How to Know the Intrinsic Value of a Real Estate?

I have a new real estate deal coming up. As you can see from the picture above, its a 2 storey home inside a gated subdivision near our place. It is walking distance to school and walking distance to a mall. The owner have migrated to Japan (married a Japanese) and wants to sell. The price of the property is P2,000,000. Is this a good deal or a bad deal?

Let’s find out.

As a value investor, what you want to do is find the real intrinsic value of something. Be it stocks, socks or real estate. In our real life example, the price is P2,000,000 think of it as the asking price of a stock. Now, how do we know the real value? There are are different ways, one way is to look at comparable houses and how much they are sold.

Comparable Houses

Upon researching comparable houses within the area are sold for P1,800,000. I tried to offer to buy the house for P1,800,000 but the owner denied that because she had spent a lot of money on improvements. This is the thing, usually, improvements doesn’t add any value to the property, because in real estate, its the land that appreciates not the building or the improvement on the building. As I hear more details about the house, he had spent around 200k on improvements. She said, she will leave the furnitures for free, including the air condition (centralized) and some unpaid utility bills amounting to 10k.

So this person spent around at least P2,000,000 on a property. 

The Numbers

So to know the real value, lets look at some of the numbers:

Lot area : 85 sqm
Floor area : 70 sqm

The price of the lot in this neighborhood is around 7,000, multipled by the lot area you have P595,000. The cost for the construction is P12,000 per sqm. Which means we multiply 12,000 x 70 and we have P840,000 multiplied this by 2 because its a 2 storey house and we have P1,680,000.

Lot area in pesos : P595,000
Floor area in pesos : P1,680,000
Total: P2,275,000 <- intrinsic value

The intrinsic value of the house is around P2,275,000 (without improvements and furnitures that the owner bought). Which is 13.75% discount from its market price. The thing about real estate is making a profit going in. This means, once I buy this property for P2,000,000, I already made profit of P275,000. Of course, this is just estimate and is not an exact figure. There might be some cost in taxes, and other hidden costs. Buying it at P2,000,000 seems to be a fair price, if we include the cost of closing this deal.

But if this is a fair price? Wouldn’t a value investor not invest in such a deal because there’s not much discount to it? True. That’s very true. Value investors don’t buy with a puny discount like that. But the future prospects of the area is a great factor on its discounted price. The thing about investing is that, if you know more, you get to see the opportunities more. Its a game where the more knowledgeable wins. I know is a growing town because I live there. I know what is happening in this town. Its my competitive advantage. The discount will not come from the house price itself, its from the future prospect of the town and property.

The area is in a booming area. There will be new universities that is just walking distance from it. An SM mall is also walking distance and there will be new malls in construction. The house is almost brand new. I think this is a great deal. 

The Cashflow

If the seller took my offer, I would be paying her P7,500 per month for the financing. I could then rent the property for the same amount P7,500 to P10,000. The market is still volatile because the town is in a very frantic state (lots of construction). But I can already see other properties renting for P15,000, that is very optimistic. The margin of safety here is that, if I could rent on the lowest end (P7,500), I can own the property without me having to pay for the loan. And if the rent went up I can be cashflow positive.

Rental yield on low end of rate: 4.5%
Rental yield on HIGH End of  rate: 9.0%

The Offer

I made an offer to buy the house for P2,000,000. With 10% downpayment and the rest financed. Let’s see if we can close this deal. Updates will be posted as they come.

UPDATE:
The seller rejected my offer because she paid in full when she bought the house, she also wants to get paid in full when she sells it. That’s the weakness of real estate as an investment. Its very illiquid. I’m not going to pay full. 😀 Never gonna happen. So the seller might get stuck on that property for months or years. I’m just gonna walk away and look for the next opportunity.