Types of Value Beyond Market Value

Chapter: Types of Value Beyond Market Value

This chapter explores various types of value beyond market value, which is defined as the most probable price 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, and assuming the price is not affected by undue stimulus. We will delve into how these values differ from market value and their applications in real estate.

1. Use value❓❓

• Definition: Use value is the value a specific property has for a specific use. This differs from market value, which assumes a typical user. Use value is subjective and based on the unique advantages a property offers to a particular user.

• Scientific Principles: Use value is rooted in utility theory in economics, where value is derived from the satisfaction (utility) a consumer receives from a good or service. In this case, the property provides specific utility to the user that is not necessarily reflected in the general market.

  • Utility Function: U = f(x, y, z), where U is utility, and x, y, and z are attributes of the property relevant to the specific user (e.g., proximity to a factory for a supply company).

• Practical Applications:

  • Appraising a specialized manufacturing facility that is strategically located for a particular company.
  • Valuing a farm for its agricultural productivity to a farmer.
  • Assessing the worth of a property to a non-profit organization which might value the location far beyond its market potential, perhaps with a view to community service.

• Related Experiments:

  • Conjoint Analysis: This statistical technique could be used to determine how much a specific user values different attributes of a property. For example, a company might be willing to pay more for a location close to transportation hubs.
  • Regression Analysis: This can be used to correlate the property’s attributes with its profitability, thereby showing the value in use of the real estate.

Example: A company can produce components in the location, due to its proximity to its suppliers. An example of use value can be the profit that the owner makes as a direct consequence of using the location.

2. investment❓ Value

• Definition: Investment value is the value of a property to a specific investor, considering their individual investment criteria, such as required rate of return, risk tolerance, and financing options. This value is subjective and may differ from market value, which reflects the perspective of a typical investor.

• Scientific Principles: Investment value is grounded in financial theory, specifically discounted cash flow (DCF) analysis. The investor’s required rate of return is used as the discount rate to calculate the present value of future cash flows from the property.

  • Present Value Formula: PV = CF / (1 + r)^n, where PV is the present value, CF is the cash flow in period n, r is the discount rate (investor’s required rate of return), and n is the period.

• Practical Applications:

  • Determining if a property aligns with an investor’s portfolio diversification goals.
  • Assessing if a property meets an investor’s minimum return requirements.
  • Evaluating the financial feasibility of a property for a specific investor considering their available capital and financing options.

• Related Experiments:

  • Sensitivity Analysis: This can be used to determine how changes in key assumptions (e.g., rental growth rate, vacancy rate) affect the investment value for a specific investor.
  • Scenario Analysis: This can be used to estimate the investment value under different economic scenarios (e.g., recession, boom) for a specific investor.

Example:
Investor A has a low risk tolerance. Investor B has a high risk tolerance. Both parties are evaluating a rental property. Investor A uses a low discount rate to determine investment value due to its low risk. Investor B will use a high discount rate. The investment value will vary for these two parties due to the different discount rates.

3. Assessed Value

• Definition: Assessed value is the value assigned to a property by a government agency for the purpose of taxation. It is often based on market value but can be adjusted to reflect specific legal or policy requirements.

• Scientific Principles: Assessed value is linked to principles of public finance and taxation. Governments use assessed value to determine property tax revenue, which funds public services. The relationship between assessed value and tax rate determines the tax burden on property owners.

  • Property Tax Formula: Tax = Assessed Value x Tax Rate

• Practical Applications:

  • determining property tax❓❓ obligations for homeowners and businesses.
  • Comparing property tax burdens across different jurisdictions.
  • Evaluating the fairness and equity of the property tax system.

• Related Experiments:

  • Ratio Studies: These compare assessed values to market sales prices to assess the accuracy and uniformity of assessments.
  • Regression Analysis: This can be used to identify factors that influence assessed values, such as location, size, and building quality.

Example:

The local government taxes real estate at 1% of the assessed value. The government assesses two similar properties as having different values. The owner of the property with the highest assessment will pay more in property taxes.

4. Insurable Value

• Definition: Insurable value is the value of a property that is covered by casualty insurance. It represents the cost to replace or repair the property in case of damage or loss. This value may differ from market value because it excludes the value of land and focuses on the replacement cost of improvements.

• Scientific Principles: Insurable value is based on principles of risk management and insurance. Insurance companies use insurable value to determine premiums and coverage limits. It is related to the probability of loss and the cost of repair or replacement.

• Practical Applications:

  • Determining the appropriate amount of insurance coverage for a property.
  • Negotiating insurance premiums with insurers.
  • Calculating the amount of compensation to be received in case of property damage or loss.

• Related Experiments:

  • Cost Estimation: This involves estimating the cost to replace or repair the property based on construction materials, labor costs, and other factors.
  • Risk Assessment: This involves assessing the probability of different types of property damage or loss, such as fire, flood, or earthquake.

Example:

The insurance company will evaluate the cost to replace the building, and set the insurable value at that cost. The real estate may be worth more than the insurable value, due to the inclusion of the land.

5. Liquidation Value and Disposition Value

• Definition: Liquidation value is the estimated price that a property could be sold for in a forced sale❓, typically within a short time frame and under duress. Disposition value is similar, but it reflects a slightly less distressed situation where the seller has a limited, but not severely constrained, time to sell. Both values are significantly lower than market value.

• Scientific Principles: These values relate to supply and demand dynamics. When time to sell is limited and the seller is under pressure, the supply of available properties increases while demand decreases, leading to a lower price. This also relates to game theory, where the seller has less negotiating power.

• Practical Applications:

  • Estimating the potential recovery in a foreclosure or bankruptcy proceeding.
  • Determining the minimum acceptable bid for a property being sold under pressure.
  • Assessing the risk of loss in a forced sale situation.

• Related Experiments:

  • Market Discount Analysis: This involves comparing the prices of properties sold under duress to the prices of comparable properties sold under normal market conditions to determine the discount applied.
  • Auction Simulations: Conducting mock auctions to estimate the price that a property would fetch in a forced sale situation.

Example: A lender has a nonperforming loan and must sell the foreclosed property quickly. The short exposure time affects the price that the lender will realize.

6. Value of the Going Concern

• Definition: The value of the going concern is the total value of a business, including its real estate, tangible personal property (e.g., equipment), intangible assets (e.g., brand name, customer relationships), and the operational business itself.

• Scientific Principles: This value draws from business valuation principles, which consider the present value of future profits from the business operation. It considers the synergistic effect of the business components functioning together.

• Practical Applications:

  • Valuing hotels, restaurants, gas stations, and other businesses where the real estate is integral to the business operation.
  • Determining the purchase price for a business acquisition.

• Related Experiments:

  • Income Capitalization: Projecting the income of the business and applying capitalization rates to the income streams.
  • Comparable Sales Analysis: Evaluating recent sales of comparable businesses as a whole, including real estate and operations.

Example: A hotel will include real estate, furniture, and other components. If the hotel has a high brand recognition, and customer loyalty, this would also increase its going concern value.

Conclusion

Understanding the different types of value beyond market value is crucial for real estate professionals. These values provide valuable insights for specific users, investors, government agencies, insurance companies, and those involved in distressed sales situations. By applying relevant scientific theories and principles, accurate estimations of these values can be developed, leading to informed decision-making in various real estate contexts.