Real Estate - Property Matters by Afra Raymond
PROPERTY MATTERS - Articles written by Afra Raymond

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COST vs. VALUE - The issue of real value
What is real Value?

Published Thursday 22nd January, 2004

ONE of the best ways to advance this series is to clarify some of the common terms used to define various aspects of property since these are the essential building-blocks of any reasonable discussion.

Cost and value are two of the central concepts used to assess property investments. We therefore need to understand the way these differ and more importantly, the way in which they relate to each other.

In this context, cost is the price of developing land which can be done in a variety of ways - levelling, paving, draining, erecting or demolishing buildings and so on.

Value is the price we might reasonably expect to get for a property if it is offered for sale on the open market. This is related to the level and nature of effective demand, which is of course related to the type of area in which the property is located.

An owner can increase a property's value by investing in it in the ways outlined above; the challenge is to ensure that we make prudent investment decisions. But what is the right decision? As always, there is no single right answer, so the investor needs to be fully aware of the costs of achieving these goals.

Investors have to take a series of decisions on the way in which they spend to develop their property so as to achieve the desired balance between the money spent and the value of the finished product. It is therefore necessary to consider the ways in which these decisions are taken and investors fall into two main groups -

  • Borrowers - The majority of property investors have to borrow money in order to finance the purchase or building of their homes and therefore they require the approval of the institution making the loan. Before lending, a financial institution will need to be convinced that the amount they are lending will be adequately covered by the value of the completed property. In order to be assured of proper cover, the lenders usually seek the advice of various professionals before advancing these large sums of money - Quantity Surveyors, Valuers and Attorneys-at-Law.

  • Self-financing - If the investor is financing the project themselves they can afford to indulge personal tastes which do not necessarily add value since they do not require the approval of anyone else before spending their own money. Despite the apparent freedom of choice enjoyed by this class of investor, it is still vital that some balance is achieved between cost and value, since the completed property may have to be used in the future to finance other expenses. If the property had a sum of money invested in it without a corresponding increase in its value, then that investment would have had a negative rate of return in financial terms.

Of course we need to bear in mind that only very few properties are 'pure investments' since most of them are owner-occupied; either by families or, in the case of commercial properties, by businesses. A family home always has significant emotional and intangible weight, which means that when investment decisions have to be made non-financial aspects can eclipse the usual objective measures.

One of the most common misunderstandings is that the cost of a building or improvement can be automatically equated with the increase in value upon completion. Cost is not necessarily equal to value.

For example, if we took an identical house and moved it from Belmont to Diamond Vale to Toco to Orchard Gardens to Beetham Estate to Fairways, we would naturally get a different value. The differences in value are because people will look for homes in the areas offering the best range of facilities to match their buying power.

Most neighbourhoods have a range of values within which most of the property sales occur - as an example, we might say that Trincity has a range of $350,000 to $600,000.

An investor might have the idea of acquiring a Trincity home at the upper end of this range and then spending considerable sums to further upgrade that property but they would not be certain to recoup that investment upon an immediate sale.

This is because no matter how much we spend we cannot change Trincity to Valsayn. Someone who is able and wants to buy in Valsayn will not pay that price to live in Trincity for the reasons outlined in our first article as to the appeal exerted by the right neighbours.

Next week we will begin to look more closely at the relationship between the State housing policies and the rest of the housing market.

Afra Raymond - Property Matters

Cost and value issue:
  • The property is the land with everything on it.
  • Apportionments between land and building are purely artificial since they are permanently joined.
  • Cost is not equal to value.   Value flows from land value.
  • Reinstatement cost has no relation to value.
  • It is possible to spend too much money on a property with no commensurate increase in value.
  • Neighbourhoods have a range of normal values, which is seldom surpassed.