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