# How much is a house worth?

I have seen a number of recent debates online about determining the accurate value of a house. Buyers are trying to determine accurate values of homes to help them craft their offers. It seems that the struggles of the real estate market have given rise to a set of more data-savvy consumers trying to avoid the pitfalls of the past few years. While I wholeheartedly endorse this sort of diligence and analysis, I have seen quite a few people being misguided by the data. Let’s look at some of the methods and pitfalls of trying to accurately value a home.

Here are some methods I’ve seen that are of limited value when determining the current market value of a home. Some of these can give you a starting point, but realize that it is simply a starting point, not necessarily an accurate value.

1. Taxable Value – Your local tax assessor has surveys and formulas to calculate a “taxable market value” for each home in your county, which is supposed to be based on the current fair market value. Based on that taxable value, they will apply a tax rate to determine your property taxes. In our case for Washington state, this assessment happens every year. The problem is that these “taxable values” are littered with inaccuracies and often lag the market by years. Value is determined based on the data they have about the home in the tax records, which is notorious for being inaccurate. Often the records lack information on remodels, additions, updates or other factors which substantially change the value of a home. There is no incentive for home owners to correct the data, as it will often raise their taxes. I have seen taxable values come in at as low as 50% below current market value and above market value by 25%. Bottom line, the only useful thing about taxable value is to determine how much you will pay in taxes.
2. Zillow ZestimateZillow’s Zestimate is a computer-generated estimate of a home’s value. By Zillow’s own admission, it is a starting point for valuing a home and is within +/- 10% of the market value of the home in most cases. Zestimates use tax records and recent sales data to calculate their estimate. Given the inaccuracies in tax records, those inaccuracies will find their way into your Zestimate. Also, there is no way for a computer to understand aspects of the home that you can only see in person. What about the recent remodel? How about the dilapidated house next door? What about the new construction that just blocked your view? All of those factors greatly influence the value of a particular home, but can’t be calculated by a computer.
3. Historical Appreciation Rates – I’ve seen some buyers try to estimate the value of a home by finding what it sold for long ago, say 10 years ago. They then apply appreciation to that price based on general statistics such as the Case-Schiller Home Price Index. There is some validity to this approach, and it should give you a starting point for value. However, once again it ignores things that have changed about the home such as remodels, additions, neighborhood, etc. It also ignores the real-time supply and demand in a particular market, which is the single strongest driver for price changes.
4. Cost to Rebuild – Calculating a cost to rebuild the home from scratch is a generally accepted approach to home value that is part of most professional appraisals. There are plenty of accurate statistics out there which will tell you how much it would cost to rebuild a home of similar finishes and square footage. You could even get a bid from a construction company. The catch is being able to calculate an accurate value for your land. In most neighborhoods, it is unlikely that a vacant piece of land has sold recently, since every piece of land has an existing home on it. Appraisers will use a combination of recent sales data and subtract estimates of rebuild costs for similar properties to infer a value for the land. This is a valid, and likely fairly accurate, way to value a home, but it is unlikely that prospective home buyers (or sellers) have access to enough data to make this calculation on their own. Ordering a professional appraisal would be the quickest way to get to these numbers, but professional appraisals are expensive.
5. Income Approach – For income-producing buildings like apartments or office buildings, this approach is frequently used. Basically you look at the operating income/expenses for a building and compare it to other similar buildings. The higher the net income, the higher the value of the building. I’ve seen people try to apply this to single-family homes by estimating how much rent it would bring in. There is little validity to this approach for residential properties since the market is not buying these homes for their income-producing capability, they are buying them to live in.

So how should a home be valued? The most commonly used method is the “Sales Comparison Approach”. This approach looks at recent sales of similar homes and assumes that the open market determines home values by what buyers are willing to pay for similar homes. Most professional appraisers give the most weight to this method, and a Comparative Market Analysis (CMA) done by a real estate agent largely follows a similar process.

1. Research the Market – Obtain information about sales, listings and pending sales for homes that are similar to the home you are evaluating. Similar homes are nearby with a similar configuration, vintage and finish level. Normally a professional appraiser will locate 3-5 similar homes that have sold in the past 3-6 months for comparison. Anything sold more than 3-6 months ago is not an accurate comparison because of changes in the market.
2. Investigate Your Data – With data in hand, you need to confirm that all of the comparables you are looking at have been sold “on the market”. Specifically you’d look to exclude sales prices that are artificially low because of an exchange between family members, special seller financing provisions, or other factors that indicate that the home was sold for a price that does not reflect current market values.
3. Adjust the Value of Comparables – It is unlikely the a comparable home is an exact copy of the home being valued. To make a fair comparison, you adjust the value of comparable homes up or down to reflect these differences. For example, if a comparable home has a stunning view, you might reduce the value of the comparable home by \$50k, or maybe the comparable home lacks a finished basement, so you add \$30k to its value.
4. Determine a Value – Once you’ve calculated the value of comparable homes, you can average those values to come up with a value for the home you are looking at. You also need to account for real-time supply and demand when valuing a house. If you are in a hot seller’s market, homes are selling quickly and competition may drive the value higher. If you are in a slow buyer’s market, it may take a number of months for the home to sell (called the absorption rate), which will lower the value of a home. It is also prudent to look at homes currently for sale to see what the “active” competition looks like for a particular house.

When you are looking at all of these methods, it is important to realize that they all have limitations and many simply providing a starting point for value. No method is perfect for determining the value of a home, and it is as much art as it is science. An experienced real estate agent or appraiser can help you in the process, as they are able to tap their own experience and data to help you come up with a reasonable value.

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• Michael P. Lindekugel

1. Taxable
This kind of sorta started out as an approximation of FMV. Today, there is very little correlation between taxable value and FMV. The taxable value and the tax rate are set by a combination of a governments need to fund operations, legislation, budgetary cycles, valuation cycles, etc.
2. Zillow
I have talked to Zillow’s VP Data and Analytics Stan Humphries, PhD a couple times at events. The calculation of the zestimate is a little more complicated. More data points are used and pumped through a proprietary algorithm to produce the zestimate. As you point out garbage in garbage out. WA tax data is famous for inaccuracies. I think it is difficult to build separate models for each area to account for the components that most influence value for that area.
3. Historical
Case-Schiller index has known issues as does the FHFA index or its predecessor OFHEO. The most accurate tends to be a combined analysis of Case, FHFA, and local statistical data. Of course, historical data is no guarantee of future performance.
5. Income Approach
Very close. There is a technical difference to the correct answer and your very close answer. The income approach uses Net Operating Income (NOI) which is rental income less actual expenses directly associated with the real property asset. Net Income includes NOI less other expenses not directly associated with the property such as depreciation or cost recovery and interest expense.
Investors will go further and use discounted cash flow techniques to calculate the assets return on capital to determine investment value to them. Commonly used techniques include Internal Rate of Return (IRR) and Net Present Value (NPV) and occasionally Modified IRR (MIRR) which includes a reinvestment rate for cash flows received.
Cheers,
Michael P. Lindekugel
Commercial Realtor
Certified Distressed Property Expert
RE/MAX Metro Realty, Inc

• Michael P. Lindekugel

1. Taxable

This kind of sorta started out as an approximation of FMV. Today, there is very little correlation between taxable value and FMV. The taxable value and the tax rate are set by a combination of a governments need to fund operations, legislation, budgetary cycles, valuation cycles, etc.

2. Zillow

I have talked to Zillow’s VP Data and Analytics Stan Humphries, PhD a couple times at events. The calculation of the zestimate is a little more complicated. More data points are used and pumped through a proprietary algorithm to produce the zestimate. As you point out garbage in garbage out. WA tax data is famous for inaccuracies. I think it is difficult to build separate models for each area to account for the components that most influence value for that area.

3. Historical

Case-Schiller index has known issues as does the FHFA index or its predecessor OFHEO. The most accurate tends to be a combined analysis of Case, FHFA, and local statistical data. Of course, historical data is no guarantee of future performance.

5. Income Approach

Very close. There is a technical difference to the correct answer and your very close answer. The income approach uses Net Operating Income (NOI) which is rental income less actual expenses directly associated with the real property asset. Net Income includes NOI less other expenses not directly associated with the property such as depreciation or cost recovery and interest expense.

Investors will go further and use discounted cash flow techniques to calculate the assets return on capital to determine investment value to them. Commonly used techniques include Internal Rate of Return (IRR) and Net Present Value (NPV) and occasionally Modified IRR (MIRR) which includes a reinvestment rate for cash flows received.

Cheers,

Michael P. Lindekugel

Commercial Realtor

Certified Distressed Property Expert

RE/MAX Metro Realty, Inc