As a national appraiser, I sometimes wonder what our lender friends must think of us appraisers as they receive our work products. On one day, we might submit an appraisal on a relatively new, four-bedroom, three-and-a-half bath home located in a nice subdivision in Dallas containing 3,465 square feet with an estimated value of $300,000. The next day, we may send them an appraisal for a 425 square foot studio apartment located in New York City. Our value on it is the same - $300,000. I can see the underwriter now taking a second look, shaking his head and saying, "We must get field reviews on both of these appraisals. Both can't be right." But could they both be accurate value indications of the respective properties?
First, let's do a little number crunching just to put everything into prospective. The Texas house not only was appraised for $300,000, but it is also under contract for sale at approximately the same price. When we divide the estimated value of $300,000 by the number of square feet, 3,465, the value per square foot is $86 plus change. Not only is the estimated value per square foot relatively low, but there are also a number of other homes in the neighborhood that have sold for similar prices per square foot. Now, let's go to New York. Our studio is also under contract for approximately the same price as it was appraised for and there are other similar units around, which are selling for similar prices. When we divide the $300,000 estimated value by the 425 square feet of living space, we derive a value per square foot of $705 plus change. Wow! Something must be wrong; let's re-compute this. After all, the studio was built 50 years ago, is a co-op with no land, has no parking and is nothing fancy. On the other hand, our large Dallas home is less than 10 years old and has a very nice one-acre lot, crown molding and a two-car garage. Is it possible that our New York apartment is worth more than eight times the value per square foot than our Dallas home?
The people in Dallas must think that there really is a Santa Claus and that maybe there is also a free lunch after all. On the other hand, the people in New York have got to be thinking of "The Grinch Who Stole Christmas" or "A Thief in the Night." Fortunately or unfortunately, neither of these concepts relate to our subject properties. Both transactions are real and are representative of what we refer to in appraisal jargon as "the market." What is the market, who creates it and why? While being trained as an appraiser a number of years ago, I was cautioned not to become egotistical about my perceived ability to determine the value of a property. I was even told that I could not determine the value; all that I could do was report it and I must get the value from the market. It must be a reflection of the market, much like a tree that we see on the side of a lake reflects an image onto the water. The market is a theoretical concept, assigned to those common threads found when we examine the fabric of the collection of real estate sales in a given neighborhood. That is not the definition used by the Appraisal Institute or the Appraisal Foundation. They are much too scientific and legalistic with their definitions. This is my definition, which does not ignore science but also has a bit of art thrown in. After all, there is much discussion as to whether appraising is a science or an art.
As for who creates the market, it is not real estate agents, appraisers, lawyers or even the government. It is those common everyday people out here buying houses who do not know anything about it. If you believe that, I have a bridge in Brooklyn that I would like to sell you. Those guys and gals are smart. Few, if any, ever take courses in appraising, negotiating, real estate or related subjects, but I have noticed how most all of them behave alike once they begin shopping for a home. They place value on similar features such as location, kitchens, décor and convenience to work. These ladies and gentlemen are creating the market and believe me, they are pros.
The last question in our earlier paragraph was "Why is there a real estate market created?" Here in the United States, we not only have one of the most efficient stock markets, but we also have, in my opinion, one of the most efficient housing markets. This efficiency serves the needs of both the buyers and sellers of homes. Sellers get the maximum amount their home is worth, while buyers get the most for their money. Can you imagine what would happen if the government set the price of homes? You may argue that in communist countries, that's the way it's done. You may be right, but who would you rather trust - a government employee or a married couple working together, expressing their likes and dislikes while doing a bit of comprising to determine which home offers the most for the money?
Now, let's get back to our large home in Dallas and our small one in New York. Additionally, please consider the fact that at any given time there are thousands of homes on the market in both markets and that there are many very self-serving buyers and sellers out there looking to get the best deal out of a transaction. Also, remember that in the case of both homes, they have been carefully scrutinized by a self-serving seller and a self-serving buyer during the negotiating process, and the seller and buyer have agreed upon the price. Furthermore, in both cases, each property has been appraised by a trained appraiser using market data from the neighborhood and the appraisers have come up with essentially the same values. Can you now conceive of one house having a true value of $86 per square foot while another has a square foot value of $705? If, in the future, you have reason to question whether the differences in home values could possibly be as much as the figures in our examples suggest, just remember our old friend the market. Perhaps he will help set your mind at ease.
Charlie W. Elliott Jr., MAI, SRA is president of Elliott & Company Appraisers, a national real estate appraisal company. He can be reached at (800) 854-5889, [email protected] or through the company's Web site at www.appraisalsanywhere.com.