Property Valuation: Part 1

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What should you expect from a Property Valuation?

I begin my valuation of a specific property by questioning the purpose of the task. There are many motivations for wanting to know the value of a real property asset. Some people want to keep track of the value of their non-liquid assets from time to time. Most people intend to sell and want to know what to expect in terms of a cash outcome. People involved in litigation, liquidation, estate planning and settling estates are among those who need to know real property value. A buyer needs to know what a specific property is worth, but typically leaves the chore in the hands of a fee appraiser. Banks, the Department of Justice, and other institutional organizations and lenders have all been clients of Red Hawk Realty for property valuations.

Many of these motivations are very different. Take, for example the motivation of a buyer and that of a seller over the same parcel of real property. Each motivation has a particular bias with an expectation; the buyer would normally want to pay a price at or below market value while the seller expects to receive at or above market value. Two heirs dividing a real property asset may also have different ideas of value when one heir intends to keep the real estate and the other heir wants to be cashed out. Collectively, these expectations occupy a range of value. Situations wherein any two value biases diverge, splitting the difference is mutually equitable.

Approaching the value of a specific parcel of real estate can be done in many ways. Appraisals are a snapshot in time of a value of property on a specific day. In my opinion, there is much more to value. Value is dynamic; having a history and possessing an identifiable inertia with a predictable future. However, in the final analysis, the only true metric for determining the value of a specific parcel of real estate is the price a buyer is willing to pay a seller for their property.

Most homeowners residing in a subdivision understand the concept of comparable market data. The idea is simple: if three houses that compare relatively equally in terms of size, age, condition, and amenities have sold within the past 6 months located a mile or so from the home being valued, the price for which they sold would box in the price the seller could expect for the home being valued. This is the common practice in lot and block subdivision valuation.

When the property is not a single family dwelling in a high density area, valuing real estate involves alternative concepts to the comparable market data approach and becomes much more speculative. In the absence of relevant market data (i.e. similar properties which have recently sold in close proximity to the property being valued), compiling information to determine the cost to replace the property under consideration is used. Like other valuation methods, the cost replacement approach has limitations. For instance, from about 2008 through the end of this year, devaluation of single family residential homes during this period has resulted in situation wherein most homes available for sale can be purchased well under their replacement cost, which is why the construction industry is at a standstill. During expansive housing markets, marked by new construction, the cost replacement approach serves primarily to identify the lower range of value. In rapidly appreciating markets, when appreciation is occurring at double digit annual rates, the cost approach is somewhat meaningless.

In addition to the two most common methods used for valuing residential property described earlier, there are other creative ways to determine. One method which I commonly use involves comparing known values of properties with dissimilar uses to find a range of value for a given property, a process I refer to as extrapolation. A simple example of this notion would involve a small parcel of vacant land and a typical single family dwelling in a market wherein homes are selling and land is not. The owner of the vacant land requests an opinion of value and no similar sized parcels of vacant land have sold in the market area within several months, while ample data are available for the sale of single family homes. As a rule, appraisals for homes in the area typically break out land from the appraisal as representing about one third of the total appraisal value and the improvements – the structures – reflect two thirds of the appraisal value. Therefore, if single family homes are appraising for $300,000.00, a vacant parcel of land similar to the lots upon which the appraised homes have been built would be worth about $100,000.00. Slight adjustments for dissimilar features would then be made to this base figure.

In the market area I service, occasionally an investment property will become available that is unlike any other that has recently sold or is available for sale. One such property in my area, the Dunham Ranch, is a 120 acre, gently rolling, oak-studded parcel with westerly views to the ocean, two large spring fed ponds stocked with fish hidden from public view. A pristine landscape with a variety of versatile features; desirable and rare – and only 70 minutes from downtown San Diego and around 2 hours from Orange County and Los Angeles. While the population of people who appreciate and can afford these postcard properties is growing, properties of this type are disappearing to development and urban encroachment, becoming increasingly rare. This combination of a diminishing environment and growing demand drives value upwards and, arguably, reflects a sort of unadulterated fair market value.  A wide range of value, narrowed by the motivations of any given buyer and seller, is the best one can hope for when determining what a rare property is really worth on the open market.

Property Valuation Part 2