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Fundamentals of Value and Influencing Factors
Definition of Value:
Value is the monetary estimate of a commodity or service at a specific time, considering all relevant factors affecting this estimate. It is the estimated market value of the property.
Types of Value:
- Market Value: The most probable price a property should bring in a competitive and open market, given informed buyers and sellers, without undue pressure. It requires adequate market exposure, appropriate marketing, prudent buyer and seller behavior, and no special relationship affecting the price. It is the primary standard in real estate appraisal.
- Value in Use: The value of a property to its current owner, based on their specific use of the property. It is used for properties with special or unique uses, such as factories or museums.
- Investment Value: The value of a property to a specific investor, based on their expectations of future returns and potential risks. It depends on analyzing and discounting expected cash flows to their present value.
- Liquidation Value: The price obtainable from a quick sale of a property, typically under duress. It is used in bankruptcy or liquidation scenarios where time is limited.
- Assessed Value: The value determined by the government for property tax purposes. It may differ from market value and depends on local laws and regulations.
- Insurable Value: The value of a property that can be insured against damages or losses. It depends on the replacement cost of the property in case of damage or destruction.
- Going Concern Value: The value of a business as a whole, including real estate and other assets, based on its ability to generate profits. It is used for hotels, restaurants, stores, and other businesses that rely on real estate.
Four Characteristics of Value:
- Utility: The ability of the property to satisfy a need or desire of a potential buyer.
- Scarcity: The limited availability of the property.
- Transferability: The ease of transferring ownership from seller to buyer.
- Effective Demand: The desire and purchasing power of potential buyers.
Relationship Between Value, Price, and Cost:
- Value: The monetary estimate of the property, based on all relevant factors.
- Price: The actual amount paid for the property in a specific transaction.
- Cost: The amount spent to create or improve the property.
- Value is not necessarily equal to price or cost.
- Price is the result of a specific transaction, while value is an objective estimate.
- Cost is an input for determining value, but not the only factor.
Types of Costs:
- Direct Costs: Materials and labor used directly in construction.
- Indirect Costs: Administrative, marketing, and financing expenses.
- Development Cost: Total costs associated with developing the property, including land❓❓ acquisition, construction, and other costs.
- Construction Cost: Costs associated with building the property only.
- Replacement Cost: The cost of building a new property similar to the current one, using modern materials and techniques.
- Reproduction Cost: The cost of building an exact replica of the current property, using the same materials and old techniques.
Appraisal Principles (Economic Value):
- Principle of Supply and Demand: Value is inversely proportional to supply and directly proportional to demand.
Value ∝ Demand / Supply - Principle of Substitution: A buyer will not pay more for a property if they can buy a similar one for the same price or less.
- Principle of Competition: Strong competition among sellers lowers prices, while strong competition among buyers raises prices.
- Principle of Change: The real estate market is constantly changing, and value is affected by these changes.
- Principle of Anticipation: The value of a property depends on the expected future benefits from it.
- Principle of Balance: There must be a balance between the different factors affecting the value of the property, such as land, capital, labor, and management.
- Point of Diminishing Returns: The point at which adding more inputs results in less productivity than before.
- Principle of Surplus Productivity: The value remaining after deducting the costs of labor, capital, and management is attributed to the land.
- Principle of Contribution: The value of any element in the property is determined by its contribution to the overall value of the property, not by its cost.
- Principle of Increasing and Decreasing Returns: Initially, adding more improvements may increase value at an increasing rate. But after a certain point, the value begins to increase at a decreasing rate, and may reach a point where the overall value of the property decreases.
Impact of Use on Property Value:
- Highest and Best Use Principle: The most probable, legal, and financially feasible use of the property that yields the highest value. It must be legally permissible, physically possible, financially feasible, and maximally productive.
- Consistent Use Principle: The property must be valued based on one consistent use. The land cannot be valued based on residential use and the building on commercial use.
- Conformity, Progression, and Regression Principles:
- Conformity: Properties that conform to their surroundings tend to retain or increase their value.
- Progression: A lower-value property in an area of higher-value properties tends to gain some value from the neighboring properties.
- Regression: A higher-value property in an area of lower-value properties tends to lose some value due to the neighboring properties.
Production as a Measure of Value:
- Agents of Production Principle: Value consists of the contributions of the four factors of production: land, capital, labor, and management.
Value = Land + Capital + Labor + Management
Forces Affecting Value:
- Social Factors: Changes in demographics, lifestyles, and cultural values affect the demand for real estate. Examples include:
- Prestige: The desire to live in a prestigious area.
- Recreation: Proximity to recreational facilities.
- Culture: Presence of cultural or community centers.
- Family Orientation: Proximity to schools and parks.
- Homeowner Restrictions: Rules and regulations imposed by homeowner associations.
- Economic Factors: Economic conditions affect purchasing power and demand for real estate. Examples include:
- The Local Economy: Economic growth and unemployment rates.
- Interest Rates: Affect the cost of borrowing and buying real estate.
- Rents: Affect the return on investment in rental properties.
- Vacancy Factors: Indicate the percentage of vacant units in an area.
- Plottage: The increased value resulting from combining two or more parcels of land.
- Parking: Availability of sufficient parking spaces.
- Corner Influence: Increased value of a property located on a street corner.
- Political Factors: Government laws and regulations affect the use and value of real estate. Examples include:
- Taxes: Affect the cost of owning real estate.
- Zoning: Determines the types of uses allowed in specific areas.
- Rent Control: Limits the maximum rents that can be charged.
- Growth Limitations: Restrict the development of real estate in certain areas.
- Environmental Restrictions: Protect the environment and limit certain types of development.
- Building and Health Codes: Ensure the safety of properties and the health of residents.
- Environmental (Physical) Factors: The physical characteristics of the property and its location affect its value. Examples include:
- Location: Proximity to amenities, services, and attractive areas.
- Climate: Weather conditions and temperatures.
- Water: Availability of water and its sources.
- Transportation: Ease of access to transportation.
- View: A beautiful view increases the value of the property.
- Soil: Soil quality and its ability to support construction.
- Size and Shape: Affect the usability of the property.
- Exposure: Orientation of the property to the sun and wind.
- Environmental Hazards: Presence of pollution or hazardous materials.
- Topography: Nature of the land and its slopes.
Chapter Summary
The chapter focuses on the fundamental concepts of value in real estate appraisal, emphasizing the definition of value, its characteristics, and the distinction between value and concepts such as “price” and “cost.” It also reviews the economic principles governing value, the impact of optimal property use, different types of value, and the forces influencing it.
Key Scientific Points:
- Definition of Value: Value is defined as “the monetary worth of properties❓, goods, or services to buyers and sellers” and also as “the present worth of future benefits” expressed in monetary terms.
- Characteristics of Value: Value is based on four main elements:
- Utility: The ability of the property to satisfy a need or want.
- Scarcity: Limited supply compared to demand.
- Transferability: The ability to easily transfer ownership of the property.
- Effective Demand: A desire supported by purchasing power❓ to acquire the property.
- Distinction Between Value, Price, and Cost:
- Value: An objective estimate of the property’s worth based on market analysis and influencing factors.
- Price: The actual amount paid for the property, which may differ from the value due to special circumstances or market pressures.
- Cost: The expenses incurred to create or develop the property, not necessarily reflecting its market value. This includes direct and indirect costs, development and construction costs, replacement cost, and reproduction cost.
- Principles of Appraisal (Economic Value):
- Principle of Supply and Demand: The balance between supply and demand directly affects value.
- Principle of Substitution: Buyers tend to pay the lowest possible price for a property with similar utility to another.
- Principle of Competition: Competition between similar properties leads to the determination of their prices and values.
- Principle of Change: Property value is affected by continuous changes in the market and surrounding environment.
- Principle of Anticipation: Property value is affected by future expectations related to it, such as potential developments in the area.
- Principle of Balance: The optimal value of a property depends on the balance between different elements of production (land, labor, capital, management).
- Principle of Surplus Productivity: The net income remaining after covering the costs of other production elements determines the value of the land.
- Principle of Contribution: The value of any element of the property depends on its contribution to the overall value of the property.
- Principle of Increasing and Decreasing Returns: At some point, adding elements of production increases the value of the property (increasing returns), but after a certain point, the value of the increase begins to decrease (decreasing returns).
- Impact of Use on Property Value:
- Principle of Highest and Best Use: The property should be valued based on the use that achieves the highest value for it, provided that this use is legal, physically possible, and financially justifiable.
- Principle of Consistent Use: The property should be valued based on one consistent use.
- Principle of Conformity, Progression, and Regression: The value of a property is affected by its conformity to surrounding properties; lower-quality properties are affected by better-quality properties (progression), and better-quality properties are affected by lower-quality properties (regression).
- Types of Value:
- Market Value: The most probable estimate of the price a property can obtain in an open and competitive market.
- Value in Use: The value of the property to its current owner, based on their specific use.
- Investment Value: The value of the property to a specific investor, based on their investment goals.
- Liquidation Value: The value that can be obtained from selling the property quickly under forced circumstances.
- Assessed Value: The value determined by government entities for tax purposes.
- Insurable Value: The value of the property that can be insured against risks.
- Going Concern Value: The value of the property as part of an existing and continuing business project.
- Forces Influencing Value:
- Social Factors: Include population trends, lifestyles, educational level, and security considerations.
- Economic Factors: Include the general economic situation, interest rates, rental rates, and vacancy rates.
- Political Factors: Include taxes, regulations (such as zoning), building and health codes, and environmental restrictions.
- Environmental (Natural) Factors: Include location, climate, water availability, transportation, view, soil quality, and environmental hazards.
