Keller Williams Realty



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Cars and stocks and other things

Perhaps the two best known examples, that people are familiar with, where market value determines the price for which items sell, are stock market and cars prices.

The term ‘stock market’ is a concept for the financial vehicle that enables the trading of company stocks. Stocks are ‘listed’ and ‘traded’ on exchanges via an auction program where a buyer ‘bids’ a specific price for a stock and a seller ‘asks’ for a specific price for the purchase.

Stock prices are governed, in large part, by the economic laws of supply and demand. Sure it’s important that a company’s financials be in good shape and that earnings be strong, etc. Financials affect desirability, hence the supply and demand for the stock. The law of demand refers to how much stock is desired by buyers. The stronger the demand ie: the more of a particular stock that buyers want to purchase, the higher price that stock will command. The law of supply says: the larger the supply, available to purchase, the lower the price it will command.

If there were 10 buyers for only one available share in the “(INSERT YOUR NAME) REAL ESTATE COMPANY”, those 10 buyers would drive the price of the stock upward… you’d be a happy camper. Conversely, if you had 10 shares to sell and only one potential buyer, wouldn’t you have to reduce your asking price for the stock and accept less money? People wouldn’t buy it, until you reduce your asking price.

If you owned 100 shares of AT&T stock that you purchased several years ago at $50.00 per share and they were currently trading on the open market for $20.00 per share, $20.00 a share would be all you could sell them for, that is current market value. (CMV) The fact that you paid $50.00 a share (once upon a time) means nothing in valuating current market value. No one would buy your stock at $50.00 per share if they can readily buy it for $20.00 elsewhere.

Prices on cars follow the same laws of supply and demand. Various blue book indices show current market value, by comparing what buyers have paid recently for similar cars. Current market value on different model cars are available in books or on the Internet; cars are compared by year, model, features, mileage, condition, wear and tear, etc. Market value on a new Mercedes is different from the market value on a 20 year old Volkswagen. Market value on a new Mercedes is different from value on a 3 year old Mercedes, or a 5 year old Mercedes, etc. To determine current market value on cars you compare like items to like items, apples to apples as they say, you compare the same model make of car, the same age, features, mileage, condition, etc.

The same laws that govern market value on stock and cars apply to house prices as well.

Estimating market value for houses, for both new and resale houses, gets a little bit more complicated than simply looking up blue book on a car. This is job a that a realtor must do well; clients rely heavily on their realtor’s ability to determine the top dollar value that their house will sell for. Without access to the correct facts, clients can only guess at what a property is worth … realtors must know what a property is worth.

The sales comparison approach is used to determine market value on most houses. Look at recently closed sales, on similar houses, located in close proximity to each other. Close proximity is important here. Don’t compare one house to another house in a neighboring city, that would prove useless in determining value, but rather you compare houses located as close as possible to the subject home.

While evaluating a 20 year old, 3 bedroom, 1500 square foot home, located on a 6000 square foot lot … and you find 3 other similar houses that closed escrow, within the past 30 days, for $300,000 each, CMV on the home you are trying to comp is around $300K. If the asking price of similar house, located close by is $400K, no one is likely to offer anything close to $400K for the house. Not if they can buy one for $100K less.

The principle of substitution

The principle of substitution helps determine the value of real property. As the name implies, you simply substitute the sold prices of similar properties in order to determine the market value of the subject house. First, the realtor collects data on recent selling prices on houses similar to the one he or she is trying to valuate. (From now on we’ll call this comping a home.) Then you substitute the values.

Compare apples to apples, in the same way that you compare the same make and age on cars to one another. Subject property and pending and closed sales need to be approximately the same age and close in proximity to each other. (Pending sales are sales where a real estate contract is in force, but the house has not yet closed escrow.) Features, amenities, house size, house age, lot size, etc., need to be as similar as possible to the subject house. Sales also need to be as recent as possible.

To illustrate this … closed sales that happened, say 5 years ago, are of little value in determining what market value is today. Aged information is of little value. It does not matter what a buyer paid last year for your neighbor’s house. That was then … this is now. CMV is also defined as what serious buyers are willing to pay now …. As in today.

Realtors are not required to report the actual agreed sales price before escrow closes, but pending sales are an excellent source of determining current market value on the subject property because they show what price serious buyers have paid most recently for similar homes. (A realtor can make a couple of calls, do a little digging, and calculate the approximate sales price.) Closed sales are sales where escrow has already closed. Selling prices on closed sales are available through public records or multiple listing service records. Generally, in a dynamic real estate market, when market value on houses changes quickly …. Pending and recently closed sales need to be as recent as possible. Most formal appraisals are valid for only 90 days. After that time period they are pretty much obsolete.

Adjustments are made, adjusting estimated market value (up and down) on the subject house, based on differences in features / amenities between the subject and other properties that have recently gone pending, or closed. (IE: add $5K for an extra bath …add $10K for a remodeled kitchen, etc.) House size, age, lot size, style, upgrades, quality of construction, plus other factors affect market value. Here is a partial list of items that affect market value on houses:

• Year built

• Lot size, layout

• Location, location, location

• Square footage of house

• Single or two story house

• House style

• Number of bedrooms and baths

• Number of rooms, room sizes, whether the house has formal dining room, living room, family room

• Kitchen features or remodels, or upgrades

• Baths remodels and upgrades

• Size, layout and appeal of master bedroom

• Number of fireplaces

• Size of garage and available parking spaces including side yard access

• Quality, age, and type of flooring

• School district

• Location of house on street (corner or cul-de-sac)

• Type of roof

• Size of rear yard

• Yard features such as in ground pool, spa, patios and decks, kid’s play area, barbecue area, shade coverings, storage shed, fruit trees, vegetable garden, landscaped area, automatic sprinkler watering system, etc.

• Cooling and heating features

Once these facts are put together an estimate of market value on the subject property can be obtained. Make your adjustments and substitute the sold and pending prices from comparable properties. If future market conditions remain the same a serious buyer will pay this CMV for the subject property. If real estate market conditions change, then all bets are off. More on this later.

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We are looking at several pending and closed sales here, not all similar properties close at the same price. So CMV is stated as a range of acceptable values, not a fixed price. Which leads us to the first two laws of TJ’s laws of real estate.

TJ’s first law of real estate.

Houses sell for market value.

Most of the time… many times houses sell for less than they are worth. Rarely does a home sell for more than it is worth. More on the exceptions to the law/rule later.

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Real estate prices are dynamic, subject to regular change in most major metropolitan areas. Factors that influence price are, but are not limited to:

• Rise and fall of interest rates

• Local economic factors (job growth, unemployment rates, area desirability, etc.)

• Supply and demand of available homes in any given area, city, etc.

House prices go up and down, in most metropolitan areas, on a regular basis. The trend, over time, is for prices to appreciate. But, it is also common for prices to correct, or go down, for periods of time. America’s favorite pastime is watching the ups and downs of house prices. Just one click of the mouse is all it takes. The housing market is usually a hot topic at cocktail parties, summer barbecues, etc. Everybody has an opinion as to where the real estate market is headed.

Houses prices live and die with the rise and fall of interest rates. Lower rates mean lower monthly mortgage payments; buyers can afford more, house buying activity increases. Demand increases. Higher rates, has the reverse effect; it puts a damper on home buying activity. Like pouring cold water on a hot grill.

Local supply and demand statistics vary from city to city, from neighborhood to neighborhood; they also vary within different price ranges within a city. House prices are dynamic.

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Which leads us to TJ’s second law of real estate…

TJ’s second law of real estate.

When in doubt about what a home will sell for … refer to TJ’s first law of real estate…houses sell for market value!!

Market value just has a tendency to change more often than not.

Market value is not cost, they’re two different entirely unrelated items. Owner #1 bought his house 20 years ago for $100,000. That is his cost. Current market values on similar houses are approximately $400K. Maybe as high as $420K if completely remodeled. If owner #1 decides to sell their home, they could expect it to sell for market value, approx. $400K. Owner #2 lives next door and owns the same model home. However, owner #2 bought his home last year and paid $400K for it. Then he spent another $100K remodeling. His cost is $500K. If he decided to sell … what would it sell for? The answer is $400-$420K, CMV. Market value and cost, when selling houses, are unrelated, in the same way that the guy that paid $50.00 a share for AT&T stock can’t sell it for more than its’ current trading price.

Market value, and what sellers want their proceeds check to be, are also unrelated. Owner #1, whose home’s market value is currently $400K would like to get $500K for his home because he wants the money to buy a bigger boat. He likes to fish. Do you think that a well informed buyer will pay an extra $100,000 because the seller wants it? The answer is an emphatic no. Whether the buyer likes to fish or not… (Now, market value and what the seller wants for proceeds can coincide, depending on market conditions. More on this later.)

The exceptions to TJ’s first law of real estate? 99.5% of the time (in my opinion) homes sell for market value. Houses do sell for less; sellers may be desperate for a sale; sellers and their agents are not working on the right set of facts / comparables. This happens when there is a large supply of houses.

When there is a large supply of houses available, rarely does a home sell for more than market value, but it happens sometimes. Nowadays, buyers are well versed on real estate prices. (America’s favorite pastime again…) People educate themselves about home prices before they buy. Most are too smart to overpay for a house.

When house supply is low and buyer demand is strong houses rarely sell for less than market value. Houses command higher prices in seller markets.

Definition of a buyer’s market

In a buyers market supply and demand take another kind of twist. Demand is down, there are fewer buyers, supply is high, with more houses available for sale. If you have more than three months supply of available houses (once again total single family houses, condos, townhomes, etc.) it is considered a buyers market. Now with 3-4 months supply available, prices are not going down too fast, or too much …. But when you have 8, 10, or 12 months supply of houses available that’s a different story.

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The above chart shows what happens when there is a 10 month supply of houses. The buyer will usually buy the most affordable house that meets their needs. They’ll usually make a lower offer, trying to make the house more affordable still. Once they buy, there are still 9 other houses on the market (not counting any new listings that may come on) Motivated sellers, wanting next months one buyer to consider their home … reduce their asking price. Next month’s buyer makes a lower offer still…. The downward cycle continues until there is roughly a 3 month supply of available houses…then prices stabilize.

This is a rather simplistic example, but an accurate one nevertheless. Houses sell slowly in a buyer’s market; motivated sellers, ( job loss, divorce, job transfer, etc.) who have to sell their house regardless of market conditions, eventually see the light and reduce their asking price.

New home builders have an advantage over resale home sellers in a buyer’s market…. Builders have deeper pockets, they can offer buyers incentives to seal the deal.

In a buyers market builders offer:

• Free upgrades

• Reduce the asking price (eventually)

• Special financing options

Builders stack the deck in their favor and offer buyers tens of thousands of dollars in upgrades in order to make the sale. Upgraded flooring, such as hardwood floors, or upgraded cabinets, granite countertops, etc., are thrown in for the same asking price in order to get the buyer to commit.

Perhaps the best tool that builders have in their ‘closing the deal toolbox’ is special financing options. A main buyer criteria for purchasing is affordability. What the house payment is each month is really, really important. Builders know this, so they offer to buy down the interest rate, for a period of time, say 3-5 years. (Buying down the interest rate means paying more fees / points to secure a lower rate.) Lower monthly payments for the buyer and is an effective closing tool, the hammer that seals the deal.

As a last resort, when the first two options don’t work, and when the market is declining and when builders project that the market will continue to decline… they will reduce asking prices. For the most part, builders won’t reduce their asking prices when they feel that the market will turn around, and get stronger, sometime soon. Big builders can weather the storm. (Deep pockets theory again.)

Resale homeowners are at a distinct disadvantage when competing against a new home builder for the few buyers available in a buyers market. Builders will offer all of the above incentives in order to sweeten the deal…about the only effective thing a resale house owner can do to compete is to lower the asking price of their home. Sure a seller can sharpen the appearance of their home … new carpet, paint, remodel … but even when sellers do this… they still might have to sharpen their pencil and reduce their asking price.

Other characteristics of a buyers market are:

• Slow homes sales

• Fewer buyers

• Beaucoup house inventory available, both new and resale

• Number of house sales is down

• Buyers are slow to decide to purchase

• Escrows fall apart as buyers change their mind, cancel the deal and decide to not to buy until house prices bottom out

• Numerous price reductions on houses

• Buyers have upper hand in negotiations

• Real estate commissions increase

• Discount and online real estate brokers lose market share

• Investment money flows out of real estate and into other, more profitable venues

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Those same sellers, who saw dollar signs in their eyes during a sellers market … are not so happy during a buyers market.

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The Real Estate Principle of Substitution

Same houses - Same age, style, location

All 3Br / 2Bth, 1500 Sq. Ft.

Just closed escrow for $400K each

=

Subject House - Same house, style, age, location, etc. Substitute $400K for market value

One month

higher

lower

Market Value over time

Time

Home Prices

* A buyers market is defined as more than 3 months of available inventory. In a buyers market, home prices decrease.

* (ie: 500 available homes, 100 pending sales per month. A 5 month supply of available homes.)

What happens in a buyer’s market??

Six months

If there are 10 houses available and only 1 buyer this month, the buyer will usually buy the house that they think is the best value for the money. That usually means the most affordable house, or the lowest priced house that they like and that meets the buyer’s needs.

* This drives current market value (CMV) on houses down. This downward cycle continues until the available supply is reduced.

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