What You Should Know About Real Estate Valuations
I recently noticed this interesting bit from the World Property Journal:
U.S. home prices nationwide rose both year over year and month over month in January 2020. Home prices increased nationally by 4% from January 2019. On a month-over-month basis, prices increased by 0.1% in January 2019...
"January marked the third consecutive month that annual home price growth accelerated in our national index, as low mortgage rates and rising income supported home sales," said Dr. Frank Nothaft, chief economist at CoreLogic. "In February, mortgage rates fell to the lowest level in more than three years, which likely will spur additional home shopping activity and price appreciation."
Good news, right? But that’s not the part that caught my attention...
{An} analysis of housing values in the country's 100 largest metropolitan areas based on housing stock, 33% of metropolitan areas have an overvalued housing market as of January 2020. The MCI analysis categorizes home prices in individual markets as undervalued, at value or overvalued, by comparing home prices to their long-run, sustainable levels, which are supported by local market fundamentals such as disposable income. As of January 2020, 29% of the top 100 metropolitan areas were undervalued, and 38% were at value.
In other words, the property is often priced (and presumably sometimes sells) at way more than it’s actually worth according to advanced real estate valuations. Almost as regularly, it’s priced (and sells) for way less. It’s only just over a third of the time that homes in this study were priced pretty close to what they were actually worth according to reputable real estate valuations. It begs the question: how does an assessor (or real estate agent, or anyone else) actually compute the value of your property?
Valuate Anything - The Accury Store
What’s It Worth?
At first glance, the question of what your home or other real estate is actually worth seems fairly straightforward. It’s worth what you paid for it, right? Or would it be more accurate to say it’s worth what you could sell it for? Maybe it’s worth what it would cost to replace it if something unpleasant happened. No, wait – it’s worth whatever the county says when they compute property taxes.
All of those can be correct in different circumstances. None of them are correct in every circumstance. Just to complicate things, we have to distinguish between the “value” of a property, the “price” you paid or someone else is willing to pay, and the “cost” of that property – price plus any other expenditures required to obtain it.
However it’s figured, there are generally four more-or-less universal elements of value when it comes to determining the value of your home or making other official real estate valuations:
Demand
Do people who COULD buy it WANT to buy it? It does not technically demand if the majority of those who’d be interested simply can’t afford or otherwise can’t realistically purchase the property. It does certainly not demand if those who can afford it simply aren’t interested.
Utility
Is the property USEFUL? If it’s a home, is it livable and maintained? If it’s an office building or other property, is it structurally sound? Located somewhere accessible to those who might wish to access or utilize it? Does it have heat, air, water, plumbing, etc.?
Scarcity
If your home is in a growing area where many people are looking to buy a house, but there simply aren’t enough of them to go around, the value of your home goes up. If it seems like a third of your neighborhood is trying to sell as quickly as possible and get out of town, the value of your home goes down.
Transferability
How easily can ownership and occupation be transferred from one entity to another? If for some reason you can’t actually access the property, or legally utilize it upon purchase or rental, it’s not very useful to you. The more difficult it is to take over, the less value it has.
Real Estate Valuations 101
Let’s look at the three primary ways the value of your home or other real estate can be determined. Then we’ll touch on the most common reasons you might be concerned about the value of your home – you’re wondering if it’s time to refinance, take out a home equity loan, or do some home improvement. Even if you’re not, read on. There’s probably something useful in here for you as well. Who doesn’t love learning more about real estate valuations?
The Sales Comparison Approach
This is the one your realtor is most likely to use if you’re looking to buy or sell a home. Essentially, a property’s value is estimated by comparing it to similar properties in the same area. If you have a 4-bedroom, 2-bath home built in the 1990’s with a nice deck and finished basement that you’d like to sell, your realtor looks for other 4-bedroom, 2-bath homes built in the 1990’s with nice decks and finished basements in your neighborhood. If she can find six or seven of them and they’ve all sold in the past year or so for between $185,000 - $201,000, we have a pretty good lock on the general value of your home.
But of course, it’s rarely that simple. So your realtor looks for homes of similar size with similar features, then adds a little to the one built in the 1970’s that sold last year and subtracts a little from the one with a nice pool out back or the really big front yard and produces an estimated value for your home that way. The homes or other properties used to generate these estimates are called “comparables,” because they’re presumably “comparable” to yours in as many ways as possible.
Even this only works if the housing market is operating in a fairly stable, normal way. Recent factory closings (or openings) or other surges up or down in the market make this method even trickier than it already is. So does gaps in the ages of the homes referenced, specific damages or other issues (strange interior colors or patterns, recent homicides in the basement, etc.). Still, most assessors and any real estate agent worth their badge can produce surprisingly accurate and useful number values using this system.
The Cost Approach
This method for determining property value is a bit more involved. It considers the cost of the actual land on which the property is located PLUS the cost of replacing the structure in question. This total is reduced by computing depreciation in much the same way business’s do for expensive equipment when figuring their taxes each year.
The land value is the easier element in this system. Since it’s usually possible to find several similar lots in the area and determine a square foot value based on recent sales. While not all land is the same, it’s far more similar than the improvements upon it.
For the homes, buildings, or other structures, replacement cost is generally used as a starting point. Using comparable materials, what would it cost to essentially duplicate the property in question today? If there are similar homes or structures nearby, a cost-per-square-foot value can be determined in much the same was as for the land itself.
The Income Approach
This system comes at the issue of value from a different angle. What does it cost to maintain or operate this property and how much income can it realistically bring in over the same time period? This is far more common with commercial real estate than residential housing, although it can be used to estimate the value of rental property or other income-generating homes.
While in many ways the most straightforward of the systems discussed here, it still requires attention to detail. Not all expenses are fixed or predictable; most income is subject to market forces and may change dramatically over time. The apartment complex which was worth millions last year and had a waiting list of dozens of potential renters can lose value quickly if the nearby shopping mall goes under or it turns out some private contractor has been burying nuclear waste in the ground nearby.
These are extreme examples, but the basic principle holds true everywhere. You can probably think right now about a few parts of your own town or region in which major retailers went out of business after promising beginnings. You’ve almost certainly been to neighborhoods which were clearly elite living in their day but now struggle to keep basic maintenance up-to-date. It’s the nature of things, and it makes estimating value an ever-evolving challenge.
What This Means For Your Mortgage
Forgive me for making assumptions, but most of us only start thinking about the various methods of calculating real estate valuations when we’re considering doing something with our own real estate – usually our own home. For most of us, our home is the single largest investment we’re going to make in one lifetime. It’s also the source of our greatest equity.
Whether its value goes up or down and how that’s determined understandably matters a great deal to many of us. It’s why the old guy across the street gets so mad when that one house has cars in the yard and why the neighborhood association tries to require a certain degree of maintenance on every home on the block. If we’re neighbors, the condition and value of your home literally impact the value of mine – yet remains largely out of my control.
Still, you’re probably familiar with the opening lines of the “Serenity Prayer”:
God grant me the serenity to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference.
That’s good advice whether you’re a religious person or not. So let’s focus on the things we CAN control about the value of our home and how we use it. I suggest beginning with a brief introduction to the different types of mortgages commonly utilized by homebuyers in the U.S. And, as it turns out, my dear friend Jackie Strauss has written just such a guide – the essentials, all in plain, simple English, and helpful mortgage tips along the way.
I know you’re anxious to get back to real estate valuations and what options they give you in terms of leveraging your equity or refinancing your mortgage, but there’s one more resource you’ll want to know about. It’s a concise recap of common home mortgage terms and definitions by my colleague, Carlie Lawson. (I still reference it whenever I need a refresher on some small point or another.) From “Acceleration Clause” to “Underwriter,” she’s got it covered. Plus, she writes so colorfully that it’s almost FUN learning about the residential mortgage process.
When you’re done with that, let’s talk about real estate valuations in pursuit of a home improvement loan.
Real Estate Valuations for Home Improvement Loans
A home improvement loan gives you the resources you need to update or renovate your home. It is not to be confused with a home equity loan or a full refinancing of your mortgage, although home improvement loans do typically rely on your house equity as security for the loan. That’s where real estate valuations come into play, since the lender will want to verify that the current value of your home sufficiently exceeds the balance you owe in order for it to act as collateral on your loan.
The use of your home as collateral helps keep interest rates and other terms relatively low, although your credit history and current three-digit credit score will impact rates and other terms as well. Typical home improvement loans are repaid over a relatively brief period, with 12 months being the most common. It’s possible to take out an unsecured personal loan for home improvement as well. There may be less paperwork, but depending on your credit score, you may have difficulty securing terms quite as favorable as those of a secured loan.
Your local bank or credit union most likely offers any number of home improvement-type loans. Don’t overlook online lenders when applying, however. Lower overhead and national reach mean many reputable online institutions can offer extremely competitive rates and quick turnaround times and tend to be slightly more flexible in terms of past credit problems or other issues.
Real Estate Valuations for Home Equity Loans
A home equity loan allows you to use the value stored in your home to borrow money, even if you’re still making a monthly house payment. The funds can be used for whatever you choose, but it’s highly recommended that home equity loans be used for things like home renovation, consolidating debt, or otherwise taking steps towards future financial security. Because this loan is by definition secured by using your home as collateral, you’re literally putting your home on the line. Make sure whatever you’re doing is worth it.
Most lenders won’t consider a home equity loan unless you’ve paid off at least 15% - 20% of the value. Your house equity is the current value of the home (hence the real estate valuations) minus the amount you still owe. If your home is currently worth $225,000, for example, and you owe $125,000 (not counting interest), your house equity is $100,000. You can’t borrow the full amount, but lenders usually offer loans of up to 80% of your current equity.
Real Estate Valuations for Refinancing Your Mortgage
Refinancing is exactly what the name implies. You’re taking the balance you still owe on your home and “starting over” as if this balance was the total cost of your home and you were buying it for the first time. If you first purchased your home for $180,000, for example, and after paying for a number of years only owe $100,000, refinancing “reboots” the process but this time your home “costs” $100,000. This allows you to stretch out repayment, lower your monthly payments, and adjust to any circumstances which have changed since you first borrowed. On the other hand, you’ll have to pay closing costs and most of the same fees associated with buying a home, so make sure the amount you’ll save by refinancing is sufficient to offset such charges. Refinancing your mortgage offers all sorts of flexibility, depending on your circumstances and goals.
Conclusion
You probably don’t need to hire an assessor or worry about the exact value of your home until it’s necessary. Hopefully, the guidelines above help you get a general idea, however, and you’ll know what sorts of factors are being considered next time someone official tells you what your property is worth.
If you decide to look into home improvement loan, home equity loan, refinancing your mortgage, or anything else, we can help with that. Just let us know what you need, and we’ll connect you to some options. If you're not sure what you need, well... maybe we can help with that, too. Reach out anytime and let's see what we can accomplish together!