As real estate agents we are always looking for ways to help our clients make sound decisions. If we find a way of doing so that also differentiates us from the market – all the better. In the next two posts I am going to share a new way to value property that not only gives clients a vastly superior ability to make home-buying decisions, but should decrease defaults and foreclosures substantially too. Do you think that will make me a better agent? More valuable? Here’s one more way to differentiate yourself in the marketplace of real estate agents. (Warning: this post and the next involves some arcane securities concepts and new ideas that will require even more of your time and effort. If this does not interest you, stop reading now. Pick up a newspaper. Enjoy the classifieds. Maybe polish up the old resume…)
CMAs
In a recent article by Greg Swann discussing the woes of the real estate market, he mentioned homes selling for less than they would cost to build. He referred to homes priced “below their fundamental value.” Over the past six months or so I have been discussing with Brian Brady different ways to value a property. Having both come out of the securities field (I was once a securities broker and “enjoyed” some pretty exciting… read: stressful… years as an options trader on the exchange floor), the discussion revolved around how property would be valued if it were a security investment. First, Comparative Market Analysis or CMAs would be used only as a qualifier or a secondary validation. They are circularly self-serving and relationally compromised. Instead of “comps”, let’s wow our clients, protect them and increase our value as agents at the same time.
A New Way to Value
Remember I warned you that this would involve extra work. That is because there should be four values to any property and they should all be calculated before we advise our clients. Here are the four values in ascending order:
- BREAK-UP VALUE – this is the value of the land itself along with any profits to be made selling pieces of the home before tearing it down, minus the cost of tearing it down. In Illinois for example, there are companies that advertise a home about to go under a radical rehab. Buyers come to the home and everything is auctioned off: staircases, doors, windows, cabinets, etc. After such an auction you combine the money in your hand, the value in your land and subtract the expected cost of your demo contractor to arrive at the break-up value.
- INTRINSIC VALUE – this is the value of the land plus the actual cost to build a model match home using today’s material and labor costs. Don’t forget the fees, permits and so on or the cost of not being able to use the home (loss-of-use cost). Total those costs and you know what a property is worth intrinsically.
- FUNDAMENTAL VALUE – this is the value of a home based on the neighborhood rents vs the cost of owning. Often expressed as a property’s cap rate (although that is more common in commercial real estate). This is how non-owner occupant investors would evaluate a property. “Does it pencil out” is another way of asking the property’s fundamental value.
- UTILITARIAN VALUE – this is the Fundamental Value plus the non-definable value that accrues to a person owning their own home. Brian Brady jokingly refers to this as the “purple wall” value: the added premium a person is willing to pay for the freedom to paint a wall purple if that is their desire. While not easily defined, it is often easy to quantify. Look at any area where “fixers” are being sold. You will find a price discrepancy between investors who wish to make repairs and still earn a profit (either monthly or as a flip) and someone who actually wants the home for their own. When you are bidding on homes to rehab and/or flip, your price is based on #3 (Fundamental Value) and you will never outbid someone looking to make it their own home because they will pay the utilitarian value.
Methodology
While giving your client four values per property involves extra work, it is not as difficult as it appears. The first two values can be based on square footage estimates, which you can update from time to time with some of your local contractor clients. (Don’t have contractor clients? Great opportunity…) The Fundamental Value requires you to get tapped into the investment side of your neighborhood or farm. Again, if you are not doing this already it is an opportunity to expand your business while making your business unique. The final value is based on a standard comp value, but should be tracked in relation to the other values. This kind of analysis will tell you and your clients when prices are out of line and once again, differentiate you by your expertise. Imagine including a four-value analysis in your counter to an offer!
Conclusion
If you, as an agent, were to make all four valuations on a property your client was interested in buying or selling you would most assuredly stand out from the CMA carrying crowd. More importantly, your buying clients will make informed, rational decisions (even while missing out on some of the run-ups) that should leave them little chance of a foreclosure. Your selling clients will know when prices are out of line and how aggressive they should be in their marketing and price reductions. Best of all, you will have yet another way to stand out, add value and provide superior results for your clients.
There is one other aspect that can be added to your property valuation tool box. It is even more securities based, but will give you the ability to analyze the values you develop and provide your clients with a sound decision-making framework. I will share it in the next post.
David G from Zillow.com says:
Sean,
This is at once both brilliant and terrible advice.
The brilliance is in the indirect education that the seller receives when presented with these four values. If a seller understands the four values they should also understand how pricing is neither simple nor is it an exact science.
Suggesting that a CMA take a back seat to these four values is a mistake. Not one of these values can answer the questions sellers are asking, namely; “what can I get for this place?” Only a CMA can answer that question.
The 4 values is useful supporting info but should never lead a pricing analysis for the purpose of selling a home – there’s too much chance you’d leave money on the table. I actually think this is better advice on the buy-side where potential owners are increasingly interested in the investment angle on their purchase. A seller couldn’t care if their home is a good investment – they just want it sold.
An important difference between the housing market and the securities market is that there are no bids without an ask. And therefore the ask has to correctly chosen by analyzing related market activity (i.e. by using a CMA.)
August 18, 2008 — 11:36 am
Sean Purcell says:
David,
Always welcome (albeit not surprising) to hear from you on pricing.
Not one of these values can answer the questions sellers are asking, namely; “what can I get for this place?” Only a CMA can answer that question
I beg to differ. A CMA provides a snapshot and is of value only in that it is more accurate than a generalized, homogenized value one might find on a national web site. 🙂 The key is not only to have boots on the ground, but to understand what the numbers mean.
The Utilitarian value of a home is a basic CMA. But being able to put that number into context with the other values provides an understanding for direction and velocity that is important. As an advisor I want to tell my clients not only what they can get for their home, but how relaxed or anxious they should be about the market and to what degree they should be holding out on offers or dropping price. As I mentioned in the post, this is a great tool for responding to offers.
I am cheating here a little David, because I know the content of the upcoming post that will discuss how to assess these values and provide a framework of action for both buyers and sellers.
August 18, 2008 — 12:03 pm
chris e says:
Way way over the common buyer’s and seller’s head
Good advice thought
“that should leave them little chance of a foreclosure.”
Most of foreclosures out there happened because of greed ,over optimism and border line illegal lending practice.
August 18, 2008 — 12:08 pm
Dave says:
Sean,
I started to write a really long post, but then realized that I would add better value by asking questions, instead of spouting off.
Simple question. What happens when “values” 1, 2, and 4 are much higher than the nearest “comp”; and value 3 is about 1/2 of the “value” as the same “comp”?
When this happens, what “value” do these “values” provide the sellers?
August 18, 2008 — 12:10 pm
Brian Brady says:
“Only a CMA can answer that question.”
Actually, that’s not true, David. The answer is “whatever a buyer will pay”. Understanding what buyer’s “might” be thinking is how to best discover that number.
CMA’s are historical data and as such are futile in a fast-moving market. This is why appraisals now have to have a “declining market adjustment” to reflect the inaccuracy of old data.
“An important difference between the housing market and the securities market is that there are no bids without an ask. And therefore the ask has to correctly chosen by analyzing related market activity (i.e. by using a CMA.)”
If there’s a bid, there’s always an ask.
August 18, 2008 — 12:13 pm
Sean Purcell says:
Chris,
Way way over the common buyer’s and seller’s head
Not always true Chris. Many of my clients understand this… once I have sat them down and gone through it. Which is another way of saying: “added value”.
Shouldn’t part of our job be to help buyers & sellers understand the fundamentals of a difficult transaction? If it were easy, anyone could do it (and they used to 🙂 ).
August 18, 2008 — 12:25 pm
David G from Zillow.com says:
Brian –
Oh, please.
Seller: “what can I get for this place?”
Agent: “whatever a buyer will pay”
Seller: “OK smart-ass, you’ve got one last chance to earn my business. What do you think is the most a buyer will pay for this place”
Philosophers don’t earn commission checks. A listing agent will still need to answer the question and a CMA (done right) is the way to do it. You’re incorrectly defining a CMA as no more than a “comp check.” Good listing agents put far more analysis into their recommended pricing. Most CMA’s include an analysis of competition currently on the market and that information is (arguably) the most important data to consider when pricing a home in this declining market.
August 18, 2008 — 12:49 pm
Sean Purcell says:
Dave,
What happens when “values” 1, 2, and 4 are much higher than the nearest “comp”; and value 3 is about 1/2 of the “value” as the same “comp”?
When value 1 and/or 2 are below “comps” you should be buying. This goes without saying. If I can buy a property for less than the land is worth or less than it would cost me to build the same property it is an under-priced value.
It would be difficult for the utilitarian value to be higher than the nearest comp because the surrounding sales are defining the utilitarian value. I don’t quite understand that one.
If the fundamental value is less than the “comps” that tells you how to advise your investor clients (don’t buy).
As for your complete question: you are suggesting that a home is for sale in your area that costs less than it would to rebuild and less than the land itself and less than some surrounding homes that have sold, but more than an investor would pay? I guess I’d say you are in a “dead market”. Rents are so bad that they do not justify the building of homes and/or building costs are so high that one cannot justify building a home. If you are a buyer you should look elsewhere. If you are a seller you may want to stick it out (if there is a light at the end of the tunnel), otherwise it is a fire sale.
August 18, 2008 — 12:55 pm
Sean Purcell says:
PS
Dave, I want to thank you for this question. It goes to show exactly why a good agent will use all four values. It provides a framework to look at what is happening and make some informed decisions rather than just saying: “Well, it’s lower than the other comps so lets buy.” Great Question.
August 18, 2008 — 12:57 pm
Brian Brady says:
David G, you’re putting words in my mouth.
Sean addresses the CMA valuation in example #4. Your arguing that a CMA is analysis; isn’t that what Sean is doing here?
“Most CMA’s include an analysis of competition currently on the market and that information is (arguably) the most important data to consider when pricing a home in this declining market.”
Knowing the seller’s why and when is even more important in this fast moving market. A sharp agent will be trying to anticipate future REO volume to make certain it achieves that why and when.
I’m biased, David. I lend in the eye of this hurricane: FL, AZ, CA, NV so I have to pay really close attention to what the pros are doing. In quickly declining markets (like mine), slapping together a CMA just ain’t getting the job done.
“Philosophers don’t earn commission checks”
Ain’t that the truth? People who get the job done, like Sean, do.
August 18, 2008 — 1:13 pm
David G from Zillow.com says:
“When value 1 and/or 2 are below “comps” you should be buying.”
and
“that tells you how to advise your investor clients (don’t buy)”
Sean – you’ve just made my point. This is an investment analysis, not a market analysis. It tells you ROI, not CMA. Great for buyers but not so great for sellers. If all sellers priced their homes at “what makes sense for an investor” we’d see home values crash a lot faster than they are. For most home buyers, investment returns are still a secondary motive for buying. While that remains true, a CMA and not a ROI will remain the preferred way to price a home for sale.
August 18, 2008 — 1:13 pm
Greg Swann says:
> If I can buy a property for less than the land is worth or less than it would cost me to build the same property it is an under-priced value.
Only if there is resale demand — which would be demonstrated by a CMA. Much of Michigan and Ohio are selling for less than their replacement cost.
I’m with David. Evaluation can be done a host of different ways. Pricing is done by CMA or BPO. Not by Zestimate or other AVM, we should note.
August 18, 2008 — 1:22 pm
Sean Purcell says:
David G,
Are you getting hung up on the idea that it might benefit my selling clients to know and understand what is happening in the market? You seem to be saying that one should only use value 4 (the utilitarian price) when selling a home. Don’t you think it would behoove them to know what the break-up, intrinsic and fundamental values are for their home, especially in an area where prices are moving rapidly? Wouldn’t my client be more informed as to how to handle an offer with all of this information rather than your single snapshot? I think a seller… an informed seller, needs to know more that the answer to “what will my house get.” They need to know why and for how long.
Also, my post had two points: not only does having all four prices inform my client as to what is going on out there and how they should behave economically speaking, but because of it I am kicking ass on the agents who do show up on a listing appointment with just a CMA.
August 18, 2008 — 1:37 pm
Sean Purcell says:
Greg,
My answer to you is similar to David G. Let me give you an example of the problem with CMAs. In the South Bay here in San Diego builders went crazy with new homes. Prices sky-rocketed and the area was out of control. It is now, of course, scraping the barrel and contributing a great deal to San Diego’s over-all poor numbers.
The problem was in-breeding. The builders built homes and priced them and the prices seemed reasonable to people based on CMAs done comparing them to other homes built in the area. There was no real way to evaluate these homes if you only used a CMA because all the surrounding homes comped out… even though any of the other three values would have created a great deal of concern.
This obviously helps buyers but it helps sellers too. If you had wanted to sell your home in the South County here and you did a CMA you would have been over-priced and watched your home sit. If you had a smart agent who raced the market down (your words) you probably would have sold the home. But if I had been your agent you would have known why homes weren’t selling and rather than racing down you would have made an informed decision based on any one or all three of the other values.
August 18, 2008 — 1:48 pm
Greg Swann says:
I don’t do CMAs to price a house. If I know the neighborhood, I already know what the house will sell for in today’s market. We do CMAs to get the seller to buy into our price. In that respect, a high-C mathematical analysis might be useful as a persuasive tool, but the house is going to sell for its current market price — or somewhat lower, very probably, given the Slinky nature of prices in Phoenix.
August 18, 2008 — 2:51 pm
Jeff Brown says:
Will Sean arrive at a given home’s value using these four methods? Yes and no.
He’ll know what it’s worth because, as he pointed out, he knew the area. He discovered what the builders had done to screw things up. He knew the replacement costs. Forget the breakup costs. Though I’m sure they offer a certain entertainment value to sellers.
Sean was able to give himself the big picture. In the end though, it’s the ability to professionally step back and understand what value is when looking at market time, closed escrows, and NEWLY active listings.
Will going through all these methods help secure a listing? Yeah, much of the time it surely will. Why? For the same reason smart agents still hold open houses, the most worthless endeavor known to man. It shows the seller, as Sean correctly points out, how much more knowledgeable he is than the last yahoo who was there with his 26 color listing presentation.
The open house impresses the neighbors, who then think, wrongly, how hard that agent’s working for his client. They then list with him. This is why many agents in San Diego never get to see a Chargers game. 🙂 Sean coming in with four ways of valuation is pretty dang impressive, especially considering his competition.
Greg lists homes and sells them quickly without anything but a vastly superior knowledge of his market. Going out on a limb, I’m gonna make the assumption he doesn’t show an ‘historical’ home seller what an investor might wanna pay for his home. 🙂
To me, this is really a marketing approach. Sean would come up with the same listing prices without doing four approaches. When younger, I used to have clients sign 5 year after cash flow analysis with IRR’s before signing offers. Was that really necessary? Yep — I was a very young man in an older man’s industry. As more birthdays came and went, I stopped doing it. They already realized I knew which way was north on the map by then. (Not to mention the lack of hair.)
Know me, you know results are what matters. Skinned cats. Every listing Sean has taken lately has sold before slow moving agents knew there was this weirdly cool sign in their neighborhood. 🙂 Of course the buyers were happy or they wouldn’t have jumped like cats on a field mouse when the home came up for sale. But the sellers have been very happy also, ‘cuz they know the price received was fair. Some of Sean’s listings sold via multiple offers, something San Diego hasn’t seen in quite awhile.
So use these methods, don’t use these methods, ‘cuz you’re gonna come up with the same listing or offering price either way. Using it might make the difference in the client’s mind. Who knows?
In the end, if it’s Sean or Greg listing the home, it’ll be gone before you know it anyway.
Sean does it using four methods. Greg does it using CMA’s.
Wonder if their bankers know the difference? (Don’t answer — it’s a rhetorical question asked by a smart ass.)
August 18, 2008 — 3:11 pm
Patti Herrington says:
I would have to agree with the others. I think it is over the buyers head. The cma is a fool proof method!!! Knowledge is power and knowing your market makes all the difference in the world.
August 18, 2008 — 3:57 pm
Greg Swann says:
Nice to see you, Jeff. I had begun to think you fell in.
FWIW, I don’t even do CMAs for our listings. Cathy does them, along with sweet charts showing market times and price reductions and all kinds of stuff. In our new MLS, you can do a CMA that would make an appraiser green. I’ll never do one, but Cathy thinks they’re the sizzle on the steak. From my POV, as I wrote the other day, the ability to make the seller go through all the comps in a FlexMLS Portal will make all the difference. Cathy in her turn swears by what I think of as over-preparation. She’ll do all her work and then I’ll say, “$350, right?” She’ll say, “$350” and we’re ready to rock. We only worry about it if we come up with different numbers — and she’s much more firm than I am about holding the line with sellers. If we don’t show, we know we have to cut hard and cut fast, but it’s her vast preparation that keeps me out of trouble.
August 18, 2008 — 4:27 pm
jim canion says:
Sean
You certainly got everyone thinking but there is no real
world value in any of the securities style valuations for
a personal residence for obvious and previously pointed out reasons. Greg is an exam[ple of what a valuable and trusted advisor is supposed to be. That is, someone who is able to sort through all the data an make distinctions
that help the seller prperly price the house to sell in a desired time frame and a buyer decide if he is getting a deal that wont be upside down in a few weeks. Also with the bozos out there posing as
appraisers none of the valuations may hold up since the
deal is usually subject to the financing available in todays market.
August 18, 2008 — 5:48 pm
chris e says:
Sean
Not to argue with you because you have a great point here.
Is just very foreign yet to sellers in SOCAL.
As the market deteriorates this approach would be very valuable.A very similar approach is used in the sale of commercial/income producing property here but the players have a completely different mind set.
August 18, 2008 — 6:56 pm
Jeff Brown says:
I’ve been living my end of the good news/bad news joke. Good news? I’m the ‘go to’ guy. Bad news is the same. 🙂
When figuring the value of real estate the only requirement is the accessibility of reliable and timely data. The proof is in the pudding, as a lister who seems to consistently sell for less than market value will soon find themselves with more buyers than they can handle, and no seller’s who’re interested in listing.
Sean and Greg, with rare exception, sell properties far more quickly than their competition. In Sean’s case, he’s even experiencing multiple offers due his impressively effective marketing efforts. His business at this point is referral in nature. This tells me clearly that his sellers have closed escrow happy with the prices they accepted.
My valuation of San Diego income properties benefits from a ‘wild card’ factor acting as a luxury for both the seller/client and me.
They’re moving equity from a stagnant market with less than stellar future potential, to relatively vibrant markets with clearly superior futures. This allows the seller to ‘cut and run’ when it comes to sales prices of their San Diego properties.
We demonstrate the difference in almost non-existent leverage in stagnant markets vs prudent (cash flow) leverage in growth markets. They quickly realize San Diego could grow at 10% appreciation yearly, and still not produce the capital growth rate of 5% appreciation in other markets.
Like I said, it’s a luxury for them and us.
August 18, 2008 — 7:35 pm
Sean Purcell says:
@chris e – thank you.
@Jeff – as usual, you “get it”. You are not normally so alone though.
Tomorrow I am going to post on some tools that can be used to evaluate this pricing method. For those that didn’t see the value here you might want to skip the next one.
My experience? This stuff is not over most clients’ heads. Over the heads of most agents? Maybe. I certainly hope so.
Guess we only learn the answer to that question in the living rooms…
August 18, 2008 — 7:43 pm
Brian Brady says:
I don’t understand why an agent wouldn’t try these valuations when explaining their pricing. Why? Jeff brown hit the nail on the head when he explained it’s good marketing. It’s a demonstration of expertise.
Appraisers are required to use three “approaches”: sales, cost, and income. They almost always default to the sales approach (adjusted comps) but the EXERCISE of the three approaches demonstrates their logical thought and expertise.
I’m not picking on David G but I wanted to come back and address my “smart-ass” answer to him:
Seller: “what can I get for this place?”
Agent: “whatever a buyer will pay”
Seller: “OK smart-ass, you’ve got one last chance to earn my business. What do you think is the most a buyer will pay for this place”
Agent: “Glad you asked again because my answer wasn’t designed to be a “smart-ass answer”. There are a bunch of ways potential buyers will value your home…”
“an investor might…
a contractor might…
a first-time home buyer, looking to paint his walls purple, might…”
“In the end, pricing the home so that it’s competitive with other offerings will ATTRACT offers; the real work comes in the negotiation. Understanding the psychology of different buyers is where I’m superior to most agents (as I’ve demonstrated in my analysis). While pricing the home is relatively simple, negotiating an acceptable price, that will close in your expected time frame, is most important.”
“In short, your home will sell for whatever a buyer will pay for it…and I KNOW what buyer’s will pay for it.. make sense?”
Seller: “Um, not EXACTLY but I don’t need to know this, that’s why I’m hiring you…and you clearly know what you’re doing”
Agent: Right. Press hard, please. You’re making three copies
That’s salesmanship, not philosophy. Salesmanship earns commissions.
August 18, 2008 — 8:29 pm
Jeff Brown says:
Sean said, Guess we only learn the answer to that question in the living rooms…
Brian said, Agent: Right. Press hard, please. You’re making three copies
Stop it guys, yer killin’ me. 🙂
August 18, 2008 — 8:40 pm
David G from Zillow.com says:
Brian – agreed. If you go back to the top you’ll read that my only disagreement with Sean is his suggestion that the CMA be secondary to these four values. I think it’s the other way around. I’d like to hear from more listing agents on this but suspect that many will agree with Greg. That said, I still think that using an investment analysis to illustrate that not all buyers will equally value the property is brilliant. It’s a great way of explaining to sellers how pricing can limit your market size and delay a sale.
August 18, 2008 — 8:42 pm
Jeff Brown says:
David’s point brings up a related thought. We all know neighborhoods in the latter stages of transitioning from owner/users to a bigger percentage of renter occupied. These pockets will most certainly be valued to a large extent by the investors who buy them, not the owner/users going around them to other neighborhoods.
We’ve seen this in several states in the last couple years. Eventually the worm will turn, which is what the investors hope for. But the future doesn’t help the home owner sell for more money today — at least for that kind of area.
When investors represent the likeliest buyer in your little pocket, Sean’s investor approach is probably the most intelligent approach to pricing.
August 18, 2008 — 8:52 pm
Apella says:
Sean,
1st this if the jouice that is good! Good Job! 2nd, you sound like an appraiser… we might need to talk 🙂
I loved this peice! Thank you!
Can not wait for the next! Please keep up the Great Work!
August 18, 2008 — 9:04 pm
Paul Francis says:
Hmm… Looking at it though the eyes of a buyer — If I see something I like better for a comparable or lower price, I don’t particularly care how you came up with your price. I’m buying the other one..
(I was the Director of Sales for a developer.. they just could not seem to grasp that idea when they were in denial about prices dropping. Buyers do not care how much you paid for the land, how much it cost to build.. etc..)
However.. I do like
#3, Fundamental Value… I think you meant to use A Rent vs. Buy calculation here since Cap Rates apply more to a cash flow analysis. A rent vs. buy calculation is exactly what we use for residential buyers right now — so that makes complete sense to use it in a CMA. (Thanks for the idea — to this point I’ve only been using it with buyers. Makes obvious sense to use it with Sellers also…)
And..Ironically — that’s everything that’s selling in our neck of the woods.
August 18, 2008 — 9:33 pm
Tom Vanderwell says:
I’ve only got one thing to add to this conversation:
Greg – Only if there is resale demand — which would be demonstrated by a CMA. Much of Michigan and Ohio are selling for less than their replacement cost.
Not only is much of Michigan selling for less than it’s replacement cost, it has been for close to 20 years. Common knowledge in West Michigan is that you can buy an existing house for more than what you can build the same house for.
thanks guys!
Tom
August 19, 2008 — 6:46 am
Brian Brady says:
“If you go back to the top you’ll read that my only disagreement with Sean is his suggestion that the CMA be secondary to these four values.”
Got it. I think I know what’s coming next from Sean. If it is what he shared with me months ago, it will demonstrate even more comprehensive expertise.
Side note: I’m working on a loan where the agent “sold” the deal as well below “breakup value”. (an owner occupant who’s willing to live in the home and ‘flip’ it after he adds value) The challenge is the Coastal Commission- it could take two years
Purchase price < Lot value+permits+plans+demo cost
August 19, 2008 — 8:29 am
Bob says:
“It goes to show exactly why a good agent will use all four values.”
Are you still beating your wife?
August 20, 2008 — 8:34 am
Sean Purcell says:
Bob,
My best guess? Your comment implies I have asked a circular question somewhere. Would you mind finding a less offensive way to more clearly express it? I’ll be happy to respond.
August 20, 2008 — 12:35 pm