Principles of Value
January 6, 2021
How is Property Value Determined?
There are three different principles of value that will affect the value of the real estate. The first thing an appraiser will consider in doing an appraisal on a property, for example, is a concept called highest and best use. The highest and best use deals with what the property can be used for to produce the best income or the best value. Would it be best used for commercial or maybe residential? The second principle of value is called substitution. Substitution says that our property is only worth what I can get something else for just like it. And in other words, we look at comparable properties to estimate the value. So, if a basic three-bedroom house sold for $180,000 last week, a very similar three-bedroom house on the same block should sell for roughly $180,000. That is the principle of substitution. Conformity deals with the issue of property should conform to the neighborhood for the best value. In other words, don't overbuild for an area. One other item to think about is called anticipation. Anticipation says we look to the future for the value. So, if we anticipate an airport going in and being built brand new, the properties around that will probably become more valuable due to what is called anticipation.
Purpose of an Appraisal
What is the purpose of an appraisal? An appraisal is simply used to estimate the value of a property. To figure a property’s value, there must be four economic characteristics for anything to have value. They are as follows. Number one, we need to have utility, which means that the property must be useful. The second characteristic is scarcity, which means there must be a limited supply. The third characteristic is demand--someone must want the property. And then finally, for anything to have value, number four is transferability, which means the seller must be able to transfer the property to the buyer. Our acronym is U S D T (uncle Sam demands taxes) to help you recall utility, scarcity, demand, and transferability. The value of real estate is affected by supply and demand. The biggest characteristic that will affect value will be local economic conditions. People go where jobs are, so the local economic conditions play a big factor in the value of real estate.
There are two types of depreciation. The first one is called tax depreciation, which is for investment properties only. Let's contrast tax depreciation, which is for investment properties as a tax write-off, with value depreciation. Value depreciation simply says something goes down in value due to age and wear and tear. What goes down in value due to age and wear and tear ultimately is called the depreciable base, which is the improvements only. The improvements would be a house you build on the land, for example. In other words, all that depreciates due to the passage of time will be improvements to the property such as houses, buildings, and structures. Land never depreciates simply due to the passage of time. Land also is not depreciable under our tax code either. When we take depreciation into account in figuring the value of a property, we will always use the straight-line method. The straight-line method of depreciation means we depreciate equal amounts each year. That is the opposite of appreciation. When your property goes up in value mathematically, we have to recompute every year how much the property does go up in value.
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