Value Theory in Real Estate

The Orlando real estate market is approaching full swing.  Lots of buyers and sellers are active in the market place now.  One of the most popular topics among our neighbors is property pricing and appraisal values.  This month I’ll re-share my writing  about home valuation.  Next month I’ll write about the truths and myths about appraisals.

There are generally 3 approaches to value theory in real estate:  (1) comparable sales (2) reproduction cost (3) income potential.  In residential resale, comparable sales approach is the method of choice.   It uses closed sales to determine the market value of a property.  Assuming the market is efficient and the buyers and sellers act in their own best interest, we can derive value based on how sellers are selling and buyers are buying.  Like stock prices, the supply and demand ultimately drive the fluctuation in price: when demand exceeds supply, the price goes up.  When supply exceeds demand, the price goes down.  A home does not have a fixed value.  Its value changes with time.

Unlike shares of a company’s stock, no two pieces of real estate are exactly alike.  Comparable sales approach takes the available sales that meet the right criteria (sufficiently similar to the subject property, sufficiently close to the subject property, and sale date close enough to reflect the current market) and compare them to the subject property.  Adjustments are then made based on established guidelines as well as subjective judgments based on experience to increase or decrease the value.  For example, if a home that backs up to a road sold at a particular price, an otherwise identical home across the street that backs up to a wooded conservation would be presumed to be able to fetch a higher price (the value adjustment for conservation frontage).  A common feature in Florida homes is the swimming pool.  We presume a home with a pool sells for a higher price than an identical home without the pool.

Two crucial factors in doing the comparable sales method correctly are: (1) Selection of appropriate comparable. If wrong comparables are used, however diligent the subsequent adjustments may be, the results will likely be off.  For example, Stoneybrook sales should be used for comparables to a Stoneybrook subject property, not Eastwood or Avalon Park.  (2) Use right adjustment values. Even when the right comparables are selected, if the adjustment values are improper, the result will be off.  For example, once comparables similar in size are selected, the adjustment for difference in square footage is not the average price per square foot.  It may only be $30-$60 per square foot based on price range of home.

Licensed appraisers are trained to do this based on their professional guidelines.  These guidelines are adhered to in order for the appraisal report to be acceptable by the bank which uses this report to assess its risk in making the loan on the property.

Real estate agents are not licensed appraisers.  Their approach should start in the same objective manner as an appraiser, but there are many additional factors to consider.  Many features in a home have different values to a buyer than to an appraiser.  For example, top-of-the-line appliances in a kitchen will certainly impress a potential buyer, who may be inclined to pay more for this home than a similar one without them, but an appraiser will not appraise the home higher because of the better appliances.

So, a skilled listing agent considers all the tangible factors such as features and amenities, as well as intangible factors such as benefits and appeal.  He/she estimates what a normal buyer would be willing to pay based on the current market environment. An understanding of market trend is paramount.  In an up-trending market, the last home that sold in the area is the base on price.  In a down-trending market, the last home that sold is the ceiling on price.  In a stable market, the last home that sold is a mirror on price.

I have to stop here.  I hope the above description is helpful to you. For more details or an evaluation of your home, you can always call or email me.