Questions to Ask and Answers to Know to Establish Purchase Price
The way a builder arrives at the value of the property is by mix of a process of "Market Mapping" and "Price Discovery". Market Mapping is similar to a "Sales Comparison Approach". Where the builder arrives at the value of the property by comparing it with other similar properties in the area adjusted for attributes such as size, location, age and other characteristics.
"Price Discovery" is a process where the builder floats a price higher than prevailing prices in the market. If he gets a good response what happens is that price gets established and other builders follow suit. Very often if uncorrected by market forces this can be the fundamental basis for a 'Asset Bubble' where prices just build without any basis. Hence price quoted is got from a mix of Technical Analysis, Market Mapping and Price Discovery.
However while this maybe the way a builder sets the price but it is debatable whether this is the sound basis for arriving at the price of a property as far as the customer is concerned. The buyer should look at the property purchase just like any other investment with capital invested and return got. Therefore the basis for arriving at the property price is the 'rentals' and the 'future potential growth in rentals' that the property has the potential for The most important questions to ask when valuing the intrinsic value of a property are
1) What is the net annual rent that the property fetches now ?
2) What is the expected growth in rentals over the future years ?
The second question if often guesswork and is the 'Art' part of investing. It’s a gut feel or estimate. See the video "Valuation Part Art Part Science" for more on the art part of investing. By knowing the rentals and its divergence from the EMI one can know if one is for instance buying into a asset bubble If the divergence is too much and is increasing at an increasing rate then this can be bad and disadvantageous time to make a purchase.
For a more detailed understanding do read the 'THE REAL DEAL' and 'NUGGETS of WISDOM' by A.Venkatasubramanian. Donot forget to visit www.therealdealbook.net