UNDERSTANDING VALUE Price mech Lyrics

UNDERSTANDING VALUE
Price mechanisms continuously operate to establish values in the marketplace. Countless exchanges of goods and services and a host of prices ultimately lead to value. Real estate value is intrinsically tied to sale prices. Value responds to price fluctuations over time, as supply/demand forces play out in the marketplace.
Differing Values
Many types of value are referenced in our complex society. The Canadian economy is filled with value: insurable value, book value, appraised value, salvage value, a__essed value, liquidation value, loan value... even sentimental value. In real estate, the primary focus rests on market value. Endless debates rage on what constitutes value. Undeniably, the ebb and flow of the market and price mechanism (asking and selling prices) are at the source. Value, for real estate purposes, is most commonly confirmed through a___ysis of historical data.

Subjective vs. Objective Value
Value has both subjective and objective dimensions: objective relating to the direct cost of creating (e.g., acquiring a lot and building a home), and subjective involving the perception of value in the minds of the buyer and seller. In subjective valuation, cost is not the primary consideration, but rather the present worth of future benefits that accrue from ownership. For example, a home and lot may objectively cost $225,000 to build, but the $195,000 selling price is subjective (value in the eyes of the buyer).

Most estimates of market value rely on subjective values. However, appraisers ensure that both dimensions are a___yzed by using three approaches to establishing value: the cost approach, the income approach, and the direct comparison approach. The cost approach favours objective value through a___ysis of actual cost, while income and direct comparison approaches emphasize subjective values. Through all three mechanisms, appraisers arrive at an estimate of value.

Market Price vs. Market Value
Market price is the price for an individual property, while market value is an estimate of value arising from many sales (market prices). Consumers are often misled by market price. For example, a sale may occur for $295,000 and neighbours a__ume that comparable homes will command at least that value. However, special circumstances may have been present, i.e., the seller was under financial duress and sold too low.

Conversely, the property may have had a distinctive feature that commanded a higher price. Knowledgeable appraisers seek various comparables (market prices) to ultimately estimate value.

Curiosity

From Marketplace to Market Value

Individuals seeking real estate values first go to the market, obtain relevant facts, and then
a___yze their findings to arrive at market value.

The real estate market involves thousands of transactions.
Market prices for individual transactions are driven by supply/demand.
Market prices are established through negotiations.
Review market transactions for most comparable properties.
Most comparable sold properties are selected for comparison (subjective).
Costs a__ociated with reproducing similar properties is a___yzed (objective).
Three approaches to value may be considered in arriving at estimate of value (cost, direct comparison, and income).
Estimate of market value is prepared and the report completed.

Market Value Defined
Market value (also referred to as value in exchange), is based on judgement arising from various sales in the marketplace. The definition, frequently found in appraisal reports, is:

The most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and a__uming that neither is under undue duress.

Source: The Appraisal of Real Estate, 11th Edition, Appraisal Institute.

Four a__umptions of Market Value

Investment Value

Investment value, as with market value, flows from the present worth of future anticipated benefits, but differs in that the value of the property is most directly related to cash flows, investor objectives, and related circumstances. For example, an individual investor may perceive added benefit due to a specific use for the property, his/her tax status, investment yield requirements, etc. Interestingly, commercial practitioners may encounter circumstances in which market value is established based on an unknown buyer with a second investment value relating to specific needs of a buyer. Market value and investment value can in theory be the same, but in practice often differ.

Focus: Value in Use

Value, while simplified for this text, is a complex issue. For example, appraisers must contend with value in use. a__ume that a small plant in Barrie is worth $750,000 to its owners given its unique layout which accommodates a specific manufacturing process. Yet, to a developer, this aging building and site has a market value of $650,000 (less building demolition costs), when contemplating a new condominium project. The property has a higher value in use to the owner than its true market value. The same could be true of a residential property in London in which a tennis court consumes the entire rear yard. To the owner, the special value (value in use) attaches given his devotion to tennis. To the buyer, the unsightly court is viewed as an obstacle to be removed for landscaping and a pool. Some buildings and a__ociated purposes are so unique in design that few buyers would seriously purchase the property. Establishing a defensible market value may be all but impossible.

Value

The quantity of one thing that can be obtained in exchange for another. Money is the common denominator by which real property value is usually measured. The utility of a commodity, such as property, is expressed in the amount of money that would be paid for its acquisition. Value is the present worth of future benefits arising out of ownership to typical users or investors and depends on the need for, and availability of, a commodity; i.e., supply and demand.
Application

Value is the key word used in practically every segment of the real estate business. Its significance and importance would imply a precisely and clearly understood meaning. Unfortunately, this is not often the case. Value is a word for which there are as many definitions as there are types of value in everyday life. For example, the tax a__essor usually thinks of value in terms of a__essed value, the insurance agent in terms of insurable value, the accountant in terms of book value, the appraiser in terms of market value, and the commercial practitioner in terms of both market value and investment value. Further, the banker or mortgagee is likely to equate value with lending value. A natural tendency exists to attach to the word value a variety of descriptive adjectives suggesting a specific kind of value: intrinsic value, sentimental value, salvage value, liquidation value, and appraised value.

A precise meaning has been a life-long study of many economic theorists. Most debates centre on objective versus subjective value. Objective value maintains that value is tied to the cost of reproduction. Subjective value states that value exists only in the minds of buyers and sellers.

Further, one of the most important distinctions for real estate purposes is that value may have one value in exchange and quite a different value in use. A second important distinction arises from activities of commercial practitioners between market value (value based on the actions of typical buyers and sellers), and investment value (value of the subject property based on individual investor needs, goals, and objectives).

For additional discussion relating to differing perspectives on value, see Investment Value, Market Value, Objective Value and Subjective Value.

Subjective Value

Created and exists only in the minds of the potential buyers and sellers. Subjective value is the price that people will pay for a property, irrespective of its cost, as differentiated from objective value in which value is a__ociated with the cost of production or cost of creating the property.
Application

An appraiser uses subjective value in both the direct comparison approach and the income approach. In fact, the subjective value dominates real estate valuation. It can matter little what costs are a__ociated with development of a property. Value is measured through the present worth of all the future benefits that likely will accrue through ownership. Future benefits do not necessarily indicate money, e.g., an income stream. Non-monetary benefits, in the case of residential property, may include subjective factors such as pleasurable living, or amenities, e.g., a park or forest reserve.

Objective Value

(see also Subjective Value)

The value of a property based on the a___ysis of costs a__ociated with the reproduction of that property (an exact replica), or one of equal utility, (a replacement). Replacement cost is most commonly used given the ease of obtaining accurate information.
Application

Objective value plays a significant role in determining value by means of the cost approach. Essentially two schools of thought have arisen over the concept of value. One school emphasizes the objective nature of value as it relates to the actual production cost of creating a property (the cost approach). The other, representing advocates of subjective value, believes that value exists only in the mind of potential buyers, sellers, owners, and users of real estate (the direct comparison approach).

In the residential appraisal process, both methods of valuation are used reflecting these schools of thought, but the direct comparison approach is more heavily relied upon.

Five steps make up the cost approach.

Market Price

The amount paid, or to be paid, for a property in a particular transaction. Market price is an accomplished or historic fact, as opposed to market value that remains an estimate until proven otherwise. Market price involves no a__umption of prudent conduct by the buyer and/or seller and does not a__ume the absence of undue stimuli, reasonable exposure to the marketplace, or any other condition basic to the market value concept. Under an efficient market system, where property is openly offered and promoted to well-informed, capable buyers, market price and market value closely approximate each other.

Market Value

The highest price in terms of money, that the property will bring to a willing seller if exposed for sale on the open market; allowing a reasonable time to find a willing buyer, buying with the knowledge of all the uses to which it is adapted and for which it can be legally used, and with neither buyer or seller acting under necessity, compulsion nor peculiar and special circumstances.
Application

Market value is not to be confused with market price, i.e., the amount paid, or to be paid, for a property in a particular transaction. Market price is an accomplished or historic fact. Market price tends to closely align with market value in an efficient market system involving willing, informed buyers and sellers acting rationally and prudently, given reasonable periods of time with no undue influences. Successive market prices in the sale of comparable homes form the basis of estimating the market value of a particular property.

Market value should not be confused with cost. Expending $150,000 in constructing a new home plus $80,000 for the purchase of the land in no way ensures a market value of $230,000. However, a__uming a reasonably efficient market, the difference between actual cost and market value may be negligible unless obsolescence was built into the property or intervening factors affect the marketplace, such as lack of housing supply, dynamic growth in a particular market, or extremely depressed market conditions.

Value in Exchange

The amount of goods and services that an informed buyer would offer in exchange for an economic good, under given market conditions. Value in exchange is relative, since there must be comparison with other economic goods and alternatives available from which the potential buyer may choose.
Application

Value in exchange is best described as the probable price at which a commodity trades in a free, competitive, and open market and is synonymous with market value.

Investment Value

Investment value is defined as the value of an investment property from the perspective of a specific investor. Investment value must be clearly differentiated from market value. Market value focuses on the most probable price that a property will sell for based on a typical buyer and seller. Many appraisers reference market value as value in the marketplace. Both market value and investment value flow from the present value of future anticipated benefits. However, differing a__umptions and conditions can alter the perception of such benefits. Investment value is slanted to the individual's objectives and unique investor circumstances that can affect yield; for example, marginal tax rate or distinct operating methods that may affect income and/or expense projections. Accordingly, forecasted cash flows will vary based on the extent and weighting of these factors and these, in turn, impact the valuation process.
Application

Many investor-oriented factors can intercede in arriving at investment value. Commercial practitioners, in providing estimates, must carefully review all income and expense forecasts in relation to the individual investor. For example, the net present value (NPV) of future cash flows is a direct consequence of the selected discount rate. The discount rate may be derived totally from the marketplace but ultimately be modified to reflect such factors as investor tolerance for risk and stated corporate policies regarding anticipated returns. Even minor alterations to a discount rate can significantly impact value. The investor's tax position will also affect cash flows after tax and directly impact both the screening and selection process.

Interestingly, commercial practitioners work in two worlds: market value estimates and investment value estimates. On the one hand, a salesperson may be required to estimate market value a__uming no specific buyer when working with a seller client. Conversely, he/she may a___yze prospective properties based on the needs and dictates of a specific buyer client and arrive at a unique investment value. The difference between these values is dependent on a__umptions made. Market value and investment value can be the same theoretically, but rarely are in practice. Practitioners may prepare both market and investment value estimates, or even a range of values for each based on selected a__umptions. The client is then furnished with parameters in which to select both an initial bid position as well as overall negotiating range.

Value in Use

The value of an economic good to its owner/user or prospective buyer that is based on the productivity of the economic good to that specific individual. This usually consists of market value plus an increment that represents some extra value to the owner/user or prospective buyer.
Application

For real estate purposes, value in use is the value given to a property by the owner who is using that property. The property would probably have been designed or used to suit the particular needs and enjoyment of the owner and takes on a special significance that translates into an additional monetary value in the owner's opinion. This type of value is difficult to measure and is normally different in every case. It may often be higher than market value, since it is looked at from the owner's viewpoint only.

Interestingly, buyers considering investment property may perceive special value due to unique circumstances, needs, or uses particular to that individual that can be applied to a property. This uniqueness can translate into value, most commonly referred to as investment value. Commercial practitioners often use investment value when a___yzing investment-grade properties. However, special value is not limited to commercial property. Residential property may also have additional value to a specific buyer given certain features or amenities.