How is Value Decided in Real Estate?

The Hancock Group

06/4/21

It's a question that's as old as the concept of trade itself - How do we decide what something is worth? For as long as goods and services have been changing hands, we have been deliberating on how to calculate the value of a given thing. It's this concept that has forged empires and waged wars, and it continues to drive us forward to this day. 
 
In many cases, we have gotten very good at calculating the value of things. The costs of many commonly traded goods and services are driven by a simple supply-and-demand model, and larger economic regulations exist to, well, regulate healthy and fair exchanges in value. Simply put, thanks to the models we have in place, we don't reasonably have to worry about the price of a candy bar skyrocketing to $300 overnight.
 
Real Estate, on the other hand, is not quite so simple. Let's face it: Houses are expensive. Because of the sheer scale of the transactions that take place in Real Estate, the value of a given home is incredibly vulnerable to a range of factors that can push a price upward or downward by considerable amounts. While some of a home's price-influencing factors may seem obvious, like its size or location, there are a staggering number of factors that can easily go unconsidered by many. Even the color of a home's siding or the species of tree in the yard can have a noticeable impact on its value!
 
There can be substantial consequences for sellers if the price they put on a home does not align with its value. If they price a home too high, they can actually end up losing money in the long run, as the home accumulates days on the market and buyers begin to assume that there is something "wrong" with it. Inversely, if a home is priced properly, there is increased potential for a buyer to offer an even higher price because of certain subjective factors that they may personally find more valuable, such as its architecture or proximity to certain locations.
 
In general, there are two main types of factors that influence the price of a home: objective and subjective. Objective factors are anything that can be quantified or recorded, including location, square footage, number of bedrooms/bathrooms, etc. Subjective factors are much harder to quantify, and can include the home's floorplan, quality of construction, and even certain design choices.
 
So, how does one navigate all of these factors to ensure that they can confidently know what their home is worth? With the advent of technology, there are many online resources that can offer some insight for someone who is looking to know the value of a property. The best examples of this would be Automated Value Models or AVMs for short. These are algorithms that compile all of a home's objective factors using transaction histories, tax records, etc. to "estimate" what a home would sell for if it were to be put on the market today. With regard to these, we say "buyer beware." They may serve as a starting point or possible range of price, but we consistently see them fall short in providing sellers accurate and relevant data. Because they only consider objective factors, they rarely if ever give you the full scope of the home's value. For example, Zillow's "Zestimates" are a very popular form of AVM.
 
A much more common and traditional way to assess the value of a property is through a formal Appraisal. This is when a licensed appraiser is invited to the property to perform an in-depth inspection in order to determine its optimal price. The reason they are so common is that most mortgage lenders will require an appraisal as part of the underwriting process, especially in the case of high loan-to-value mortgages. This is primarily to verify that there is enough collateral to secure the mortgage in case the borrower were to default. In some situations where the risk is lower, however, a lender may simply opt to use an AVM. Typically, if you are not looking to sell but are just curious, an appraisal may be the way to go. We don't recommend this method, however, for people looking to potentially sell their property, as appraisers are not involved in the resale process and often don't understand the intangible dynamics of market conditions.
 
For those who are looking to sell, we recommend the third option: a BPO, or Broker Price Opinion. As the name indicates, a BPO is a licensed Real Estate Agent's estimate of the value of a property. While they can vary somewhat between different Realtors based on their experience with certain types of properties or their involvement in a specific market (e.g. waterfront, acreage), they tend to be more sensitive to the actual market, since Agents can consider any subjective factors. A good Realtor will also use their experience to observe comparables, or similar homes in the area that are for sale or have recently sold/expired.
 
Being able to price a home accurately and properly is crucial to navigating the Real Estate market successfully. Failing to do so can result in tens of thousands of dollars being left on the table in a transaction! While AVMs are a useful tool that can give you a somewhat functional snapshot of how to price a home, if your goal is to get top dollar for your next sale, your best bet is to use a trained Real Estate Professional with extensive knowledge of the industry. That's where we come in. Our agents have 30 years of combined experience both buying and selling houses in the southwest Twin Cities metro, and they're backed by a team of administrators who work tirelessly to ensure that each transaction is a smooth and successful one.
 
Whether you're looking for a single-family home in Waconia, a townhome in Chanhassen, or a lakefront property in Minnetonka, our team is here to help! Click Here to learn more about us and give us a call today! We're looking forward to hearing from you!
 
 
 

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