Let’s look at the property price curve again: So at 12 noon we can see that the property price is at the lowest point below the real price. Now in order to find out if you have found an area that is in the 12 noon to 3pm range you need to compare the real price with the actual price the property can be bought for. So the two key figures in all of this are: If the actual price is less than the real price then BINGO!

The Actual Price

We determine this as being 95% of the advertised price of a property. As an average properties sell at 95% of their asking price. So for example if we see a property advertised for £60,000 then the actual price will be:


In reality the actual price is the price you can get the property for. It could be 95%, 100% or even 105% of the asking price dependent on how competitive the market is. However, under normal conditions 95% is about average.

The Real Price

Fundamental principles need to be applied when calculating the real price. The fundamental principles that apply to the property price are:

The greater of:

So whichever is greater out of these two figures will be the real price of the property. Therefore we need to calculate both of these prices.

The Price A Professional Investor Is Willing To Pay

A professional property investor would look for a return greater than a long term risk free rate. A good indicator of a long term risk free rate is the rate offered by the government on a 20 year fixed interest government gilt.

A government gilt is a loan to the government. You can assume that the government will not go bankrupt so we can assume that it is risk free. Property is considered to be one of the next lowest risk investments out there. I reckon the professional property investor requires a minimum of a 2% loading on a 20 year fixed government gilt in order for them to invest.

This will determine the yield required and hence set the real value of the property. Lets look at an example:

Variables:

20 Year Fixed Interest Government Gilt	5.62%
Property Investor Loading	2.00%
Annual Rental Value of Property	£5,000

The real value would be:

This would be the maximum a professional investor would pay. This gives the property with a rental value of £5,000 per year a 7.62% yield. If the property price was higher then the professional property investor will seek an alternative investement such as another property in a different area or simply wait for a property to come within his price range.

The Price A First-Time Buyer Is Willing To Pay

The price a first-time buyer is willing to pay will be what banks are willing to lend. You would calculate this as follows:

This assumes that lenders will lend four times the first-time buyer’s salary if they put down a 5% deposit on the property. So, in the same example above, if a first-time buyer wants the same property and their salary is £21,000 then they could afford a purchase price of:

So in this example the first-time buyer would outbid the professional investor and effectively ‘win’. Thus the real value of the property would be set as £88,421.

So looking at the actual price compared to the real price we have:

Actual price	£57,000
Real price	£88,421
Under-valuation	£31,421

Looking at it split between the investor and the owner-occupier:

	Owner-occupier	Professional investor
Actual price	£57,000	£57,000
Real price	£88,421	£65,616
Under-valuation	£31,421	£8,616

We can see clearly that we are within the 12 noon to 3pm quarter. Both the investor and the owner-occupier are interested because to the prices each is willing to pay are above the actual price. We can see that the owner-occupier has more to gain in buying than the investor so aggressive bidding will occur thus pushing the price up quickly and dramatically. Looking at it in relation to the property pricegraph:

So we can see who drives property prices – we all do! It’s our attitude that drives a property price not interest rates – even though all the city analysts believe that it does so. Interest rates do play a part but it’s our propensity to borrow, the availability of borrowing, the willingness of lenders to lend and our fear of missing the boat that cause prices to rise.

What is happening between 3pm and 6pm? Effectively properties are being sold above the asking price. Using the same example as above let’s say asking prices have rocketed to £100,000. Then we would have the actual price as:

Both the professional investor and owner-occupier prices will remain the same as nothing would have changed. That is to say that over the period of rocketing property prices the following would have remained stable:

 

• gilt rates
• salaries
• rental value of the property
• lending criteria of the banks.

 

So we would have the following table:

	Owner-occupier	Professional investor
Actual price	£95,000	£95,000
Real price	£88,421	£65,616
Over-valuation	£6,579	£29,384

This over-valuation is what I call the bubble element to the actual property price. Specifically the bubble element is £6,579 as it will be the lower of the two over-valuations. So in this case it is the owner-occupier because an owner-occupier has a higher valid bid price than the investor.

Looking at the graph again:

So who is buying at £95,000? Well it certainly isn’t the:

 

• professional investor or
• standard owner-occupier.

 

The people who are buying at inflated prices are:

• The speculative investor. This investor is banking on prices rising at the same rate as in the past. Also if the stock market is under-performing then the attraction of the property market is heightened. They can buy and sell within a number of months or years and make a tidy profit. This type of investor can make money if they know when to sell but they will only be selling to another speculative investor or...
• The scared owner-occupier. This type of owner-occupier is scared of prices rising beyond affordability so they buy a property for more than it’s worth, e.g. a professional working couple buying an unsuitable property to live in like a studio flat or an ex-local authority one-bed flat. They should wait for prices to fall so they can get a two-bed flat but their fear makes them buy a smaller property for an inflated price.
• The over-borrower. This type of buyer will buy by using a deposit that has been raised by borrowing from a bank, credit card or loan company or get a self-certified mortgage where they lie about their income. Either one of these strategies results in over-borrowing. They also think, like the scared owner-occupier and speculative investor, that if they do not buy now they will miss out.

 

The best way to spot a bubble element is to calculate it. The equation holds, where ‘P’ = price:

So the bubble element exists when the actual price is greater than the real price. To spot bubble elements look at the following:

What to look for	Why
Type of property	If you’re buying a studio flat for the price equivalent to five times the salary of the typical purchaser then a bubble element may exist as the property you are buying is unaffordable to the typical purchaser. It may not have a bubble element if the rental value stacks up – see below.
Type of purchaser	If you are considering buying a small one-bed flat that’s in a city centre then consider what the average salary is for a worker in that city centre. Calculate what the average city worker could afford as they will be your main buyer as they invariably pay more than an investor. Can the city worker afford what you are paying? If they can’t then you may be buying at an artificially high price unless it has a decent rental value – see below.
Rental value	What does the property yield? If the property yields greater than a 2% loading on the 20 year gilt rate then it’s priced correctly. If it yields below then there may be a bubble element to the price.
Second and third time buyers	Bear in mind that people move up the property ladder and so there is a gain from the sale of their original property which contributes to the overall purchase price. If you are buying a two-bed home then it may be a second-time buyer that is the typical purchaser of this property. The real value will be four times their salary plus the estimated gain on their previous property. If you are paying more than they can afford then a bubble element may exist.
20 year government gilt figure	This is the long term investment risk free rate. There isn’t much fluctuation in this figure but you could look at trends. Adding a 2% margin (or whatever you set) to this figure will determine the yield you require from any property investment.
Differential between long term rate and current rate	There are two types of interest rates: a long term fixed rate and a variable rate. So you could get a fixed rate for 10 years of 6% when the current variable rate is 5%. This would assume that rates are going to rise in the long term as the best rate you can get over the long term future is in excess of the current rate. If your model looks like it cannot cope with a higher rate in the future then you should consider selling or reducing your holding in the property market.
Rental value of property	The calculations above rely on an accurate figure for the annual rental amount receivable. Rents rise as well as fall so you should keep abreast of current rental values in order to calculate accurate real prices.
Current market value of property	If you’re in the property game you have to keep track of property prices! This is the only way you’re going to spot undervaluations. You need to see the price, determine the actual price, work out the real price, and then say to yourself “Oh – that’s cheap, I’m going to buy!”

So in the last four chapters we have set out the basis for the property clock. Now let’s get in to the detail of each quarter.