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When is it necessary to pay a premium for a property?

No one wants to pay a premium for property, but sometimes it’s an imperative.

It’s particularly important during rising markets when buyer competition is at its most fierce.

The upward shift can often wrong-foot buyers, who fail to meet the market, and resist paying a necessary premium for quality properties.

What often unfolds can be a painful, but an all too common scenario.

The market races away. High-quality properties, once within their price range, move out of reach – leaving them on the sidelines or having to settle for something lesser.

No one wants to pay a premium for property, but sometimes it’s an imperative  

Let’s look at the What, Why, When and How when considering whether you should pay a premium for a property.

What type of purchase

Is it an investment or a lifestyle property? Typically an investment property is going to be more economically focused. Whereas with a lifestyle purchase, is more driven by personal preferences and requirements, and emotion. However, there are circumstances for either one of those scenarios, where it is justified to pay a premium.

Why pay a premium

Growth potential is a crucial aspect when considering property investment. If you’re confident in a property’s capital growth prospects due to its inherent scarcity, then you’re on the right track. Scarcity arises when there’s a limited supply of a specific type of property, yet the demand is robust.

I’ve often spoken about the distinction between anomalous and scarce properties. While anomalous refers to properties that deviate from the norm or expectations, scarce properties are those in high demand but limited in supply. Properties that can’t be easily replicated and exhibit diverse demand tend to have strong capital growth potential. In such cases, paying a premium is often justified.

Another important factor in gauging capital growth potential is the balance between the land value and the improvement value of a property. If a significant portion of the purchase price reflects the underlying land value rather than the value of improvements, the property is likely to appreciate more. 

Conversely, paying a premium for a property where the improvements be they brand new or the result of significant renovations constitute a significant part of the value can be risky. Such improvements typically depreciate over time, and it may not be wise to pay extra for someone else’s renovations.

A property may have special value to you as a buyer, independent of general market forces. 

These can be strategic considerations, such as purchasing an adjoining property either to deter potential unfavorable neighboring developments or to boost the existing property’s value with additional street frontage. 

It can also stem from personal preferences, like the aspiration for more land space for amenities like a tennis court or swimming pool. 

Furthermore, the desire to keep family members close might lead to acquisitions of properties adjacent to one’s own, catering to the needs of elderly relatives or children. 

Given the one-of-a-kind opportunity, it’s prudent to approach negotiations with discretion. 

Using a representative can be beneficial in maintaining a buffer, ensuring the seller remains uninformed of the property’s special value to the prospective buyer, and isn’t presented a strong upper-hand at the negotiating table.

When to pay a premium 

The considerations under the why category often intersect with the when. This is fundamentally anchored by a property’s uniqueness and its non-replicable nature, enhancing its scarcity value.

Location: A coveted apartment block or a specific school zone that rarely has openings may necessitate paying a premium. Proximity requirements for work or family can also fall into this category.

Style: The style of the house can be pivotal. If you’re seeking a Victorian house in an area dominated by California bungalows, or perhaps you favour brick over the prevailing weatherboard houses, the rarity of your desired style can drive the price.

Accommodation: If most homes in the area are smaller, but you require more space, a premium may be warranted. For example, a four-bedroom terraced house, which is not common, can justify a higher cost.

Fit-Out: A high-quality interior fit-out can add a premium, particularly in areas where such renovations are scarce due to difficult logistics or shortage of local builders. Rather than go through the hassle of a full scale renovation, buyers can purchase a finished product.

Potential resale value: Is the property likely to attract a premium when sold later? If there’s a deep interest in this property type or if it embodies a classic style and timeless attributes that will always be in demand, it can be worth paying extra initially.

Limited sales evidence: A lack of comparable data can sometimes send people down the wrong path. Limited sales evidence might seem like a property is priced at a premium. However, this may in fact be due to an absence of comparable sales. 

A scarcity of similar property sales can instead indicate limited supply and increased demand, which justifies a premium.

How to pay a premium 

Buyers should be prepared to pay a premium in the right circumstances, but even then they must ensure they strike the right balance, and are paying a price that is aligned with market forces and future growth trajectories. 

The approach and tactics will be largely defined by the method of sale, which is of course determined by agents and vendors. It is essential not to blindly pay any amount demanded. 

It’s much harder to justify paying a premium in an off-market transaction as they lack transparency. It’s also difficult to assess if the market has truly been tested and that the price premium can be justified.

In contrast, auctions provide buyers with greater transparency and confidence given the visible competition. Here, any premium paid is genuinely a result of competing parties visible market forces determining fair value. 

If you do find yourself navigating private sales or off-market deals, diligence is paramount. Ensure the sale price aligns with your objectives, whether you’re prioritising lifestyle, accommodations, or viewing it from an investment lens balancing risk against potential reward.

Take home message

It’s essential to recognise that while no one enjoys paying a premium, there are circumstances where it’s not only warranted, but is also imperative.

The key lies in understanding the real value the property holds for you and your circumstances, be it from a lifestyle and financial perspective, and judge that against its broader market value. 

Remember to think through its future capital growth potential. A property bought for a premium in the present day market, may ultimately look like a bargain with several years of capital growth behind it.

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