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COST, PRICE AND VALUE - we use the words interchangeably in normal conversation, but in the real estate world they have distinct meanings. The words have more specific meanings when linked with descriptive modifiers, such as construction cost, sold price and market value.
Cost
Cost refers to production rather than exchange. Construction Cost is the cost to build or remodel something. Development Cost is more comprehensive and includes the cost of the land, construction and the profit the developer requires to bring the project into being. Cost can refer to the actual amount paid or an estimate.
Companies such as Marshall and Swift publish detailed construction cost manuals using information provided by building materials suppliers and contractors all over the United States. The manuals issue monthly updates and include adjustment factors for different regions. Insurance companies use sophisticated computer programs to estimate Replacement Costs.
The cost approach is one of the three standard methods for estimating real estate value (the other two are the “sales comparison” and “income” approaches). The cost approach is based on the theory that land is always valued at its highest and best use as if vacant and the improvements are valued according to how they contribute to (or detract from) the value of the land. This is a useful valuation approach when there are a lot of comparable land sales, when the improvements are new, or when the property is unusual or unique. A knowledge of current construction costs can also help buyers make the decision to buy or build.
The tricky part about using costs to estimate value is depreciation. Land, by definition, does not depreciate. Land can lose value in a number of ways, but it’s not called depreciation. Improvements, on the other hand, begin to depreciate as soon as they’re built or installed. They can lose value from physical aging and from functional problems such as bad design or obsolescence. They can even depreciate from external forces such as noise, contamination or an oversupplied real estate market.
Price
The Sold Price is what someone actually paid for a property. This is usually the best indication of value, but not always. For any number of reasons buyers may pay more or less for a property than it’s theoretical market value. The buyer or seller may be uninformed. The seller may be under duress and accepted a low offer because of a divorce, job layoff or an impending foreclosure. The buyer may have “fallen in love” with the property or paid more in return for favorable financing.
The sales comparison approach is a way of estimating value by comparing the subject to comparable sales, called “comps.” This approach is based on the economic theory of substitution – a buyer will not pay more for one property than for another that is equally desirable.
There are several problems using sold prices to estimate value. Sometimes there are no comparable sales. Sometimes the available sales are totally different from the subject and require large adjustments. Also, good real estate sales data is not generally available to the public.
The best source of real estate sales data is the local multiple listing service, or MLS. This is a proprietary database available only to real estate brokers, agents and related professionals who pay a fee. The MLS includes details about property which has sold, the terms of the sale and how long it was on the market. It even includes previous expired and withdrawn listings.
Most people rely on someone else to estimate value – an insurance agent, a lender, a real estate agent or an appraiser. It’s important that the person providing the value estimate be unbiased, technically competent, well-informed about the property and familiar with the motivations of local buyers and sellers.
Real estate agents often help buyers and sellers by preparing a free “comparative market analysis” using recent comparable sales and listings. A CMA is not as detailed as the process which a licensed real estate appraiser must use, but both types of reports usually rely on MLS data.
However, MLS data is not perfect. It often contains errors such as incorrectly-measured lots and improvements, wrong zoning designations, unknown construction dates and undiscovered property defects. The trend is clearly in favor of better real estate information, increased disclosure and more consumer protection. Even with good real estate information, selecting comparable sales takes a certain amount of skill, experience and judgment.
The next best source of sold prices are the up-and-coming real estate information services such as Experian, DataQuick, MetroScan and others. These companies purchase MLS and county assessor data and enhance it with maps and other information extracted from appraisals and lending documents. Commercial real estate information services such as Comps.com conduct detailed interviews with buyers and sellers. A variation on the real estate information service is the regional MLS, operated in some parts of the country as a proprietary network or “intranet” with paid subscribers.
The only public source of real estate sales data is the County Assessor’s records. Getting access to this information used to require a visit to the county courthouse or owning a bulky microfiche machine. Private vendors now publish these records monthly on CD-ROM. A few County Assessors are starting to publish their real estate data on the Internet, which has raised some hot debates about privacy.
In some areas the assessor’s records are not open to the public, depending on the laws and policies of the particular state and county. But assessor’s data, especially in rural areas, can be pretty sparse. Most public records include little more than the owner’s name, the assessor’s parcel number and the current tax assessment.
The best way to find out what someone paid is by talking to one of the parties involved in the sale – the buyer, the seller or the agent. This is also a good way to confirm sales data derived from another source. A personal interview can reveal important details about the sale that may have influenced the price, such as sales between related parties, sellers who were under duress or major property defects.
The Asking Price – In real estate, the asking or list price is the most widely available type of real estate information. The public has traditionally relied on newspapers, magazines and real estate offices to provide them with real estate listings. Until recently, the public has never had complete independent access to real estate listings over a wide geographic area.
The Internet is now becoming a major provider of real estate listing data through sites such as Realtor.com, HomeSeekers.com, HomeAdvisor.com, HomeScout.com and CyberHomes.com. Buyers all over the United States (and other parts of the world) can now compare real estate prices in different cities while getting related information about jobs, recreation, cultural amenities, school districts, weather and even crime statistics.
Because buyers and sellers don’t have very good access to sold prices, they may place too much emphasis on the asking price, which can often be a poor gauge of value. In some cases, the asking price is the sellers “dream price,” and can be far above the market value. High listing prices are more common in rural areas where there are few comparable sales, uncertainty about real estate value trends and poor real estate information.
Real estate agents normally advise their clients about listing prices, but they can get caught in a dilemma. If they bend to client pressure and list too high, the property won’t sell. If they urge their client to set a more realistic asking price, the client may list with someone else.
Value
Unlike cost and price, value is always expressed as an opinion or estimate rather than a material fact. Value is more accurately described as a range rather than a precise number. The process of estimating introduces an initial margin of error. Buyers and sellers add another margin of error because they make decisions based on emotions and personal preferences, not just rational thought.
Value is a simple, theoretical concept based on complex human behavior. Because there are a wide variety of beliefs and assumptions about economics and human nature, there is an ongoing controversy regarding the definition of value. As a result, people have created different value definitions for different uses.
All real estate value is derived from the market place, but not all types of value are called market value. Among the 40 or more definitions of value I have found, some are worth mentioning here.
Market Value is the most commonly-used type of real estate value because lenders use market value to make decisions about real estate loans. There are a number of definitions for market value, but they all include the same elements – specific property rights, a date of value, an informed buyer and seller, no undue stimulus, reasonable exposure in an open market and payment equivalent to cash.
Fair Market Value, used in California condemnation practice, employs a slightly modified definition of market value which uses the term “highest price” instead of “most probable price.” This definition acknowledges that value is best described as a range and assigns fair market value to the upper end (rather than the middle) of the range, favoring the owner of the condemned property.
Assessed Value is what the County Assessor uses to figure your property tax bill. In California, since the 1978 passage of Proposition 13 (the Jarvis-Gann Initiative), real property is assessed at its 1976 value and can trend upward only 2 percent annually, regardless of what the real estate market does. If you have owned your house for any length of time, your assessed value may only be a fraction of market value.
Retrospective Value and Prospective Value are market value estimates based on some date in the past or the future.
Liquidation Value or Quick Sale Value is a type of market value based on a short exposure time (days on market before selling).
Investment Value is the value of a real estate investment to a particular investor which meets his or her investment requirements.
Book Value or Fair Value is the value of an asset as shown on an accounting ledger, usually the original cost less a standard allowance for depreciation. Commercial investors know that real estate can decrease in book value while increasing in market value.
Going Concern Value or Business Value is the value of a proven business enterprise, including patents and goodwill. This is a type of non-realty value usually estimated by accountants.
Insurable Value is what the insurance company pays when a property is damaged or destroyed. This may be the full replacement cost or the replacement cost less depreciation. Insurable value does not normally include the land, which is not easily destroyed or damaged.
Use Value or Value In Use is the value a property has for a specific use to a specific user, which may not necessarily be its highest and best use.
Assemblage Value or Plottage is the increment of value created when two or more lots are combined to produce greater utility.
Excess Land Value is the value of the land not needed to support the highest and best use of the land in use. Excess land can be dividable or undividable. It can be salable to an adjacent landowner through a boundary line adjustment. It can be underlying parcels that can become legal lots with a Certificate of Compliance. Or it can be land that is subdividable under existing planning and zoning regulations.
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