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How to assess a property’s value in a rising market

Despite ongoing lockdowns stifling market activity, strong demand continues to underpin Melbourne’s property market.

While there is no shortage of vendors looking to sell, restrictions have seen many decide to hold off until buyers can attend auctions and open for inspections in person.

This has led to frustration amongst many buyers eager to transact, and in turn driven up market prices amid fear of missing out (FOMO)

In a fast rising market it’s vital buyers are able to accurately assess a property’s accelerating value to ensure they aren’t overpaying, or conversely missing out by going too low.

There are three typical methods to assess the value of property.

The capitalisation approach involves calculating the annual rental return for a property.

An appropriate yield for the property is assessed, before dividing that percentage yield into the rental return – to determine the value of the property.

While this method can be useful as a cross reference for residential homes, it’s typically more applicable to commercial property, which derive far greater value from ongoing leasing arrangements.

The summation approach involves adding the cost of improvements – such as a house, garage, landscaping, pool and outbuildings – to the value of the land, to determine the overall value of the property.

This method is most useful when assessing house and land packages or when improvements are relatively new.

Older improvements, as is typically the case with the majority of residential properties, need to have depreciation factored in, to gain an accurate reflection of where true value sits.

The direct comparison approach is the most common and appropriate method for residential property and the focus of this article.

This method relies on breaking down comparable sales that are directly relevant to the subject property; and analysing how those properties compare with select elements of a target residence.

It’s important that the comparable sales analysed are actual transactions, as opposed to asking prices, to ensure a true market reflection can be determined.

Key components when assessing direct comparisons

Location is probably the most important factor, especially when assessing a property’s underlying land value.

There’s a range of components that need to be considered when determining land value, which can include proximity to public transport and retail strips, as well as beaches and parklands, which have become particularly important under COVID-19 travel restrictions.

It’s also important to assess subject and comparable properties from a negative perspective.

Is it too close to a commercial development? Is there a neighbouring high rise building that overlooks the property? Or is it too close to a noisy main road?

Another important factor, particularly in Melbourne’s middle ring suburbs is a property’s location within different school zones.

High ranking state schools can drive up property prices in the area, so there might be a significant difference in value between two properties in close proximity, but split between differing zones.

Land size and layout are also significant factors. While the square meterage of a block is obviously the major consideration, the shape of the block also impacts the value, particularly if it’s an irregular shaped block, or relatively wide or narrow. While having a corner block with multiple street frontages is often seen as an advantage, particularly for developers.

The position of the improvements on the block is also something to consider. You might be looking at a 400 square metre block, verus a 600 square metre piece of land and automatically assume the larger lot to be of higher value.

However, if the 600 hundred square metre block has heritage overlay restrictions that limit modifications, it may be less attractive than a smaller block.

From another perspective, a smaller block with a house positioned towards the front gives ample space for extension at the rear, as opposed to a larger block with a dwelling positioned at the rear, providing less opportunity to expand. In this scenario both lots may end up with similar values.

Orientations are another important component when assessing a property’s value. The position of a block of land, as well as the location of an existing building, both need to be considered.

North facing rear locations are often the most popular for a typical suburban family home, as they receive plenty of direct sunlight, particularly through Melbourne’s colder months.

However, a terrace house in an inner Melbourne suburb with confined boundary walls, can actually benefit from an east-west facing orientation, as they suit modifications to optimise the available sunlight, along longer boundaries.

Dwelling style and sizes are also a major factor. It’s important to compare like-with-like and understand the property type preference for a particular suburb.

For example, there’s no point comparing a three bedroom townhouse to a three bedroom period home, if market expectations in the suburb lean towards period homes, or vice versa.

While the size of the improvements is a significant factor, the nature of the floor plan informs the functionality of a dwelling.

This includes the size of bedrooms, bathrooms and living zones, as well as the number of living areas included – particularly amid the work from home trend, where home offices and separate spaces have become increasingly important.

A less than ideal floor plan that can be easily modified, is obviously more attractive than one that has limited options.

The quality and age of any renovations also have an impact on the value of a property.

Off street parking is another component to consider when comparing properties. For many areas, off street parking is a standard inclusion and therefore does not add extra value.

However for other suburbs, such as Middle Park where this feature is rare, it can add a significant price premium.

This is particularly crucial for apartments, where off street parking is often a deciding factor before buyers even consider a property.

While the above list covers the major components, it’s important to realise that each property type will have specific characteristics that will need to be analysed independently.

For example, despite being located in the same high rise, an apartment with an amazing view of the city will be valued higher than an apartment looking onto another building.

The moving market

Ensuring comparable sales are as recent as possible is an important consideration when working to accurately judge values.

That’s particularly the case when the market is moving quickly – on a monthly, or even weekly basis.

Assessing values in a rising market is typically guided by two components – the technical value of a property, as well as current market sentiment.

Assessing direct comparisons is primarily used to determine the technical value of a property.

In a stable market that may be sufficient enough to gain an accurate indication.

However, gauging market sentiment becomes increasingly important within a rising market.

Market sentiment

There are a number of considerations that need to be assessed when gauging market sentiment.

Determining market sentiment means stepping back and assessing movements and trends more broadly.

Are there similar types of properties consistently on the market? Are they increasing or decreasing in supply? If the supply is quite limited for a popular type of property then the market sentiment is likely to be quite strong.

The next strategy is to attend auctions and get a feel for the momentum and level of interest for a particular property type, this includes the atmosphere, urgency and number of bidders in attendance.

Are you seeing the same people attending auctions and open for inspections? Are they bowing out at a very similar price point each time, or are they getting frustrated and starting to push past their original budget?

These first hand in-person observations can be crucial in helping you uncover key insights into a rising market.

It’s also useful to research similar type properties that sold earlier or prior to your search; to help determine whether they presented good value compared to current sales.

This will help you gauge whether the market value is progressing, and at what speed.

Even if you have paid a premium in comparison to past sales, by settlement time your purchase will probably present value, if prices continue to surge within a fast rising market.

Be prepared to step out of your comfort zone in such cases.

This doesn’t mean jumping wildly over budget, but instead taking a step in front of the market.

Sidestep agent values

Finally, don’t get caught up in an agent’s quote range, and certainly don’t rely on the statement of information. While these contain comparable sales, they are typically used to justify the agent’s quoted price – with more relevant sales left off to suit the vendor’s campaign.

Another one to avoid is the common refrain, that adding 10 or 20 per cent on top of the quote price provides a solid indication. In a rising market, you may need to pay significantly more.

Every auction is different and must have the appropriate amount of due diligence and research conducted before assessing where true value sits.

Take home message

Once lockdowns eventually lift, Melbourne’s property market can expect a surge in activity, as buyers and sellers eager to transact make the most of the eased restrictions.

Given Melbourne’s rapid run of price rises following last year’s extended lockdown, we can naturally expect to see a similar trend play out this time around.

Those that are able to accurately assess a property’s value in a rising market, will be well positioned to capitalise on the investment opportunities that lie ahead.

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