“How much is my villa worth?” This is probably one of the most difficult questions to answer for a real estate agent in Bali. And rightly so.
After decades of growth and increasing prices, making Bali one of the top performing real estate markets on the globe, the Bali property market has seen an unprecedented downturn at the end of 2016. Whilst there are numerous reasons for this development, a few stand out, mainly the crackdown of the Indonesian government on corruption and money laundering and the negative press regarding foreigners holding property interests through nominees. Whilst there are no reliable statistics on the performance of the luxury villa market in Bali, our own observations and those of our peers indicate that prices of transacted properties went down 30-40 % in the upper bracket (> USD 1 million), 10 – 30 % in the middle bracket (500 – 1 million USD) and up to 5% in the lowest bracket compared to the years before the downturn.
The problem is that this correction is not visible when looking at published asking prices as many vendors haven’t realized what has happened in the market and keep clinging to the price levels before the downturn and many agents are too lazy to argue with their vendors and come up with fair market value.
That’s why the number of transactions in the Bali villa market has declined dramatically. Based on information from notaries, we estimate that the number of sold properties went down more than 50% compared to the years before 2016. The market has become thin and only correctly priced properties find a buyer.
But how does one assess fair market value? What does it mean, correctly priced?
Here are 3 different approaches to this question:
- The sales comparison approach (comparing a property’s characteristics with those of comparable properties that have recently sold in similar transactions).
- The cost or replacement value approach (the buyer will not pay more for a property than it would cost to build an equivalent).
- The income approach (similar to the methods used for financial valuation, securities analysis or bond pricing).
In general, the sales comparison approach is difficult to apply in Bali as there are very few comparable properties that have recently sold and there is no database of sold properties to be consulted. A lot of the information out there is biased and those people who seem to know at which price a certain villa got sold, haven’t witnessed the transaction personally and only know so from the vendor, who probably rounded up the true amount quite a bit to look better in front of his friends and peers.
A more useful way is the replacement value calculation. This is basically a calculation to assess what it would cost to replace a particular property today. It is very much the same approach an insurance would take to assess the replacement value of a property.
Whilst the replacement value of a property is a valuable guide in the price assessment process, the most crucial factor is obviously demand. Note that today, most properties sold in the upper bracket wouldn’t even achieve replacement value.
For leasehold properties, the paid up term is another factor that needs to be considered in the equation. Buyers typically expect a minimum of 25 years when considering the acquisition of a leasehold property. The assessment of leasehold villas with less than 20 years will follow a slightly different logic than the replacement value approach. Here it makes sense to assess the long term or short term rental potential of a villa and discount it based on the remaining lease term.
This leads us to the income approach to arrive at fair market value. Here we would compare the potential rental income of a villa for both short (holiday rentals) and mid-term rentals (1 year) and compute net present value at a discount rate of 5-10%.
Here is an example how it works: assume Villa Paradiso achieves a net profit of USD 100.000 per annum through holiday rentals. Assume that it is on leasehold for 25 years and assume that an investor buying the villa, would like to get 8% return on investment on his capital. What’s the net present value or the price of that villa?
Use Excels net present value formula and you will get this:
|Payments or Income per annum||$100,000.00|
|Interest Rate or Discount Rate||8.0%|
|Years during which income is earned||25|
|Net Present Value||$(1,067,477.62)|
This means, that buying Villa Paradiso at a price of USD 1,067,477 our friendly investor will make anice 8% return on investment on the villa if the annual profit remains at USD 100,000.
Another way to approach the same question would be the following: if my villa creates a net profit of USD 100.000 per annum and has 25 years of leasehold and I would like to sell it for USD 1 million net, what would be the return on investment of my potential buyer?
Use the Rate financial ratio and you will find out that the answer is 8.8%.
I personally like the income approach to discuss prices with owners as there is no argument against financial logic. And you may just turn the question around and ask your vendor: if you were to buy a villa for investment today, what return would you be willing to accept?