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The Danger of Investing in Cheap Property
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The recent credit crisis is highlighting the danger of cheap property.
"So Cheap The Market is Bound to Explode" - a typical sales man's pitch as reported by the FT in a recent article on falling prices in Florida.
For many months on the Property Secrets forums we've been debating whether 'expensive' property in Romania is a good investment vs 'cheap' property in Berlin (or Hungary).
My view is that the search for 'cheap' property is both financially dangerous and also a fundamentally flawed argument.
Why?
Because of the Apples and Bananas problem.
When you compare one development in Bucharest with another in Bucharest (or one in Warsaw with another in Warsaw) you can say that one is 'cheap' in comparison with the other.
You can also say that one development has future potential (which basically means that you believe things will happen in the future to increase demand and therefore prices for those properties).
However, you can not say that one development in Bucharest is 'cheap' or 'expensive' in comparison with Berlin, Bogna, Bogata or Budapest.
Why? Because the fundamentals that drive property in any city are - exactly that - fundamentally different.
And, there is not sufficient evidence to think that price growth in one city will affect another. (Okay, in the UK we are all used to a ripple affect - but the UK is an exceptional country for many reasons; 1. It is an island! 2. It is very dense (and really just one big city) 3. It is a small island that has been develop over hundreds of years and has limited unused spaces...)
If we take another country - Spain - we can see that the ripple effect has no impact. For instance, two of the fastest growing cities - Madrid and Valenia are seperated by mountains - in the middle of which lies Teruel, Spain's cheapest and poorest performing property market.
No ripple effect there, then.
So, once we look outside small dense islands, we see that the ripple effect doesn't apply.
And that means you can not imply that Berlin prices will rise just because there is a boom in Poznan and Warsaw (the nearest neigbours).
There may be a boom in Berlin IF (and it is a big IF) the economic development of the Polish / German border delivers substantial GDP growth and starts to feed new investment into Berlin's local economy.
... but the point is that we have now switched from talking about property markets and property price ripples to economics...
... and if the economic case for Berlin was strong, then we'd believe that investing in Berlin would be a good idea (regardless of its relative cheapness or expensiveness).
Hence, it is time to stop worrying about whether a development 'feels' cheap or expensive and instead ask ourselves these two questions
- 1. Is the development good value in comparison with neighbouring developments in the same city (you can ask a valuer to provide this information as we do in any of our investments as well as build some local comparative analysis of similar properties in the same city - see some of our Investment Reports for examples of this...)
Please do not fall into the trap of thinking that a #40,000 flat on the Bulgarian coast is cheap and good value - because a flat on the Spanish coast might cost you #100,000.
The chances are that they will now both go down in value (Bulgarian coast very rapidly, and Spanish coast moderately - which will only serve to make the Bulgarian coast look even cheaper!).
Likewise, Florida might look 'cheap' now but it is only going one way, price wise.
My view is that it is 'cheap' for a reason - and that is that there is a lot of supply and not much demand.
So, what is the solution? Well, stick to the two key questions listed above and this will (inevitably) lead you to invest in cities with excellent mid to long term growth prospects.
Find these cities, then find a good value investment - by comparison with other developments in the same city ... and there you have it.
Just don't fall into the trap of buying anything that is 'cheap' and missing out on all the 'expensive' stuff - which has all the potential for capital growth.
Cheers
Neil
ps. Putting this another way - you can 'value invest' in stock markets - but if you try the same in property markets you'll get burnt.
pps. Is Sofia cheap in comparison to Bucharest (this is a question we get asked a lot) and it can not be answered. What we can say is this - Sofia is at an earlier stage of development than Bucharest - therefore offers more opportunity (perhaps) - along with more risk (perhaps).
ppps. A trend I have noted is that bigger investors like more expensive units! They 'just' buy cheap...
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POSTED BY
NEIL LEWIS
ON
TUE 27TH NOVEMBER
AT
10:24 GMT
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TAGS:
Spain Property, Sofia Property, Property Investment, Property Economics, Florida Property, Cheap Property, Bulgaria Property, Bucharest Property Prices
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