I get asked this question more and more by my clients as the market is rebounding and prices are rising. Tough question, no easy answer. So exactly what is “Market Value?” The academic answer for real estate is, “Market value is the price a willing buyer and willing seller agree to without the presence of duress.”
This is an interesting word, duress. Duress in this definition refers to stress that might pressure a buyer or seller to make a decision they might not normally make. The reason I find this so curious is that we have been in a period of economic duress since the demise of Lehman in fall of 2008, wouldn’t you agree? And for many areas it’s been even longer. After all, losing one’s job would constitute the presence of duress. Facing a foreclosure would too. How about a job transfer that requires selling in an unforgiving market, where prices are generally off by as much as 25-30%? That would be pretty stressful. So if all that is true, couldn’t we argue that none of the sales over the past 6 years were reflective of market value since we have been under a period of perpetual duress? It’s an interesting argument because we have been forced over these past few years to deal with the “new normal,” as the pundits like to say. Yet that flies in the face of the definition of market value. How about when prices were rising from 2004-2007? Wasn’t that a period of duress for all the buyers? Were they not forced to pay for more than comparable sales suggested was a fair price for a particular property? You bet they were. I suppose one could argue that the only time there isn’t the presence of duress is when the market is in balance.
Bummer, we haven’t had a balanced market in nearly a decade.
The National Association of Realtors defines a balanced market as 6 months of available inventory. That may be so in many parts of the country, I can’ say really, but in California I believe that magic number to be 3 months of available inventory. The reason is simple, if we weren’t in a perpetual state of shortage, why would a home in Malibu sell for any more than a home in Houston? Why would suburban Westlake Village cost any more than suburban Cincinnati? The answer is they wouldn’t sell for more, therefore, we must have less than 6 months available inventory and 3 months seems to me to be about right; it only makes sense.
So back to the question at hand, how do you know if you are paying too much? An appraiser would tell you to look at the comparable sales over the past 6 months and look for homes of similar, size and location; usually within a mile or so of the property you are considering. You make adjustments based on condition, lot size, small square footage variations and features. Amenities like a view could trigger an adjustment of 5%, though to me I would pay 10% more for a view because it’s the most rare of all amenities in my opinion, and it’s important to me.
I just said something there that is of paramount importance so it bears repeating, “It’s important to me.”
When comparing properties to determine market value, an appraiser will consider the a fore mentioned adjustments, but that’s not to say you’ll value all variables equally. For examples consider things like schools; is the better elementary important to you? If you have small kids absolutely, but not necessarily so to a senior, though any astute real estate person will tell you schools are never unimportant, because someone is always looking for better schools, thus it’s significant for future resale. Another example would be one story vs. two. If you are a young couple, maybe a ranch home isn’t so important but if you are a senior or physically challenged, it could be paramount. One time I had a single story listed for sale and an offer came in but it was low. I asked the agent who brought me the offer, why and he referred to comps (comparable sales) of similarly sized two stories. I told him that those weren’t comparable because they were two stories. He said he didn’t understand. I explained the rarity in our area of one story homes and thus supply and demand dictated it was more valuable. He didn’t get it, so I concluded by saying, “Then maybe your buyer should buy one of those cheaper two stories.” He replied, ” No she has to have a one story.” The agent not only didn’t understand, but did his client a terrible disservice; the buyer ended up not buying the home she could have had and really wanted, because the agent failed to apply his client’s value system to the home, rather than his own. So what was market value in that example? Clearly it was not strictly an unbiased assessment of similar sized homes that closed in the previous 6 months.
OK, so we all can agree that value is very much a case of the “eye of the beholder,” but I still haven’t addressed the original question of “how do I know if I’m paying too much?” The reason is there are too may relative factors in the decision itself, so there is no set answer.
However, I’m not going to leave you with that. As a practical measure, let me tell you what I’m doing now. First I do look at the comps. That will give me a basis for analysis. Then I make my adjustments and come up with a general sense of where it should be if we were in a balanced market. Then I consider the market we are in. In my local market prices are rising, having gone up 5-7% since last spring. Then I apply what I consider the 30% rule. Presuming prices were off 30% from the peak (your area might vary), I’ll go back and look at the peak price for similar homes in the neighborhood, I’ll multiple in by .70 and see how close that price is to the asking price. Some neighborhoods I might use the 25% rule. By and large this is as good an indicator as any, as to the fair market value for the home in question. Given the rise in price I described earlier of 5-7%, I’ll then apply that adjustment and viola!
If that doesn’t sound scientific enough, I understand, but real estate is not scientific, rather it’s largely emotional and therefore the laws of science don’t firmly apply. The application of logic does best. And if that too falls short for you, then there’s the old standby: Do you like it? Can you afford it? Are you planning on staying a long time? If the answer is yes to those three questions then buy the darn thing for whatever the price it will take to get it. In the end, a home is a long term investment and ten, twenty even fifty thousand dollars won’t make a big difference to the payment, after all, what is the fair market value for happiness?