Let’s talk about value, the market value of real estate, to be specific. If you ask people if they know what market value is, most of them will say that they do know. And they will probably mention that that is an easy question. Most will say that the market value of a property is the price for which it will sell. If only it where that easy! Defining, understanding and appraising market value is a sophisticated problem, it is not something that everybody can do. It takes knowledge, understanding and common sense, logic. Often, in literature, you will find explanations about the ties between the art and science of real estate appraisal and determining market value. To be honest, it is a combination of the two.
For argument’s sake, let’s say that a property is foreclosed and sold on the market. Is the price that is paid the market value? Probably not, since it was sold through foreclosure. Most properties that are sold through foreclosure are sold for less money than they would have been sold for if they hadn’t been in foreclosure. What would happen to another property that is on the market, but the seller is in no rush to sell it, unless he gets a specific price that he has in mind, something slightly higher than what may be expected? And then she/he was able to sell their house at that price, but they had to wait a long time and wait for that buyer that is willing to pay that price because, let’s say, it is close to where he works.
So, what is the market value of those two properties? Is it the price that they were sold for? Definitely not.
Let’s take an even better example. Let’s imagine two houses, exactly the same, one next to the other. One is sold as soon as it hits the market for, let’s say, 500,000 euros, dollars, pounds, whatever. The other property is sold after a period of 6 months on the market. It is sold for, let’s say, 750,000 units, under the assumption that nothing has changed on the market. What is the value of each property? Some may say it is 500,000 for one house and 750,000 for the other, but how is it that two houses, exactly the same, on the same location, one next to the other, have two different values? The answer is that they don’t have different market values. Both houses, under the assumption that they are exactly the same, have the same value, and it doesn’t necessarily mean that the market value is the price for what they were sold.
So, what then is the value of these two properties? I do not know until I have more information about both properties. As you can see, it’s not as easy it may seem at first glance.
If you are a real estate professional, this concept is more or less easy to understand, but what about the average buyer or seller? What are their thoughts? More likely than not, they will assume that the one of the sales prices or both are the market value. The buyer will probably assume that the lower price is the market value, while the seller will assume that the higher price is the market value.
If there is one thing that you should take away from these few examples, it is an understanding of how hard it is to determine the market value.
To understand the market value concept of real estate, let’s go back to the basics, back to school and straight into the text books. What is the definition of market value? Depending on where you are located, the market value is defined by the EVS, IVS, and AI standards.
European Valuation Standards (TEGoVA):
The estimated amount of money for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without being under compulsion
International Valuation Standards (IVS Council):
Market Value is the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.
The Appraisal Institute:
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 assuming that neither is under undue duress.
Basically, these definitions are the same. The only difference is in the fine points, but in general, it is the same definition. No matter where in the world you are, the definition of market value is basically the same. So, what do these definitions tell us? They say that the market value is the expected price that a property can or will be sold, under the assumption that all sides in the process, buyer and seller, know everything that there is to know about the property and that they are not acting out of haste, or in a rush, or under any kind of pressure that may affect the sale of the property.
These are pretty much ideal conditions. How often do they apply in the sales process? Often? Not so often?
What happens during the sale of a property? Are the conditions of the sale market conditions? Does one side have a special interest? Are both sides acting prudently, or only one side? These are the very important questions that must be answered before we know if the sale was at market value.
If the buyer and seller do not know how important this is, the agent does. What is the market value for the agent, how important is it for them? It’s the starting point and not the end point. The agent looks at a property and starts with the market value, but she/he also looks at a property to see if there is a possibility to sell at something above the market value. And if there is a possibility, what is it that drives the values to something more than the market value? This is no easy task, if it were, then we would all be millionaires.
The job of an agent is to be able to understand these factors that can drive the value above or below the market value. The better that she/he understands this, the better an agent they are. For the agent to be able to do this, they must do a multitasking job. The agent starts with the market value, but they also have to recognize the conditions of the sale. Does the buyer have any special interests, or is the seller in a rush? All of this affects the value of the property and can either drive the value down or above the market value.
So, how do we know at what value a property will sell if the terms of a market value sale are not fulfilled? It is not a case of the agent looking into a crystal ball, instead, the agent must use the tools, research and knowledge that are available to him/her to solve this problem.
The agent is faced with several problems, or tasks, while selling real estate. On the one side, the agent has the seller, who has their expectations, a price range in which they expect to sell their property. On the other side, there is the buyer, who also has their price range for how much they plan on paying for a property. Usually, finance dictates this price range. Everything is easy if in the start the buyer’s and the seller’s price ranges overlap. The sale is imminent and just a matter of negotiations on what price to settle on. But what happens when there is no overlapping? It is the job of the agent to try to see if there is room for both sides to make changes to their price range so that there is an overlapping of price ranges and the sale becomes imminent.
Is this new overlapping range something that represents the range in which the market value falls, or is this just a range that the agent produces arbitrarily so that it falls into the range of the buyer and seller? This range should be the range at which it is believed that a sale will occur, taking into account all factors, even those that do not define the market value (see definitions above).
Most properties will be sold for the market value, but not all. In a world, in which an agent works on a provision and the buyer or seller are trying to get top dollar (EUR, LBS), it is of the most importance for the agent to understand the market value concept. But more importantly, for the agent, is that she/he understands the new overlapping range and what it is in regards to the market value. It is in this range that hidden value and profit can be found.
This may seem like a very unfair process, but it is far from that. The process is transparent, both sides have access to the same information. The more transparent and open the process, the easier it is for everyone to buy into the need to find a range with common ground. But as mentioned before, this is not an arbitrarily formed range, but a range based in the first place on market evidence, thus market value, but it also takes into account other factors and this becomes a science and art form and we all know how difficult that can be.
Once we start taking about this range at which we believe that the property will be sold, we are going into a new area and that is the worth of a property. More about this in the next blog.