- November 30, 2018
- Posted by: Michael
In the Dallas real estate market there are several participants concerned with the price, cost, and value in a typical real estate transaction. The terms have very different meanings but are often used interchangeably, which can lead to confusion and frustration.
In general, buyers, sellers, and real estate agents are concerned with the asking or selling price. Builders and real estate investors are concerned with price and value, but even more about the cost. The majority of real estate is bought with a loan from a bank or mortgage company. They rely on local appraisers to determine a home’s market value so they can make a lending decision.
As a Real Estate Appraiser in Dallas, it is my job, almost every day, to determine the market value of real estate. Early on in my appraiser education, and I’m sure most appraisers have similar memories, it was repeated over and over and over that cost does not equal value and price does not equal value. While value, cost, and price all sound like the same thing they are very different concepts with very different meanings.
Let’s start with some definitions and apply them to buying blueberries at the supermarket. Then, we can look at the differences.
What is Cost?
USPAP (2018-2019 edition) defines cost as “the amount required to create, produce, or obtain a property” with a comment that cost is either a fact or an estimate of fact.
For simplicity sake, we are going to start with ABC farm that produces multiple blueberries and sells them to different supermarkets. The cost for the supermarket is $1,000 for 1,000 pounds of blueberries. A few specialty supermarkets only buy 250 pounds but their cost is higher per pound. Another bulk supermarket buys 10,000 pounds of blueberries and their cost is slightly lower per pound. For most supermarkets, the cost is $1 a pound for 1000 pounds of blueberries. In real estate, the basic costs (land, labor, and materials) are generally the same for builders in a competing market. However, the price and the value of the homes they produce can vary greatly.
What is Price?
According to USPAP (2018-2019 edition), price is “the amount asked, offered, or paid for a property” with further comment that “Because of the financial capabilities, motivations, or special interests of a given buyer or seller, the price paid for a property may or may not have any relation to the value that might be ascribed to the property by others.”
When you go to the specialty store, the price for blueberries is $3.79 a pound or more. When you go to the bulk supermarket, the price is $1.99 per pound and sometimes less. However, when you go to most other grocery stores the price ranges from $2.49 to $2.79 a pound for the same blueberries. The price of blueberries can vary from store to store, much like the price of a home can vary from street to street.
What the Heck is Market Value?
There are several sources for the definition of market value which appraisers rely on. Per The Appraisal of Real Estate, 13th Ed., p.23 (available from the Appraisal Institute), market value is defined as:
“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.”
Basics of Market Value
- the most likely price (not necessarily the highest or the lowest)
- on a specific date (a house could burn down tomorrow and be completely different)
- between unrelated parties (among family members would not qualify, nor would a landlord selling to a tenant)
- the property must be exposed to the market (typically listed for sale on the local MLS)
- both parties must be working in their own best interest (falling in love with your dream house is sometimes not in your best interest)
- neither party should be under duress (divorce, foreclosure, short sale, must sell or buy now)
Market value and appraisals rely on the principle of substitution. Essentially, the value of a property is established by the cost of acquiring an equivalent substitute.
If you only purchase your groceries at the specialty store then you are willing to pay $3.79 for blueberries. If you are a bargain shopper, you may drive across town to get a great deal and pay only $1.99 or less. If you have a dinner party and forgot to buy the blueberries this would be an example of being under duress. You would likely stop at the closest or most convenient store and buy your berries with no regard to the price.
In berries, as in real estate, there’s a reasonable range of what is typical in the market. In our case, the value for a pound of blueberries is between $2.49 to $2.79. If the berries are especially fresh and shiny the value could be closer to $2.79. If they have been sitting a little longer and there are a couple of discolored berries it would be closer to $2.49.
Appraisers are generally required to put a singular number on the market value for our clients. Based on this data it is reasonable that the Market Value would be about $2.65 for a pound of blueberries.
A blog post in the Sacramentoappraisalblog.com, by Certified Appraiser Ryan Lundquist, may have summed up Market Value in one image.
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