Ask yourself the question…. Would you prefer to have a portfolio of 100 properties earning a total of £5,000 per month, or a portfolio of 4 properties earning a total of £10,000 per month?
If you would opt for the 100 property portfolio, carry on. If you would opt for the higher income, read on.
I still speak to numerous investors who think that buying below market value, as an overall strategy, is a good focus. I personally think that it can be the most deceptive and damaging strategy an investor can adopt. Here is why…..
Why would someone sell something at a lower price than it is worth? There is always a reason for this, and understanding the reason for it is key.
But first you need to grasp the fact that the state of the market is not a factor. The market value of a property changes with the state of the market, so buying a property in a recession at a discounted price is not buying below market value, because the market value is lower because of the market.
There are a number of reasons, but the main reasons lead to the need for a quick sale and when dealing with an individual / private seller, this can be a genuine reason, but only if they have been given bad advice on the market, or they are really desperate.
There are a few differences between buying off an individual seller and a developer selling multiple properties in the same location. For the purpose of this discussion, I am going to focus on developers.
When dealing with developers, the need for a quick sale should ring alarm bells with any investor. It usually means that the demand is low, or local supply it too high, or that the properties are over-priced to begin with.
The only other reasons for selling a property below market value that I have experienced are:
- if the true value falls slightly higher than the tax-band for a stamp duty, but this is only ever going to be a small adjustment
- One or two of the cheaper properties offered in a large development are purposefully priced lower in order to use a lower “Prices from” statement on the marketing material
- The remaining properties in a development are in a less desirable position (eg. no view, next to the lift etc)
The perceived advantage of buying below market value is that when you come to resell the property, or refinance the property, you will make more money, but investors with this strategy usually find that they face the same problems as the original seller and they make less money than they would have done with a well-priced, high demand property with organic growth.
Valuers will consider market conditions first, followed by how desirable the property is to other potential buyers and most importantly, the ease of exit (how easily a bank could sell your property if you defaulted on the mortgage payments and it was re-possessed). Valuers representing lenders bring a much-needed honesty to the market.
When pricing a development, developers must assess how much a valuer is likely to value the properties at. If they value the properties lower than the price, their investors / buyers may not be able to get the mortgage they needed to complete on the property, which may cause long delays in completing sales.
One strategy developers use to assess the values is to hire their own surveyor (normally a RICS certified surveyor similar to those who value the properties for the lenders). However, I have experienced a number of cases where the surveyor will be much more lenient towards a developer at the start of the project, than they would be when representing a lender at the end of a project. After all, this is a business, and the surveyors will protect themselves in the “small print” in terms of the market and the quality of finish which may cause a change in value. They will also usually “band” their prices for each property type as opposed to giving an exact value for each property.
A developer may have their own “favoured” surveyor, which they may promise future business to subject to getting a favourable report, or they may go to numerous surveyors and select the most favourable. And although these are certified surveyors, the reports mean very little to the eventual “real” value as they are usually based on ideal conditions.
A developer knows that if their pricing is too high, they won’t get the sales, and if the launch a new development and don’t sell a property in the first few months, there is no urgency and incentive for others to buy, and it could take them years to sell before the market catches up with their pricing. This is the most common instance that forces developers to offer a discount.
There are other possible reasons such as developers going “bust” or buying off banks who are looking for a quick sale to recoup outstanding loans but all of these instances have large risks and complexities which most investors don’t have the time or experience to entertain. There are also scammers out there, so using a reputable and experienced agent will always add value and peace of mind.
Here are some interesting facts about buying below market value that I have learned, along with some real-life examples:
Bulk Buyers – if a developer offers a discount for a bulk buy, then they are usually worried about their stock levels and the ability to sell to individual buyers. Believe it or not, sellers prefer individual buyers because they usually take less time to fully commit to the purchase and if they cannot complete on the purchase, it is not going to have a detrimental effect on the development. In 2016, an overseas investor overlooked our high yielding apartments and bought 70 new apartments in Bradford discounted from £95,000 to £70,000 with the intention of flipping them within the following 12 months. They didn’t manage to sell even one of the apartments and still own them today. They are valued lower than £70,000 and more than half of them are un-tenanted.
Slow Sales – if sales are slow then there could be one of a number of things wrong with the properties. The usual reasons are that the properties are over-priced or there is an over-supply. Either way, a discount is likely to be a more realistic reflection of the actual market value but the case has already been proven that the properties cannot sell at the higher price, so this will have a negative effect on your ability to re-sell. In my experience, fast sales is always a good sign of a good deal, but you must also be aware of some tricks used by developers here. We have previously been approached by developers wanting to inflate list prices by 10% to 15% in order to readily offer discounts to buyers, we have also had experience of developers blocking off large numbers of apartments as “sold”, only to release them at a later date. Needless to say, we didn’t work with either developer.
Off Plan – in the best locations, cash-rich developers will sometimes choose to build the property first and then sell on completion because they know that they will be able to sell at a higher price. When buying off-plan, in most cases, you are buying at below market value (below the market value of what the property will be on completion). A developer will generally sell off-plan for one of two reasons, either they have funding in place which reduces in line with committed off-plan sales, or it better fits their business model as they have other projects on-going. Generally speaking, the larger developers will accept off-plan purchases and increase the prices through build to reflect the true market value. In 2014 I was selling a block of apartments in Manchester off-plan. A local lady was looking to down-size to a two-bedroom apartment at £89,000 in the city centre but withdrew from the sale because she was offered a discount on another apartment for £85,000 (reduced from £105,000) outside the city.
Unfortunately, as the development didn’t sell well, the development was cancelled, and she was (fortunately) refunded her money. She came back to me in 2016 and asked if we still had anything available in this price range. The original apartment that she cancelled on had sold and was now valued at £165,000 and I was unable to source any apartments under £100,000.
End User – different property types may have different values depending on the end user. For example, you cannot compare the price of a holiday let property to a residential property as they are valued differently. Pricing is very important to an investor. No one wants to pay over-the-odds, and doing your due diligence is very important, but you must ensure that you are comparing like-for-like. I recently had a buyer pull out of the sale of a two-bedroom cottage in a gated holiday village in Cornwall because there was a four-bedroom detached house priced lower 2 miles away. In 2019, the four-bedroom house had been let giving the owner a return of 2.8% whereas the two-bedroom cottage had yielded the owner 9.1%. Different property type, different market, different end user, different price.
In summary, in a buyers market, you should expect to buy property at a lower price, but sellers who do not price their properties according to the market, will struggle and should be avoided. For this reason, a strategy based on buying property at below market value is destined for failure.
In a sellers market, like we are currently experiencing in 2021, anyone selling below market value should be approached with even more caution.
I see many properties being offered over the internet, branded as “Below Market Value”, and these are usually cheap properties in poor areas, with little growth prospects, limited demand and a very poor tenant profile. I speak to people every day who have lost money in this market and want to get out. Most do, at a loss, to the next punter who is more focused on the number of properties they can own as opposed to the returns they can generate.
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