Property Value Concepts and Impacts

Value and Its Impact on Real Estate

Introduction:

The concept of value is the cornerstone of real estate appraisal. Understanding value and its impact on real estate assets is crucial for making informed investment decisions, determining fair prices, and developing effective real estate policies.

Definition of Value and its Dimensions:

• General Definition of Value: Value is the monetary expression of the benefit or utility of something (real estate, commodity, service) for a person or group of people at a specific time.
• Dimensions of Value: Value is not an inherent or fixed property of the real estate itself. It is a relative concept that depends on four main elements:
  1. Utility: The ability of the property to meet a specific need or desire of the buyer or user.
  2. Scarcity: The availability of the property in the market. The lower the supply and the higher the demand, the higher its value.
  3. Transferability: The ease of transferring ownership of the property from seller to buyer.
  4. Effective Demand: The desire to own the property supported by purchasing power.
• Value vs. Price vs. Cost:
  1. Value: An estimate or opinion about the price a property can fetch in the market.
  2. Price: The actual amount paid for the property in a specific transaction. Price may be affected by specific circumstances of the seller or buyer.
  3. Cost: The expenses required to create or develop the property. Cost does not necessarily reflect the value of the property in the market.
  4. Replacement Cost: The cost of creating a substitute for the property with the same utility.
  5. Reproduction Cost: The cost of creating an exact replica of the property.

Economic Theory of Value and the Impact of Market Forces:

• Real Estate Market: A place of interaction between sellers and buyers for the purpose of exchanging real estate. The real estate market is influenced by supply and demand forces, economic conditions, and social and political factors.
• Supply and Demand and Their Impact on Value:
  1. Increased Demand: When demand for real estate exceeds the supply, prices and values rise.
  2. Increased Supply: When the supply of real estate exceeds the demand, prices and values fall.
  3. Principle of Substitution: The value of a property cannot exceed the price of a similar alternative property in utility.
  4. Opportunity Cost: If the income generated from a property is less than the opportunity cost (the return that can be achieved from an alternative investment), the rational investor will not buy it.
  5. Competition: Competition works to restore the balance between supply and demand.
  6. Formula:
     • Value ↑ when Demand > Supply
     • Value ↓ when Supply > Demand
• Real Estate Cycle and Changes in Value: Value is affected by fluctuations in the real estate cycle, which goes through different stages:
  1. Development: Increase in the supply of real estate.
  2. Maturity: Stabilization of supply and demand.
  3. Decline: Increase in supply and decrease in demand.
  4. Revitalization: Increase in demand and decrease in supply.

Productivity as a Measure of Value:

• Factors of Production and Wealth: Wealth is created in real estate through four main factors:
  1. Capital: The funds and financial resources used in property development.
  2. land❓: The location, area, and natural resources.
  3. Labor: Human effort expended in property development.
  4. Coordination: Management, planning, and organization of the development process.
• Balance Between Factors of Production: The optimal value of the property is achieved when the factors of production are in a state of balance.
• Productivity Surplus: The productivity surplus is attributed to The land.❓ It is what remains of the net income of the property after deducting the costs of capital, labor, and coordination.
• Marginal Productivity: The value of any component of a property is the amount of increase that this component adds to the value of the property as a whole.
• Law of Diminishing Returns: Successive increases in investment in one of the factors of production will initially lead to an increase in the rate of return, but eventually will reach a point (the point of diminishing returns) where the return begins to decline.

Impact of Use on Real Estate Value:

• Optimal Use: The property must be valued based on its “best use”, which is the reasonable and legal use that achieves the highest profit.
• Valuation of Land and Improvements: Land and improvements (buildings) must be valued based on the same use (consistent use).
• Compatibility: The value of the property increases when the uses of the surrounding properties are compatible with its use.

Types of Value:

• Market Value: The estimated value of the property in the open market, under specific conditions:
  1. The buyer and seller are sufficiently knowledgeable about market conditions and the property.
  2. The buyer and seller are acting rationally, in their own self-interest, and without coercion.
  3. The property is offered in the market for a reasonable period of time.
  4. Market value may vary depending on its specific definition.
  5. The market value must be adjusted to reflect financing terms that are not equivalent to cash and any other non-typical concessions in the market.
• Value in Use: The value of the property for a specific purpose only, and not for its best use.
• Investment Value: The value of the property to a particular investor, and not its value in the market.
• Liquidation Value: The amount that the property can fetch with a limited offering period in the market, as in a mortgage sale.
• Assessed Value: The market value multiplied by the applicable assessment ratio.
• Insurable Value: The value for compensation purposes under an insurance policy.
• Going Concern Value: The value of a continuous business project that includes real estate as an integral part of its operations.

Factors Affecting Value:

• Social, Economic, Governmental, and Environmental Influences: Real estate values are affected by a variety of factors:
  1. Social Influences: Such as demographics and social norms.
  2. Economic Influences: Such as the cost of capital and the purchasing power of buyers and investors.
  3. Governmental Influences: Such as zoning laws and regulations, taxes, environmental laws, financial regulations, and building codes.
  4. Environmental Influences: Such as land characteristics, climate, infrastructure, and location.

Examples and Practical Applications:

1. Example of Utility and Scarcity: A property located in a vital and well-served area (high utility) but rare (high scarcity) will be of greater value than a similar property located in a remote or unserved area.
2. Example of the Law of Diminishing Returns: Investing large sums in luxurious improvements to a property located in a modest neighborhood may not lead to a significant increase in the value of the property, as the market does not appreciate these luxurious improvements in this location.
3. Example of Optimal Use: A plot of land located on a main road may have its optimal use as building a commercial center, even if the surrounding area is residential.
4. Example of Market Value vs. Investment Value: An investor may value a property higher than its market value if they have specific plans to develop the property and increase its income.
5. Example of Environmental Factors: The presence of a chemical plant near a residential area will negatively affect the value of properties in that area.

Mathematical Formulas (where applicable):

• Estimated Market Value (EMV): EMV = Σ (Pi * Vi)
  • Where:
    • Pi: Probability of scenario i occurring
    • Vi: Value of the property in scenario i

Conclusion:

Understanding the concept of value and its impact on real estate is the foundation of real estate appraisal. The real estate appraiser must be aware of the relevant economic theories and principles, carefully analyze the factors affecting value, and apply this knowledge in their valuations.