Accurate property valuation is important to home buyers and sellers, lenders and real estate investors in order to make good, well-informed decisions. As such, one could surmise the process to determine the economic value of real estate would be uniform, consistent and subject to only minor variations. However, making that assumption can lead to misconceptions, three of which are discussed here.
Valuation is not necessarily equivalent to price or cost
The price of a property is what a buyer actually pays on the day of sale. Cost is the total of expenditures the property owner has incurred through a specific point in time. A property’s value can be affected by price and cost, but value is not determined by price and cost. For example, a property owner who is in distress and facing foreclosure may well sell the property at a discounted price because time is running out. And many are familiar with the example of the property owner who has “over-improved” the asset, effectively making it impossible to recoup the costs within a realistic sales price range. In the first instance, the value is more than the price; in the second, the value is less than the cost.
Market valuation is not the same as bank valuation
Market valuation is an estimated amount of what a property should sell for in a certain period in an arm’s length transaction between a willing seller and a willing buyer. In essence, it is an educated prediction of what the price will be. A bank valuation is the amount the institution is prepared to lend against a specific property. The bank’s primary consideration is what the property can reasonably be expected to sell for in the event of borrower default.
Any variations in valuations are less significant because property prices always go up
There is no shortage of incentives for people to believe this, but it is, in fact, a myth. While overall, the long term trend has been price appreciation, there are reasons why property values can, and do, go down. A simple acronym can be helpful for keeping in mind some basic factors that are relevant in any property valuation:
- Demand — how many potential buyers for the property exist
- Utility – the benefits to the buyer of the property
- Supply – who the seller’s competitors are
- Transferability — the ease and quickness by which the seller can deliver title to the buyer
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