“Its only worth what someone is prepared to pay”
You’ve no doubt heard this many times from industry ‘experts’ and your friends and family alike. In fact its said so often most of us just offer a knowing nod as if it’s an historic fact we all know to be true. Unfortunately, such flippant comments risk financial harm to those who take it seriously without fully understanding the mechanism behind ‘market value’.
Firstly, what is market value or worth?
The accepted industry definition is:
“the estimated amount for which an asset will exchange on a given date between a willing buyer and a willing seller, following adequate marketing, wherein the parties had each acted knowledgably, prudently, and without compulsion.”
Essentially the definition paints a picture of two sensible and informed people arriving at a mutually beneficial outcome. Fair, balanced, reasonable.
Drilling down further and taking out the key terms, we can see:
Estimated – the result is the opinion of the person assessing value – not a fact.
Amount– the result must be specified in monetary terms
Exchange – the parties actually have to do the deal and settle; not just discuss and agree
Date – the result only applies on a specific date. After that date, prices can rise or fall
Marketing – the asset needs to be properly exposed to the market to appeal to a wide pool of prospective purchasers
Willing – the parties must both want to do a deal and be capable of settling
Knowledge – the parties must have all relevant information about the asset available including condition, scale, consent status, all relevant sales data, comparable listing data, development potential, costings etc.
Prudence – having obtained all this information, did the parties make sensible decisions?
Compulsion – neither party was forced to do a deal. E.g., mortgagee sale, job relocation, compulsory acquisition, acrimonious divorce etc.
So when a valuer talks about market value, these are the factors they consider. It is a balanced view of the likely transaction price between buyer and seller taking into account all of these items as best they can.
But how about real estate agent appraisals? How are they different?
A real estate agent is not trying to determine what is fair for both parties. Their job (quite rightly) is to try and get the best price possible for their vendor. There is no criticism here – it is exactly as it should be and what I would want in an agent. But how does a focus on the vendor alter the direction of perceived value? Upwards of course! And this happens primarily due to an asymmetry of information. While there is typically disclosure about the key property attributes, more often uncertainty surrounds the relativity of comparable sales and listings and future potential and risk associated with the subject property. The buyer may or may not get independent advice from a building inspector, engineer, or valuer. These additional costs present a barrier to the buyers being fully informed – albeit I acknowledge it is their choice. The agent is focused on finding the one buyer who will pay the most, regardless of their level of knowledge, prudence or motivation. To make matters worse, this phenomenon is exacerbated by the auction process, which discourages proper due diligence (costly for multiple properties with an uncertain outcome), incentivises hype and places time pressures on decision making.
So in the vendor’s eyes, there is some merit to the maxim ‘its only worth what someone will pay’. After all, they only have the one asset to sell, and turning it into money is their only way forward. The sale price is what it is worth to THEM and nobody else. The issue is the day after the deal is done, and contemplating what the buyer is now left with. If they turn around and re-sell the property, could they get their money back? This is what valuers and bankers are concerned with – and why the sale price alone carries limited reliability and weight.
If I can distill this all into one sentence, I would say:
A sale price is what it is worth to that particular vendor and purchaser on a specific day - informed, motivated or otherwise - whereas value is what it is worth to everyone else.
But the famous Warren Buffett says it much better: “Price is what you pay – value is what you get.”
I hope you find this useful, of course, if you have any ideas for future articles, or questions about the valuation process I would welcome your email.