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Factors That Do Not Affect the Value of Real Estate

Written by David Fialk on Tuesday, 04 August 2009 7:00 pm
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When selling a home, there are many factors which affect market value and the eventual sale price of a home, such as location, condition, size, amenities, features, improvements and upgrades, local economic conditions, the current real estate market and mortgage interest rates, among others. Some of these factors are within the control of the owner, and others are beyond the control of the owner.

The definition of Fair Market Value includes various terms such as: the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale; the buyer and seller each acting prudently and knowledgeably; assuming the price is not affected by undue stimulus; normal marketing time period, informed buyer and seller.

In helping owners obtain a Market Value estimate for their home, Realtors can provide a Comparative Market Analysis (commonly referred to as CMA). A thorough Market Analysis will include full property details and pricing information of the most comparable type properties currently listed on the market for sale, pending or under contract sales where a contract offer has been recently accepted, closed sale transactions and listings which have expired, those that did not sell during the marketing time period. The purpose of a report like this is to provide the owner with factual information to help them in their decision to sell by providing a recommended asking price and estimated sales price. While no two properties are truly identical, an analysis like this can provide home owners with the most reliable method of obtaining a market value estimate for their home.

In the process of reviewing the pricing information however, it is quite common for owners to question the market value estimate and pricing recommendations. The questions and concerns they have about price, while valid in their situation, do not have an affect in determining the market value for their home. What are some of the factors that do not have an effect in establishing Market Value?

The price paid for a home one year ago, three years ago, five or ten years ago has nothing to do with what the home is worth today. Real estate values exist at a fixed point in time. A home may have been purchased for $300,000 three years ago, and may be worth $315,000 today. Someone else may have bought a substantially similar home for $250,000 five years ago and it is worth $315,000 today. That is a drastic difference in equity in a relatively short period of time.

Real estate ownership has been blessed with appreciation in home values, but that appreciation is not always in a straight line. Real estate values are not static. Over the long term, an investment in real estate is generally considered the most valuable type of investment, one with the best financial returns. Over the long run, it is probably the best investment people can make.

Depending on the market conditions when the home was purchased, some owners were fortunate and purchased their home in a buyers market before the increases in real estate values like we just recently witnessed between 2001 and early 2006. Others may have bought at the end of a strong real market and were forced to pay top dollar in a highly competitive sellers market, as many owners are experiencing now who purchased their home in 2006. It is economic market conditions, the economy, employment, mortgage rates and supply and demand that create changes in the real estate market and cause real estate values to increase, remain stable and perhaps drop at different periods of time. These are the factors that are beyond a seller’s control.

All owners would like to get the price they feel they should get for their home when they choose to sell. The reality is, their home is worth what it is worth, and that is the price a buyer is willing to pay. A buyer will not pay more for a home than what they would have to pay for another home with similar features and amenities in a similar location, something called the "Principle of Substitution".

It is for that reason why so much reliance is placed on sales data when establishing market value, and not personal emotions or personal circumstances.

Whether a home was purchased twenty five years ago, three years ago or just last year, the purchase price was the value when it was purchased, and has nothing to do with it’s current market value when being sold. A seller with twenty five years of home ownership and substantial equity has the same right to fair market value as an owner with just 3 years of home ownership and perhaps little or no equity.

Decisions to sell may be more difficult for owners with short term ownership especially when real estate values have not increased or have dropped since the home was purchased. Home owners with short term ownership may have mortgage balances higher than the value of the home and a sale would require bringing cash to the closing to pay off the mortgage balance.

Home owners with long term ownership and substantial equity can make selling decisions easier than owners selling their home without the benefit of real estate appreciation.

In either case, the real estate market is the real estate market, regardless of when the home was purchased, and the home is worth what is worth.

While it is true that that the condition of a home has a definite affect on its market value, and that a well maintained home will sell for more than a home in need of updating and repair, the actual cost of making repairs and improvements may not be equal to the increase in market value. Why? Cost does not necessarily equal value in real estate. Repairs and improvements are two different things.

A repair corrects something that is broken or is not working properly, and does not necessarily add value to a home when fixed. Some types of repairs are considered necessary repairs. A leaking faucet, broken windows, clogged drains, screens with holes, gutters hanging from the roof, missing downspouts, cracked concrete walkways, among others, are examples of this.

Repairs like these can be considered deferred maintenance, and are considered minor repairs. They are maintenance related and are easily noticed by buyers. They draw attention and become distracting to buyers when viewing a home. If not taken care of, conditions like these will definitely have a negative impact on the marketability of a home, which then will have a negative affect on market value. When repaired or fixed, these type repairs make a home more saleable, not necessarily more valuable.

In other words, just because repairs like these cost $1,500 does not mean that they have increased the value of the home in the same amount. However, if not repaired, they could result in a loss in value of more than the cost to repair and, maybe more important, the loss of potential buyers because they feel the home needs too much repair and work.

What about the roof, exterior siding, windows, heating system, electrical system, central air conditioning system and hot water heater? These type improvements are more costly than the repair items noted above and can have a larger impact on marketability and market value. While a buyer may not rave about how beautiful the furnace looks because it is now, they will definitely have negative thoughts on a home where the furnace is original and is 50 years old. A new or newer furnace will be more efficient than the original, save the buyer money in monthly fuel bills and, more importantly, is an item that will not need to be replaced by the buyer in the near future. These type items relate to the effective age of a home. The chronological age of a home can be much different than its effective age. There is a life expectancy in how long a roof will last, how long a furnace will last, etc. A 50 year home can have an effective age of 20-30 years when improvements like these have been made. When comparing homes, buyers are concerned with near future essential repairs and improvements which need to be made, especially those that are costly, like these.

Quite often buyers will pass up on homes they are interested in simply because they need too much near future updating, even if the asking price is appropriate considering the condition of the home. Why? Very often buyers just do not have the time or inclination to take care of major updating, but more importantly, they may not have the additional cash to make the improvements after closing as they have exhausted their savings for the down payment and closing costs.

Should a homeowner replace the original 50 year old furnace when they are ready to sell? Should they invest the $2,300 to $4,000 and have the furnace replaced? A furnace is an integral system in the home, and something buyers are concerned with. However, it is just one aspect of the home. The question relates more to whether it will cost more to sell the home with the original furnace than what it would cost to replace it. If the furnace is the only item requiring immediate attention, it may not prevent a sale. However, if there are other must do improvements, the furnace will have a negative impact on market value.

Decisions like this have to take into consideration the overall condition of the home. When investing in a new furnace today and spending $2,500, what is the likelihood of receiving a full return on the investment? The reality is that it will help sell the home, but not necessarily at a price to recapture the actual cost of new furnace.

What about the home where a state of the art kitchen or main bath are new improvements made by the owner? Can a seller expect to recapture all or most of the cost? Improvements like these are very costly, and will definitely add to market value. But will the seller recapture all or most of the cost? That depends on various other factors, such as how recent the improvements are, what the overall condition of the home is, the price range the home is in, where the home is located and, more importantly, what buyers are expecting to see in a home like this.

With regard to major improvements in a home, all too often the improvements are made for the benefit and enjoyment of the owner and not solely for recapturing the total investment! Each and every major improvement to a home is unique. There is no rule that guarantees an exact amount of value added for specific improvements.

There are studies available that approximate increased values for specific improvements, but every real estate market area is different! For more information, just Google "cost versus value improvements".

How Much the Seller Needs Whether a home owner has owned their home for 30 years and has paid off their mortgage, or is one who has owned their home for only a few years and has an equity loan on top of the original mortgage, the market value of their home is what it is. Market value has nothing to do with mortgage balance.

Likewise, where the owner is planning on moving to another home, what they need to spend for their next home does not have an affect on the value of their current home. Their home is worth what is worth, whether they are moving into a home they already own, buying a less expensive home or are purchasing a much more expensive home. Market value has nothing to do with the amount the owner needs to purchase another home.

In either scenario, there is a reality however. In order to sell a current home, there needs to be sufficient sale proceeds to pay off the existing mortgage(s) and, or, provide enough equity to enable the purchase of the next home. For many owners, it is a matter of choice. Is it worth it to me to sell my current home and move forward or not? For others, the options are not that simple.

Home buyers make their purchase price decisions based on how much a home is worth to them, not on how much the seller is asking or how much the seller needs. Buyers look and compare one home to another. They ask to see comparable sales, and they base their contract offer on what the real estate market is saying the value of the home is. In most cases, a home buyer will not pay more for a home than it would cost them to find a similar home, in similar condition and with similar amenities, commonly referred to as the "principle of substitution".

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