As real estate agents we are always looking for ways to help our clients make sound decisions. If we find a way of doing so that also differentiates us from the market – all the better. In the next two posts I am going to share a new way to value property that not only gives clients a vastly superior ability to make home-buying decisions, but should decrease defaults and foreclosures substantially too. Do you think that will make me a better agent? More valuable? Here’s one more way to differentiate yourself in the marketplace of real estate agents. (Warning: this post and the next involves some arcane securities concepts and new ideas that will require even more of your time and effort. If this does not interest you, stop reading now. Pick up a newspaper. Enjoy the classifieds. Maybe polish up the old resume…)
In a recent article by Greg Swann discussing the woes of the real estate market, he mentioned homes selling for less than they would cost to build. He referred to homes priced “below their fundamental value.” Over the past six months or so I have been discussing with Brian Brady different ways to value a property. Having both come out of the securities field (I was once a securities broker and “enjoyed” some pretty exciting… read: stressful… years as an options trader on the exchange floor), the discussion revolved around how property would be valued if it were a security investment. First, Comparative Market Analysis or CMAs would be used only as a qualifier or a secondary validation. They are circularly self-serving and relationally compromised. Instead of “comps”, let’s wow our clients, protect them and increase our value as agents at the same time.
A New Way to Value
Remember I warned you that this would involve extra work. That is because there should be four values to any property and they should all be calculated before we advise our clients. Here are the four values in ascending order:
- BREAK-UP VALUE – this is the value of the land itself along with any profits to be made selling pieces of the home before tearing it down, minus the cost of tearing it down. In Illinois for example, there are companies that advertise a home about to go under a radical rehab. Buyers come to the home and everything is auctioned off: staircases, doors, windows, cabinets, etc. After such an auction you combine the money in your hand, the value in your land and subtract the expected cost of your demo contractor to arrive at the break-up value.
- INTRINSIC VALUE – this is the value of the land plus the actual cost to build a model match home using today’s material and labor costs. Don’t forget the fees, permits and so on or the cost of not being able to use the home (loss-of-use cost). Total those costs and you know what a property is worth intrinsically.
- FUNDAMENTAL VALUE – this is the value of a home based on the neighborhood rents vs the cost of owning. Often expressed as a property’s cap rate (although that is more common in commercial real estate). This is how non-owner occupant investors would evaluate a property. “Does it pencil out” is another way of asking the property’s fundamental value.
- UTILITARIAN VALUE – this is the Fundamental Value plus the non-definable value that accrues to a person owning their own home. Brian Brady jokingly refers to this as the “purple wall” value: the added premium a person is willing to pay for the freedom to paint a wall purple if that is their desire. While not easily defined, it is often easy to quantify. Look at any area where “fixers” are being sold. You will find a price discrepancy between investors who wish to make repairs and still earn a profit (either monthly or as a flip) and someone who actually wants the home for their own. When you are bidding on homes to rehab and/or flip, your price is based on #3 (Fundamental Value) and you will never outbid someone looking to make it their own home because they will pay the utilitarian value.
While giving your client four values per property involves extra work, it is not as difficult as it appears. The first two values can be based on square footage estimates, which you can update from time to time with some of your local contractor clients. (Don’t have contractor clients? Great opportunity…) The Fundamental Value requires you to get tapped into the investment side of your neighborhood or farm. Again, if you are not doing this already it is an opportunity to expand your business while making your business unique. The final value is based on a standard comp value, but should be tracked in relation to the other values. This kind of analysis will tell you and your clients when prices are out of line and once again, differentiate you by your expertise. Imagine including a four-value analysis in your counter to an offer!
If you, as an agent, were to make all four valuations on a property your client was interested in buying or selling you would most assuredly stand out from the CMA carrying crowd. More importantly, your buying clients will make informed, rational decisions (even while missing out on some of the run-ups) that should leave them little chance of a foreclosure. Your selling clients will know when prices are out of line and how aggressive they should be in their marketing and price reductions. Best of all, you will have yet another way to stand out, add value and provide superior results for your clients.
There is one other aspect that can be added to your property valuation tool box. It is even more securities based, but will give you the ability to analyze the values you develop and provide your clients with a sound decision-making framework. I will share it in the next post.38 comments