The Changing Housing Market - Part Two
Intrinsic Value: What is it, and why is it important?
This is part three of my short series of articles on the changes
going on in the property market.
Last week we left things where a large proportion of house buying was
being done through companies seeking to invest clients' money for a
relatively safe return. In short, the market for property investment
funds is growing rapidly, and houses are being bought for their rental
return. This also means that properties are being bought with cash, not
As you know I keep banging on about buyers using interest rate changes
to their advantage, which means buying when rates are high but falling.
Rates will currently have to rise, which means the cost of a house
bought on margin (mortgage finance) will start to increase. Those
properties bought for cash will not cost more as interest rates rise
because they have already been paid for.
Those who bought in for a low price will get a better return on the
investment than those who buy later at a higher price, assuming prices
go up. Naturally, if house prices come down, the ROI will go up.
This could be a good thing for the housing market as it will lead to a
stabilising of prices, as when a large enough segment of the market is
being driven by companies seeking yield, that search for yield will
drive the market. As yield drops, so the funding will tend to dry up,
and so sales will fall, and prices will drop to attract more buyers. As
the yield rises, more funds will come in to take advantage of the
better rates, and prices will rise, but they will have to stabilise
around an acceptable level of yield.
I dont know where the long term sweet point is, but this will be found
over time, and can then be calculated using a bell curve. My belief is
that over time that band will probably centre around 8% ROI.
Home ownership is going to drop over the next few years. Renting will
become more popular. The economics of this change will eventually dawn
on the average holiday property buyer, and the retirement home buyer,
and they will move towards renting as well. This move is going to
impact heavily on the holiday/retirement property markets across
southern Europe. At the moment, I can only see these markets trending
lower and lower as demand falls, and ROI begins to become more and more
important to an increasingly savvy group of purchasers.
Up until recently I have been a lone voice preaching the sense of
valuing a house in terms of what I call Intrinsic Value. The market is
now coming to its senses and grabbing that concept and riding with it.
Those of you who dont want to lose money had better start looking at
intrinsic value. The current seekers after ROI are investing to get
10%+. I think the yield curve will fall slightly from there, and I
think it will be safe to value a house at an 8% yield. If the notional
yield is less than 8% the purchase price is too high.
How do you work out the yield on the type of house you are thinking of
buying? Let's leave that calculation to next week.