Four Parts of Value in Real Estate
Every kind of real estate derives its value from four characteristics: demand, supply, utility and transferability. Demand is the need or want.
Supply is the quantity that’s available either immediately or in the foreseeable future. Utility is the property’s real (or perceived) capacity to satisfy the need or want. Transferrability is the ability for ownership of the property to change hands.
Obviously, value tends to rise where supply is short and demand is strong. A property’s utility, however, is often determined by perception and not reality.
For instance, buyers might purchase a property because they think it will meet their needs, even if it really can’t. Even if supply, demand and utility favored higher prices, a property’s value will be depressed just because the title to it couldn’t be transferred.
Suppose a builder is pre-selling home sites. He’s in the process of subdividing a parcel in a desirable location into 30 lots and six of them back up to open space. Buyers would quickly snap up those six home sites even if the builder charged hefty lot premiums for them.
However, the picture would change dramatically if the municipality imposed a two-year moratorium on issuing building permits. This would mean that no new houses could be built for two years (unless the building permit had been obtained before the moratorium went into effect).
The six lots backing up to the open space still have a desirable location, but the market for them would now exclude all of the buyers who wanted or needed to have their homes built in the near future. The lots could only be used by buyers who could afford to wait for two years. The value of the home sites would drop because their utility (usefulness) had substantially decreased.
The same result would be achieved but for a different reason if the municipality decided to stop approving subdivisions for two years. Buyers wouldn’t be able to get title to the individual lots because the builder wouldn’t be able to get the parcel subdivided until the subdivision ban was lifted.
The value of the prospective lots would plummet because they couldn’t change hands – they lacked transferability.
Why Location Is Key in Real Estate Investing
We’ve all heard about location, location, location. But why is it so important? The answer is very simple: location is the only thing about a property that you can’t change. Wait a minute, you say. That’s not correct because you can move the house. That’s true – maybe.
Look at the houses below. Quick. Is this a good location or a bad location?
It’s often not feasible physically or economically to pick a structure up and move it. The operation may require negotiating such modern obstacles as overpasses and wires in addition to tree limbs, hills, streams and gullies. It takes a long time to move a structure a short distance, and it’s not cheap to do.
But even if you can move the house, you can’t change the property’s location because you can’t pick the parcel up and move it. It’s the land that gives the property its location, not the house. The house isn’t permanent – only the land is. So for better or worse, you’re “stuck” with a property’s location.
What makes a location good? The answer depends on the intended scenario for the parcel. Commercial uses, such as retail and office facilities, thrive in areas that have high visibility and traffic and easy accessibility through public transportation.
Neighbors like power lines and water towers don’t negatively impact the value of these properties. On the other hand, sale prices of single-family homes are more sensitive to locational challenges such as train stations, busy roads and shopping centers.
Location has to be scrutinized differently and to some extent, more rigorously where residential uses are involved. The criteria for good and bad locations changes when home buyers are choosing where to live.
While a good location can’t necessarily overcome every negative about a property, it can go a long way. In addition, a parcel’s location determines many things, including the current zoning, the types and values of properties in the immediate area, and the proximity of public utilities.
And if you’re thinking about developing a property, these issues can mean the difference between success and failure so a quick scan over at realtor.com or zillow can give you a good idea where your potential investment is
Importance of Screening and Evaluating Land
Sometimes a property you buy has things on it that you didn’t realize at first. This video below is from a guy who bought a piece of land at an auction and discovered (through use of a drone) that there was an abandoned house on it. Watch video below-
Some builders and developers search for residential development property strictly by geographic area. Others search for land parcels that would enable them to reach specific buyer sub-markets (housing type, price range, lifestyle, age group).
Either way, builders begin the investigation by casting the net into their areas or markets of choice and sifting through potential acquisition candidates. They have to pick through dozens of sites before they find one they think they can develop profitably.
Sometimes they can tell quickly if a property is worth pursuing further. More often, however, they don’t know this until they spend varying amounts of time, effort and money collecting information about a parcel.
They spend their resources on investigating critical questions and often have to obtain answers to them in relatively short periods of time. Land buyers need to focus on everything that might impact and restrict how the parcel could be developed profitably.
Literally and figuratively, the range of issues involved covers a lot of ground. It includes, for instance, all of the property’s physical characteristics (such as soils, floodplain and topography), uses permitted by-right and by special exception or conditional use under the current zoning, those that may be possible given changes in use, prohibitions and limitations imposed by private land use controls (e.g., deed restrictions and restrictive covenants), development costs, and the location, availability and capacity of existing public utilities.
Most of what land buyers need to know about a property isn’t visible or readily apparent, so due diligence is a critical component of their evaluation process. Their research begins with their introduction to the parcel (if they decide to purchase it) and it methodically, persistently continues through the day of closing.
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