The Meaning of Intrinsic Value in Real Estate - "What's It Worth"?

The Meaning of Intrinsic Value in Real Estate - "What's It Worth"?

 

In residential real estate, one of the most important factors is valuation.  What is a property worth?  Seems simple, right?  Just see what has sold in the neighborhood and you should get a pretty good idea, yes? Just get an appraisal, correct?  Well, the valuation of residential real estate is not quite that simple.

 

In the mix of residential real estate valuation is a huge principle called "intrinsic value".  Huge enough that you can sometimes call it the "elephant in the room".  What I mean by that is that it is an enormously heavy factor that is not a tangible, scientific approach to valuation that you can put on paper.

 

Have you ever heard the phrase "a property is only worth what a buyer is willing to pay for it".  Well, there is so much truth in that phrase, yet most people consider it to be cliche'.  But I'm here to tell you now, that it is the most powerful factor in residential real estate, yet at the same time, the least talked about.  So I'm going to bring the dirty little secret out of the closet and talk about it!  And I'm going to explain exactly why it's so important.

 

What causes a home to sell at, above, or below list price?  INTRINSIC VALUE

So you're probably saying "Whachu-talkin'-bout, Ralph?!"  What's "Intrinsic Value?"

The best description I can provide of Instrinsic Value is:  What the property means to the buyer.  WHY the property holds strong positive or negative value to a certain buyer.

 

We can all talk "comps", or comparable sales in the neighborhood, all day long.  But intrinsic value trumps all.  We've all seen a sale occur where it was surprising about the actual sale price, yes?  A property in which you were surprised it sold for the price it did?  Well, that was intrinsic value reigning supreme once again.

To make this crystal clear, I'm going to cite some examples of intrinsic value, and how it is something unknown to many people other than the buyer:

 

1. Parents of young children are looking for a new home.  The current one they are in has become too small for them as their family continues to grow.  Education for thier children is critical to the parents, but financially things are becoming a little tight.  So they've decided to not continue their children's enrollment in the super-expensive private schools, and start to look for a new home in which their children can enroll in one of the most highly rated public schools or charter schools around.  They find the perfect home located in the boundaries of one of these schools.  The home is listed for $450,000.  There are multiple offers on the property.  It appears that the offer amount it is going to take to win this house is about $480,000.  This is $30,000 over asking.  Most homes of the same format in the area are selling for approximately $450,000 to $460,000.  Sounds like quite a bit over asking to win this house right?  But the buyers decide to proceed anyway.  Even though they are using a loan, and realize that it may not appraise with their lender, they are perfectly prepared to bring in the extra cash for any gap if it gets right down to it.  Here's why:  The children are going to be in the elementary level school for the next 6 years.  The cost of putting their children in private school per year is $32,000.  By purchasing this home, not only will they be saving that $32,000 per year, but they have the right sized home in the boundaries of one of the most highly acclaimed public schools in the area.  Not only that, but they no longer have to make the morning and afternoon commute to the private school, which will save them a daily commute time in rush-hour traffic by one hour per day.  So in this instance, paying $30,000 over asking is well worth it because it not only makes sense mathematically for these buyers, but logistically they are so much better off that it makes the $30,000 over asking seem like a no-brainer compared to how much they will save.

2. A middle aged couple living in a condo have an elderly mother who lives on her own.  She is getting up there in years, and they are seeing signs that the mother is going to need some assistance with living.  They are faced with either placing the mother into assisted living (which the mother is opposed to), or having the mother live with them.  Well, the one-bedroom condo the currently live in simply won't work, and they can't afford to buy a home on their own.  However, the mother owns the home outright and their is enough equity to put down on a house and the couple can qualify for a loan of up to $450,000.  So the mother agrees to sell her home and work with her daughter and son-in-law on finding a single family home with a guest house that is absolutely perfect for the Mom.  They find the perfect home.  It is located in the neighborhood that the mother already lives in, is right next to her place of worship, her favorite grocery store, it has a large lot perfect for gardening which both the daughter and son-in-law love.  There are multiple offers.  It appears that it will take an offer of about $50,000 over asking to win this house.  Both the mother and couple agree to purchase it for $50,000 over asking.  Why?  Because for this particular set of buyers, this home is so perfect for their life logistics, and it will actually LOWER the couples monthly mortgage payment from what they are paying now on their condo, that it will make mathematical sense even at the selling price they have to pay, to be able to be comfortabel with the expenses they will pay in caring for Mom at home.

3. A single male is currently living in a condo that he purchased 4 years ago.  Last year, he was given an opportunity by his employer for a new position that doubled his salary.  However, it required him to work out of another of the company's locations that is 80 miles from his condo.  He accepted the position because the opportunity was so great, and the income was amazing.  Well, after a year of commuting 160 miles a day in traffic, it's getting to be too much to bare.  He starts looking for a new condo that is closer to work.  One day, on his way home from work, he saw an open house sign 2 blocks from his company's location and thought he would check it out.  It's an amazing condo that not only has a bonus room perfect for his office, but it has a very large patio that is perfect for his small dog.  Currently, he has to hire a dog walker because the condo he lives in now has no outdoor living space.  The agent informs him that they are already in counter offers, but that he still has a chance.  His offer would have to be quite aggressive due to the multiple counters.  He runs his numbers and decides to write an offer $45,000 over asking.  Why?  Because the money he will save on gas, a dog-walker, and the overall psychological well-being of not making that nasty commute each day is WELL worth it for him.

 

I could go on and on with more examples like this.  There are other examples I can cite that have absolutely nothing to do with money and perhaps emotion and/or psychological values.  But the point is, these are scenarios that we do not see nor know about when we see properties sell over asking substantially.  YOU NEVER KNOW the intrinsic values for a particular buyer.  What doesn't appear to make sense to you may make perfect sense to someone else.

Were the buyers in the 3 examples above aware of comps in the neighborhood?  Of course.  But it didn't matter to them because the most important factor were THEIR particular set of instrinsic values.

So the next time you are looking at comparable sales in your neighborhood, and/or looking at purchasing a property with multiple offers, just know that there may be some very strong intrinsic values going on in the background with other buyers.

Don't fool yourself into thinking that you know values well enough to predict a sales price or that Zillow tells you everything you need to know.  Neither of those sources stand up to the strength of intrinsic values.

And at the same time, don't be ashamed and/or 2nd-guess yourself when you are considering paying over asking for a home.  Your own set of intrinsic values are unique to your own equation.  Everyone else's mathematical equation is comprised of an entirely different set of values.  Above and beyond that, make SURE that you express your set of intrinsic values to your agent!  If you do not express those values and let them know why they are so important to you, then all they have to work with is comparable values.  Let your agent be the warrior for your set of values.

In general, don't be afraid in life to be able to make a statement that says "This is what's most important to ME"

Ralph Gorgoglione

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