How Not to Price a Home

March cover

Happy March!  Hope you are doing well in 2014.

By popular request, I will talk about how the value of a residential home is determined.  This month, I will first discuss how NOT to price a home:

  1. Average Price Per Square Foot:  It’s a popular perimeter for the general public but not used by appraisers or seasoned real estate professionals.  It is useful sometimes when comparing certain construction cost without considering land cost, and situations such as when pricing leasable square footage.  There are too many factors it does not account for.  For example, features such as lot size, lot quality (water frontage, conservation, golf course, interior lot, road frontage), swimming pool/spa, interior features (remodeling, granite countertops, hardwood flooring, fireplace, number of bathrooms, garages) are all important elements in pricing differentials but unaccounted by the average square foot method. There are built-in biases as well.  For example, smaller homes generally average out a higher price per square foot than larger homes in the same neighborhood.  In other words, when homes are similar in other aspects, additional square footage has decreasing return on value.  There are value theories and principles that are quite academic, but suffice to say, this is why banks use expensive appraisals on each and every loan, rather than use their own computer averaging models (which they already have).  It’s quite convenient to think of the price per square foot range when discussing a neighborhood, but whenever one tries to estimate a value by multiplying that average with an actual home’s size, the result often can be wildly off.  The very first service a competent real estate agent provides a client is an expert pricing analysis.
  2. Construction Cost/Reproduction Cost:  The construction cost of a home actually has no bearing on the market value of a home.  During the foreclosure crisis in Orlando, homes were selling below reproduction cost.  This is why there was little activity in new construction fields during those years.  The builders simply couldn’t compete with resale.  Your home insurance policy may also have insured a value higher than the assessed market value, because it would cost more than its current market value to rebuild the home.  This is also true when it comes to home improvement items.  Most projects do not recoup full cost when the home is sold.  For example, on a $250,000 home, when the owners put in a high end $50,000 pool, it would only fetch a maximum line-item appraisal value of $25,000.  So when a seller adds up the cost of all the upgrades and improvements in his home and hopes to recoup them, it may price the home outside of the market range.  Many of the improvements are inducements to sale, without having the same contributory value.
  3. The Asking Price of Homes in Your Neighborhood:  The market value of your home does not change with the asking price of homes on the market in your neighborhood.  It does change only if/when these homes are sold.  Many homes are listed but never sold.  Only actually closed homes become the comparison basis for market value.  It is important to consider the asking price for other reasons:  1. If you are going to list your home, it’s important to understand your competition.  2. Existing active listings provide market intelligence.  If a similar home has been on the market for some time without selling, that asking price indicates a market ceiling.  Someone else has tested the market for you.  This information provides valuable insight to formulate your own strategy.

Okay, I will stop here.  Next month, I will continue this topic by discussing how we DO price a home!  Stay tuned!

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