How Property Values are Determined

Over the past decade, homeowners have enjoyed skyrocketing property values. At the same time, buyers have been struggling to find reasonable digs at affordable prices. High or low, how are property values determined?

Property values are influenced by many variables. The process of determining the value of real estate may seem complex but it’s really just based on two things: basic economic forces and physical property characteristics.

The Economics of Value

In the big picture, property values are affected by social, economic, governmental and environmental forces. Some of these are controlled while others are arbitrary. An example of a controlled force is the prime interest rate. Low mortgage rates have driven home prices up by giving buyers more purchasing power and thus creating more demand.

The economic factors that drive the real estate market apply to the market at large but vary between specific locations. Economic supply and demand depends on local as well as federal conditions.

Municipalities that have a strong job base have housing demand and properties in these areas garner higher sale prices. Regions that are struggling economically have less demand that is reflected in lower property values.

Value is Physical

Individual property values are relative to market trends but are determined by specific variables in the physical characteristics. There are many that affect a home’s value including size, location, age and condition.

The best way to understand property value is to take it down to basics because although the real estate market is filled with variables, it is based on tangible goods – real property.

Building an understanding of property value is not unlike building a home, it’s a practical application. There are standard characteristics and then variable components. Homes have a basic structure – four walls and a roof – and are built on specific sites. From there, doors, windows, rooms, finishes and other variables distinguish a final form. It’s the same idea with property values.

Location, Location, Location

Most of us have heard this cardinal rule of real estate but not everyone truly understands how it works. Like size, location is a physical characteristic of a property that can be used to measure value.

The exact same home can be built in two different locations and valued differently. This is because location is a key element in the supply and demand forces that create property value. The local economy where a property is located provides a backdrop for its value.

For example, Rochester, N.Y., is a beautiful city with a very high quality of life. The same can be said about New York City at the other end of the state.

An 1,800 square foot, three-bedroom colonial home in Rochester sells for around $100,000. A property in Manhattan can be a quarter of that size but sell for four times as much. The reason is location.

Manhattan is an island where real property is finite and earning potential is unlimited. In economic terms, supply is limited and demand is very high. Rochester’s housing supply is unlimited while demand is low. It’s a great city with lots of amenities, but doesn’t have the dynamic micro-economy of its southern counterpart.

A property’s location also defines what amenities are available nearby. A property’s access to desired local services and facilities increases its value if demand for those services is high.

Schools, jobs, transit and recreation are all considerations for a property’s value and demand. Buyers with children place school quality high in their priorities. Commuters desire easy access to highways or public transportation. A surplus of nearby restaurants, theaters, museums or outdoor activities increases a property’s value because homeowners can enjoy the quality of life they desire.

Size Matters

The size of a property is one of the most relevant characteristics when building a home and when determining its value. Real estate agents, appraisers and assessors all look at square footage when analyzing a property, although each with different objectives.

Assessor’s value reports use square footage as part of property tax assignment while appraisals are most commonly used to meet financing requirements. Real estate agents look at “per square footage” sale prices to generate comparative market analysis (CMAs) and set asking prices.

The three analyses have a dynamic relationship when a property is placed for sale on the market. For example, in 2003 I sold a very unique property. It was a custom designed home with non-standard finishes. There were very few comparable properties and none that had been sold recently.

The one physical characteristic this home had in common with nearby, recently sold properties was square footage which was 2,937. The home was assessed at $206, 220 or $70.21 per square foot. Surrounding homes were selling on average 1.7 times their assessed value. Square footage is a physical characteristic that conveys relative value.

Based on square footage the property was worth about $350,000. It also happened to be on an extraordinary setting so this was factored in and the asking price was set at $379,900. The property received a full price offer after just ten days on the market. An independent, third-party appraisal supported the selling price, justified lending based on the appraiser’s value indication and the property transferred.

This approach to determining property value is based on sales comparison in relation to common physical characteristics. A value comparison based on size is a straightforward way to determine value.

Age Old Expectations

Some people have an insatiable fascination with old homes and I’ll admit I’m one of them. But age is a measurable characteristic that’s value is perceived differently. For vintage home lovers, a dilapidated Victorian evokes childlike joy while others wonder why nobody has razed it to the ground.

In general, old homes that need repair appeal to specific buyers and their value is relative to that demand. Mainstream tastes consider age less important than condition. There are certain expectations that buyers have when looking at real estate.

We often hear the terms “outdated” and “newly remodeled.” They relay a home’s value in relation to current expectations. If we take two homes similar in age, the one that has been updated to meet current tastes is more valuable than the other. A 1970s ranch with green laminate countertops throughout is much less appealing than the same home with granite replacements.

The same applies to a home’s structural and operational characteristics. New HVAC systems, wiring, windows and roofs have more value than elements that are near the end of their life-cycle. If a property needs repairs this detracts from its value because of the costs these updates will incur to the new owner.

However, this doesn’t mean that renovations add value on which sellers can expect a return. Updates and repairs usually just restore value that would otherwise be subtracted from a property’s value. This is one of the most common misunderstandings that homeowners have in regard to value.

For example, let’s consider a home that is twenty years old and has a roof that is at the end of its functional capacity. Comparable homes with functional roofs are selling for $200,000. The property in question has less value equal to the cost of replacing the roof. If the roof is repaired prior to selling the home, the property is on par with the competition. The home’s value is now $200,000, not market value plus the cost of the new roof.

This application applies to most remodeling efforts. The key to understanding how age and remodeling affect value is to recognize that comparable properties set a standard. A home in need of repairs or updates is valued lower than those that meet the current standards. Updates don’t translate into added value; they only work to meet buyer expectations and keep a property competitive among comparable listings.

If you are considering remodeling your home, it’s a good idea to consult a professional real estate appraiser to find out how the project will affect your home’s value. Keep in mind that repairs and energy-efficient improvements often yield the best returns.

You shouldn’t expect a dollar-for-dollar return but there are ways to improve your home that increase its property value and make it competitive among comparable homes. Visit open houses in your area to get an idea of what buyers want.

The Value of a Good Deal

When a property transfers between owners, selling price is the most obvious indicator of value. However, the terms of the sale have significant value as well and should be considered when comparing properties for sale or purchase.

For instance, in some property transactions sellers contribute to the buyer’s closing costs. In this scenario, the property value remains set but buyers save upfront, out-of-pocket expenses.

A similarly valuable term is when sellers buy mortgage points as part of the deal. Each point paid on a 30-year loan lowers the interest rate by 0.125 percent. This allows the new owner to get a lower interest rate on their mortgage. The buyer’s mortgage payment is lower and they can take an income tax deduction on the points.

Other embedded value that may not be reflected in sale price can include appliances, fixtures or services that were part of the deal. For instance, two identical condominiums may have sold at the same price but the one that included a year of paid home owner association fees was a better value.

Your Home’s Value

Knowing how to gauge the value of your home is a critical factor in your financial decisions. Whether you are thinking of selling, refinancing, borrowing equity or remodeling, an understanding of how property values are determined can help you make the right decisions.

There are plenty of resources available to help you. Real estate brokers and salespersons can develop a comparative market analysis (CMA) for you. This service is for both clients and potential clients and usually free. You can also hire a professional appraiser who will assess your home’s value for a fee.

If you have an objective mind, you can do your own research. Visit open houses, watch sales in your area and use online real estate websites to compare properties. Talk to neighbors and friends who’ve recently sold a property. How long did it take them? How close was the sale to their asking price? All of this information will give you an idea of local demand and supply.

Real estate value is affected by both subjective and objective factors. The key is to distinguish between the two but use them both to create factual information. For example, if most of your neighbors express worry about losing their job the demand for local real estate could be in jeopardy. Subjective information can be a useful hint to more concrete economic forces. The trick is learning how to use it to research the facts.

The more you understand how property values are determined, the more you can implement successful strategies in your own real estate investing. Use the resources below to find comparative sales, market trends and other useful information on how property values are determined.

*Note: The information in this article is general advice and not meant as a substitute for personal guidance from a financial advisor, real estate professional or legal counsel. Although the author is a licensed realtor, the advice given in this article does not constitute any client contract or agreement between the author and the user. The author is not responsible for any losses, damages or claims that may result from your decisions.