Part of the disconnect between homeowners and agents is that agents rarely break down their valuations in detail, engendering suspicion in clients. Clients conjecture that the valuation of their biggest asset is the product of a vague, faulty, or perhaps nonexistent process. In fact, arriving at a valuation is painstaking, arduous work, and it’s one of the most important services an agent provides a client. The process and the building blocks should be transparent and described to clients in detail so that they can understand the valuation’s underpinnings.
It’s important to know what a home is worth, or can be worth, based on rational analytics, divorced from inflated ideas of value, wishful thinking, or false expectations created by others. Overpricing a home you are selling, or undervaluing a home you want to purchase, are costly mistakes.
In this chapter, I am going to deconstruct how homes are valued for purchase and sale, including the objective and subjective elements of the valuation. I’ll also compare it with the other common method of assessing the value of a home—the lender’s appraisal.
The Mechanics of Home Valuation
A comparative market analysis (CMA) is the standard valuation approach that a real estate agent undertakes. A CMA compares recently sold properties (“comps”) that are similar to the subject property and adjusts for differences. Active listings are not used as comps because they only represent the seller’s valuation and are not necessarily an indicator of market value.
To identify comps, agents can use sites like Redfin and Zillow, but the multiple listing service (MLS) has the most accurate and comprehensive information.
A CMA can determine market value only if the most comparable properties (i.e., the most similar) are selected. The key criteria for selecting the appropriate comps are timing, location, and property characteristics:
The date of sale should be as recent as possible. Sales more than a year old are less useful, particularly in fast-moving markets. The more recent the sales, the less likely the market has moved enough to render the comparable sale prices obsolete.
The comps should be in the same neighborhood, subdivision, or market—but be aware that there can be big disparities within a defined geographical area. Even being on the same street doesn’t necessarily make the location of two properties comparable. One could be in a flat area, within a walking distance to town, while the other might be on a hill and require a car ride.
The comps should have as many of the property features of the subject home as possible, including the number of bedrooms and bathrooms, lot size, and age of the home. Ideally, the square footage of the comp should be within 15 percent of the subject home.
The agent then adjusts for the differences between the subject property and the comps. Comparing the fundamentals of properties—square footage, land, year built, number of bedrooms and bathrooms—for a CMA is a fairly objective and mechanical process. It’s relatively easy to assign monetary value to, and then adjust for, the differences among these elements.
Websites like Zillow and Trulia capture millions of eyeballs every month using these variables as the basis for automated valuation models, but home buyers, sellers, and investors should be wary of using computer estimates to make decisions. It’s like marrying someone based on a Bumble dating profile. Even Zillow acknowledges their estimates are inaccurate. Their chart of median error percentages in major cities runs between 4 and 7 percent.12 Half of the home values in the area are closer than the error percentage and half are greater than the error percentage.
This is because, no matter how identical properties may appear, no two properties are exactly alike, and they differ in ways that are more complex to quantify. All factors that impact value must be evaluated. A diligent agent doing a CMA will add or subtract the amount that all material features contribute to or detract from the value of a comparison property.
Property valuation is an art, not a science. Appraisers and agents both build an opinion of market value based on data, but most would acknowledge that their methodology relies on gut instinct and experience. You can convince yourself you are scientific when valuing tract housing, but even when homes seem identical, judgments that impact pricing are necessary. This is especially true when it comes to a property’s more subjective factors.
Love Thy Neighbor…and Don’t Block the View
I was once called to be an expert witness in a legal dispute between two homeowners in Belvedere, California. Belvedere is a small island off Tiburon with wraparound views of Sausalito, San Francisco, and the San Francisco Bay. The homeowners were neighbors who lived at opposite ends of a cul-de-sac facing the bay. The defendant had a forty-one-foot-high Acacia tree which blocked the plaintiff’s view of one of the two towers of the Golden Gate Bridge. The plaintiff had never been able to see through that point in the property, but expansive views are worth millions of dollars in Belvedere, so it ended up in court. I was asked by the plaintiff to quantify the value of the obscured view of one tower of the Golden Gate Bridge.13
To value the view, I pulled the sales records of every property that traded on the view side of that street going back ten years. I examined historical photographs of each home to see whether it had a one-tower or a two-tower view. I compared the sale prices of similar homes with unobstructed views of both towers, those that could see only one tower, and those that had no view of the bridge. I accounted for other features that raised or lowered the value of each home as well. Then, I analyzed all the data and arrived at a valuation of $350,000 for the view, which was a little more than 1 percent of the original cost of building the bridge, not adjusting for inflation!
An accurate home valuation requires delving into the less tangible elements that enhance or lessen value in a home: the design and flow of the home, finishes, the outdoor living space, the contours of the land, curb appeal, and environmental factors, among others. The consideration and weighting of these factors is challenging, but makes all the difference in deriving the correct market value for a property.
Valuing these elements requires a deep understanding of the market, the neighborhood, the psychological factors that influence today’s home buyers, and, above all, knowing what drives value in a home.
What Buyers Want Drives Value
What buyers desire determines what the market “values.” The more closely the characteristics of a home measure up to the desires of home buyers, the higher the value the home will be awarded in the marketplace.
Design and lifestyle trends—how people want to live in their homes—drive residential real estate values. It’s a universal truth, whether you live in Topeka, New York, or London. People often think architects and designers are the arbiters of style, but it’s buyers, and how they want to inhabit the spaces inside their homes, that propel design.
A shift in design taste happens every seven to ten years. As the seller, you must keep up with the shift if you don’t want to leave money on the table. The following are the most important design and lifestyle trends to consider when valuing a home today.
Living Space
The interior layout and design are critical factors in the valuation of a home. The overarching questions are, “How closely does the living space mirror what the current market wants? Does the layout reflect how buyers want to live in a home?”
Not all rooms are valued equally. The most highly valued rooms in today’s market are an open kitchen connected to a family room, bedrooms, a secondary family room, and a home office for telecommuting. Extraneous spaces like a sauna, a walk-in wine cellar, a crafts room, or a massage room don’t hold the same per-square-foot value. The price per square foot for these spaces gets adjusted down because they are not necessary for everyday living. For example, I valued a home in Sausalito, California, with an indoor pool. The owner thought it was a unique selling feature and wanted me to understand how special it was. He said, “How many homes in Marin have indoor