How to correctly price one’s property and what constitutes fair market value is the question every vendor (and buyer) must face eventually.
What does “correctly priced” mean? How to assess the price of my property? Here are 3 different approaches to come up with an answer:
1. The sales comparison approach: comparing a property‘s characteristics with those of comparable properties that have recently sold in similar transactions.
2. The cost or replacement value approach: the buyer will not pay more for a property than it would cost to build an equivalent.
3. The income approach: similar to the methods used for financial valuation, securities analysis, or bond pricing. In general, the sales comparison approach is difficult to apply in Bali as there are very few comparable properties that have recently sold and there is no database of sold properties to be consulted.
A lot of the information out there is biased and those people who seem to know at which price a certain villa got sold, haven’t witnessed the transaction personally and only know so from the vendor, who probably rounded up the true amount quite a bit to look better in front of his friends and peers. Replacement value calculation A more useful way to assess the price of my property is using a replacement value calculation. This is basically an exercise in assessing what it would cost to replace a particular property at current prices. It’s very much the same approach an insurance company would take to assess the replacement value of a property.
Whilst the replacement value of a property is a valuable guide in the price assessment process, the most crucial factor is obviously demand. If demand is low, you may not even get the replacement value and on the other hand, if demand is high you may get a price well above that mark. The income approach to arrive at fair market value compares the potential rental income of a villa for both short (holiday rentals) and mid-term rentals (1-year) and computes net present value at a discount rate of 5-10 percent.
• Let’s assume Villa Ciao Calo achieves a net profit of USD 100,000 per annum through holiday rentals.
• Let’s also assume that it’s on leasehold for 25-years and an investor buying the villa, would like to get an 8% return on investment on his capital. Using Excel’s net present value formula you’ll get the following:
• Payments or Income per annum: USD 100,000
• Interest Rate or Discount Rate: 8.0 percent
• Years during which income is earned: 25
• Net Present Value USD 1,067,477.62 This means, that if buying Villa Ciao Calo at a price of USD 1,067,477 an investor will make a healthy 8 percent return on investment on the villa if the annual profit remains at USD 100,000 throughout the future period.
If my villa creates a net profit of USD 100,000 per annum and has 25-years of leasehold and I would like to sell it for USD 1-million net, what would be the return on investment of my potential buyer?
Use the Rate Financial Ratio and you will find out that the answer is 8.8 percent. We like the income approach to asses the price of my property because there is no argument against financial logic.
Here is the spoiler of all the above logic and science: “If you want to know the ‘real’ price of a property, make an offer and see what happens.”