Show me the money! But, how much?

Show me the money! But, how much? A look at value, price, and cost.

Headlines are daily proclaiming the seller’s market that has persisted since before the Covid pandemic and shows no signs of slowing in 2022. Home values are rising, buyers are paying over asking price, people wonder if values will remain or will drop, but what does all of that mean? Let’s take a look at some of the basic components of housing values, prices and costs.

Market Value

Value itself has many different meanings depending on context; however, in real estate, there are several values we can encounter. For instance, tax assessors use assessed value when calculating a property’s annual real estate tax bill. For purposes of buying, selling, and financing real estate, we are most often dealing with market value. According to federal mortgage lending, market value is “the most probable price which a property should bring in acompetitive and open market under all conditions requisite to a fair sale, the buyerand seller each acting prudently and knowledgeably, and assuming the price is notaffected by undue stimulus.” Market value assumes a reasonable seller and reasonable buyer and exposure to an open market.

The reason for this definition becomes clear when we understand the purpose of the appraisal performed for the lender in many real estate transactions. It is usually assumed that the appraisal makes sure the house is worth what the buyer has agreed to pay for it. While this is true, the real meaning takes it a step further. The lender wants to know that if the buyer defaults on the mortgage, what would the next “reasonable” buyer be willing to pay for the property. The appraised value in a mortgage is basically answering the question for the lender, “if we end up foreclosing and own this property, what could we sell it for?”

It is important to note that the definition of market value changed throughout the mid to late 20th century. According to the Appraisal Institute, market value was once considered the highest price a property would bring. Throughout the 1950s, 60s and 70s, the definition began to evolve, contain additional characteristics and even mentioned probable price, but the 1980s saw the major shift from highest price to most probable price.

Value versus Price

I often hear, “it’s worth what someone is willing to pay for it.” While that certainly makes sense, there is a subtle difference between price and value. Price is the amount of money one buyer pays for one property from one seller at one moment in time. Many factors go into the price paid for a property, such as motivations of the parties. If the house next to my father’s house came for sale, I would certainly pay more than the average buyer to buy that particular property. A bank who is lending me money,however, isn’t concerned with my motivations. It is concerned with the next buyer should I need to sell or should they foreclose and need to sell.

Due to the subtle difference between price and value, many sales are not used when determining the market value of a property. Homeowners sometimes worry about a recent distressed sale in their neighborhood and whether it will affect their value. The simple answer is no, it won’t. During a typical appraisal, appraisers will not use atypical sales such as bank-owned properties or estate sales. These types of transactions do not represent the most probable price with buyers and sellers acting without undue influence.

In the current seller’s market, the individual prices paid for properties will eventually in aggregate become value. In the appraisal world, three comparable sales are needed to establish market value. A seller’s market that persists this long does reestablish new home values.

Value versus Cost

Sellers regularly ask me why their $20,000 project does not increase their home’s value by $20,000. Cost very often exceeds the value it adds to a property’s value. The cost/value dilemma also can drastically change based on location and other economic factors. The cost of a project, as we have seen the last couple years, can be affected by supply chain issues, price of materials, and even gas prices. The additional value on a home is simply what a buyer is willing to pay for that amenity and is extremely independent of cost. For instance, in Central PA, for the majority of properties, no value is given to a pool. In Arizona or Florida, a pool, or lack thereof, could affect value.

I have visited many homes and advised on which projects are worth the investment in terms of resale value. Many home projects increase desirability, but not actual dollars. If looking to increase your home’s value, adding finished square footage and upgrading items (laminate countertop to granite countertop) are some of your best bets. Because of the complexity of the market and buyer expectations, a simple consultation with a REALTOR® can give a home owner great insight into their specific property.

So, what’s my property worth?

Your property is not worth what one person is willing to pay for it. Your property is not worth what it cost to build or renovate. Your property is not worth what a website tells you it’s worth. Your home value is actually just an opinion, whether an appraiser’s or Realtor’s. The opinion is based on previous sales of similar homes that were not distressed or affected by atypical factors. While many factors affect value, there is no secret wizardry or alchemy involved. Your REALTOR® will be happy to “show you the money,” and explain exactly how much.