3 Ways to Valuate Homes

When it comes to purchasing or selling a home, most people make decisions based on emotion rather than logic.  This is natural, but it always helps to at least have the facts to explore the logical implications of various options.

Option 1: Advertisements

Mass media will offer home values to us through billboard postings, newspaper articles, flyers, online messages, etc.  It is natural to think that we should value homes based on these advertisements because in so many other areas, the advertised price accurately reflects the real value.  However, with homes, this is not the case.  With real estate, profit is gained on the buy and realized on the sale, so it is not surprising that realized sales can be as much as 50% of advertised prices.  In fact, the goal of mass media is to set the initial bar high, so that above value home prices seem reasonable:  "Wow, that home only costs $300,000!"

Option 2: Cost Comparison

Other people will look through county records and look at sale prices of homes in the area, performing a cost comparison.  While this is more accurate, it is still a ways off, because the underlying assumption here is that the basic economics of supply and demand are at play.

However, the sale of houses is heavily guarded by average fees totaling 11% of the purchase price when combining the purchase and sale of a home (commission, title, loan fees, etc).  Therefore, the barrier of entry into the real estate market means that the market is not efficient.  In other words, factors like your real estate agent can make a huge impact on the price and you cannot just assume that because others have sold for a given price, that you can as well.

Option 3: Rental Value

The true way to value a home is based on rental values.  The value of a home will be somewhere between 100 to 200 times the monthly rental price.  This may be discouraging to many and it suggests that renting is often the best option.  However, taking the advice will help you keep your head on straight when it comes to determining the financial implications of purchasing a home.  In addition, it may help you avoid a foreclosure when an emergency situation arises.

This post was reposted from http://finlit.biz/debt/3-ways-to-valuate-homes/, originally written on November 20th, 2013.