Real estate valuation is the process of estimating a single price that one would realistically pay to own a particular property. The residential property valuation method that is most familiar to brokers and agents, of course, is comparative market analysis (or CMA). This property valuation process involves an estimate of value based on the sales prices of other similar (or comparable) properties within the local market area and/or other similar markets.

When preparing a CMA, a minimum of three recently sold comparable properties and three currently for sale comparable properties are typically chosen to infer the price of the subject property. Differences between comparable properties and the subject property are evaluated to add or reduce value in the analysis and to estimate a fair market value of the subject property using a comparison approach.

The valuation of commercial properties (ie, office buildings, apartment buildings, single-family communities, and land) is largely influenced by several economic principles. These principles are generally not taken into account in the typical CMA report for residential properties. The goal of this article is to shed some light on these principles because they can be applied to any property valuation effort. They form the basis of our approach in this discussion as we look at and summarize six applied economic principles that can help give you an idea of ​​the impact they can have on a property’s value.

1) Anticipation

This is the expectation of future benefits. In other words, real estate investors measure the value of the real estate investment based on the anticipated future income stream generated by the property. They are more likely to value a property for the income it generates rather than the perceived market value inferred by comparative analysis, or the construction and land costs required to replace the property. The expected or anticipated earning capacity of the asset is the primary focus.

This approach is not a surprise to those who have some knowledge of commercial real estate investing; However, it is not common knowledge to the average property owner or buyer. The focus on purchasing anticipated cash flows can also help broaden the understanding of value in residential property. For example, instead of thinking “how much is the property worth now?”, also think, “how much would you get back if you bought the property and rented it out later?” In a competitive environment, this focus and insight can make all the difference.

2) Compliance

This is defined as the need for reasonable similarity and compatibility at a given location. Compatible land uses, for example, may generate higher values ​​than those with limitations imposed on the property due to location.

For example, an apartment complex located primarily in a residential area will likely have more value than one located in a highly industrial area. Savvy commercial real estate investors are interested in this concept, while many residential home buyers may not pay much attention to adjacent or nearby land uses. Taking a broader view of surrounding uses can provide a deeper understanding of value, or perceived value, from an investment perspective.

3) Supply and Demand

This principle encompasses both the scarcity and the demand for the property in question. Although investment properties with similar physical and economic characteristics may sell for similar prices, property valuations can be greatly affected (up or down) in a market that lacks a reasonable balance between supply and demand.

For example, land in a metropolitan area where undeveloped land is scarce would command a higher value than land in a rural area with large parcels of vacant land. Similarly, an apartment complex that sells at a time when there is more than enough supply to meet rental demand would be worth less to a real estate investor than the same complex during a time when the supply of apartments in the area is smaller and does not adequately meet the demand.

4) Higher and better use

This is an important concept that relates to the highest possible use and the best possible use of a property, as opposed to its current use. In other words, when it is legally possible, appropriately compatible, physically possible and financially viable to change the use of a property, its value can increase significantly.

For example, an office building can be expanded to add more profitable office space or a retail store on the first floor; Or, an apartment complex can add more units or add mixed-use features to the community to improve its value.

Commercial real estate investors and developers use this principle to create value and improve cash flow. The principle can also be used in residential real estate when a buyer or owner of a residential property evaluates the highest and best use of the land under municipal zoning and building codes, and considers adding or expanding the features and features of the property to increase its value. .

5) Contribution

This, essentially, means that the value of an income property can be affected when it is physically, legally, and economically feasible to add more space to the property at a cost equal to or less than the marginal income it generates. That is, when the added value offsets the cost of making the contribution or investment. Unlike the principle of highest and best use, this principle compares the income or value with the benefits that the investment or contribution can produce. The question to ask yourself after you have identified the highest and best use of your property is whether the investment or contribution required to achieve the highest and best use of the property makes financial sense, or is justifiable. You can add features to a home, such as a pool and deck, and you can add units to a multi-family building; The contribution question is, “Will you be able to sell the house for the added value you perceive it’s creating, or will you rent the new apartment units?”

6) Replacement

This is an opportunity cost concept. In other words, a rational real estate investor will not pay more for an investment property than the next best substitute with similar levels of risk will produce in financial benefit. For the residential buyer, owner or investor, this means carefully considering all other options. Residential homebuyers often fall in love with the first home or second they see and can easily forgo better opportunities as a result. This principle suggests evaluating and comparing numerous opportunities in the market before making a decision.

The six principles mentioned in this article are meant to be an overview, to give you an idea of ​​how other economic factors can affect property valuations. While these principles are demonstrated in the valuation of commercial real estate, they also affect residential property and should be observed when analyzing the value of any real estate property.