Real Estate Valuation

Factors in Property Valuation

The most obvious application of real estate valuation is when a real estate property is being bought and sold, where both sellers and buyers become very interested in the value of a property because this will influence the price that is paid for it.

We would think that whatever price becomes agreed upon would reflect the true value of the property, since what we are after ultimately here is market value and the price that was paid is certainly a market value.

It’s not hard to imagine how the price paid would not be that accurate in assessing the true value of the property though. Perhaps the seller is desperate, or the seller is a bank who is simply looking to move a foreclosed property to get it off their books.

Real Estate ValuationThe buyer may also be overvaluing the property for a number of personal reasons, or maybe they didn’t do their homework, or perhaps they just simply didn’t negotiate very much. Offers for the purchase of real estate can vary considerably, and there are certainly personal factors that may have a property being worth more to one person than another, matters of fit or taste or other preferences for example.

The price that is ultimately paid for a property will come down to a number of things, and valuing real estate is far from an exact science or exact anything for that matter. We will usually start by comparing what we consider to be comparable properties, and look to see the price they brought in recent sales, but this is at best a very coarse way of comparing and deciding value since these properties are often not so comparable and there are so many other factors present in the sale of these other properties.

This at least gets us in the ballpark though, and over time, the market will speak, although the amount of time that a property is on the market will matter as well. Quicker sales, where the seller is eager and may accept the first reasonable offer, may produce a different price than a more patient seller who will spend a lot of time assessing the market and taking more offers.

The manner in which the property is marketed will matter as well, and this can differ quite a bit among agents. The degree in which a property is staged or whether renovations are performed or other alterations to the appearance to make the property more attractive to buyers will also influence the price.

Increasing the Value of Real Estate

When a property is bought and sold, the market itself will determine the value of it to some degree, but the property from an appraisal standpoint is less variable. However, different appraisals will still tend to produce at least somewhat different evaluations, as there is at least some subjectivity involved, and this is why banks tend to use a single appraisal company so that this can be standardized more.

As far as residential real estate goes, owners can take steps to make properties more valuable and achieve better appraisal values, although one must be careful not to spend more on improving it than what will be gained from higher valuations of it.

When property owners spend money on renovations, they will at least capture some if not most of the money they spent back in higher valuations, and sometimes they will even show a profit so to speak, but one must be careful with these improvements if improving the value of the property is a primary goal.

Some improvements may benefit the homeowner more than it would prospective buyers in general, particularly if the improvements are of a particular subjective taste or function which may not be as valued generally.

As a general rule, it is a good idea to look at the improvements you are looking to make and try to decide whether people generally would pay this much for the improvements, if they were spending their own money. General tastes as well as fashion need to be well accounted for in order to achieve at least satisfactory results with influencing the value of the home.

Improvements with commercial real estate do follow function more than style, and commercial properties do seek more efficiency, so it’s important to consider whether other buyers or tenants will value the improvements enough.

One’s personal tastes and preferences do factor in here as well, and should, to some degree anyway, although if one is planning on selling the property, the general preferences of others need to be accounted for as well. Real estate is a competitive market generally, and even differences which may be perceived as rather small and insignificant by sellers may be deal breakers for buyers who may decide on a property a little more suited to their tastes and needs.

There is often a trade off here though, between what the owners want and what the market may prefer, and often times owners will make changes to their property that don’t really add much value if any due to just wanting a change.

This may not be a very efficient way to spend one’s money, to change things around and often times spend quite a bit of money in renovations and not really change the value of the property very much. This is perfectly fine as long as one is aware of all of this, and some people don’t really think about how their renovations will affect their property value very much until later, when they start caring about such things more.

Property Valuation Isn’t Always About Getting More When Selling

Some people may not be planning on selling their property in the foreseeable future, or may not intend to ever sell it at all, and they may think that market value therefore isn’t very important or may not matter at all.

Unless we own our homes free and clear and do not ever plan on borrowing again, property valuation is indeed important and generally very important, because this will determine how much equity they have in their property and how much they can borrow against it.

One may have a lot of equity and may not be concerned about less significant changes in its value, but as a general rule it is wise to pay attention to such things, should one need to use a significant amount of their equity such that this may matter.

One’s wealth is measured by how much equity one has in one’s home or other real estate, so this really needs to be something that we become and stay aware of, as far as how what we do or do not do with our properties is going to affect it.

How much someone would pay for our home, even if we do not have any intention of selling it at all, is therefore going to matter. Not only does this affect our net wealth calculations, it also has practical consequences, as wealth tends to have. If we need to borrow, the equity we have built up is what we will be borrowing against with secured financing, and secured financing is always preferable to unsecured borrowing, as it comes with significantly lower interest rates.

When we spend money on real estate that is not captured by corresponding increases in property value, we are actually spending the money, the same way as we would spend it on chattels such as disposable personal property, like a car for instance.

It’s a benefit to drive a nice car, and we get more than just economic benefits out of this, just like we will get more than the economic benefit out of property improvements. Improving real estate does have the potential for economic benefits as well though, where we may be able to use the increased equity that results to borrow more if we need to, and ultimately capture part or all of our spending later when we sell.

Real Estate Increasing in Value Over Time

Real estate does tend to increase in value over the long run, and this is what makes real estate such a successful and valuable investment over time, but this effect does tend to vary quite a bit in the shorter term.

Whenever we buy real estate, we really need to be looking at the overall market as far as whether properties in general tend to be overvalued, and exercise caution whenever this is the case.

The housing bubble in the early part of the 21st Century is a good example of this, where the market was artificially spurred by unsustainable lending practices, which led to the market pulling back very significantly.

As good as it is to see your property go up in value, it can be pretty ugly to see it go down. This not only affects the price you get when you sell, it also affects your ability to borrow against it, which can really limit your options and even strangle your borrowing power.

During periods of economic boom, and especially during periods of low interest rates, this can cause real estate markets to rise quite a bit. The idea of what goes up must come down really doesn’t always apply to real estate, as real estate can just keep going up, but sometimes these rises are just not sustainable.

Real estate value does come down at times, and can come down with quite a thud, and this can result in loss as well as financial hardship.

We need to both be aware of the probability of such declines happening and also plan well for them in accordance. In particular, if one expects that there is a real risk of one’s property losing value, one must be more conservative in their borrowing practices and rely less or not at all on using their home equity to bail them out of paying too much interest or being overburdened by debt in the shorter term.

Given the importance of all this, lots of people spend lots of time analyzing real estate markets, and one need only do a little homework to be kept up to date on what may be expected. No one can see the future, but if analysts are predicting some sort of crash and using words such as bubble, it pays to pay attention and conduct oneself accordingly.

Real estate is generally a fabulous investment, but like all investments, can have its pitfalls at times, and whenever one is investing, it is a good idea to look to account for the market and now changes in it may affect us from a practical standpoint.

Monica

Editor, MarketReview.com

Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.

Contact Monica: [email protected]

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