Market Price

The price paid for a property; the amount of money that must be given or which can be obtained at the market in exchange under the immediate conditions existing at a certain date. To be distinguished from market value.

The Evolution of Real Estate Market Value

As a real estate professional, I sometimes wonder how many opinions of values are out there when it comes to real properties. It certainly seems that the dollar value of an interest in land and its definition change according to whom you ask – talk about subjectivism. There is a value to the owner, a value to the buyer, a market value, a realtor’s market evaluation, a development realized value, a property appraisal, a lender’s value, an assessed value, an estate value, an expropriation value, an insurable value, a taxation value, a latent value, an investment value, an economic value, a residual value and an actual value one can think off the top of the mind, enough to be tempted to take all these numerical values and go play the lottery.

In real estate, of course, no value is more important than market value - and no other factor is of a more ephemeral nature. This is so because real estate is an imperfect market. Although commonly and somewhat misleadingly referred to or otherwise thought of as one market, real estate consists of several, smaller markets each one of which is constantly subjected to and shaped in accordance to external influences and in direct function of economic variables. Externalities the likes of demographic variations, income fluctuations, trends and social preferences, technological progress and government policies – all have a bearing on the desirability of a certain real product and all are proximate factors affecting demand and, conversely, supply at any given time. As such, the numerical determination of market value is also shifting over time to follow the impact of externalities.

Market value, therefore, varies according to the interpretation of variables. Here are a few definitions:

1. The highest price estimated in terms of money which a property will bring if exposed for sale in the open market allowing a reasonable time to find a buyer who purchases with knowledge of all the uses to which it is adapted and for which it is capable of being used.

American Institute of Real Estate Appraisers

2. The amount that would have been paid for the interest in land if, at the time of its expropriation, it had been sold in an open market by a willing seller to a willing buyer.

Canadian Federal Expropriation Act

3. The highest price in terms of money that a property will fetch in a competitive and open market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and assuming that price is not affected by undue stimulus.

Urban Land Economics Institute

The differences in these definitions reflect different assumptions concerning the conditions and circumstances under which the sales transaction will occur. They also introduce an element of subjective opinion. More specifically, they require a definition of ‘fair’, the degree of ‘knowledge’ that is required of market participants, what’s ‘prudent’ in a real estate market and how ‘undue stimulus’ affect price. Opinions relating to the meanings of these words within the context of a transaction are difficult to support with market data. However, these difficulties can be somewhat avoided by recognizing that a sales price represents ‘value in exchange’, but that there are also other kinds of value which do not necessarily reflect price. The study of how human and social biases affect economic decisions and how such decisions, once taken, affect market prices, returns and allocation of resources are the subject of a very specialized branch of Economics known as Behavioral Economics. There are three main themes in Behavioral Economics:

1. Heuristic – from the Greek ‘eureka’ which means “I find”, heuristic is the art and science of discovery and invention. As applied to Behavioral Economics in real estate, heuristic lays out the tenet that people often make decisions based on approximate rules of thumb, not strictly rational analyses. This is due to how people are affected by biases, especially cognitive biases, that is distortions in the way reality is perceived.

2. Framing - the way a problem or decision is presented to the decision makers will affect their action.

3. Market Inefficiencies – defined as outcomes in the market that are contrary to expected behavior based upon prior economic models. These would include mispricing, non-rational decisions and decision-making processes, and market anomalies from a behavioral perspective.

Herd behaviour is one important subject of scrutiny in Behavioral Economics. Herd behaviour refers to situations wherein a group of individuals react coherently without there being any co-ordination between them. Such a group is called a herd. The impact of herd behavior can have very long and sometimes devastating consequences. For instance, the fear of a real estate bubble – although economically unfounded – can have a very real impact if a large enough group of market participants believe in it in the same or similar lapse of time. In such a circumstance, demand for products would be affected clearly to the point of causing a marginal or absolute price depression.

Groupthinking, like herd behavior, involves a group of people where each individual member of the group attempts to conform his or her opinions to what they believe to be the consensus of the group. In a general sense this seems to be a very rationalistic way to approach the situation. However this can result in a situation in which the group ultimately agrees upon a certain collective course of action which each member might individually consider to be unwise. This happens in strata general meetings where the individual agrees to a certain conduct for the benefit of the condominium which, ultimately, turns out to be wrong.

Risk aversion – defined as a participant’s willingness to accept a lower, expected payoff in exchange for a more predictable outcome – is another important facet of Applied Behavioral Economics. In real estate, this would translate for instance in a seller of a leaky condo deciding to sell at a loss to avoid confrontation and emotional strains as opposed to going through the whole process of waiting for the real property to be repaired – with the ensuing stress and ongoing litigation – so as to sell later on at a higher price.

And, finally, cost of opportunity is scrutinized in Applied Behavioral Economics as the worth of a benefit forgone in a decision-making process vis-à-vis the cost of actualization of a certain decision. In simpler terms, how much is the net return obtained by, say, the act of selling an interest in land minus the cost of opportunity of not selling it.

Real estate, as we all know, is more a matter of emotions than anything else. Participants make their decisions based upon the extemporaneous factors of the moment, and understanding these decision-making processes will help realtors in bringing buyers and sellers together and lawyers in ironing out differences, when circumstances warrant, in a court of law.

 

Luigi Frascati

Luigi Frascati is a Real Estate Agent based in Vancouver, British Columbia. He holds a Bachelor Degree in Economics and maintains a weblog entitled the Real Estate Chronicle at http://wwwrealestatechronicle.blogspot.com where you can find the full collection of his articles. Luigi is associated with the Sutton Group, the largest real estate organization in Canada, and is based with Sutton-Centre Realty in Burnaby, BC.

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