The Power of Buying Below Market Value
In the real world very few property investors go down to their local estate agents, choose a property, and then offer to pay full price for it.
Any well advised and self-respecting property investor will want to negotiate and then buy at what they consider to be a bargain price.
A mantra we hear repeated almost as often as “location, location, location” is “the profit is made on the purchase”, in other words, if you can buy at a low enough price your profit is already built-in.
Many investors target properties they can buy BMV, below market value, or put another way and perhaps more simply, buy at a bargain price.
At this point we could go off at a tangent about how we define value, and what constitutes a genuine discount, but for now, if an investor can buy at a price which is genuinely below the true market value, they can buy using less finance and so the cash-on-cash return will be that much greater.
The question many new investors ask is how does one find a property which is BMV? The simple answer is to first find a ‘motivated seller’.
Sellers can be motivated to sell quickly for a number of reasons, but one thing they will pretty much all have in common is that selling the property, and selling it quickly, is more important to them than price.
The only proviso is that if they have a mortgage, the level of mortgage may limit the amount by which they can drop price. If that is the case then an investor might be able to agree terms other than price which still makes the property an attractive proposition. However, that is a subject for another time.
Many property experts and advisors have highlighted that it is relatively easy to find ‘Motivated Sellers’ during a down market (when prices are falling).
However, this doesn’t mean that one can’t find equally motivated sellers when the market is stagnant or recovering.
For a start, even when a market does recover, there will be a time lag period during which some property owners who found themselves in financial trouble at the tail-end of the falling property market, or the tail-end of the recession, still need to resolve their difficulties. Sadly quite a few people find that the seeds of their financial problems have been sown during the tough times months, or even years, previously and they may well need to bail out quickly even after the market turns.
And equally sadly, there will always be those who, usually because of negative life events, will find themselves needing to off-load their property quickly no matter how benign the prevailing market conditions.
So, buying at a bargain price is a way that any serious property investor should try to use to supercharge their already impressive prospective returns. Let’s see what this does to the figures.
Let’s assume that each of our 3 investors can buy their properties at a genuine discount of 25% from the true open market value.
If they “gear-up” using their £100,000 they can buy 4 properties, each worth £134,000, for £100,000. (In practice we’d say these properties are worth £135,000 but I want to try and keep the maths as accurate as possible to help with comparison).
Although the properties are worth £134,000 each, the bank will lend on ‘the lower of the purchase price or the value’. In this instance the purchase price is £100,000, and is lower than the value, and so that is the figure the bank will lend against.
As we’re assuming we are gearing up, we’ll think just of the 20 year figures (as this is a reasonable term for a buy to let mortgage) although I’ll calculate the 30 year figures for your interest and curiosity.
So, on day one each investor will have 4 properties, each worth £134,000, each with a mortgage of £75,000 and each with equity (the value less the amount of the mortgage) of £59,000.
Their £100,000 has now purchased £536,000 of property .Here’s how things will look after 20 years.
Investor No 1 will have properties worth a total of £1,411,288, say £1,400,000 with equity of £1,100,000.
Investor No 2 will have properties worth a total of £2,498,296, but say £2,500,000 with equity of £2,200,000.
Investor No 3 will have properties worth £5,170,416 say £5,170,000 with equity of £4,870,000.
Here’s how things will look after 30 years.
Investor No 1 will have properties worth a total of £2,316,538, say £2,300,000 with equity of £2,000,000.
Investor No 2 will have properties worth a total of £5,393, 607, but say £5,400,000 with equity of £5,100,000.
Investor No 3 will have properties worth £16,058,506, say £16,000,000 with equity of £15,700,000.
So, thinking only of the 20 year figures we can see that by actively seeking a seller who is prepared to sell their property at a price which is genuinely 25% below the open market value, our investors are greatly increasing the return on their money.
Investor No 1, who has made the least possible effort to find his properties, has increased his return by around 300%, investor No 2 has increased his or her return by around 400%, and the pro-active investor No 3 has increased the return on the money invested by 500%.
Here’s a graphical summary of where we have got to:
|£ Equity after 20 years|
|Investor No 1||Investor No 2||Investor No 3|
|With gearing & BMV||1,100.000||2,200,000||4,870,000|
But there’s still more they can do as we’ll see in the next post.
Next time we’ll look at how our returns can be increased significantly by adding value.
Here’s to successful property investing
Peter Jones B.Sc FRICS
Chartered Surveyor, author and property investor
PS. By the way, I’ve rewritten and updated my best selling ebook, The Successful Property Investor’s Strategy Workshop, which is an account of how I put together my multi-property portfolio, starting from scratch and with no money of my own, and how you can do the same. For more details please go to: