Feb 8th 2010 I write notes on the various property bulletin boards. One guy asked for some advice about going into Buy to Let now to provide an income for his old age. He brought up the old chestnut about buying below market value BMV, and when I pointed out that his biggest worry should be if interest rates rise, as a 2% rise in interest rates equals a 30% rise in mortgage repayments. Anyway, I thought you might like to read my reply. I dont know who invents these silly terms, but perhaps you could tell me what "below market value" means. And why do you think house prices will go up if interest rates go up? Traditionally, when rates go up house prices come down. Think about it for a minute. If rates go up you get less bang for your buck, so why would prices rise? Interest rates are as low as they can go. They can only go up. When they do, house prices will stall or fall. I am old fashioned. I believe in simple obvious things. The price at which something sells is its market value. Below market value is a price below what it actually sells for. That means you cant buy below market value. If something sells for a price, that's what it's worth on the day. Maybe some days later it would be worth more, maybe less. So? You need to understand some basics. First you need to be able to value a house. Can you? One can value a business. It is done on a daily basis for public companies on the stock exchange. I recently bought a Japanese company. It was trading at a tenth of its book value, but I bought it at its market value, i.e., what is was selling for on the day. A year later its price is half what I bought it for. That makes no sense, but I have still lost money. What it's value ought to be is one thing, but what it sells for is what actually leaves, and then returns to my wallet. There is a book value, and a value in the market place. There is also a timeline. Put all those together and you get a trading situation. You buy low, sell high. You can only do this if two things come together at the appropriate times. You need to be able to compute the intrinsic value of what you hope to buy, and find that value is above the market price or what I call sentiment value. In short, you seek to do the opposite of what the idiots do. You do not buy below market value, you buy at market value when it is below intrinsic value. There is a world of difference. To be successful you therefore need to be able to work out intrinsic value. I tell you how to do that in my books, no-one else to my knowledge does that. The clue is above. How do you value a business? A buy-to-let is a business. Which is why I always say if you cant do maths keep clear of the property business. So, what you are seeking is to find houses or flats that are selling for less than their intrinsic value. If you are one of those folks who thinks estate agents and banks can value houses, then please tell me why they all got it so wrong by over-valuing them in 1998, and again by undervaluing them in 1992? I sold in 1988, and I bought in 1992 because I know how to value a house. The idiots didn't. I make money out of idiots, it has always been the best way. In one of my books I give the example of a flat I am currently selling. In 1987 an idiot bought it for £47,000. In 1993 I bought it, fully furnished, for £20,000. Someone valued it in 1987. Someone valued it in 1993. Did the intrinsic value of that flat vary by such a vast amount over the course of six years? Or was it the case that the market value bore no relationship to the intrinsic value of the flat? The smart guy buys not below market value, but when the sentiment value (the price in the estate agent's window) is below intrinsic value. If you dont know the difference, and how to work out intrinsic value then you have a problem, and you'll get screwed. You also need the timeline. The timeline is important because it carries information on two very important issues. The first is the interest rate. That is important because when the rate is low you can effectively buy more bang for your buck. But the corollary of that is that when the rate rises, your commitment rises too, and there is bugger all you can do about it. External factors are changing the terms of your contract with the mortgage company to your detriment. The way round this is to buy when interest rates are falling. You cant do that when rates are already on the floor. The problem at the moment is to know whether rates are likely to remain on the floor for several years or not. The Japan situation indicates they may well do so. The sovereign debt problems would indicate otherwise. Dont ask me which way the wind will blow in this instance; I dont know. The second issue with the timeline is the movement of house prices, the ebb and flow of what I call sentiment value. It goes up and down with fashion, and the availability of money and credit. Nothing else affects it, despite what the "experts" say. Look at the economic situation. When it is bad house prices fall. They rise after the economy improves, not before, hence any rise now is a false dawn. The affordability index for various parts of the UK ranges from 7 in Bournemouth to 5 roughly everywhere else. The comfortable level is 3. In a recession/depression I would expect the actual figures to be low not high. So I have to ask myself why they are still high? And when they are likely to fall. Look at the charts back in 1929-35. The real crash came late, and it crept along at a painfully destroying pace. Are we in for a re-run? I dont have a crystal ball. But these are the real issues you need to address. The bottom line is: 1    Learn how to value houses. Learn their intrinsic value. 2    Suss out the cost now, and the cost when rates rise, and plot that against the rental return. That means you need to take a view on the economic trajectory. Look at Japan over the last 20 years. Look at the sovereign debt problems in the world, and ask yourself if all is well. Then ask yourself where you will feel comfortable. With regard to btl do remember that if the income model works, who cares what the sentiment value of the house is? You are in it for the income not the capital gain. My personal view is that it is a funny time to go into this business. I am recommending my kids stay on the sidelines. I may, of course, be wrong. I prefer to go into a business that is screaming success at you, not one that looks a bit iffy. But we all have different comfort zones. I hope that helps john Back to the Top

© The Property Organisation 2010