The past six months have provided people little faith in understanding price and participating in the property market with many current owners breathing relief they are not navigating this minefield.
It has been such an unprecedented time with so much pandemic-driven uncertainty, cheap money with nowhere to put it. Everyone is looking for a safe haven to ride out the crisis. People looked towards the bedrock of Australian society being residential property. That’s when the irrationality began. Buyers frenzied creating a very hot market where auction results were broadcast over the media as “Sold $1 million over reserve.” “Sold 30% over price guides,” and in some cases sold almost double the price paid for the property the year before. I am talking of the former AMP CEO house in Woollahra. Bought in 2020 for $7.5m sold in 2021 for circa $13m. These results are the ones that reach the headlines and not every sale follows the exact same route. They do represent the general sentiment of the market. How can you understand the price in such a market.
No one knows how much a property will sell for. Given the hubris in the market, it has been even harder to derive value. The price of the property is what someone is willing to pay for it. How can you work out what that figure is; especially when people are willing to pay more than what we thought was possible?
Understanding that irrationality is part of the human behaviour which drives the market. Understanding the types of people looking to buy property, essentially your competitors, then understanding their motivations. What incentivises them can help delve into what your competitors are willing to pay.
We need to break this down first to locations. Demographics of a location will provide a general idea of the financial capacity of your competitors based on the general types of employment. This is a great first step but too general to provide you with meaningful property specific information.
The type of property and their characteristic in conjunction with the location provide far more valuable and insightful inferences than location alone.
I’ll provide a real-life example to best illustrate the idea.
Property: Two Bedroom Apartment with parking with a price guide of $750,000.
Buyers: You can deduce that the most likely purchaser of this property. Would either be a First Home Buyer (FHB) looking to get a foot onto the property ladder or. A cashed property investor looking to put money away somewhere other than the bank.
What are the motivations and incentives of each buyer?
First Home Buyer
First Home Buyers are generally taping into the Bank of Mum and Dad. Which according to the fin review is the ninth biggest lender. They are cash strapped and scraping every cent towards the purchase. Any concessions or mechanisms to allow them to save more money will be utilised. The First Home Buyer stamp duty concession up to the threshold of $800,000 will be a key indicator of understanding price limits of any first home buyer. A $1 bid over the $800,000 will cost the first home buyer thousands as they will become liable for what is now fully payable transfer duty.
Any savvy investor will understand that the capital gain on property is where you really make a return. Rental yield still plays an important consideration in any purchase for mainly two reasons. The first is potential rent to be earnt and how quickly the property could be rented (faster the better) is indicative of the potential capital gain as it shows that the property is desirable. The second, is the yield indicates the opportunity cost of choosing this property over other potential investments. What I mean by that is, At what yield is this an infeasible investment where you would be better off to place your money in another property or investment vehicle with a similar risk profile such as government bonds?
If this particular property earns a market rent of $500 per week which amounts to $26,000 gross income per annum. If the investor paid $750,000 for the property that calculates to 3.467% Gross Yield. Lets say gross yields of 2.5% in this area are very normal. If the rent stays the same in the short and medium term, the maximum that an investor would pay to look to gain a similar return to the market would be $1,040,000. If Australian 15-year Government bonds have net yields of 1.78%. At what price above $1,040,000 would an investor be comfortable with this investment and how sure of a future capital gain in order to justify accepting a lower yield?
This thought process can be applied to virtually every property in the market. Stepping outside of one-dimensional thinking in what you believe the property is worth to you and think about what the property is worth to someone else will help you shape where the market for your particular property is.