Concepts of Value
by Nancy Chadwick
All products, services and things have value, but the value is not static. It
changes when events occur that increase or decrease the product’s desirability.
In addition, the value of the same product, service or thing isn’t the same to
everybody. Different people have different needs and wants at different times.
Value is based on need and the ability of the product to satisfy that need. Real
estate is no different from other commodities. Every property has value, and
that value goes up or down over time. Property derives value from its capacity
to be used. For value to increase, there must be a demand that exceeds current
or projected supply, and the property must be capable of satisfying that need
either at the present time or in the future. For example, only 6 home sites in a
builder’s 30-home new construction community back up to property maintained by
the municipality as permanent open space. Superior location in limited supply
increases demand for these home sites and allows the builder to charge hefty lot
premiums for them.
Types of Property Value
It’s virtually impossible to come up with an all-encompassing definition of
“value” because its meaning varies widely depending on who’s defining it. There
are different types and sub-types of value – for instance, insurance,
replacement, reproduction, rehab (before and after), wholesale and retail value.
The criteria used to measure these kinds of value are different.
Market Value and Highest and Best Use
Real estate appraisers define “market value” as the most probable price at which
a property will sell in a competitive and open market where both buyer and
seller are acting knowledgeably and without duress or abnormal pressures. With
the sales comparison approach, appraisers identify properties that have recently
sold that are similar to the subject property in several respects (e.g., use,
type, location, size, condition). Estimating value is at best an inexact science
because buyers and sellers often make decisions that can’t be explained or
rationalized. Consequently, determining value isn’t a cut and dried process
accomplished merely by applying objective criteria. The “highest and best use”
used by appraisers in arriving at an opinion of value is the most profitable use
that is legal, reasonably probable, supported by demand, physically possible and
economically feasible. The potential use must meet all of these criteria.
“Warts and All” Value
Present or “as is where is” value is the value of the property as it currently
exists. This value assumes that no change will occur. It’s the value that is
arrived at after taking into account the property’s current uses, conditions and
physical or other limitations, both known and unknown, and is usually discounted
to reflect the property’s “warts.” If you bought a property in its as-is
condition, you’d be taking it as you found it. You wouldn’t be making your
purchase contingent on satisfactory results of inspections or the seller making
any repairs.
“What If” Value
Future value is based on the assumption that at some point in time there will be
some change to how or if the property can be used. This value involves
anticipation and is the one on which developers generally base their
projections. They ask themselves: what can I do to this property that will
increase its value. This might be getting some type of municipal approval (like
subdivision or zoning) or it could involve a physical change, such as modifying
or demolishing an existing structure or converting it so it can be used in a
different and more profitable way. Future value is not guaranteed. The event or
change may be probable but it won’t become reality until it actually occurs.
Perceived Value
People’s decisions are based in part on their perceptions and the reality
becomes whatever they believe it to be. Perceptions as well as facts define
value because perception is directly tied to demand. Increased demand for a
property results from the perception that the property is desirable – e.g.,
property in a certain school district that is considered top-notch. Stigmatized
properties have reduced demand. For instance, properties located next to power
lines. The reality may be that the power lines don’t present health hazards, but
until people believe that and their perception changes, the properties will
continue to be viewed as undesirable and their values will suffer.
Now vs. Later Value
Property values do not necessarily increase over time, and the passage of time
can actually reduce and not increase value. For example, the owner of 20 AC of
land throws his fishing line in the water and puts an inflated price tag on the
property. Nobody “bites.” Months go by and the municipality declares a
moratorium on issuing sewer permits, thus prohibiting new connections until the
existing plant is expanded or another one is built. The owner here would have 3
options:
1. take the property off the market until the moratorium ends;
2. sign an agreement contingent on the buyer being able to subdivide and
purchase sewer permits; or
3. sign a non-contingent agreement selling the property in its as-is state.
Site yield and sale price would be maximized with Option 2. If the owner doesn’t
want to wait for the moratorium to end (Option 3), buyers would likely discount
the purchase price to compensate for increased risk and holding period. If the
owner weren’t willing to discount the price, the property might not sell at all
unless there were special circumstances, such as a very strong seller’s market,
a unique property or heightened demand.
Future value is greater than present value if changing its as-is state results
in a broader market for the property. A municipality targets an area in its
comprehensive or master plan for future growth, zones it accordingly and plans
to extend public services to facilitate development. Investors scramble to
control parcels suitable for development and land values spike. Some of these
parcels are subdivided and communities of new homes emerge over time. These sell
for higher prices than the existing homes. The older homes also increase in
value because: (1) the higher prices of the new homes tend to raise the overall
value of the neighborhood; and (2) the market for the resale homes now includes
more buyers–those, for instance, who only want to purchase properties that have
public utilities.
Value is always relative to use. The price that a buyer is willing to pay for a
property is directly proportionate to the ability of the property to satisfy
that buyer’s needs and wants. The greater the number or categories of buyers who
can use the property, the greater the property’s inherent value. The real value
of any property is ultimately the price that a buyer is willing to pay for it in
exchange for the terms and conditions agreed to by the seller. When buying
property, think like a seller because some day you will be one. Don’t over
improve a property relative to the value of its surroundings.
Bio:
Nancy E. Chadwick, President and Broker of Chadwick Real Estate, Inc., is a PA
licensed real estate Broker and Instructor. She entered the real estate business
in 1982 following her career in the Philadelphia legal community as an
environmental and litigation paralegal. She has specialized in land development
for most of her real estate career, achieving top-producer status in several of
her past agency affiliations. Her services have been sought by a wide range of
clients, including builders and developers, non-profit organizations, estates,
REO departments of financial institutions, medical groups, consumers and other
real estate professionals.
Her book Land Buying & Selling is based on the state-of-the-art courses she
created that have been approved by the PA Real Estate Commission (for real
estate brokers and agents) and the PA Board of Certified Real Estate appraisers
(for certified appraisers and appraiser candidates). She also teaches courses
exclusively for consumers.