Property Valuation for Home Sellers

Expert guidance on valuing your property before you sell

Introduction

Assessing the value of your property is one of the most difficult and important tasks of the house selling process. The valuation assessment will help you decide upon two key prices:

  • The asking price
  • The lower price limit - below which you will not sell

Asking just one estate agent his/her thoughts on the value of your property is simply not sufficient. A good valuation involves a lot more effort than that. Appraising the value of a property is a complex issue where many factors have to be taken into account - it is a combination of art and science.

Estate Agents' Valuations

Independent property valuations are performed by chartered surveyors. It is a common misconception that Estate Agents value your property for you. Agents simply guide you to a suggested asking price - their services do NOT include the provision of objective and accurate valuations which they underwrite.

It is important for the home seller to realise that the asking price an Estate Agent recommends may be over-inflated because of their desire to win an instruction. On the other hand, Estate Agents may encourage a seller to accept a low offer in order to secure a quick sale (a high turnover of properties tends to be of most importance to agents). Since you cannot be sure of your Agent's motives, it is generally recommended that you perform an independent valuation.

DIY Valuation

It is perfectly possible for non-professionals to gain a sufficient understanding of their house value.

Unfortunately, thorough understanding of valuation theory and methodology is not commonplace. There has been little comprehensive literature available as to what constitutes value and what the different methods of determining the worth of a property are. The following article will provide some insight into theoretical approaches to value and valuation methodology.

There are two main theoretical approaches to determining the value of a house, namely the "Comparable Sales Method" and the "Income Approach". The first valuation method focuses on actual market data, whereas the second calculates the profitability of the investment. Since the two approaches complement each other, a diligent valuation will always use both.

Value

Value for You and Me

Value is, of course, a subjective rather than an objective term. If a buyer favors a detached house with a garden somewhere in the Cornish countryside, your two-bedroom apartment in central London is of little value to him or her. Even small features like the size of windows are worth more or less to different people. The forces influencing the value of property include the property features and its location; social institutions in the area; wage levels; tax codes; and also building zones and environmental legislation. It does make a difference whether a flat is in Sheffield or Swindon, whether the next good school is two or ten miles away, and whether it is a 12th floor flat with a view onto Hyde Park or a basement flat with a view of by-passers' footwear.

Price vs. Value

The appraisal methods discussed below are theoretical approaches to the question of value and help you estimate the worth of your property in accordance with overall market trends and your personal investment calculations. In practice, however, it is the free market, i.e. the forces of supply and demand, which decide what amount of money a house changes hands for.

There may be a substantial gap between subjective valuations and the fluctuations of the free market. Thus, the subjective value of a property rarely corresponds to its actual price. The forces of supply and demand cannot be scientifically predicted. You might be lucky and be approached three days after you put up the "For Sale" sign, by someone who is in desperate need of a property just like yours and possesses the necessary funds to pay the price you are asking for. On the other hand, there might be many similar houses like yours on the market, and the lack of buyers may force you to cut the asking price. Every property valuation can only ever be a guideline to what your house will eventually change hands for.

The Comparable Sales Method

The "Comparable Sales Method" is also called "Inferred Analysis" of property value. This method estimates the value of a house by comparing it to the prices of like-kind properties sold in similar locations within a recent period of time. The basic assumption is therefore that a property is worth what it will sell for, in the absence of undue stress and if reasonable time is given (a case of stress could be a divorce, for example, or the sale of property after a loved one's death).

This method estimates the actual market value of homes by examining factual data. It givs a good indication of what a house can be sold for and is the most prevalent method in the residential property market.

Procedure

1. The central task is to systematically collect data on comparable properties. Basically, the forces influencing value have to be weighed against each other. The relevant elements to look for can be split up as follows:

  • Transaction Characteristics - Date of transaction, means of payment, transaction speed, etc.
  • Asset Characteristics - Size, location, conditions, utility, building regulations, business climate, etc.

2. The best way to compare property would obviously be to inspect it in person. Since this option is very time-consuming and not always possible, the next best solution is to search a property transaction database. Since two properties are almost never exactly alike, less comparable elements of the data should be eliminated or adjusted in order to ensure accuracy.

3. The simplest way to do the comparison is to assemble all relevant information. Since there are hardly ever two properties exactly alike, less comparable elements of the data should be eliminated or adjusted in order to ensure accuracy.

Property Transaction Database

Property transaction databases provide the UK's leading comparable transaction data. These services are the preferred choice of surveyors and valuers across the country, offering cleansed versions of the entire Land Registry dataset for England & Wales - containing every sale since April 2000 and continually updated with the most recent prices.

To find comparable data we recommend:

  • Specify the location by using a partial postcode - we find the Postcode Sub-Sector works best, e.g. 'SN11 8D' - all the postcode except for the last letter
  • Use the 'Most Recent Sale' filter

Example: Let's say you are the owner of No. 54 Milton Street, York YO10 3EP and are looking to sell. A search on a property database would tell you that over the last 18 months three houses on the same road had been sold, for £177,000, £172,000 and most recently £197,000.

Advantages & Disadvantages

Advantages:

  • It is the most straightforward method and has become general practice, especially in the residential housing market
  • As a theoretical approach it most closely reflects the actual market value of a property, and therefore its objective value

Disadvantages:

  • Sometimes it might be difficult to locate enough similar, recently sold properties
  • Market value and price might differ due to "unreasonable" actions by either sellers or buyers
  • This technique makes no reference to intrinsic value. If a property's price is reasonable on a comparable basis, it does not necessarily follow that this is a reasonable buying or selling price for an individual

Example: An overview over the market shows that property similar to mine has sold for around £530,000 lately. However, by selling it at that price I would make a loss since with interest, I paid £550,000 for the house. Thus, I need to try to sell it for a higher price (if possible).

The Income Approach

The "Income Approach" is also termed the fundamental or intrinsic method of property valuation. In this method, the present worth of a property is estimated on the grounds of projected future net income (in rent, for example) and re-sale value. Using this technique, a buyer can estimate whether a certain property would be a profitable investment.

The process works with the discounted cash flow (DCF) model to determine the present value of an investment. One underlying assumption of this approach is that, because of opportunity cost of capital, money is of more value to its holder today than in the future.

Although complex, this method is essential to any property valuation, especially for buy-to-let investments. It is frequently employed by financial and investment professionals when valuing assets.

Procedure

1. First, the prospective income and re-sale value have to be estimated. This appraisal is based on the principle of highest and best use and on comparable data.

Example: I want to buy a three-bedroom flat and let it out. Historical data show that I can expect a 50% increase in market value within 10 years. Market analysis tells me that the average rent of comparable properties in a similar location is £4,000 per annum.

2. In order to calculate the present value of a property, prospective future income has to be discounted to reflect the cost of equity capital. This is part of the discounted cash flow (DCF). The opportunity cost of capital means the loss of income from other interest-generating investment opportunities (eg. a 4% interest rate in a savings account).

3. The difficult part in calculating the DCF is how to estimate the risk involved. In property dealings, these estimates are usually based upon historical data on interest rate fluctations, and records of comparable investments (eg. 4%).

4. The way to calculate present value (PV) is to divide the future value of a house by (discount rate + 1).

Example: A three-bedroom flat costs £120,000. I expect to be able to sell it for £180,000 in 10 years. I set my discount rate at 8% (4% costs of equity + 4% risk rate). The calculation looks like this:

Sale PV = £180,000 / (1 + 0.08)¹⁰ = £83,375

5. A property also generates income, however. This has to be incorporated into the calculation. A buy-to-let property produces a constant cash flow in the form of rent, whereas if I buy a house to live in myself I increase my income by saving on rent.

Example: The three-bedroom flat generating £4,000 per year in rent costs £1,600 in expenses. That means I have an annual income of £2,400. I set my discount rate at 8%. The calculation for the net present value of the first year's income is:

PV = £2,400 / (1 + 0.08).

PV = £2,222

It results that the present value of my new income in year 1 is £2,222.

Yet, I do not plan to re-sell my flat after one year; instead, I will keep it for at least 10 years. In that case the calculation goes as follows:

PV = (£2,400 / 1.08) + (£2,400 / 1.08²) + (£2,400 / 1.08³) + ... + (£2,400 / 1.08¹⁰)

= £2,222 + £2,058 + £1,905 + £1,764 + £1,633 + £1,512 + £1,400 + £1,296 + £1,200 + £1,112

= £16,102

It results that the present-day value of the three-bedroom flat is:

PV = £83,375 + £16,102 = £99,477

I would therefore be ill-advised to buy the flat at the current price of £120,000.

The valuation that this method generates is highly sensitive to the following variable assumptions: Rental Net Income: £2,400 | Re-Sale Value: £180,000 | Discount Rate: 8%

Advantages & Disadvantages

Advantages:

  • It focuses directly on the value of the property to the individual concerned
  • Income analyses are very detailed and derive specific conclusions (in contrast to the more general approach practised in the Comparable Sales Method)

Disadvantages:

  • This method is more complex and less intuitive than the Comparable Sales Method. This is one of the reasons why it is often overlooked
  • This method ignores the actual market prices for property by neglecting the comparable sales analysis

Overview & Conclusion

The Comparable Sales Method focuses on market data of sales of similar property in a recent time period and thus gives an estimate of which price is adequate for a particular kind of property. Sales comparisons can easily be performed by the layman using internet databases of property transactions. The advantage of this method is that it reflects the actual market prices, but it neglects whether or not a property investment is profitable for seller and buyer.

The Income Approach concentrates on the profitability of a property investment. It analyses the present worth of projected future net income and anticipated future re-sale value. This method gives a good appraisal of whether a certain property is worth its price to the buyer, but it neglects the relation to the overall market.

In order to obtain a good estimate of value for a property it is necessary to employ both the Comparable Sales and Income Methods.

Conclusion

It should be clear by now that there is no perfect method of assessing the value of a property. Appraisal is an art as much as a science, and in the end it is supply and demand which determine the actual selling price of a house.

Nevertheless, the methods discussed above provide guidelines for home sellers on how to estimate the approximate worth of your house - both to yourselves and to potential buyers. By performing an independent valuation, you will be able to set a reasonable asking price for your house - reasonable in terms of both market conditions and your personal financial needs.

You should keep in mind that potential buyers usually perform their own valuations and are thus likely to be able to spot an over- or under-valued property. Furthermore, you cannot predict whether you will be lucky enough to find buyers needing a house exactly like yours after a short while, or whether your ad might still be in the paper after two months. In the end, no valuation can tell you what you will get for your house. This matter is decided by the forces of the free market. But a valuation provides you with a good prediction of what to expect.