What’s a Property Worth?Posted on March 8, 2011 by
The press is full of gloom and doom about real estate prices depending on which “report” you read. Prices have hit bottom. Prices will fall another 10%. Prices will fall another 3%. The headlines keep coming. Different parts of the country are reacting to the current conditions in different ways. Prices are very sensitive to supply and demand. Some parts of the country have experienced substantial price reductions, while others have not. Even within a single market area, prices will vary. So how do you figure out what a property is worth in today’s market?
A number of experienced investors are sitting on the sidelines right now. They are sitting for a variety of reasons. One of the issues is value. They have seen values erode and are concerned that the values will continue to erode. How do you determine value in a static to falling market? “Very Carefully”.
Determining value starts with the principle of “Substitution”. The Principle is based on the concept that a rational “buyer” will pay no more for a property than he can pay for a “comparable” property and looks to recent sales as the benchmark. The concept takes into consideration properties recently sold as well as properties currently on the market.
There is some controversy as to what determines a “comparable sale”. Up until recently appraisers were instructed to avoid “distress” sales. They were told to avoid using foreclosure and pre-foreclosures as the definition of market value presumes that a “ready willing and able buyer and seller” conclude the transaction, neither acting under duress. Unfortunately in the market we are operating in currently, foreclosures and short sales make up a large part of the market. It can be argued that foreclosures and short sales are not generally in the same condition as market properties. It is argued that sellers in distress are unable and unwilling to spend the money to keep their properties in marketable condition so they are not comps. Nevertheless in today’s market, appraisers must consider “distress sales”. The buyer certainly will.
Appraisers are looking for sales that took place within the last 90 days. They want properties that are similar in size, configuration, and condition, and are in close proximity to the property being appraised.
A group of investors were discussing getting properties appraised. A veteran appraiser and several seasoned investors were in the class. One of the investors said that he understood that appraisers were instructed to ignore distress sales (foreclosures and short sales). The appraiser responded that in a market such as ours, he is thrilled to get any “comparable“ sale within a reasonable proximately to the subject.
He indicated that recently he had to go 5 miles to get any kind of comp at all. He indicated that if he was instructed to ignore foreclosures by the client, he would do as the client requested, but that he would have to place a statement in the appraisal that he had ignored foreclosed properties at the client’s request. It certainly is a balancing act. When negotiating on a short sale or purchase you want a “low appraisal” and when selling or getting financing you want a “high appraisal”.
So in this market it is important to find sales data that is current. It is necessary to determine whether the property was in close proximity and that close by sales are not ignored. It is also important to take into consideration properties currently on the market as they will tend to place a ceiling on value. Rental data is certainly important not only as an indicator of value but as an important bell weather in determining exit strategy. In this market it is critical to dig for current comparable information and to verify sales data.
See Gordon’s Determining Property Values Workshop on March 26, 2011.