Market Value PRINCIPLES OF VAL Lyrics

PRINCIPLES OF VALUE Market Value

If the real estate market is built on numerous individual transactions and market prices are set by countless negotiations, what underlying principles are at work? Fortunately, appraisal research has contributed significantly by explaining and codifying underlying forces. Fifteen generally accepted principles of value are detailed that, in concert, provide insight to anyone when delving into market prices, market value, and the subtleties of real estate negotiations.

Anticipation
Buyers Buy the Present Worth of Future Benefits
A buyer purchases a home with a double garage and pays $240,000 when a similar home with a single garage is available at $225,000. The anticipated benefit of that additional garage is $15,000. Interestingly, the added value may have little to do with the actual cost of the garage, but rather the perceived value of having more storage room/parking and/or the improved appearance of the home (anticipated resale value).
Balance
Maximum Value is Maintained through Balance
Three hardware stores in an area warranting only one; none will likely achieve their true potential given an imbalance of supply and demand. From a residential perspective, consider a 5,000 square foot home with only a single car garage. The home will probably not achieve its true value, as the house and garage components are not in balance.
Change
A Value Today is Valid only for Today
Salesperson Lane estimates the value of the Smith home at $249,000 today. Tomorrow, an announcement confirms that 20% of the community workforce will be laid off within 60 days. The next day, Smith calls to list his home, but the value is significantly less due to economic change.
Competition
Excess Profit Breeds Ruinous Competition
Two entrepreneurs, perceiving market opportunity, open identical stores across from each other; neither will probably achieve maximum value for their investment. Two builders overestimate market demand and build excess housing units on the same street. Neither achieves anticipated profit levels.
Conformity
Reasonable Conformance with Existing Standards Protects Value
Standards Protects Value Housing or other structures that reasonably conform with one another tend to hold their value. Inharmonious uses can impact value. See also Progression and Regression.
Consistent Use
No Double Dipping When a___yzing Value
One value cannot be given to the building for a specific use and another for the land. The two must be viewed together. For example, a residential house on a commercial lot cannot be summed as the value of the residence as a home plus the value of the commercial lot for development. The cost of demolishing or renovating the home to commercial purposes must be taken into consideration (a__uming that the highest and best use is commercial).

Contribution
Value Relates to Contribution, not Cost
An owner wants to install a swimming pool at a cost of $35,000. An appraiser estimates that the value of the home will increase by $28,000. The contributory value is $28,000, not the true cost of the pool. Owners typically wrestle with many improvements as to what their contribution to value is in relation to their cost.
External Factors
Things Nearby Can Influence Value
Buyer A purchases a home in a quiet residential neighbourhood. Buyer B purchases a similar home located nearby, but at a noisy intersection. The noise factor will probably negatively impact Buyer B's value.
Highest and Best Use
Focus on the Use that will Produce the Greatest Return
Appraisers typically view both the current use as well as its highest and best use. A large single family home situated on a lot permitting a four-plex would probably have more value (highest and best use) as an income property, a__uming that the conversion could be accomplished economically and that zoning provisions permit such a change. Marketplace negotiations and price mechanisms pursue the highest and best use.
Increasing/Decreasing Returns
More is Not Necessarily Better
Adding one garage to a new home may increase its value by $20,000, but adding two more (totalling three) does not usually translate into $60,000. Another example might involve a landlord painting a rental unit and receiving $150 more per month due to the improved condition. However, buying more expensive paint or applying a third coat will probably not result in additional rent. In other words, there is a point at which adding value results in diminishing returns. The principle is often referred to as the principle of diminishing returns.
Progression
The Smallest House on the Street May be the Best Buy
Where neighbouring properties are dissimilar, the value of the poorer property will be positively impacted by properties of higher value in the immediate vicinity.
Regression
The Largest House on the Street May Not be the Best Buy
This principle states that where neighbouring properties are dissimilar, the value of the higher valued house will be negatively impacted by properties of lower value in the immediate vicinity.
Substitution
Buyers Look for the Best Bang for the Buck
This principle a__erts that a prudent buyer will not pay more for something than the cost of acquiring an equally desirable substitute in the marketplace. Buyers, often unwittingly, become astute appraisers of value. For example, when viewing a new home at $299,500 and a resale with equally desirable (but differing) features at $279,500, the buyer may conclude that the resale is better value, in effect substituting newness for other features and a lower price. The principle of substitution is continuously at work in the marketplace.
Supply and Demand
Market Forces Are Always at Work
No property sits in isolation. All real estate is impacted by the constant ebb and flow of supply/demand forces. Lack of availability in the face of strong demand typically drives prices upwards. Excess properties, when buyer interest is lagging, tend to lower prices. Real estate practitioners typically watch listing inventory, selling price ratios, number of days on the market, total sales volume, and sale prices to get a sense of supply/demand forces.
Surplus Productivity
Net Income Flows to the Land
A principle stating that after all costs are satisfied in a venture, the net income flows to land and establishes the value of that land. For example, if a farmer received $38,000 in net income after all farming expenses have been paid, those funds flow to the land. If the capitalization (cap) rate is 10%, then the value of that land is $38,000 ? .10 = $380,000. Additional discussion of cap rates is addressed in a subsequent Module.

Market Focus

The Cost vs. Value Debate

Heated debates between dollars spent and value received reach every corner of the marketplace. The sellers adamantly want $200,000 for their property, because that's what they've got in it. Buyers will pay only $175,000 because that's what it is worth. Cost v. value goes to the heart of negotiations. New hardwood floors may cost $14,000, but their value may only be $10,000 in the eyes of the buyer. Essentially, buyers and sellers are arguing over subjective versus objective value. Knowing the difference and listing property based on value not cost is vital to any sales career. Recently, the Appraisal Institute of Canada conducted a member survey about payback on renovations. In other words, for every dollar spent, what payback (increase in value) would occur:

The reader is reminded that this information is derived from a survey of Institute members and does not constitute a formal research project.

Source: Appraisal Institute of Canada, 1999

Study Links

Encyclopedia

Principles of Value (Appraisal)
For those seeking more information about commercial sales and the principle of surplus productivity, look up:

Factors of Production

(the above reference is NOT required for exercises or the examination).

Principles of Value (Appraisal)

The appraisal of real estate involves various principles that are either fundamental to understanding value or explain how various components of real estate contribute to value. These principles are isolated for discussion purposes but, in fact, are interrelated in the marketplace.

Factors of Production

(see also Economics)

Components, also referred to as agents of production and factors in production, used in the production of wealth, income, or services that can be sold for money. Factors of production include labour (natural resources), management (co-ordination), capital, and land.

Labour has the first claim on the gross income from any enterprise. The costs of labour include wages, salaries, and benefits, such as health insurance and employment insurance. Costs of co-ordination follow labour and involve entrepreneurial incentive together with those services necessary to co-ordinate the other three factors and weld them into a productive unit. The cost of capital refers to payments for the use of capital, and interest on and amortization of investment concerning buildings, equipment, and furnishings, but not land. Lastly, a claim for land is made against the residual portion of the gross income.
Application

In appraisals, factors of production are used where applying the principle of surplus productivity. This principle states that when the net income remaining after all expenses necessary to the operation have been paid and the capital invested in improvements has been satisfied, the remainder is imputable to the land and tends to fix its value. The land is valuable according to the surplus productivity imputable to it. More simply put, the land is only as valuable as the income that can be attributed to it after all expenses have been addressed.

Figure F.1 illustrates the successive levels in which gross income is applied. The last of which is land.

Perspective

What's Around Us!

Value involves a complex interplay of what exists on the property, as well as what is present nearby. The principle of external factors best highlights the challenge for anyone estimating value. Clearly anything beyond the control of the property owner can impact value, whether it be the type of property next door, the number of competitors in a commercial complex, or the services available within a specific neighbourhood. Recently, the environment has taken centre stage as one more external force to be reckoned with. Both positive and negative possibilities are highlighted.

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Contamination:

The Property Next Door
Many factors can affect value. Increasingly, contamination has become a hot topic in real estate marketing. For example, in Brantford, a large underground chemical contamination from a former refrigerator making plant was recently discovered. Trichloroethylene, known as TCE, is a toxic chemical used as a degreaser in manufacturing. Initial estimates suggest that a 12 block residential area in the city's east side may be affected.

In Port Colborne, high levels of lead were discovered in the soil. Elevated levels have been linked to various medical problems. Near Waterloo, residents voiced objection to mega farms and the potential impact of offensive odours and possible water contamination involving farms that can house more than 2,500 pigs with storage for 15.5 million litres or more of liquid manure.

Ontario is not alone. Perhaps, the most-publicized contamination story lies in the No Co (North of c__e Ovens in Sydney, N.S.) where a neighbourhood is caught in the aftermath of more than a century of steelmaking, ironically the result of the government-operated Sysco plant and c__e ovens that became a provincial crown corporation in the late sixties.

This story is far from over, even with millions now spent on research and clean-up, and more funds allocated. For years, c__e oven emissions floated over adjacent residential areas and leaked into Sydney harbour. Concerns centre on high levels of polycyclic aromatic hydrocarbons, but testing has also revealed concentrations of other chemicals, such as a___nic, lead, manganese, copper, and cadmium.

The difficulty from a real estate perspective involves the stigma attached to the No Co area. According to some practitioners, the demand for homes has dwindled, as buyers shun affected neighbourhoods. Others have minimized the health risk and point to huge funds now invested in remediation (clean up involving soil removal). However, despite such efforts, the issue still casts a shadow on the marketplace.

While sincere efforts to clean up the area are positive, perceptions and the lingering memory of problems are more difficult to erase. Time may be the only solution.

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Green Value

Teeing Off
Even those who don't play the game are attracted to golf course communities. This new hot niche in the residential market provides open s___e, a different lifestyle, and often an opportunity to reclaim land once relegated to dump sites, quarries, and brownfields (contaminated sites). Premium prices are now a__ociated with lots backing onto the course. Open s___es, green vistas, and rear yards that don't b___ up to neighbouring houses are in demand.

Clearly, real estate values follow these sought after locations, as choice lots are few and supply/demand forces dominate. Presently, golf course communities are springing up in urban as well as rural settings. From a planning perspective, such communities can pose certain challenges (e.g., water resources to keep greens and fairways in excellent shape), but the trend is clearly growing.

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Noise Pollution:

Taking Off
The sound of aircraft may cause some to daydream about travel, but not those near an airport runway. The creation of new runways or extensions to existing ones typically evoke debates and extensive community consultations.

Courts have awarded settlements to disgruntled neighbours, recognizing that property values are affected. But noise problems are becoming much more pervasive than taxiways and jet engines. Canadians are living in closer proximity to one another. What soundproofing should be installed in condominiums, what windows will block street level noise, and what to do about noisy neighbours? Quiet and privacy are increasingly in demand... and demand usually translates into value.