Looking to buy property but concerned it may be the top of the real estate market cycle? Alleviate the fears of uncertain times by understanding this fundamental truth about real estate. Whether you are buying a house to be your primary residence or looking to invest in a property, learning how to determine the intrinsic value of real estate is absolutely crucial to ensuring you don't end up being on the losing end of buying property. This video shows you how to do that quick and easily.
How to Buy Real Estate at the Top of a Real Estate Market Cycle
( and it make good financial, good investment sense)
First of all, I am not saying we're at the top of a real estate market cycle. I have an amazing video "Are We In A Real Estate Bubble?" Please watch that video if you haven't already. It's a prerequisite in a way to what I am about to share.
If you are an investor that believes the real estate market is about to crash, please consider this quick thought. I recently had a YouTube comment that said, "I have been betting on the Toronto real estate market to crash for the last seven years. Boy, have I left a lot of opportunity on the table." This example shows that we don't necessarily know when we're literally at the top or the very bottom of a market. I will say with certainty that we're not at the bottom. We've had a really good run over the last five years in most parts of North America. Yes, we're not at the bottom, but we don't know if we're at the complete top.
If you decide, "I'm not going to do anything," you could miss out on opportunities. What if this incredible run we've been on continues for another three to five years? You don't want to lose out on the opportunity to be in the game.
I have a video that will show you how to determine property value the right way. It's based on comps. If you're in an uncertain market situation and relying on comparable sales, then you're basing your decision on that market condition. Which can be great if you're flipping house, but what if you're buying a home for the long-term? What if you're buying an investment property for the long-term?
Warren Buffett described intrinsic value as the idea that you add up the assets; the building, the employee value, the intellectual property, and any other tangible assets; and you come to an understanding of what the intrinsic value of that business is. In real estate, insurance companies call intrinsic value the "replacement cost". If you're talking to a contractor or a home builder, they would call it the cost to build. This will help you make the right decision and feel confident in the decision to buy, especially if you fear you're at the top of the market.
If a house is listed at $200,000, but you research and discover that the seller bought the property six years ago for $100,000. You start thinking to yourself, "Oh my goodness. This is a perfect example of a real estate bubble."
Let's assume that the $200,000 price is completely supported by comparable sales. Again, you've already followed my video on determining property the right way. Now you're trying to determine if you should purchase the property or not. I want you to ask yourself this question:
"How Does it Compare to the Cost to Build?
To determine this, take the square footage of the property itself (not including garages or screened in porches) and divide it by the cost of the property. This gives you something called "price per square foot". The price per a square foot is the intrinsic value, or cost to build/replace the property.
Example: If a house is 2000 Square feet and listed at $200,000 then the intrinsic value is $100 per a square foot.
What's Required to Build a Property
There are five major expenses that go into building a property. It is nearly impossible to build even the cheapest property with the cheapest materials under $100 a square foot. This might be possible in some areas, but I have personally never seen it. If your price per square foot is below the cost to build then that is a good thing. If your intrinsic value is $300,000, there's no way you can replace that property for less than $300,000. Purchasing a property with an intrinsic value of $300,00 for $200,000, is a good deal, even if the previous seller bought it for $100,000. If you're buying a $300,000 property, because that's the cost to replace it, that's the cost to cover all these bills, for only $200,000 that's fantastic.
Supply and Demand
The current real estate market comps may go up or they could go slightly down. Ultimately the cost to build in any reasonable, stabilized area is the great equalizer. If real estate prices drop below the cost to build then contractors will stop building houses. It doesn't make sense to build a property for $300,000 and sell it for $200,000.
Eventually populations grow and due to supply and demand the property prices go up until they eventually meet intrinsic value. Even if you are at the top of the market, as long as you're buying properties below intrinsic value, you will remain in good shape.
Single Family Homes
If you're buying a single-family home to live in or investment property, it's imperative that every time you buy real estate you consider intrinsic value. The only exception is if you are flipping the house. If that is the case, you need to focus on comparable sales and just get in and get out. If you're going to own property long-term, you need to look at intrinsic value. When looking at income-producing properties, look at the cost to replace and the true value of the rental income. Although rental rates can go down to some degree in some rare instances, they usually hold steady or go up.
When I am specifically looking at single-family homes, I'm looking at intrinsic value. This allows me to make decisions even when the market is booming. If you are on the sidelines waiting for the market to drop, and the market continues to go up for the next three years you miss out on huge opportunities. Intrinsic value allows you to stay off that roller coaster, because you don't even know where that roller coaster is going. You don't know when you're at the top and you don't really know when you're at the bottom.
Costs in Your Area
I told you the prerequisite was the "Are We In A Real Estate Bubble?" video. Make sure you've watched that, because we don't know with certainty where we're at in the real estate bubble. We know with certainty what the replacement cost or cost to build is by calling a local builder or contractor. I've seen the price to build be up to $600 square foot in some island areas or really in-demand areas. This can be because it's hard to get the materials, hard to find good contractors, or the labor's really expensive.
Find out what your cost to build is in that area. If you're getting an insurance policy, you'll always know what the replacement cost is because they have replacement cost calculators. That's another way to figure it out. Just call up the insurance agent, give them the address. They will run a quote for you. They'll tell you what the replacement cost is going to be. . I've never bought real estate where the replacement cost was less than what I paid. The replacement cost is typically hundreds of thousands of dollars more than what I pay for the property, even at the top of the market. Buy well below intrinsic value in addition to making sure you stay below the comps too.