How to price real estate
I last blogged on my search to buy a new condo in November. In early December, I stopped looking for two reasons. The first was the practical issue of just not having enough time to look with the holidays coming up.
The second reason was that vendors continue to believe their condo was worth more than what the market thought. Looking at a very narrow desired price range and in a small geographic zone, we (my real estate agent and I) saw three different places drop their prices after languishing on the market for a long time. I was unwilling to buy in such an inflated market especially with a large supply of condos coming on board locally.
However, as promised in my last update about my real estate search, here is how my real estate agent looks at pricing (any mistakes are my own). My one huge caveat is that this type of analysis is only supposed to give you a rough guide into valuation.
There are other factors that will play into price (willingness/desperation of vendor or purchaser cannot be captured into a spreadsheet). The primary purpose of this analysis is to see whether the vendor is even in the ballpark and to walk into negotiations with more than “your pricing is crazy” as the primary negotiating point. Without further ado,
- Take the price the vendor purchased the condo for (for new builds, you are looking at price per square foot in the area for a comparable space)
- For each year held by the vendor, add to the original purchase price the percentage of increase/decrease of prices in the MLS zone; make sure that if it is a house, you are looking at housing increase/decrease and if for a condo, you are looking at price increase/decreases in condos only.
- Add to the price the sum of: (cost of improvements)(percentage of return). Percentage of return is, admittedly, a subjective number. However, you can be reasonable about it. For example, my agent attributed the cost of new paint as providing 100% return in one unit since it was done a month before a condo listed.
(What I have deliberately omitted here is the impact of property taxes on the analysis. Since I am purchaser side, I am not concerned about property taxes on my return on investment. If you are vendor side, you have to add in the effect of property taxes on your return. In jurisdictions with high property taxes or where the province/state and the municipality charge property tax, it takes more to get back to even where the property is being purchased and sold in a short period of time.
The impact of property tax is consistently overlooked in vendors making decisions. It is also, in my opinion, a primary cause of why inexperienced or unsophisticated real estate investors are losing money in the real estate market. A buy and flip strategy, which frequently occurs in many condo purchases in Toronto, has to consider the cost of property tax on return on investment- especially since Toronto and the Province of Ontario assess separate property taxes, requiring a shrewd vendor to now price in the cost of acquisition, the cost of recovering property taxes and inflation in pricing to get them even back to even. In a market full of supply of certain types of condos, obtaining the right price in short term speculation is becoming increasingly difficult. The longer a vendor holds a property, the greater the mitigation of these factors. I digress so back to the post).
To give you an example, assume a condo was purchased in 2010 for $300,000. The average increase in condo prices in the MLS zone was 10% and the vendor spent $1,000 on a new washer and dryer. Let’s assume the percentage of return is 100% that year on the washer/dryer. At the end of 2010, the condo is worth $331,000 [($300,000)(1.10) + $1000).
In 2011, the average increase in the condo prices in the MLS zone was 5%. The vendor makes no upgrades. Let’s assume the percentage of return on the washer and dryer is now 80% (again, this part of the analysis is subjective. The purpose again is not to get an exact price but to provide some analysis). At the end of 2011, the condo is worth $347,300 [($330,000)(1.05) + $800).
The vendor lists this condo in early 2012 for $370,000. Even building in 5% commission, the condo should be in the range of $365,000. Therefore, you have yourself some wiggle room in negotiations. If the condo is listed for $380,000, you know the vendor is starting to push towards the upper range of acceptable pricing and there must be something unique about the place or they are being greedy.
This analysis requires a lot of data. Thus, you need a real estate who is willing to work hard. The cost of improvements figures must be provided by a willing vendor and the real estate agent has to crunch some numbers. It is by no means an easy process but, if you are interested in a place, it will help provide some guidelines as to valuations. The point is not to match the number correctly given there are some imperfections to the methodology. The point is to see whether to see whether the price is within a ballpark to begin reasonable negotiations.