Managing Change
How Constant and Shifting Factors Affect Value
Why do people buy real estate? Because it meets the need
for a place to live (a residence) or go to do things (a commercial property)
and therefore provides value. One way to look at real estate value is a numbers-based
"Cost Approach" which estimates, using current price data, the dollars needed
to buy land and put up a building. Qualitatively oriented Needs-based analysis – a "Market
Approach" which adjusts recent purchase prices of similar nearby properties for
differences in features (such as size of lot or structure, age of structure or
interior finish, rooms, appliances) or an "Income Approach" which applies
investor return requirements to current rental potential – relies on more subjective and changeable
factors.
Why do appraisers talk about "functional utility"? Because this identifies real estate features that indisputably provide value – physical shelter, reliable storage, specialized rooms like kitchens and baths that meet particular needs. Plus, it assesses the practicality of interior finish and layout flow – factors with variable value impact drawn from buyer preferences, which can shift. Market Approaches reflect buyers' priorities and right now "low inventory" keeps offers high, despite the fact that rising mortgage rates plus growing tax bills from higher values after two+ years of robust real estate gains increase monthly ownership outlays, another way of saying "decreased affordability". Income Approaches are strained by higher investor returns needed to cover rising interest costs, and value-protecting income must be found through higher rents or more efficient use of the property.
Looking at short-term factors, we know that lack of listings along with affordability or income pressures make buyers content with features (or lack of them) that might detract from value under different conditions. A Cost Approach noticeably higher than Needs-based analysis can indicate the cost of outdated design or add-ons and amenities buyers don't want to pay for. Owners can relate to cost/benefit analysis, so keeping track of trends helps explain what buyers are thinking. Looking to the longer term, Census Bureau data tells us to question the utility (or added value) of extra bedrooms as a lower percentage of homes have married-couple households living in them.
One
way to identify elements of value and judge how trends influence them has the
unexpected acronym of DUST: Demand, Utility, Scarcity and Transfer. The
examples above describe some Utility basics. Demand and Scarcity capture buyer
and seller motivations, which will change with the economy. Examination of Transferability
assures that the seller has "free and clear" right to sell the described real
estate (this legal status requires recorded amendment to change) and that the
buyer can get the funds to close the purchase (an issue if rates rise or mortgage
lenders pull out of a property type or high-risk area, such as flood zones).
DUST away.