I remember about a decade ago my boss (at the time) was talking about how many thousands of dollars of value his home had lost the past week, which he had seen on a website. I was not a REALTOR® at that time, but it was hard for me comprehend how he knew the exact dollar amount of value that his home had lost.
However, since then I’ve figured out what happened: he didn’t know the exact dollar amount of value his home had lost; he only thought he knew.
The reality is that home values are often misunderstand. Home values aren’t some secret formula of appreciation or depreciation that you can apply week-on-week. Nor are home values a measure of the materials the home is made of. Home values are very simple. Here is my definition:
Home Value – what a home will sell for if listed on the open market.
That’s it! If your Uncle Joe tells you his home is worth $300,000, but when he lists it for that price it doesn’t even get any showings, then it’s not worth $300,000. It’s that simple.
So calculating home values is about calculating what we predict a person will buy the home for. As you can imagine, since none of us have a crystal ball to tell us what homes will sell for, there is a bit of an art to figuring it out. So how do you go about it? Let’s talk about some “Dos” and some “Don’ts,” starting with the “Don’ts.”
DON’T put much stock in websites like Zillow or tax records.
Ok, I’ll admit it – I use Zillow and tax records, but not to find out what a home will sell for in the open market. There are other things that those resources are useful for that we can discuss another day. For now, all you need to know is that the Zillow’s CEO’s recent housing transactions have reflected wildly different prices than what Zillow listed for the home values.
Tax records are similar. Trust me, the government doesn’t have the time (or patience) to do the type of research necessary to have accurate tax value estimates done on every home in the US. These sites make broad assumptions based on broad trends, but those trends may or may not have anything to do with the price point at which someone will buy your home.
DON’T expect to sell at the top of your neighborhood
Here’s some fun trivia: What percentage of sellers believe their home will sell below what it’s worth?
Give up? The answer is zero percent. No homeowner wants to believe a home will sell below what it’s worth because every homeowner wants to believe their home is valuable.
So maybe Jane, who is interested in selling her home, has come to the light and realized that no website has a magic formula to figure out what her home will sell for on the open market. So she starts looking at comps to see what homes around her are selling for, and she notices that a neighbor’s house sold recently for $250,000 – the highest they’ve ever had in their neighborhood. It doesn’t occur to her that her neighbor’s house may have been upgraded far beyond what her home is, only that “I should be able to get at least $250,000 for my home.”
Wrong. Jane’s home is not going to sell at the top of her neighborhood unless her home is either: a) bigger than the other homes, b) nicer (and more upgraded) than the other homes, or c) a combination of the two. That may seem simple enough, but you’d be surprised how many people automatically assume their home can sell at the top of their neighborhood.
Understanding Comps
Before we get to the “Dos” section, let’s discuss a few tips for understanding strong comps vs. weak comps.
- Think “near to far.” A comp down the street is much stronger than a comp a mile away. In fact, unless you’re in a rural area, you shouldn’t even be looking at comps a mile away. The most accurate comps will be within a half mile of the home, and the most accurate of those comps will be the ones on the streets immediately surrounding the house. Closer comps are stronger comps.
- Think “recent to less recent.” A house that was sold last week is a stronger comp than one that was sold a year ago. Markets change, and real estate could be hotter or slower now than it was a year ago. Ideally, keep your comps no more than 6-12 months old.
- Think “similar construction to dissimilar construction.” Looking at the comps for a brick ranch built in the 60s? Don’t compare it to a two-story home built 20 years ago with vinyl siding. “But it’s only a quarter-mile away!” Maybe that’s true, but it’s not a real comp. Do you think someone interested in a 20 year old two-story home would be lured by a 50 year old ranch? No, those are two very different houses that would have two very different types of buyers, even if the homes are nearby.
- Recognize some comps are stronger than others. If you’re selling a home and it’s in a subdivision with other homes that all look fairly similar, comps within that neighborhood will be strong (i.e., an accurate predictor of home value). Why? Because the home-builder probably built all the homes similarly, and a buyer willing to buy your neighbor’s home for $300,000 would also likely be willing to buy your home for that price, since it’s a similar home. On the flipside, homes in rural areas are generally weaker since they will often be spread out over many miles, have very different construction, or have dramatically different features. It’s hard to predict if someone who bought the house two miles away that has the large in-law suite would be interested in your home on the other side of town that doesn’t have an in-law suite.
DO realistically compare/contrast home to comps
This is one of the key mistakes that cause people to over-value their home. They see Wally’s home sold for $250,000 and assume that their home could do the same, but it doesn’t occur to them that Wally’s home looks like a resort with all the upgrades they did, including landscape, bathroom, and kitchen upgrades. Your home, on the other hand, has the same kitchen and bathrooms it originally did, besides some paint and decor that was recently updated, and the landscape is clean but nothing special. These two properties are not comps of each other.
In this instance you have two options. Option One is to reverse-engineer the value of Wally’s upgrades along with any other major differences between your homes and factor that in. For instance, let’s say you are able to look at some other properties with similar upgrades to Wally’s home, and they consistently sell for $40,000 more than other comparably-sized, non-upgraded homes nearby. If your home is comparably sized and is near Wally’s then, generally speaking, you can probably assume your home will sell around $210,000 ($250,000 minus $40,000).
Option Two is to find better comps. Maybe there are other homes in the neighborhood that are similar to yours and haven’t been updated. If so, then the easy thing to do is to use those homes as comps rather than Wally’s home.
DO look the price per square foot but don’t forget to consider other factors.
Price per square foot is one of the most important metrics used when figuring out home values. Larger homes sell for more money than smaller homes because they’re larger, and accurate price analysis should reflect that.
But there are other considerations, particularly what I call neighborhood “floors” and “ceilings.” For instance, if Rick has a 3,500 square foot home, and the homes generally sell for $100 per square foot, it would be easy to assume that Rick’s home will sell for $350,000. But when you look at the comps, you notice all the homes selling for $100+ per square foot are all less than 3,000 square feet, and, in fact, none of the homes in the neighborhood have sold for more than $330,000, even the ones that are over 3,300 square feet. In that case, a good assumption to make is that the neighborhood has a pricing “ceiling” of around $330,000 for a home sale and that this ceiling will be difficult to break through.
Similarly, neighborhoods have pricing “floors.” Maybe three bedroom, two bathroom homes are extremely popular in Mary’s neighborhood, but her home is much smaller than the normal “3/2.” It’s possible that her home could sell for more than the normal price per square foot simply because the number of bedrooms and bathrooms partially outweighs the lost value of the home being smaller.
Conclusion
There are many considerations when attempting to calculate home values. If knowing your home’s exact value is important to you, then you will have to do more work than simply going to a site and looking up the latest home value estimate they provide. Fortunately, much of the information you will need is available online in some form, and hopefully this guide will help you to navigate that information more effectively.