Back in April I announced that we were forming a brokerage to help people buy and sell homes. Some of the comments were less than enthusiastic. Despite the few naysayers, we believe there is a need for the service we provide, so we have been working over the last few months to ready ourselves to take on this task. In September I am going to present a series of introductory posts describing how we will operate.
I chose the song Take it Easy this morning because we want to provide peace-of-mind with the process. Part of making people be at ease is providing accurate information so people can make informed decisions. To that end, we have developed proprietary Property Valuation Reports for the IHB community based on the principles I have been writing about for the last few years. I would like your feedback to make the reports better.
Much of the information presented in the report is freely available on our site, and with our calculator (new and upgraded ones coming) this work can be done by anyone independently. However, many people do not want to do this work themselves, and for those people, we are here to help.
The report cover sheet contains summary information; it has some pictures, the address, and a few defining characteristics to identify the property. The first piece of summary data is the asking price, and this is followed by the Comparable Value, the Likely Transaction Price, and the IHB Fundamental Value.
When we prepare a Brokers Opinion of Value, we include what we believe to be the most Likely Transaction Price based on recent comparable sales and the trend of the market. This is our best guess at what the final sales price of this property will be.
The IHB Fundamental Value is based on the rental comps with some subjective adjustment based on a property’s desirability. Since market information is always changing, the report is time sensitive, and it is dated for reference. What follows is our report for today’s featured property.
Cost of Ownership and Acquisition
The second page of the report is full of of data and calculations. It looks daunting at first, but it is arranged to provide six (6) data points critical to understanding a property purchase:
- Monthly Payment
- Monthly Cash Outlays
- Monthly Cost of Ownership
- Monthly Ownership Gain (loss)
- Total Cash Costs
- Total Savings Needed
The first three items on the list look superficially similar, but they all provide slightly different information. The monthly payment is the check you will write each month to your lender; pretty basic. We assume conventional 30-year mortgages in our calculations because it is the stable financing of long-term homeowners.
The monthly cash outlays is the total amount of all checks a homeowner will need to write each month to be current on payments, including property taxes, insurance, HOA fees and other expenses. This amount is often much larger than most people realize. Some will try to reduce their monthly cash outlays by deferring property taxes to a lump sum payment every six months, but the expense is still there, and this total can eat up a significant portion of someone’s take-home pay. I recommend using an impound account to pay property taxes to avoid the last-minute scramble.
The monthly cost of ownership is a more accurate accounting of the true cost of owning property. There are many items which add to or subtract from the actual cost of ownership such as (1) income tax savings, (2) equity hidden in the payment, (3) lost income on the downpayment money, and (4) maintenance and replacement reserves.
Once the full cost of ownership is properly calculated, this figure can be compared to the cost of a comparable rental. Any cost savings or ownership premium is reflected here. As mentioned previously, blue chip properties often carry an ownership premium whereas undesirable properties generally demonstrate significant positive cashflow.
The final area of concern is having the cash available to close the deal. The downpayment is an easy expense to identify, but it is not the only cash a buyer will need to obtain the property. Buyers have to budget moving and furnishing expenses, closing costs and interest points (if any) to accurately assess their cash needs. Also, it is not a good idea to spend all your cash on a house and leave no emergency reserves. The spreadsheet estimates 6 months net salary based on the financing qualifications for the loan amount. The total cash costs plus emergency reserves equal the total amount of liquid savings needed to close the transaction.
Estimates of Value
The third page looks at values and sets the stage for negotiation. It is composed of three sections:
- Comparative Sales Value and Negotiating Range
- Cashflow Value and IHB Fundamental Value
- Asking Price and Value Ranges (chart)
Back in May, I wrote Negotiating for Real Estate, where I outlined the negotiation process and described how the top and bottom of the negotiation range is established. The Comp Range is a measure of the highest and lowest prices of recent comparable sales. The Comparable Sales Value is a blend of the mean and the median of comps used to establish value. By blending the two values, it recognizes outliers without putting too much emphasis on them.
In a stable market, properties may trade at a premium or discount to rental parity based on their desirability as owner-occupied housing. The most desirable “blue chip” properties trade at a 10% premium to rental parity, and transitory rental properties trade as low as 25% below rental parity. When the IHB prepares a Brokers Opinion of Value, we subjectively rate the property based on its owner-occupant desirability, and we adjust the cashflow value of based on our market experience. The resulting value is a theoretical basis for a property’s minimum value in the open market. When prices begin to fall, they generally do not stop until all properties in a market reach their fundamental value.
The chart showing asking prices and value ranges displays all the numbers in an intuitive format and shows the relationships between the numbers. For instance, in the chart below, the negotiating range and the comp range is significantly above a property’s current cashflow value. A buyer wanting to pay cashflow value will not obtain this property as market comps reflect a large ownership premium. This is currently the case in Irvine and in the beach communities. It is not the case in most other markets.
Comparable Sales, Comparable Rentals and concept notes
Page four of the report has the raw data on comparable sales and comparable rentals used to generate the report. This important raw data eliminates much confusion and debate over current valuations. The sections on Comparable Sales Value and Likely Transaction Price and Cashflow Value and IHB Fundamental Value generates the most questions and confusion, so a more detailed explanation of these concepts is included.
In an effort to explain many of the concepts and calculations in the report, we have included a line-by-line series of notes detailing any assumptions.
Ignorance is …
George Orwell in 1984 wrote, “Ignorance is Strength” to describe how power is maintained by the few through the ignorance of the many. Those who are responsible for helping people buy and sell homes have preyed on the ignorance of buyers for generations to maintain their strength. They see little reason to change.
Thomas Gray in “Ode on a Distant Prospect of Eton College” wrote the line, “Ignorance is Bliss” to illustrate that ignorance to a problem creates happiness — while the ignorance lasts. This bliss may be welcome at times when the problem is intractable, but ignorance that prevents people from taking appropriate action does not lead to bliss, it leads to pain.
Ignorance is Pain. Ignorance is paying $889,000 for a property you can’t unload for $360,000; ignorance is paying $1,306,500 for a property worth $750,000; Ignorance to the housing market can lead to foreclosure and bankruptcy. There is nothing noble or romantic about ignorance to the value of real estate. I have no need to exaggerate the importance of getting this decision right.
I used the tools encapsulated in this report to avoid buying during The Great Housing Bubble. I have shared my methodology with you, and now, the IHB set up to work with you to apply these techniques to your personal situation.
I want people to make informed decisions. I wrote about the housing bubble because I wanted people to have information, and for a couple of years, all data pointed to renting — in Irvine, it still does. This is changing, and many markets have properties trading at or below the IHB Fundamental Value (IHB_Brokers Opinion_of_Value_14802_Devonshire_Ave_Tustin,_CA_92780.pdf). Based on these reports, some people will wait, some people will look elsewhere, and some people will buy anyway. We do not attempt to persuade; most people are self-motivated when it comes to real estate, and when contemplating such a large purchase, pressure just makes the process stressful.