It’s worth what anyone is willing to pay for it, which is an utterly useless comment but about as close as you might get for some special properties. For the rest, we can surely come up with a better answer.
Most people simply pay what they can afford to. In the last global property boom, cheap money and wage inflation meant people could borrow more, so without confidence or incentive to invest elsewhere they borrowed blindly for housing. Clearly unsustainable, some banks eventually had defaults on their hands resulting in write-downs and money having to be called in to cover it. This meant there was less money for people to borrow and property prices fell (leaving some banks with major write-downs, bailouts.. and others with a greater share of household equity..).
Property is a sound investment; it is easily understood and largely free of taxes as opposed to other investments i.e. putting it in the bank. But most people borrow (leverage) into a house which means gains or losses in home equity are magnified which is why buying (or selling) at fair value is so important.
Property valuers come in and give you a number based on what has been happening in the market. For example Mrs Jones paid X for a similar house one year ago, prices generally have gone up 2% since then and taking a guess having or having not seen the place, the house is worth Y. This follows any trends, ignores any theory and is generally pretty accurate –everyone believes in them so prices set a self fulfilling trend so long as the ability to pay keeps pace. But this approach does not in anyway attempt to put a fair value on the property.
The astute investor values property like any other asset - yield. That’s it, the Y word unfortunately few are familiar with. For property this can be remarkably easy – cash flows are quite consistent and reasonably predictable so in many cases we can assume the same thing every year.
Let’s run through a simplistic example: a plain, freehold house with no issues renting at $100 per week gives a gross income of $5,200 per year. We should allow for a little maintenance, say $500 per year, and rates another $500 and perhaps 2 weeks vacancy $200 to get a net income of $4,000 per year.
Ok so it generates $4,000 in free cash each and every year, and we can expect it to keep doing so for the foreseeable future (assuming maintenance keeps up with depreciation). What’s that worth? If we were to put our money in the bank in dollars (which generally depreciate unless you are Japanese) you might get 5%, less tax so 3.85% net at 33% tax. If we consider property to be slightly more risky than putting it in the bank then we might expect a little bit more to compensate for that risk – let’s say 6%. Assuming we don’t pay tax on property income by offsetting mortgage interest, we could say we only need to achieve 4.6% yield. I wont bore you with the maths but the value of all the money earnt from the property, year in year out in today’s dollars (present value – look it up if you’ve never heard of the term) is $4,000 / 0.046 = $86,956.
Note that a linear decrease in the discount rate results in an exponential increase in value and a linear increase in the discount rate results in an exponential decay in prices. This is where speculation comes in, where your view of long term factors comes into play. Factors such as yields you could get on other investment opportunities, any tax benefits and your view of general wage inflation (the more people earn, the more they will borrow to push up property prices or visa versa), demographics, building costs etc.
If there are obvious opportunities for value add (subdivision, coat of paint etc.) then you might try and meet half way on the potential for value add.
Capital gains (or losses) are pure speculation – so unless you know something the rest of the market doesn't..
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