--------11------------------------2.75%-----\$236,325
No.46--------3--------------------------0.75%-----\$216,108
No.66--------9--------------------------2.25%-----\$206,545

3. December value for house 54 can be calculated using straight line interpolation between houses 20 and 66 and 46 and 66 and then avaraging the two estimates.
(54-20) / (66-20) = (236325-X)/(236325-206545)
=> X1 = 214314 less 60000 repairs = 154314
(54-46) / (66-46) = (216108-X)/(216108-206545)
=> X2 = 212283 less 60000 repairs = 152283
Averaging: X = 153298.5

howsthat?

Say cheese ,

Lotana

Lotana,

As far as I'm concerned, you ACED it!!! \$20 out? I was happy to get as close as I did, but you hit the bullseye in my opinion. Congratulations!!

Now, a lucky guess would not have counted, but your workings showed a very realistic approach. Well done, GURU !!

I'll use your "worksheet" (slightly modified) to reflect how I arrived at my answer too (hope you don't mind).

1. Since we are valuing an even number and our stats contain just one odd number we dismiss it. Then capitalise repairs:
Les>> Agree completely

2. Knowing property appreciation rate, we standardise historical prices to the month of December (i.e. how much would a property be in December).
Les>> Agree - except I compounded monthly, instead of "straight-line"

This results in the following:

House No.-- Months - Rate -- Future Value - Les% -----Les Value
No.20--------11--------2.75%-----\$236,325 -- 0.25%pm--236404
No.46--------3----------0.75%-----\$216,108-- 0.25%pm--216113
No.66--------9----------2.25%-----\$206,545-- 0.25%pm--206591

3. December value for house 54 can be calculated using straight line interpolation between houses 20 and 66 and 46 and 66 and then avaraging the two estimates.
Les>> This is where we diverge somewhat. I used a kind of "straight-line", but got the impression that lower numbers increased more exponentially than straight-line

So, first I noted "average growth per house" between 20 and 46 was \$1560.84 while "average growth per house" between 46 and 66 was only \$952.20 - this tells me that "straight-line" is not the answer, and that growth is more exponential.

Since I don't know how to do exponential calculations, I took a few "punts" - expecting to get within a few dollars anyway.

So, given that the AVERAGE growth per house between 46 and 66 was \$952.20, I can be reasonably sure that 56 would be pretty close to average (probably a little less) - and that price is (before repairs) \$211352.

Now - #56 price of \$211352 is probably a little higher than it should be (I've used "straight-line" to arrive at this figure - and, if exponential, it's value will actually be somewhat lower (a few dollars)

And HERE is where I stuffed up - leaving my price much lower than it should have been

#54 is going to be higher than #56 - I had been using "street numbers" rather than houses, and when allowing for the house next door to #56, I only allowed one house number, instead of 2. So, my answer should have been \$211352 + \$952.20 (less repairs) or \$152304 rather than \$151829.

.....still well short of Mike's answer - so, not sure where the difference lies. I'm interested to see the answer. Any "exponential differences" should see this figure get LOWER, not higher

And, Lotana, even though your worksheet showed a figure higher than you originally posted, it was still closer than my original, or revised, figure. Were you going for a "bargain", guru?

Whatever, it was a bit of fun - thanks, Mike - looking forward to how you got what you did as an answer ....

I'de have thougvht somewhere in the vicinity of \$180,000 not to be unrealisitic

So is this the basic method that we should be using to value a potential IP?

Peter

G'day Peter,

I would think this kind of thing is PART of the equation - as already mentioned, it takes no notice of :-

surrounding suburbs (have they leapt recently, and is this one next to go?),

infrastructure changes (SOMETHING values lower #'s as worth more - closer to the shops, railway station, whatever... so some consideration exists for existing infrastructure - perhaps)

X factor - in this puzzle, the houses were quoted as being IDENTICAL (probably very unlikely in the real world)

So, though the puzzle tends to a logical "valuing" of a property, it certainly would not be the complete answer. But, an interesting question/post anyway IMHO.

Hi Lotana and Les,

I'm just off to work so can't give a detailed response right now but in reading your responses I realized I made life very difficult for both of you for not giving you the adjustments regarding Side of street and End of street. Sorry about that. Although you both seem to have done well without them.

No. 85 is given a +10% adjustment because its on the wrong side of the road. No adjustments given to other houses on the right side of the street. However, I notice that you both didn't consider it necessary to work out its comparable value.

No. 85 also gets a further +10% adjustment because it is at the wrong end of the street. No. 20 is at the right end of the street so it has to be trimmed somewhat to compare with houses in the middle of the street so it's adjustment is -10%. No. 46 is -3% and No. 66 is +4%.

The idea behind working out the comparable value of No. 85 is to give you one more comparable which can be used to get a more accurate average comparable value. Will give my workout when I get home, tonight.

Regards, Mike

G'day Mike,

This intrigues me:-

Mike: However, I notice that you both didn't consider it necessary to work out its comparable value.

Mike, considering it necessary didn't enter into it. It was not possible for a couple of reasons:-

1. We knew that "the other side of the street" was valued less, but had no parameters to identify by how much.

2. Although we can reasonably assume that e.g. #54 will be right next door to #52 and #56, there is no guarantee that #85 is opposite #84 or #86 - it could be opposite #66 !!!

Still, as posted previously, I enjoyed the puzzle - it has some very interesting perspectives that are worth considering in IP investing. Thanks again,

Hi Les,

I noted the two points in your previous post and both are fair comments. Thanks for all who participated in a very worthwhile exercise. What I didn't tell you was this was just a warm up exercise for the next scenario which is how to calculate the rent and value of a shop. Anyone can participate. I'll post that one tomorrow. Meantime here is my workout:

Step 1 Find the value of each property by adding the cost of repairs to the price paid.

No. 20 = \$200,000 + \$30,000 = \$230,000
No. 46 = \$174,500 + \$40,000 = \$214,000
No. 66 = \$190,000 + \$12,000 = \$202,000
No. 85 = \$140,000 + \$35,000 = \$175,000

Step 2 Add or deduct the adjustments for date purchased (growth at 0.25% per month), side of street and end of street the property is situated in to give you a comparable value.

No. 20 = \$230,000 + (Jan @ 3%) \$6,900 + Nil - (10%) \$23,000 = \$213,900
No. 46 = \$214,000 + (Sep @ 1%) \$2,140 + Nil - (3%) \$6,420 = \$209,720
No. 66 = \$202,000 + (Mar @ 2.5%) \$5,050 + Nil + (4%) \$8,080 = \$215,130
No. 85 = \$175,000 + (Jun @ 1.5%) \$2,625 + (10%) \$17,500 + (10%) \$17,500 = \$212,625

Step 3 Add the comparable values of each property together and divide by the number of properties to give you an average comparable value.

No. 20 = \$213,900
No. 46 = \$209,720
No. 66 = \$215,130
No. 85 = \$212,625

Total = \$851,375
Average= \$212843.75

Step 4 Deduct the repair costs needed to bring No. 54 up to scratch from the average comparable value and you have a valuation of the property and a good idea of what price you should not go beyond.

Average= \$212843.75 - \$60,000 = \$152,843.75

I had a look at Lotana and Les' workouts and all three are different which caused slight differences in the result. In any case I am happy with the logic of their workouts and both should rate Guru status, in my opinion.

While knowing the correct value of a property is good because it helps to know what your limit is, I suspect the reality is that in most cases you will be out-bid by someone with only a vague idea of the true value who invariably allow their desire to secure the property to cause them to overbid. This can be frustrating because you have put a lot of time into researching the comparables. How soon will you get fed up with losing properties because you won't go over the real value of the property? Has anybody got some advice on this point?

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Mike>> ".....allows their desire to secure the property to cause them to overbid. This can be frustrating because you have put a lot of time into researching the comparables. How soon will you get fed up with losing properties because you won't go over the real value of the property? Has anybody got some advice on this point?"

Mike,

Good points worthy of further discussion.....

"This can be frustrating because you have put a lot of time into researching the comparables."

Where investors tend to focus on one area, this would cease to be a problem, as they would know the place like the back of the hand. The research would be ongoing, and bargains snapped up (because of this knowledge) would tend to offset the "losses" where an emotion-driven buyer out-bids you.

"How soon will you get fed up with losing properties because you won't go over the real value of the property?"

Ah, but maybe you WOULD go over the real value. Because of your knowledge, you may know:-

1. That this area is likely to "jump" in value soon.
2. Maybe you can negotiate a delayed settlement, with access to renovate prior to settlement, in exchange for meeting a higher price.
3. Rentals may be in high demand for special property (e.g. 4 bdr rather than 3) and this property could EASILY be turned into a 4 bdr.

There are a couple of ideas, Mike - I'm sure there are plenty more out there too.

Help me out people ..... What else would have you bid above your estimated (bricks and sticks) value?

Regards,

Gurus, Shares, and Moving a House

It's amazing how much interest was generated by this thread, given the problem was simplified to a very large extent.

But.. I have done 2 real-life estimations of a similar kind in the last 6 months and they both were very close to the actual price. Here is the story:

IP1 was a beachfront block of 6 units in a run-down condition in Sydney's eastern suburbs. Factors taken into account: renovated waterfront comparable unit sales in the area, refurbishment cost, expected profit, floor area of the units, site area. Mathematical model gave an estimate of \$2.4 million. It was not for sale, so we approached the vendor who said he would start talking from \$3.2 m. In 2 months time the block was advertised for \$2.5 m.

IP2 was an unrenovated 3br unit in Bondi, deceased estate, going for auction. Factors entered into the model: comparable unit sales, cost of repairs, location (+ to be close to the beach, - to be next to a pub), floor (ground), found another (IP3) ground floor unit in Bondi going for auction the same night, partly renovated, 3 br. The model gave the same price of \$350K for both units. At the auction IP2 was sold for \$360 (\$20K over what I was prepared to pay, and I think they overpaid for it). IP3 was passed in at \$350.

Now, wouldn't it be much easier with shares? Think about it - all Coles Myer shares are exactly the same. You can buy Solomon Lew’s - or mine its still the same share. Even if you give it a coat of paint.

And to finish it off. Mathematics is too far away from real life. Until recently I thought that to move house A to house B and house B to house A all you have to do is
A = A + B
B = A - B
A = A - B

Say cheese ,

Lotana

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