Real estate has three physical characteristics that give land some inherent value. These unique characteristics are not present as a group in other types of property. Only real estate has this combination of physical attributes and, as a result, they have the ability to affect value. As we discuss the three physical characteristics of real estate, note how they often intertwine with the four value characteristics.
Uniqueness is a physical characteristic of real estate referring to the fact that each piece of land, each building, and each house is said to be a different piece of real estate. No two are exactly the same (also called no homogeneity).
Even if two houses or two buildings look the same, they are said to be different because of their location. Since more land cannot be created in a given location, this uniqueness leads potential buyers to view land as a scarce commodity. When people want to build in a certain area, they must compete with others for the limited supply of land in that area. Value is derived from this perceived scarcity due to uniqueness.
Immobility is a physical characteristic of real estate referring to the fact that it can’t be moved from one place to another. This is an equal benefit or detriment to all parcels of real estate in the same general area. This immobility of land helps its value in a good market, since other land can’t be moved in to take away potential customers (as can be done with other products), but it can also hurt land value in a bad market. Note that customers are somewhat immobile as well. It’s impossible to move a house and land from Boston to Chicago where there’s a buyer, and usually a person in Denver won’t buy a house in Atlanta if that person’s job can’t move too.
Indestructibility is a physical characteristic of real estate referring to the concept that it can’t be destroyed.
Thus, real estate is said to always have some minimum value by virtue of its existence. Land is not consumed, nor does it wear out like other goods. But the actual and perceived utility of land can be affected by the marketplace or other forces. Land always has the potential to be useful, but its usefulness, and hence its value, can change over time.
However, the land itself can move or change shape by natural forces, for example:
- Erosion, which is the wearing away of soil due to the action of wind, water, or other forces
- Accretion, which is the addition to land, such as through deposits by water of sand or silt
Property-Specific Factors Affecting Real Estate Value
There are additional factors to consider when valuing a specific piece of property. More or less in their order of importance, these are: Highest and best use, location, substitution, conformity, contribution, and depreciation.
Highest and Best Use
Highest and best use is the use that is physically possible, legally permissible, most economically feasible, and maximally profitable or productive. To expand on this:
- Physically possible means that any potential use must conform to the size, topography, shape, and other physical characteristics of the subject property.
- Legally permissible refers to uses that are not forbidden by zoning or other government regulations as well as uses that are not prohibited by any deed restrictions or other covenants.
- Economically feasible refers to the ability to get the best dollar return out of the property without overspending on acquisition and improvements.
Highest and best use may be the most important property-specific factor that an appraiser considers before making a determination of value. As you can see from the comprehensive definition, a number of factors contribute to this determination. Of course, with most houses this isn’t necessary since they’re in the middle of residential Neighbourhoods.
The highest and best use becomes a vital consideration, though, when examining vacant land or land that has changed zoning since the original structure on it was built.
Highest and best use is such an important and complex topic that entire real estate and appraisal courses are taught on it. For our purposes here, it’s important to understand the basic concept. If a house sits on a widened street and is surrounded by commercial buildings, it’s very likely that land would be more valuable if it were also put to a commercial use. We must consider other parts of the definition, as well. That is, the zoning laws must permit the intended use and the owner must be able to build the proposed structure on the land. All of these factors must be considered when valuing a piece of real estate.
Location is the exact position of a piece of real estate. Location can be talked about with respect to a given Neighbourhoods, and even within the Neighbourhoods itself. It’s easy to understand that homes in a growing, popular, and prosperous Neighbourhoods are more highly sought after and valued than those in other Neighbourhoodss. It’s also important to recognize, though, that each individual home’s location within that Neighbourhoods affects its value. A home on a corner lot, next to the park, or on a cul-de-sac would usually have a higher value than that same home sitting next to a railroad track.
Best” and “Worst” Homes
An important corollary to the concept of location is the effect of surrounding homes on valuation. There are technical terms often used to describe this concept, but you only need t understand the theory. Basically, the theory is that the value of the “worst” home in a given area is increased by the other homes in the area. The value of this theoretical “worst” home can only go so low, because the desirability of the other homes in the Neighbourhoods keeps it from falling too far. Conversely, the value of the “best” home in a given area is decreased by the other homes in the area. The value of this theoretical “best” home can only go so high, because if the other homes in the Neighbourhoods are less expensive, people that can afford this “best” home will be attracted to other Neighbourhoods
For example, if each of the homes in a Neighbourhoods average $200,000, a run-down home in that area, that may only command $120,000 in another area, is helped by the fact that people will pay more than that in this particular Neighbourhoods. The reason being is that they anticipate a higher value for the investment they make by improving the property.
Conversely, in another Neighbourhoods where the average home price is Rs.70,00,000, a much larger-than-average home with a swimming pool and other amenities, that would command Rs.1, 50, 00, 000/ in another area, is hurt by the fact that people who can afford this home probably want to live in a Neighbourhoods with homes closer to that average price, and they may fear a lower future resale value in the less expensive area.
Substitution says that an informed buyer will not pay more for a home than a comparable substitute. Although each home is said to be unique, there’s a price point beyond which a buyer won’t select a particular home. Of course, no one really knows what that point is until trying to sell a home for too much, with no resulting sale. The theory of substitution can also be applied to items within a home. When an appraiser determines the value of a fireplace in an area where most homes don’t have one, the appraiser must take into account that a buyer is not going to pay more for that home than for a similar home plus the cost of adding a fireplace. In other words, if a fireplace costs $2,500 to add to a typical home in the area, an appraiser can’t justify adding much more than that to the value of a home.
Conformity says that a particular home achieves its maximum value when surrounded by homes of similar style and function. This applies to Neighbourhoodss as well. Neighbourhoods as a whole are more desirable when there is a general similarity in utility and value for all homes in it. This relates to our best/worst home scenario. Most people want to live in areas with like homes. A home that stands out as being too different from the rest is worth less than that same home would be if it were in a different, more homogeneous Neighbourhoods. If too many homes stand out as different, the Neighbourhood’s desirability is hurt, as well.
Economic Factors Affecting Real Estate Value
When considering broad economic factors, the law of supply and demand says that for all products, goods, and services, when supply exceeds demand, prices will fall and when demand exceeds supply, prices will rise. This has a very important role in real estate because of the inherent difficulties in adjusting supply and demand. Because of the lag time for market forces (e.g., construction companies) to respond to supply and demand situations, there are often buyer’s markets and seller’s markets.
A buyer’s market is a situation in the housing market when buyers have a large selection of properties from which to choose. This may be due to population shifts away from an area, overbuilding by construction companies, or bad economic conditions like a plant closing. A buyer’s market can be neutralized if some sellers pull their homes off the market. But a glut is a glut, and usually there’s downward pressure on real estate values. When more homes are available, the increased supply tends to keep home values lower. Often, in this situation, a buyer is in a position to negotiate for a lower price or more favorable terms of sale.