- VALUE vs. COST
Value can be distinguished from "cost" as well as from "price," for neither is necessarily synonymous with value. The principal differences may be explained as follows:
- Value has to do with the combined factors of present and future anticipated enjoyment or profit. The value sought in the appraisal of property may be said to be the discounted present worth of all desirable things (benefits) which may accrue from a skillful use of it. A conclusion in regard to these things will clearly be a matter of opinion: an intelligent estimate based on a thorough analysis of all available influencing factors and on reasonable and more or less warranted assumptions.
- Cost represents a measure of past (or prospective) expenditures in money, labor, material or sacrifices of some nature in acquiring or producing the commodity. While cost may be, and frequently is, a factor upon which value is partially based, it need not be, as it does not control present and future value. An example of this fact is the value of an apartment property as compared with an oil well (assuming that the building and drilling costs were the same). The oil well may prove to be a big producer and of great value, or it may prove to be a dry hole and of no value. An apartment building might be costly to build but have little value because of its bad location and high vacancy factor.
- Price is what one pays for a commodity, regardless of pressure motives or intelligence of the seller or buyer. Usually it is considered to be the amount of money involved in a transaction. Whether we receive in value more or less than what we pay for will depend on the soundness of judgment in the analysis or appraisal of value. Under an efficient market structure, price will usually tend to equal value, varying only as buyers and sellers have unequal knowledge, negotiating skills, or economic strength. Some factors influencing market price (as distinguished from value) are favorable financing, distress sale, forced purchase, uninformed purchaser or seller, misrepresentation of facts by the seller and high pressure sales practices.
Appraisers carefully distinguish between market value, cost and price in refining their appraisal conclusions.
Purposes and Characteristics of Value
The purpose of a valuation or an appraisal is usually indicated in the value concept employed, for example: market value, assessed value, condemnation value, liquidation value, cash value, mortgage loan value, fire insurance value, etc. The purpose of an appraisal frequently dictates the valuation method employed and influences the resulting estimate of value.
- Intended use. The intended use of the report has become distinct from the purpose of the appraisal. This relates to how the process has been separated from the writing of the report (Standard 1 vs. Standard 2 in USPAP). The purpose of the appraisal may be, for instance, to help in settling an estate. The intended use of the report may be to communicate the value findings to heirs only, or may include attorneys and/or taxing authorities. The purpose helps to define how the appraisal process will be laid out. The intended use will help to determine which report type is most appropriate for communicating the results of the process.
- Four elements of value. There are only four elements of value, all of which are essential. These are utility, scarcity, demand (together with financial ability to purchase), and transferability. None alone will create value.
- For example, a thing may be scarce but, if it has no utility, there is no demand for it. Other things, like air, may have utility and may be in great demand, but are so abundant as to have no commercial value. Utility is the capacity of a commodity to satisfy a need or desire. To have utility value, real estate should have the ability to provide shelter, income, amenities or whatever use is being sought. Functional utility is an important test for determining value. Likewise, the commodity must be transferable as to use or title to be marketable.
Generally speaking, a commodity will have commercial or marketable value in proportion to its utility and relative scarcity. Scarcity is the present or anticipated supply of a product in relation to the demand for it. Utility creates demand, but demand, to be effective, must be implemented by purchasing power. Otherwise, a person desiring a product cannot acquire it.
Fundamental to the concept of value is the "highest and best use" principle, discussed earlier in this chapter. Location is a most important factor in determining highest and best use. Any analysis to reach a decision as to the "highest and best use" must include consideration as to the future supply and demand for such use within the area and a possible oversupply or undersupply with attendant effect on market demand and value.