How do you place a value on your home? Is it difficult to determine housing values in the tumultuous real estate market in which we are battling right now? Is there a science or method that works the best?
Anybody who knows me has heard me often say "I am long-term bullish on home values." Of course, anybody who reads what I write will tell you that I am confident home values are dropping, and home values will continue to drop for the next several years. There is too much evidence of unwanted supply to believe we will see real estate appreciation within the next three years, so only somebody not paying attention (or somebody with an agenda) will say otherwise.
The purpose of this blog post is to discuss how you place a value on the home that you own today, and why you should consider developing a long-term real estate acquisition strategy.
Three Methods For Determining Real Estate Value
Any novice real estate agent (or appraiser) can tell you that a real estate appraisal considers three methods for determining the value of real estate. I will address them briefly, then show you the hidden secret about their relationships that will allow you to invest successfully in the real estate market.
- The Cost Approach - The cost approach works on the basis of analyzing what it would cost to build the subject property in today's market, adding in the current value of the parcel of land on which it sits and then subtracting a factor for any depreciation or obsolescence.
- The Income Approach - The income approach is typically used with investment properties. The net income a property generates (Net Operating Income (NOI)) is used to derive a market value based on a multiple of the property's annual income. The more income a property generates, the more it is worth.
- The Sales Comparison Approach - The sales comparison approach (market approach) works on the basis of looking at the selling prices of similar properties that have recently changed hands. Each sales price is adjusted up or down to make the comparable property more similar to the subject property.
The real value of a property includes all three approaches, but the resulting value is heavily weighted in the direction of the market value. Ultimately, a property is worth what a Seller is willing to sell for and what a Buyer is willing to pay for it. The sales comparison approach shows recent examples (proof) of what the home would fetch in the market if both the Buyer and Seller are reasonable.
How You Place A Value On Your Real Estate
An appraisal of a property utilizes the three approaches listed above. To understand what an appraiser will report, one only has to do the research to determine how to satisfy the three approaches, and then apply a weighting to each value that basically minimalizes the first two approaches (meaning the sales comparison approach is what an appraiser will report as market value).
But an appraisal value is not necessarily the current market value of a home. This is not a knock on appraisers, their job is not determining the value at which a property will sell, rather it is more of an insurance policy (a second set of eyes) for the buyer or lender to ensure that a purchase or loan is not outside of normal market expectations.
A real determination of value must consider the three methods above, but then also must consider the relationship of current market factors to the three methods above. Here is what I mean.
The Real Estate Market Seeks "Cost" Over Time
This is the hidden gem, the secret to understanding long-term values in real estate. If your definition of "long-term" involves the use of a buy strategy and a sell strategy (as opposed to a market reaction strategy), then you must have a good grasp of these two (mostly local) key measurements:
- Is the population in your region growing, or is it shrinking (long-term)? If the area that you live in is growing, there will be more need for housing (supply) in the long-run and thus, the cost of creating new housing will be a major factor in the value of real estate holdings.
- Are the costs involved in making new homes going up, or are they going down. Ultimately, this is where real estate values are heading if the area in which you live is growing. Just remember, all markets are subject to supply and demand, and if more supply is needed, then the cost of creating additional supply will affect the values of the supply that is already in the market.
Coming tomorrow: Developing A Long-Term Real Estate Strategy
Joe Manausa, MBA is a 26 year veteran of real estate brokerage in Tallahassee, Florida and has owned and managed his own company since 1992. He is a daily blogger with content that focuses on real estate analytics and providing his clients with a tactical advantage in today's challenging market.