4 steps to evaluate a property investment

One of the most fun parts of property investment – for me at least – is spending time looking at different properties you could buy.

But after all that browsing – once you've found something that's caught your eye – how do you know if it's a “good buy”?

This is where many wannabe investors get stuck: they enjoy looking, but can never get to a point of being confident enough that any given property is the right one to buy. As a result, they never buy anything at all.

This is fine in a way – there are more unhealthy and expensive hobbies to have than browsing Rightmove in your evenings and weekends. But without the confidence to pull the trigger on a deal, you'll never actually get closer to your goals.

(Find out how to set property investment goals.)

Four steps to evaluate a property investment

The way to get that confidence is to have a clear process for assessing a deal. Follow the process, and if a property makes it through your analysis still looking good, you can move ahead without any niggling concerns to hold you back.

I'll share my process for assessing an opportunity – which involves answering these questions:

1. What's it worth?
2. What will it rent for?
3. Does it make sense for me?
4. Are there any hidden issues?

Let's dive in…

What is it worth?

Calculating the market value of the property is the first step. But before getting into that, we need to take a brief detour…

Understanding BMV

If you've spent any time researching property online, you'll have come across the term “BMV” – standing for Below Market Value.

Every company selling property claims that they offer “BMV” deals. And everyone looking for deals has BMV as one of their requirements. But what does it really mean?

Well, some people will tell you there's no such thing. And technically, they're right. You could define “market value” as:

The price agreed between a willing seller and a willing buyer

Meaning that whenever you buy, you set the market value – so by definition, it's impossible to buy below market value.

That's true, but taking such a strict definition isn't helpful. I prefer to think of BMV as:

Buying at a better price than might have been possible under other circumstances

This is definitely possible – and is one of the big advantages of property over other asset classes.

Just imagine a situation where two houses are for sale. They're absolutely identical in every way – same size, same condition, and next door to each other. The only difference is the situation of the person selling:

• The seller of house #1 is in no rush to sell: they'll leave it on the market for as long as it takes to get the best price
• The seller of house #2 absolutely must sell the property within 30 days to avoid being repossessed

You'd imagine that house #2 would sell for less, wouldn't you? The seller doesn't have time to wait for the best offer – and they'll probably need to sell to a “cash buyer” (not using a mortgage) for reasons of speed.

Purely due to the situation of the seller, you can buy at a better price than might have been possible under other circumstances. That's – in my opinion – what most people really mean when they say “BMV”.

For another slightly more complicated example, imagine a situation with another two houses. Again they're identical in every respect, except:

• House #1 has some kind of unidentified structural problem that's causing cracks in the side wall
• House #2 is structurally absolutely fine

If you had lots of construction experience, you might know that the structural problem isn't as serious as it appears and would only cost £10,000 to put right. You'd therefore expect house #1 to sell for £10,000 less than house #2. (Maybe with a bit more of a discount to reflect the work involved in fixing it.)

But most people don't have construction experience, and won't consider buying house #1 at all: they don't know if it will cost £10,000, £20,000 or £50,000 to fix it.

As a result, there will be a limited number of buyers – keeping the price low.

So as a buyer with experience, you might be able to buy house #1 for £25,000 less than house #2. After spending £10,000 fixing the structural problem, you've effectively bought it for £15,000 BMV.

So: if you take BMV to mean “getting a better-than-usual deal due to some kind of circumstances”, it is possible.

But to know whether or not a particular purchase price is “BMV”, you first need to know what the normal “market value” of the property is.

How to assess market value

How do you work out market value? In a word: comparables.

Comparables are what professional surveyors use to work out what a property is worth. A “comparable” is a property that's:

• Similar
• Nearby
• Has sold recently

The more similar, more nearby and more recent the sale, the better the comparable.

It’s no good if they’re a mile away or twice the size, and you can’t tell anything from a property that sold two years ago or is still on the market and just has an “asking price” (which might be totally disconnected from reality).

But if an identical property across the road sold for £175,000 a few months ago, that's a strong comparable. From there, to work out the value of the property that's being sold now, the surveyor would take the £175,000 and:

• Increase or reduce it depending on the property's condition
• Increase or reduce it depending on whether the property market in general has picked up or slowed down in the intervening months

When you’re assessing a deal, it makes sense for you to calculate market value in exactly the same way: using similar properties, that are very nearby, and have sold recently.

How to value a property yourself

Let's imagine that an estate agent is marketing a property for £160,000. How do you work out what that property is really worth?

• Step 1: Completely ignore the agent's asking price of £160,000. Pretend you don't even know it: it has no relevance at all.
• Step 2: Generate a list of recent sales:
  • Go to Rightmove
  • Click on “Sold house prices”
  • Enter the property's postcode
  • Set a radius of 1/4 mile
  • Select “freehold” if it's a house, or “leasehold” if it's a flat

  You're now looking at a list of properties that have sold nearby, with the most recent sales at the top.

• Step 3: Go through the list, using the photos and number of bedrooms to find properties that are most similar to the one you want to know the value of.Ignore anything with a different number of bedrooms, or which is clearly not similar – like a detached house instead of a terrace, or just one that's obviously much smaller.If there are very few results, change your search radius to 1/2 mile and start again.
• Step 4: From your list of similar properties, work out the range of selling prices. It might be that those in ordinary condition went for £160,000, those that had been extended or had a big garden went up to £180,000, and perhaps there were some wrecks down towards £130,000. There will usually be some strange outliers too, which sold at a particularly high or low price for no obvious reason.Give the most weight to properties that sold recently. If the sale was more than a year ago, be careful because the market in general might have gone up or down since then.

This 4-step process isn't scientific, but gives you your “best guess” of what the property is worth.

Other ways of finding a property's value

If you're willing to spend some money, you can pay for a valuation report from Hometrack. It follows the same basic methodology as the “manual” process we just went through, but with a clever automated model.

You can also call local estate agents and ask if they've recently sold any properties similar to the one you're looking at. This is helpful for getting up-to-date information: it takes a few months for sales to filter through to Rightmove, so an estate agent might tell you about a sale last month that you wouldn't find online.

How confident can you be?

There are some obvious other factors you need to account for – like the condition of the property. If the property you're looking at needs £5,000 of works to bring it back up to scratch, you should deduct at least £5,000 from the value of “mint condition” comparables.

But of course, it's hard to exactly calculate what a refurbishment will cost: you might think it will be £5,000, but it could turn out to cost much more (or more unusually, much less). So this will affect the accuracy of your valuation, and you should be more conservative just in case you're wrong.

Another factor is the number of good comparables. If there's a row of identical houses and two of them have sold within the last year, you can be pretty sure about what another house in that row would sell for today. But if there aren't many comparables and the types of property are very variable, it'll be much harder to be confident.

Just remember: be conservative in your estimation, and always look for anything you might have missed. Nobody gives a property away cheaply because they're feeling generous: if you think a property is worth much more than the asking price it might be a bargain, but there's more likely another hidden factor that's holding the price down.

What will it rent for?

For properties you intend to keep (buy-to-let) rather than sell on (flip), when assessing a deal you'll need to answer two extra questions:

• Will it rent?
• If so, how much for?

(If you're flipping the property, you could ignore this whole section. But actually, it's a good idea to understand the rental aspect too – so you can have it as a “Plan B” if you're not able to sell it for some reason.)

Rental markets change over time and often move cyclically throughout the year (especially in towns with a large student population), but they don’t change that much or that fast. With a bit of research, you should be able to estimate the monthly rent you’ll achieve to within £50.

Doing this research is important – because if you need to rent the property out for £100 per month more than the closest comparable in order to cover your costs, you'll find yourself with an empty property. Rental prices are set by the market, not landlords – so you need to be confident that you'll find a tenant at a price that works for you.

Unfortunately, there's no database of rental prices that have been achieved in the past. So unlike using historical “sold prices” to work out the property's value, you'll need to work from current “asking prices” – which isn't ideal, but there usually isn't much of a discrepancy between the rent that's advertised and the rent that's eventually agreed.

The process is very straightforward, and very similar to calculating market value:

• Step 1: Get a list of what's on the market:
  • Go to Rightmove
  • Click on “Rent”
  • Enter the property's postcode
  • Set a radius of 1/4 mile
  • Select the property type (house, flat, etc.)
  • Select the number of bedrooms
  • Tick the box for “let agreed”

  If there are very few results, change your search radius to 1/2 mile and start again.

  Then when the search results come up, search by “highest price” so you see the results in descending price order.

• Step 2: Disregard anything that distorts prices at the top end (like “short lets” available by the month) and the bottom end (like listings that are actually just a room in a shared house).Then, note the range between highest and lowest rents. It normally won't be more than a couple of hundred pounds per month.
• Step 3: Click into different results to see what seems to separate those at the high end from those at the low end.With exceptions caused by landlords trying their luck or agents not really knowing the correct value, the patterns are pretty obvious: rents are higher for bigger properties than smaller, good condition than mediocre condition, furnished than unfurnished, facilities in the building than none (in the case of flats), and parking than none. There’s also a premium for locations that are well placed for transport links.While you won't have enough information to be completely accurate, you should be able to work out roughly where “your” property slots into the rankings. From that, you should be able to have a decent guess about what it would rent for – as I said, you can probably be accurate to within £50 or so.
• Step 4: Then there's the issue of how quickly it would rent. You can get a rough idea from the search listings by looking at a few different things:
  • What's the ratio of “let agreed” to available properties? If there are 10 listings and 7 of them are “let agreed”, that implies that the market moves faster than an area where 8 of them are available
  • How long has each listing been up for? You can see the date that each listing went live – which isn't perfect (agents often forget to remove listings or re-use the same one for another property in the block), but is better than nothing
  • Are many of the listings offering incentives – like a discount on the first month's rent – for someone to move in? Incentives imply, for example, that there's an oversupply of similar properties so there's competition for tenants
• Step 5: You can also test the accuracy of your own research by calling local letting agents and asking.You might think that they're motivated to lie to you, or would resent answering your questions at all, but in my experience by calling and asking a straight question you generally get a straight answer.

Does the property work for you?

By this point, you know:

• How much the property is actually worth – so you won't overpay
• How easily it will rent – so you know it won't sit empty
• What it will rent for – allowing you to run some calculations…

These calculations are critical in working out whether the property hits your personal criteria.

Because knowing you're not overpaying for a property is great, but there's no point even slightly underpaying if owning the property won't make sense for you.

(Again, if you're flipping this is less of a concern: as long as you've calculated a healthy margin when you re-sell, you don't need to worry too much about anything else. Read this post about flipping to make sure you've got your buy-to-sell numbers right.)

This is where the 3 essential property calculations come in – read that article if you haven't already, and calculate the yield and ROI of the property.

If you work out that a property is worth £150,000 and you can get it for £140,000 that sounds good…but what if it gives you an ROI of 4% and your target is 8%? Then you could argue that it's not worth buying it at all – unless you can get it for a drastically lower price.

This is where understanding your property investment goals is so important. Depending on your eventual aims, your priority might be:

• Getting a significant discount
• Meeting a certain ROI target
• Having strong capital growth potential

Or many more.

Are there any issues?

Once you've got a good understanding of the numbers, the situation and whether it makes sense for you, there's just one more question…

Is there some kind of hidden issue with the property that you don't know about?

And unfortunately, that can be a tricky question to answer without investing some cash and time.

Structural issues

If you don't have a background in construction or surveying, it's easy to miss major issues that could turn a property from must-buy to can't-run-away-fast-enough. I've seen buyers miss:

• Cracks and slopes suggesting that the foundations are crumbling
• Japanese knotweed that would make the property unmortgageable
• Creaking floorboards and a musty smell that suggest low-level rising or penetrating damp

And a whole lot more. Unless you're an expert yourself, the only way to have some degree of certainty is to pay one – in the form of a RICS survey.

Surveyors will be able to undertake either a HomeBuyer Report, which gives a general look at the condition of every aspect of the property, or a full structural survey which goes into more detail about the structure if you've got a particular reason to be concerned (and is more expensive).

Generally speaking, a HomeBuyer Report will do the job unless you can see indications of structural issues and want to know how serious they are.

In Scotland, the seller of the property must get a survey done and show it to you before you make an offer – which is entirely sensible, and much easier all round.

Elsewhere, you'll normally have to make an offer and have it accepted before you pay for a survey – running the risk that if it comes back with something unpleasant and you want to pull out, you'll have spent the money already and may have incurred legal fees too.

For more about that “what happens when?” side of buying a property, read this article about the buying process.

Legal issues

There are also potential issues with a property that you couldn't see even if you were an expert. These are related to the legal side, and could include:

• Restrictive covenants that prevent you from doing certain things
• An issue with the title, which makes it hard to prove legal ownership
• An extension or alteration that was done without permission
• A dispute over the property's boundaries
• Arrears in the ground rent or service charge, if it's a leasehold property
• A looming major works bill
• A short lease

And so, so much more.

Again, you won't know about these in advance: they'll only come to light once you've committed to the purchase and incurred legal fees. It's against the law for estate agents or sellers to withhold information that could have a material impact on the buyer's decision…but often, nobody will know until the solicitors get to work.

Conclusion

By the end of this process, you've analysed the property enough to know:

• How much it's worth
• What it will rent for
• Whether it works for you, based on your goals
• How much you should be paying for it
• Whether there are any structural issues
• (And later, if there are any legal issues)

It sounds time-consuming, but with practice you can do a “desktop analysis” in under 10 minutes.

As a result of this analysis, you should avoid the major mistakes that property investors make:

• Overpaying
• Buying a property that's a pain to rent
• Taking on a “problem” property
• Buying a property without knowing that it moves them closer to their goals

There's just one very important factor in your analysis that we haven't mentioned yet: gut feel.

If you're not comfortable with a property for any reason, don't buy it. Chances are, your intuition is right and there's some kind of problem that you can't quite put your finger on.

But even if you're wrong and it would have been fine, there's no point going through the whole process worrying that you're doing the wrong thing.

Run the numbers, look at the facts, check with your gut. If everything comes back looking and feeling good…go make your offer.