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“Something is only worth what someone is willing to pay for it.” We’ve all heard this saying, right? When our clients ask us what their home is worth, or whether a property they are considering is priced well, we generally start our research with this perspective. After all, the goal is always to offer clarity and insight that our clients may not have found on their own.
Another saying of equal value is “One man’s trash is another man’s treasure”. The point is that value often depends on perspective. In real estate, many people forget this important concept. For example, it’s common for sellers to attach extra value to a property where they’ve created decades of family memories, a perspective upon which most buyers will not place much importance.
This article will look at the valuation of real estate from several perspectives, and using several methods. We will also discuss some often-overlooked factors which can have a strong influence on the price a home will eventually sell for. Like most things, there are levels of complexity to valuation of real estate, and circumstances and priorities will often dictate how deep the research goes. Experience and resources play a role, as well, and choosing a Realtor who can bring these to the table will usually provide a significant advantage.
There are many reasons a person would want to understand the value of a property. Here are a few:
- Selling a property and need to decide on a price to list
- Purchasing a property and want to know a fair price to offer
- Considering re-financing and want to calculate how much equity the owner has in the home
- Considering improvements to the home and would like to calculate the impact improvements will have on the home’s value.
It’s important to understand that the definition of value can vary subtly, depending upon the context. For example, if one buyer is willing to purchase a property for $1M, it doesn’t necessarily mean that a financial institution will share the opinion that the property is worth that amount. A lender’s risk tolerance is much lower than that of some buyers, and often their valuations are more conservative than the emotional impulses of a home buyer who has fallen in love with the house and “has to have it”. The buyer places value based upon the lifestyle the property will provide, while the lender primarily looks at re-sale value.
Buyers will all perceive value of a property in different ways, because everyone has different priorities when searching for a home. If one buyer has an elderly parent they care for, they will place a higher value on a property near to their parent than others. A car collector places a higher value on an oversized garage.
For these reasons, pricing a home for sale is not an exact science. Generally, your Realtor can provide you with a price range to consider. Where you’d like to ultimately price the home within that range will depend upon other factors, which we will examine below.
To start with, most Realtors will create what’s called a comparative market analysis (CMA) to organize market data and compare other listings with the subject property. The most traditional and basic method is to look at similar properties which have sold recently, and extrapolate a price based upon these closed transactions. A traditional CMA will vary in accuracy depending upon market conditions, location, and the subject property. We have often told our clients “Houses are like snowflakes”. No two homes are exactly alike, even if they are built from the exact same plans! A condo on the 2nd floor won’t have the same value as the same floorplan on the 32nd floor.
Despite this, a traditional CMA is a great tool for getting a general idea of a home’s value. The difference between the subject property and the comparable properties (“comps”) can also be roughly adjusted for to fine-tune the results. For example, if the subject home has granite countertops, but one of the comps does not, you may add $5,000 to the price of the comp to reflect what the home may have sold for if it did have them. Sometimes it’s uncanny how these types of adjustments can bring a list of similar properties into a very tight price range. One must be careful, however to avoid “cherry picking” adjustments to create a desired result. This type of bias can often be accidental or unconscious, and having a strict system to follow will improve overall accuracy.
While the traditional method can be effective, it can be quite complicated, especially if the list of comparable properties is short. Another, simpler method is to list all the properties sold recently in a given area in order of price. By comparing the subject property to those on the list, it’s relatively simple to see where the property “fits in” to the list. For example, if there are 10 properties sold within the last 6 months within a half mile of the subject property, we would search for the spot on that list where the properties below are “worse” and the ones above are “better”. While there is obviously a level of subjectivity involved, this method is much less complicated and can produce surprisingly accurate results. In fact, using this intuitive approach can take into account more subtle factors that would be difficult to capture using the traditional method. Sometimes, just the “feel” of the pictures on a listing, or differences in floorplans can be recognized by experienced eyes and will influence which homes are preferred over others.
Generally, a combination of these approaches will produce the best results, and the most successful Realtors will naturally aim to provide the appropriate level of detail when discussing their findings with you. Once the past market data has been examined, however, it’s critical to look at current market conditions before deciding on a real value.
Everyone knows the law of supply and demand. When something is in plentiful supply, its value is lower, and when supply is scarce, its value is higher. For this reason, after looking at the home sold over the last several months, we must compare the supply of properties available then to what is currently available. If supply was low in spring, but is higher now, we may account for this by adjusting our value downward, and vice versa. Demand works exactly the same way. Many things can affect demand for real estate. Economic factors like interest rates, unemployment rates, local businesses coming or going, and inflation can all create more or fewer buyers. Seasonal factors like weather, holidays, or school schedules will come into play as well. Longer-term forces like generational demographics, political trends, and community planning are also always working in the background. More buyers will mean higher prices, fewer buyers will drive prices down.
Finally, personal motivation is perhaps the most critical piece of the puzzle when valuing a property for purchase or sale. In other words “How badly do you want to buy or sell this property?” There are so many scenarios we could use as examples, but suffice it to say that obviously some buyers and sellers are much more motivated than others. If you NEED to buy fast, you may have to be willing to pay more, if you HAVE to sell fast, you may need to be willing to sell for less. On the other hand, there are financial realities that everyone must deal with. If you still have a significant mortgage on your property, there are certainly limits to how low you can price your home. Buyers are naturally limited to the amount of money they have or can borrow, and if the home they’re searching for is unavailable in their price range, they may need to adjust their expectations and compromise on what type of property they’re willing to buy.
Understanding the market conditions will always provide an advantage. If a buyer really loves a property, but knows that they are in the minority, they can assume that the seller is motivated to find a buyer and may be willing to accept a lower price. If a seller’s property has defects, but there is very little inventory to chose from, they may elect to price their property more aggressively, knowing that buyers have few options. Taking advantage of market conditions is a normal and natural part of any capitalist endeavor.
For buyers, when there is heavy competition for a home, there is yet one more thing to contemplate. With multiple buyers fighting over a home, it’s not uncommon for a property to sell above the actual value supported by market data. If a buyer’s motivation is strong enough for them to consider offering significantly over the value of the property, it may not matter, especially if they buyer can bring enough cash to the deal (since the appraised value may end up being below the purchase price). After all, who care’s what the home’s really worth if you’re happy with your purchase, right? If you’re in this situation, it’s important to think about the future, and where the value is likely to move over time. If the buyer plans to own the property for many years, it’s very likely that the value will catch up to the purchase price in a few years. If the buyer is planning to relocate in 2 or 3 years, however, careful consideration must be given to what direction the real estate market is likely to move in the short term, because a downturn in property values could put the buyer in a difficult situation.
Placing a value on real estate is perhaps the most important part of buying and selling properties, and understanding these essential concepts will give you the clarity you need to make good decisions, avoid bad deals, maximize your results. As always, expert help from an experienced professional in your corner may be the secret ingredient to give you the ultimate advantage.
Would you like to learn more about pricing real estate? Would you like help understanding the value of your own home? Let us know! We’d love to hear from you!
