Beyond Market Value: Use, Investment, and Influencing Factors

Chapter 3: Beyond Market Value: Use, Investment, and Influencing Factors

I. Introduction

While market value represents the most probable price a property should bring in a competitive and open market, various other value concepts are crucial in real estate analysis. These concepts delve into the specific utility, investment potential, or circumstances surrounding a property, offering a more nuanced understanding of its overall worth. This chapter will explore “Use Value❓❓,” “investment value,” “liquidation value,” “assessed value,” “insurable value,” and “Going Concern Value❓❓” and how social, economic, political, and environmental (physical) factors can influence the value.

II. Use Value

A. Definition:
Use value is the value a specific property has for a specific use. This value is inherent to the owner/user’s needs, operations, and perspective. It focuses on the present worth of the future benefits derived from the property’s continued use for a specific purpose.
B. Relevant Scientific Theories and Principles:

1. Utility Theory: Use value is fundamentally rooted in utility theory, which posits that value is derived from the satisfaction or usefulness a good or service provides to an individual. In the context of real estate, the utility is derived from the property’s ability to facilitate a specific business operation, service, or activity. The utility could stem from location, design, or use.

2. Discounted Cash Flow (DCF) Analysis: While market value often uses comparable sales, use value commonly relies on DCF analysis. The expected cash flows generated by the property’s use are projected into the future and then discounted back to their present value using an appropriate discount rate.

   Equation:

   PV = ∑ (CFt / (1 + r)^t)

   Where:

   PV = Present Value (Use Value)

   CFt = Cash Flow in period t

   r = Discount rate

   t = Time period

C. Practical Applications and Related Examples:

1. Industrial Property: A factory’s use value to its owner might be significantly higher than its market value due to its strategic location near raw material suppliers, specialized equipment, or skilled labor pool. As noted in the PDF content, if the supplier relocates, the use value to the manufacturer diminishes.

   Example: Consider a manufacturing plant producing specialized electronics components. Its location near a major semiconductor supplier significantly reduces transportation costs and ensures timely delivery of critical inputs. If the supplier were to move 500 miles away, the increased transportation costs and potential supply chain disruptions would directly decrease the plant’s use value to the manufacturer.

2. Agricultural Land: Governments often provide property tax relief by assessing agricultural land at its use value (farming) rather than its potential market value (residential development). This policy encourages the preservation of agricultural activities.

3. Properties with Limited Markets: For unique properties like large factories, schools, or public buildings where comparable market data is scarce, use value may be the most appropriate valuation approach.
   D. Experiment: Sensitivity Analysis of Key Variables:
   A sensitivity analysis can test the effect that changes in key variables such as the discount rate and the revenue increase/decrease per year have on the use value.
   For instance, the sensitivity analysis could be done with a spreadsheet, where the change in use value is calculated when the discount rate increases by 1% or the revenue decreases by 5%.

III. Investment Value

A. Definition:
Investment value is the value of a property to a particular investor, considering their unique investment goals, financial resources, and risk tolerance.
B. Relevant Scientific Theories and Principles:

1. Portfolio Theory: Investors often evaluate properties based on how they fit within their overall investment portfolio. Investment value is influenced by factors such as diversification benefits, correlation with other assets, and the investor’s desired risk-return profile.

2. Capital Asset Pricing Model (CAPM): Investors use models like CAPM to determine the required rate of return for a property based on its risk relative to the overall market. This required rate of return is then used to discount future cash flows and arrive at an investment value.

   Equation:

   r = Rf + β(Rm - Rf)

   Where:

   r = Required rate of return

   Rf = Risk-free rate

   β = Beta (measure of systematic risk)

   Rm = Expected market return

C. Practical Applications and Related Examples:

1. Strategic Land Acquisition: As demonstrated in the PDF content, a developer who has already acquired several parcels for a planned development may be willing to pay a premium (above market value) for the final parcel needed to complete the project. This is because the value of completing the project far outweighs the incremental cost of the additional parcel.
2. Tax-Advantaged Investments: An investor in a high tax bracket may place a higher investment value on a property that offers significant tax benefits (e.g., depreciation deductions, tax credits).
3. Synergistic Acquisitions: A company may be willing to pay a premium for a property that complements its existing operations and creates synergies (e.g., increased efficiency, market share).

IV. Liquidation Value

A. Definition:
Liquidation value is the estimated price a property would bring if sold under duress, with a limited marketing period and often in a forced sale situation (e.g., foreclosure, bankruptcy). It is distinct from market value because it does not assume “reasonable” exposure to the market.

B. Relevant Scientific Theories and Principles:

1. Supply and Demand Imbalance: Liquidation value is fundamentally affected by an imbalance in supply and demand. The forced sale creates an artificial increase in supply, which typically drives down prices.

2. Auction Theory: Liquidation sales often involve auctions. Auction theory analyzes how bidders behave in different auction formats and how these behaviors affect the final sale price. Factors such as bidder risk aversion, information asymmetry, and the number of bidders can all influence liquidation value.
   C. Practical Applications and Related Examples:

3. Foreclosure Scenarios: Financial institutions use liquidation value to assess the potential recovery from foreclosing on a property. The difference between the outstanding loan balance and the liquidation value represents the lender’s potential loss.

4. Bankruptcy Proceedings: In bankruptcy cases, assets are often liquidated to pay off creditors. Liquidation value is used to determine the amount creditors can expect to recover.

V. Assessed Value

A. Definition:
Assessed value is the value assigned to a property by a government tax authority for the purpose of calculating property taxes. It is usually a percentage of market value.

B. Formula:

Assessed Value = Market Value x Assessment Ratio

C. Practical Applications and Related Examples:
One state may specify that property is to be assessed at 100% of market value, while another assesses property at 10% of market value. A $100,000 property would be assessed at $100,000 in the first state (100% x $100,000), and at $10,000 in the second state (10% x $100,000).

VI. Insurable Value

A. Definition:
Insurable value is the value of a property for insurance purposes, representing the cost to replace or reproduce the structure in case of damage or loss.

B. Relevant Scientific Theories and Principles:

1. Cost Estimation: Determining insurable value relies heavily on cost estimation techniques. These methods involve calculating the cost of labor, materials, and other expenses required to rebuild or replace the property.

2. Depreciation: Depreciation can affect insurable value, depending on the insurance policy terms. Some policies cover replacement cost (the cost of a new replacement), while others cover actual cash value (replacement cost less depreciation).
   C. Practical Applications and Related Examples:

3. Homeowner’s Insurance: Homeowners need to determine the insurable value of their homes to ensure adequate coverage in case of fire, natural disasters, or other covered perils.

4. Commercial Property Insurance: Businesses use insurable value to protect their buildings, equipment, and inventory against potential losses.

VII. Going Concern Value

A. Definition:
Going concern value is the total value of an operating business, including the real property and all other assets (tangible and intangible) that contribute to its ongoing profitability. This value reflects the business’s ability to generate future income and maintain its operations.

B. Relevant Scientific Theories and Principles:

1. Business Valuation: Going concern value is a key concept in business valuation. Various methods are used to estimate this value, including discounted cash flow analysis, capitalization of earnings, and asset-based valuation.

2. Intangible Assets: A significant portion of going concern value often comes from intangible assets such as brand reputation, customer relationships, and intellectual property.
   C. Practical Applications and Related Examples:

3. Hotel Valuation: The going concern value of a hotel includes the real property, furniture, fixtures, equipment, and the value of the hotel’s brand, management contracts, and customer base.

4. Restaurant Valuation: The going concern value of a restaurant includes the real estate, equipment, inventory, and the value of its location, menu, recipes, and reputation.

VIII. Forces Affecting Value

A. Overview
Value is influenced by the forces of supply and demand. These forces are affected by external factors that can be broken down into four categories: social, economic, political, and environmental (physical).

B. social factors❓❓
Social factors encompass the demographics, lifestyles, and preferences of a population within a market. These factors shape the demand for different types of properties.

1. Prestige: Desirability of certain locations due to historical or social reasons.
2. Recreation: Proximity to or access to recreational activities.
3. Culture: Availability of cultural amenities such as libraries, museums, and theaters.
4. Family Orientation: Areas with good schools and children’s activities.
5. Homeowner Restrictions: Restrictive covenants of homeowner associations that can affect value.

C. Economic Factors
Economic factors pertain to the availability and cost of money for real estate lending, construction, and investment, as well as the purchasing power of buyers in the market.

1. The Local Economy: Local economic conditions, including growth, employment, and wages.

D. Political Factors
Political factors include government policies, regulations, and taxes that can impact real estate values.

E. Environmental (Physical) Factors
Environmental factors relate to the physical characteristics of a location, such as climate, topography, and proximity to natural resources or hazards.

IX. Conclusion

Understanding the various value concepts beyond market value is essential for making informed real estate decisions. Use value, investment value, liquidation value, assessed value, insurable value, and going concern value each provide a unique perspective on a property’s worth, considering its specific utility, investment potential, or circumstances. In addition to understanding the different values of a property, it is important to consider that they are subject to social, economic, political, and environmental forces. A comprehensive analysis of these factors is crucial for accurate valuation and sound investment strategies.