If the words of Warren Buffet are to be believed, investing is all about buying dollar bills that are selling for 10 cents in the market. In essence, he talks about understanding the difference between the quoted valuation of an investment as well as its intrinsic valuation.
Now, in case of stocks, temporary greed and fear in the market may make it possible for the prices to go high and low. However, when it comes to real estate, it seems highly unlikely that someone will sell their million dollar home for less than what it is worth only because of temporary ups and downs in the market.
The massive ticket size of real estate investments automatically makes investors more patient. Hence, the question arises, “When and how can someone come across an undervalued real estate investment ?”. This article will list down some of the common scenarios under which properties sell for less than their worth.
The prime reason that any real estate investment will sell for less than what it is worth is seller duress. When we assume free market prices for properties, we make an underlying assumption that neither the buyer nor the seller are in any rush to close the deal. They are aware of what the property is worth and are willing to put in the time required to find a buyer that agrees to the valuation.
However, in reality, a lot of sellers face financial duress. Sometimes they are laid off from their jobs. At other times, they are filing for divorce. Still others have racked up credit card debt or have suffered losses in the stock markets. The answer to most of their predicaments is fast cash. It is important to pay attention to the word “fast”. These sellers value time a lot and are willing to offer a bargain if the seller can provide immediate cash and alleviate their financial duress.
Also, we have made the assumption that the seller is fully informed about the worth of their property. This is a farfetched assumption. The reason being that real estate prices are not listed like stock market prices. Rather they are approximate prices and can differ from property to property. Therefore, it is very likely that the sellers of some properties are not aware of the particular advantages that are provided by their property and do not charge a premium for the same. As such, it is highly likely and probable that an investor may come across an ignorant seller who accepts an offer for less than what the property is worth.
Many times, buyers default on their loan obligations. This could be due to a personal financial emergency like a job loss. Alternatively, it could be because the interest rates on their mortgage went up significantly. As a result, they can no longer afford to make the payments. In either case, the property is foreclosed on by the banks.
Once the banks have control of the property, the scenario completely changes. Banks have no interest in making profitable investments with repossessed properties. Their motive is simple and clear. They want to minimize their losses and sell the property to the first buyer that offers a decent price. As such, banks may not wait a whole lot of time, to realize the true worth of the property that they have acquired. Many real estate investors have made their fortunes by consistently hunting for foreclosed homes.
Another strategy to create a positive cash flow from a real estate property is that certain creative improvements are made to that property. This means that you buy, let’s say a big family house with 4 bedrooms. Now, there are very few families who may want to rent out a 4 bedroom apartment. Therefore, you retrofit the house to create 4 self sufficient studio apartments. These apartments can be leased out by students or working professionals. The combination of 4 studio apartments which are fully furnished for their target audience may provide at least 50% more rent than if the same property were leased out to a family.
The real estate investing world is flush with stories of investors who made millions making creative improvements to their property. However, this seems to be a risky strategy to say the least.
Lastly, some real estate investors are more well connected than the others. As a result, they have a better idea of the development plans that the government has created for a particular neighborhood before such information is made public. As a result, they have an edge over other investors and know about the adjustment in the value of the property whereas the rest of the market does not. Therefore, they are poised to buy the properties at undervalued prices and make a gain as the prices rise.
This form of investing is called insider trading. It is illegal and can lead a person to prison. However, in the real world, there are many real estate investors who have made their millions this way.
Therefore, there are multiple scenarios under which a person can obtain title to a property at a price which is less than its market value. One just needs to be more diligent and watchful for such opportunities and utilize them one they arise.