Let’s look at a story from Zen Buddhism:

 

The wind was flapping a temple flag. Two monks were arguing about it. One said the flag was moving; the other said the wind was moving. Arguing back and forth they could come to no agreement. 

 

Finally the Master said, "It is neither the wind nor the flag that is moving. It is your mind that is moving.”

 

Similarly, we are seeing property prices moving up and down, most of us get so confused as to what is the true measurement of their values.  The question is whether there is something else that is moving.

 

When we talk about the true value of an investment property, there is an underlying assumption that a property can be valued objectively (being independent of personal opinions) regardless of the subjective (being dependent of personal opinions) views of the buyers and sellers.  But is this true?

 

Before we can understand whether there is a true value of an investment property and how to measure it, we need to go back to some basics of economics.

 

A classic definition of economics is the study of the use of scarce resources which have alternative uses. 

·          From an individual standpoint, because resources (such as properties, money & time, etc) are limited for all of us and they all have alternative uses, each one of us is ‘forced’ to look at the efficiency of our resource allocation.

·          From the standpoint of the economy as a whole, resources tend to flow to their most valued uses when there is price competition in the marketplace. 

·          Prices help allocate scarce resources to their most valued use from their alternative uses in a market economy like Australia.

 

The fact that property prices fluctuate over time, and occasionally have a sharp rise or a steep drop, misleads some people into concluding that prices are deviating from their “true” values.  But their “normal” level under “normal” conditions is no more real or valid than their much higher or much lower levels under different conditions.

 

In fact, there is no such thing as an objective or “true” value of a property.  Or even if there is one, no one would know what it is and nor would anyone care in a real transaction.  Let me explain why.

 

Let’s say you pay $500k for a property, obviously the only reason you do so is that the property is more valuable to you than $500k.  At the same time, the only reason why the seller is willing to sell the property to you is that $500k is more valuable to them than the property is.

·          If there were any such thing as a “true” or objective value of a property, neither the buyer nor the seller would benefit from making a transaction at a price equal to that objective value, since what would be acquired would be of no greater value than what was given up.  Why bother to make the transaction then?

·          On the other hand, if either the buyer or the seller was getting more than the objective value from the transaction, then the other one must be losing – in which case, why continue to be cheated?  Continuing property transactions in the market between buyers and sellers make sense only if property values are subjective; each side is getting what is worth more subjectively.

 

So when we look at the value of an investment property, we need to understand that property values are very subjective to the transaction participants.  It makes sense that property investors should measure the quality of an investment property subjectively, rather than just relying on the so-called objective measurements as growth and yield.

 

This is like if the minds of the two monks are not moving, they wouldn’t even notice the flag or the wind, let alone their movement. 

 

Obviously you have to set yourself up in a way that your minds don’t have to move, and you can afford to ignore the flag and the wind, because it is silly to pretend nothing happens when the flag is flapping on your face!

 

Hence the reason why it is important that property investors should set themselves up to the position that external shocks from the market do not require them to get out of meditation!

 

Let me use your next investment property as an example to demonstrate how you can measure its quality subjectively while using some ‘objective’ data available for everyone to help your decisions.

 

You may ask some of the following subjective questions when you look at your next investment property.  Let’s assume this list is all you care about at this stage and the order of importance at this very moment is how I list it here.  (It is obvious that other investors will have a different list with a different order at different times).

 

You may say the quality of your next investment property is measured by how well it answers the questions on your list, acknowledging that you would give higher weighting to the ones that are more important to you and that some of the questions in the list are interrelated (more on this later).

 

Let’s look at the list and see why they could be important to you.

 

1.      How long do you want to keep it?

The duration you will hold onto the property can determine what kind of properties you want to buy.  Here are some examples:

·          If you want to hold the property for more than 10-20 years until your retirement, you would probably buy a good conditioned property in a very established suburb.  It may not have spectacular growth immediately, but its consistency will give you a handsome return in the long run.

·          If you want to hold the property for only a few years, you would probably find a newly discovered suburb which has great potential, you will get in early before other people find out, and sell with a handsome profit when everyone is paying too much to get in a few years later.

·          If you want to flip the property with minimum holding time, you would probably find a property with potential to add massive value with minimum cost in areas where there are lots of buyers currently.

 

2.      What is the minimum growth you are happy with?

Any residential properties in Australia that can achieve consistent annual compound growth of 10% or more over the last 25 years are considered very good as most major cities median house price have grown about 8% annually on average.

 

There are properties that experience 20% to 40%+ growth in one year. But this growth usually does not last more than 3 years consecutively. Very often they can overshoot the market and come down from its peak later.  Spectacular growth can be caused by real improvement in the area or pure speculation. Speculation is usually not sustainable unless the fundamentals are there.

 

In new suburbs it is possible to have a property growing 20% over the next 2 years and then remaining flat for the next 10 years. While it is also possible to have a property just doing 10% each year for the next 10 years in an established suburb.

 

Which one of these two properties has better quality to you?  It really depends on how long you want to hold onto it: if you were to sell it after 2 years, you would be better off with the new suburb property, if you were to sell it after 10 years, the established suburb property is better.

 

Can you see the ‘objective’ data, growth in this case, can’t determine the quality of an investment property?  Quality of an investment property is very subjective to the investor.

 

3.      What is the minimum yield you are happy with?

Currently the rental yield for residential properties is between 3-5%. Occasionally you would see properties fall outside of this range. Typically they are either very expensive luxury properties or very inexpensive regional properties.

 

Luxury properties become very expensive because people are willing to pay for it, that willingness overshadows the importance of cash flow income from the property, hence lower rental yield.

 

Regional properties become very inexpensive because people are less willing to pay for it, hence rental is more reflective of the true cost of accommodation as a percentage of the property value.

 

Occasionally you will find some extraordinarily high yield (above 12%) residential properties. They are situated in areas which usually have a limited life span such as a mining town, etc.  The yield is so high that it almost seems like the investors are expecting the property value to be reduced to zero in a few years time. They have factored the capital loss into the yield and try to recover their money plus profit before the property becomes useless to anyone. 

 

Obviously not all extremely high yield properties are definitely given a short life span. However for those which are in this category, investors need to be aware that some of these properties can experience short term growth in value due to the fact that lots of uninformed property investors rush in for the scarce high yields and end up pushing the prices up temporarily. This price growth may not last and you also need to calculate the possible capital loss as well.

To read page 2 please click here
Property & Money Strategies for an Uncertain Time
Your Guide to Sustainable Property Investing with Bill Zheng CD or DVD Set

Whether you are a first time or an experienced property investor, the events that shook the world financial markets towards the end of 2007 would have prompted you to ask a number of questions:

- Will the current global financial crisis worsen and for how long?
- How will it affect property prices in Australia?
- What do you need to do to manage your finances in such an uncertain time?
- What should you do to manage our financial risk?
- Should you buy more properties now or later?
- What properties should you avoid if a financial crisis unfolds?
- How can you benefit from the opportunities that come with a crisis?

In this seminar on DVD or CD Bill Zheng gives his honest and hard-hitting insights into what the future may have in store for Australian residential property investors and what strategies you should consider implementing in a possible time of transition. This is an opportunity for you to review where we are, what your future options are and what your future actions should be.
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