HOW THE PRICE WAS SET AND WHY IT IS VERY FAIR TO THE BUYER AND ALSO FAIR TO THE SELLER
INTRODUCTION AND BACKGROUND
I used to manage my own retail store, and plus I have a degree in economics, and I have always prided myself on having the right price on everything I sell. In this case, my objective was to set a price that was without a doubt very fair to the buyer, without being substantially unfair to me, the seller.
But no matter how low the price of a property is, there are always going to be a number of folks who believe that the value of it is even less. And in the current bad real estate and real estate financing markets, that number of folks is going to tend to be a bigger number than usual.
Why are there always going to be people who think the value of a property is less than the fair value of it? Economics gives us the answer. According to universally accepted economic theory, for every item that exists and that can be sold, if the sale is a normal free market sale, the price is such that supply and demand is in equilibrium. Of course, this rule generally applies to real estate. But this means in the case of a single, unique item, that most prospective buyers are going to value the property at less than it’s true fair price; only the actual buyer, by definition, will agree completely with the true fair price.
For the great majority of properties, no single property is really all that unique. In every town and city of any size, there are other houses that are quite similar to a house that someone was considering buying. But in the case of a unique property being sold, such as this Kansas property being sold with the assistance of this web site, the supply is technically one unit. There are roughly similar properties and there may be a few somewhat similar properties for sale in the region of the country where this property is, but there are probably no extremely similar properties or essentially identical properties available for sale right now, particularly if you limit the consideration to Kansas or to Kansas and surrounding states. In fact, because of it’s unusual characteristics, including the peaceful, private, rural location, the extremely low price, the freedom from zoning hassles, the combination of outbuildings and house, and the much larger than usual lot size, this property has in theory very few that are close to identical to it anywhere.
But there has to be a price for this property, and the basic law of economics still applies. Fortunately, there was an excellent place to start the calculation of what is the true fair price for this property.
THE STARTING POINT AND WHY IT IS A GOOD ONE
The starting point or base for determining the market value of this property is the Pawnee County assessment value, which is the County’s best estimate of the true market value of this property. Every year the County declares what it believes the market value of every property in the County is. Every year, in late winter, the County sends a “Valuation Notice” to every property owner, which among other things lists the ‘Total Appraised Value” of the property in question. The Total Appraised Value is the best estimate of the market value of the property, that is, what it would sell for if it were being sold right now, and assuming that the uninspected details of the property worked out to be average among the comparable properties.
In order to make these values accurate reflections of reality, there are two processes that are followed by the County. First, an appraiser/assessor visits the property every so often and inspects all of the land and the structures, paying especially careful attention to the overall structural soundness of the house and the outbuildings, including of course the foundation of the house. (If a house is shifting on its foundation, that is obviously a very bad thing, and the market value of such a property is much lower than when there is no foundation problem.) Second, the property is conceptually placed into a class or category or generic type, defined by the part of the County the property is in, by whether the property is in town or not, and by the primary structures and the amount of land. Then all recent sale prices of other properties in that same category are researched and averaged out. In some but not in all years when an appraiser does not visit the property, the County can do a new comparable analysis, thus updating the Total Appraised Value or estimated market value to reflect up to the minute market conditions.
The properties in the category are all going to be a little different from each other in a rural area like this. Some will have a larger house and smaller outbuildings. Others will have a smaller house but more outbuildings. Others will have a similar house and similar outbuildings, but maybe 1 acre of land instead of 2 ½ acres. But the differences in the primary characteristics of the different properties in the category offset one another for the most part, or else the differences are relatively small when you look at the universe of all properties.
However, just because the County says a property is worth $26,000 does not automatically mean that it is definitely going to sell for $26,000 or even extremely close to that. Why? Simply because the details of the inside of the house are not inspected.
But the County figure gives you a base or starting point from which you can proceed to determine the fair price. The true fair market price is most likely going to be in a range of, say 75% of $26,000 at the very least to 125% of $26,000 at the very most, with the specific correct amount depending on the details of the condition of the inside of the house. Because the County does not inspect the inside of the house and does not know, when the market value is estimated, to what extent the inside of the house is updated.
The property being sold has a 1,200 sq. ft. house, a 2,800 sq. ft. Quonset building, a barn estimated to be about 1,000 sq. ft., a small workshop that is about 120 sq. ft, 2 small circular storage buildings, that used to be “potato sheds” or grain bin sheds of about 200 sq. ft. and 107 sq. ft., and 2 1/2 acres of land. These are the obvious, primary features of the property that are what the County starts with when it looks around for similar properties so that it can estimate the market value. The County does a thorough inspection of the outside features of all structures. For the house, this would include the siding, the paint, the roof, the foundation, the porch, the chimneys, the windows, and the window sills. The County uses specialized equipment to verify that the house has not begun to shift on it’s foundation so as to make sure the house is structurally sound and does not need any foundation repair work. The house being sold was so inspected in May 2006, a few months after I bought it, and was found to be structurally sound in all respects.
But to reiterate, the County makes no attempt to inspect the component parts of the insides of houses that make houses livable and that make houses comfortable and that make houses places that you can show off to your friends and relatives. So in other words the County does not attempt to adjust the root market value, based on overall, large scale features, for interior components of the house. The costs of doing so would be ridiculously higher than would be the benefits.
Even an inside of a house that needs a total makeover including not only cosmetic upgrades but also plumbing and/or electrical work, in other words, the worst possible house you could imagine, would need at most roughly $10,000 of work to make it average among the comparable properties. So theoretically, there might be a property that the County claims is worth, say, $30,000 that is really only worth $20,000, because the house is a disaster area on the inside where nothing works and everything needs updating
So getting back to the property being sold we know that the property is said to have a market value of $26,000 by Pawnee County. In other words, it is similar overall and outwardly to properties that have recently sold for an average price of $26,000 in Western Pawnee County.
Here is a record of what the County estimated market values were for this property in recent years.
2006 23,200
2007 26,000
2008 26,000
There was no change for 2008 apparently because no comparative analysis update was done for this year.
After I bought this property in late 2005, an assessment was done on it for the first time in many years. Notice that there have been two reassessments done since I purchased the property in late 2005: one in 2006 and one in 2007. Each time, recent sales of comparable properties were taken into account. The 2007 reassessment acts as a confirmation of the accuracy of the 2006 assessment. Thus, one can have a high degree of confidence that the $26,000 figure is an accurate starting point for determining the real market value of this property.
Remember that the property has 3 major components: (1) the land, (2) the outbuildings: Quonset building, barn, two circular grain bin buildings, a small workshop, and (3) the house.
The value of the 2 1/2 acres of land being sold is separately tracked by the County. The land component is estimated to have a market value of $6,450 by the County, so the other two components combined have a market value of $19,550. Unfortunately, the county does not break down the outbuildings from the house, so someone making a customized fair market value estimate for this property has to do his or her best to do that breakdown to start off the effort. The quonset building has to have a substantial value considering its size and structural strength. I have prospective buyers who are more interested in the quonset building than they are in the house, so for them the following breakdown would be way too low for the quonset building and way too high for the house. On the other hand, for those not much interested in the quonset building, the breakdown is going to tend to be way too high for the quonset building and too low for the house.
The point is, everyone is going to have a different breakdown in mind, so all I can do is come up with my best estimate of the average breakdown among all prospective buyers. So I did this:
BASE VALUATION AMOUNTS
Land: $6450
Quonset Building: $6,200
House: $11,700
Barn: $750
Grain Bin Buildings $600
Small Workshop: $300
TOTAL: $26,000
REPAIRS AND UPGRADES
Now the next thing to consider are the repairs and upgrades needed now or in the next few years on items that were not inspected by nor known by the assessor during his personal visits and during the analysis of the actual sale prices of the comparable properties in this part of the County that led to the $26,000 valuation. There are several questions that had to be answered:
1. What are the repairs and upgrades that can be identified, some percentage of which would be needed to make this property average among the comparable properties?
2. What is the estimated costs of all of the repairs and upgrades, most of which did not factor into the County assessment?
3. How many of these identified desirable repairs and upgrades would be needed to bring this property up to the average status among the comparable properties? I have long since realized that this property is below average to one extent or another in terms of the amount of repair and upgrading needed compared with the other properties that went into the comparison analysis for the market value estimate done by the County. The question was by how much and the devil was in the details as always in microeconomics.
The relevant question is not what the combined cost of repairs and upgrades needed to make this property the best or one of the best properties in the comparison group is. Rather, the relevant question is: what is the combined cost of repairs and upgrades needed to make this property average among the comparable properties? Because if and only if it is average among them, this property would be worth about $26,000. If it were above average, it would be worth more; the best properties in the comparable property group could be expected to sell for roughly 25% more, or $32,500.
So I proceeded to do all of the following:
1. I broke down the market value into the major component parts (see above).
2. I made a list of every substantial desirable repair and upgrade on the property that was not inspected or known by the County when it made the market value estimate. These items were categorized into the component parts of the property.
3. I made estimates of the cost of getting all the items in (2) repaired or upgraded. All of the estimates were assuming that each job would be contracted out, which produced substantially higher dollar amounts in most cases than if the jobs were partly or totally done by the new owner. In other words, I did not cheat the next owner by assuming that he will save money by doing work him or herself, even though it is quite likely that the actual next owner will in fact do some work himself or herself. Estimates were done by extensive internet research and were aided by my degrees in economics and another degree I have in accounting. Moreover, wherever possible, estimates from contractors who would actually do the work were given a very large amount of weight, especially where the estimate was going to be tough for me to do accurately.
4. I added up the contracted out costs for each component part of the property that might get an update, and of course I came up with a grand total of all proposed repairs and updates.
5. As explained above, the trickiest part is to, after you have your grand total of proposed repairs and upgrades, make an estimate of how many of the repairs and upgrades need to be done in order to make the property average among the comparable group of properties that were used to come up with the $26,000 County estimate. Because if you knew exactly what was needed to make the property average, you would then have an excellent idea of what the exact market value of the property in its current state is. It would be $26,000 minus the sum of the costs of all the repairs and upgrades needed to make it average.
6. Since I would have to gain access to and spend several hundred hours inspecting the comparable properties in order to see how they compare in detail to this one, and since that is obviously not possible, all I could then do was to make the best estimate possible of the correct percentage of all possible repairs and upgrades that would be needed to make this property average. Unfortunately for me, to avoid cheating the buyer, I had to be as generous as possible with my estimate without unreasonably overestimating how wonderful the comparable properties are.
7. Since the exact percentage (amount of repairs and upgrades) can not be known, you need to come up with a reasonable range. When that is done, the following results become known:
CORRECT CURRENT MARKET VALUE OF PROPERTY BEING SOLD BY % OF THE COST OF ALL REASONABLE REPAIRS AND UPGRADES NEEDED TO MAKE THE PROPERTY AVERAGE AMONG PROPERTIES COUNTY CONSIDERS COMPARABLE
40% $23,200
50% $22,500
60% $21,800
70% $21,100
75% $20,750
THE FINAL ANALYSIS
As anyone who understands this and who is good at math can determine, the sum total of the cost of all repairs and upgrades identified for this property, some percentage of which would be needed to make it comparable to other properties, was almost exactly $7,000. Even in 2008, that amount of money is enough to make a lot of repairs and upgrades to a property, especially when low western Kansas labor rates are involved. To see how the resulting prices are calculated, consider for example the 60% level. 60% of $7,000 is $4,200. And $26,000 minus $4,200 is $21,800, which is the price you see above next to 60%.
Since I believe that the correct percentage of all possible repairs and upgrades to bring this property to average is somewhere between 40% and 75%, and the cost of all of them with virtually no do it yourself labor is very close to $7,000, my best estimate is that the exact, true, correct market value of the property right now is between about $20,750 and $23,200.
My current price of $22,000 is in the middle of that range, but an argument can be made that I should be ready to sell for as little as $20,750, since I don’t know what the real, true correct percentage is within the range shown. When all is said and done, it is impossible for me to be more exact about the true price than to specify it as a range that spans about $2,500, from $20,750 to $23,200. Any price in this range is just as fair as any other one, really.
I have buyers who want to buy at $22,000, but they have been delayed by banks refusing to make them loans that they would have made to them as recently as about 12-18 months ago. This is no surprise, because currently, most banks have overly restrictive loan policies. Due to these policies, which everyone expects and hopes will be temporary, there has been a delay in selling this property, exactly what all of my efforts were supposed to prevent. Under normal housing market conditions, I would not want to consider selling this property for less than $21,975, the midpoint of the correct price range. However, these are not ordinary conditions, and I may possibly have to seriously consider selling the property for as little as $20,750 at some point in the future, if banks keep preventing potential buyers from getting financing, and if potential buyers keep having a lot of trouble selling their current real estate, and if no one else who has cash on hand steps forward to buy the place.
Next, we will break down the property by its components and see what I am really selling each component for. We will start with the base amounts, the ones that add to the County value of $26,000, and then we will see what the effective price of each component is assuming the property is sold for $22,000.
BASE VALUATION AMOUNTS:
Land: $6450
Quonset Building: $6,200
House: $11,700
Barn: $750
Grain Bin Buildings $600
Small Workshop: $300
TOTAL: $26,000
BREAKDOWN OF SALE
This shows the price that the buyer will be paying broken down by component. Remember, this is a package deal; legally I have to sell all of these components at once. When you look at the price breakdown, you can quickly see what a bargain this property is. You get a livable house for $8,500, a 2,800 sq. ft. strong quonset building for $5,600, and more as broken down here:
1. House, 1180 sq. ft. $8,500 ($11,700 county value minus $3,200 upgrade allowance)
2. Land, 2.55 acres $6,450 (Listed County market value)
3. Quonset Building, 2,800 sq. ft. $5,800 ($6,300 county value minus $500 upgrade allowance)
4. Barn, approx. 1,000 sq. ft. $750 (estimated County market value; roof damage factored into county value)
5. Two Circular Grain Bin Buildings, 110 sq. ft. and 175 sq. ft. $200 ($500 minus $300 for junk removal)
6. Work Shed, approx. 120 sq. ft. Free (due to roof repair needed from recent roof damage)
7. Furniture and Appliances $300
Note that if I was selling just the land and the house, the price would be about $14,950, which would more than accurately reflect the extremely low real estate prices of the area for houses that have not been updated in recent years and would also accurately reflect the very reasonable price of land.
SUMMARY OF SALE
TOTAL COUNTY MARKET VALUE: $26,000
Minus total of allowances for upgrades and repairs to make the property average in its comparable class: $4,300
Plus conservative estimate of value of furniture and appliances included: $300
SALE PRICE: $22,000 firm and not now negotiable. However, offers for less than $22,000 will be filed and considered at a later date if and when I have to lower the price a little more.
It is possible due to the economic situation that I will have to lower the current price to $21,500. It is unlikely that I will ever have to lower the price to $21,000. It is very unlikely that I will ever have to lower the price to $20,500. It is extremely unlikely that I will ever have to lower the price to $20,000. It is virtually impossible that I will ever have to lower the price below $20,000.
As you can see, the house is being sold for $8,500. The house and the land are being sold for $14,950.
The 2,800 sq. ft. quonset building is being sold for $5,800.
The small workshop is being sold for nothing or very close to nothing, because the estimated cost of putting on a new roof is roughly equal to the estimated market value of the workshop in its current state without a roof. Similarly, the two circular grain bin buildings are incredibly cheap. Both of these buildings have lockable doors and can be used to store anything. One is about 175 sq. ft. and the other is about 110 sq. ft. They are being sold for just $300 for both! They would normally go for $600, but unlike the quonset building, which is completely cleared of all property and is wide open space ready for the new owner, the two grain bin buildings have some junk in them that needs to be hauled to the Pawnee County landfill, a job that will require no more than $300, so this amount is deducted from the $600. Incidentally, there is never a charge for leaving any type of junk at the Pawnee County landfill.
The barn is being sold for $750 as my best estimate of what it is worth with about 1/12 of its roof missing. The cost of repairing the roof of the barn, or of putting a whole new roof on the barn, is not among the possible repairs that add to $7,000, because the assessment of the property as a $26,000 property was done after taking into consideration the overall outward condition of the barn, including the fact that 1/12 of the roof is missing. So the price of the barn is fixed at $750 and it does not change under various repair/upgrade percentages because there are no barn repairs or upgrades that are relevant. The barn is structurally sound and the roof problem is the only substantial problem with the barn.
Incidentally, if my breakdown between house and building is incorrect, the odds are I have the quonset building a little too low. If the quonset building were located in a more populated area, it would obviously be worth far more than $5,800. But since this property is served by Fed Ex and by UPS, and since high speed DSL internet service is available as well, this building could be used in a business not open to the public in the same way it could if it were in a town or a city! In any event, if even considering where it is my estimate of the value of the quonset building is too low, then my unadjusted market value estimate for the house is too high, and so the real selling price of the house would be less than $8,500!
Furthermore, and more broadly, for those who have a valuable use for the Quonset building, there is no doubt that they will value it as worth much more than $6,200. For those prospective buyers, the effective cost of the house could easily end up being a trivial amount, or even free.
VALUATION VARIATIONS OF DIFFERENT POSSIBLE BUYERS
Let me move on to another important subject regarding the price of this property. There are actually numerous ways that someone might incorrectly believe that the property as a whole is worth even less than $21,000:
1. He or she might be mostly interested in the house and place very little value in the quonset building. If 75% of all repairs and upgrades is the correct percentage to use, than the correct current value of the house alone is a shockingly low $7,600. And that is actually within the realm of possibility. But the total value of the property is nevertheless still at least $21,000, because the land in that case is worth about $6,450, the quonset building in that case is worth about $5,600, the other outbuildings are worth about $1,050, and the furniture and appliances being sold are worth at least $300.
2. He or she might be mostly interested in the quonset building and place very little value in the house. This is the flipside cousin of (2). Clearly, a buyer needs to desire the house, the quonset building, and the land in order to fully agree about the value. Or, at the very least, the buyer has to realize that he or she will have to pay a few thousand dollars extra to get something he doesn't put much value in, (house or quonset building) and not be able to get a refund on that until he or she resells the property, or until he or she makes a few thousand dollars from the use of the quonset building..
3. He or she might believe that even more than 75% of all possible repairs and upgrades are necessary to make the house average among properties that were considered comparable when the $26,000 assessment was done. I would have to disagree with that.
4. He or she might overestimate the costs of the repairs and the upgrades that seem necessary or desirable. Also, he or she might overestimate the hypothetical deadline for effecting certain repairs in order to head off hypothetical increased damage from delay.
5. He or she might be too pessimistic about future maintenance and repairs, and so he or she might overestimate the cost of unknown maintenance and repair items in the future. You can not be overly pessimistic about the future of a country property that has numerous component parts to it like this one does, or you will undervalue it in the here and now.
In summary, I have spent several dozen hours researching by internet, researching by phone, and making various calculations, to come up with the correct current market value of this property. Most would claim I was foolish for buying this place for that reason alone: that it took so much work to figure out what it is really worth!
Fortunately for me, I do not need to cheat the buyer in order to avoid a loss; I uncannily, mostly by luck, if the truth were told, paid at the high end but within the correct, fair value range.
INVESTING IN THIS PROPERTY
If someone buys this property for $22000 and invests the whole $7,000 needed to do every upgrade, they would most likely get a profit of between $2,000 to $5,000, because the resulting fair market value would be between $31,000 and $34,000. This would be a very good return on investment, although it would not be the type of “killing” that real estate speculators like to make. Since the location of this property is very insulated from poor housing market and credit market conditions elsewhere, the economy would have to sink into a full scale 1930’s style depression for the return on a $7,000 investment to be lost completely.
As for buying this property and making little or no investment in it at all, you can also do that safely, because I have done all the research and analysis needed to make that a safe thing to do. And unlike many, many other locations, there are no regulations in this County concerning how upgraded the property needs to be before the County starts trying to fine the owner for not meeting those standards. As I like to say about a property like this: you can do as much as you want, or as little as you want, and no matter how much or how little you do, you are not going to be harassed, charged permit fees, or penalized by the County. Compared with most other areas, there are far fewer zoning regulations here, and far fewer fees and penalties assessed.
Whether you do almost nothing at one extreme, or all of the potential upgrades at the other extreme, or spend any amount in between those extremes, you are not going to lose a substantial amount of money on this property, as my research and analysis demonstrates. The only way there could be a loss would be if the country sinks into a 1930’s style depression, in which case you might lose a small amount, while owners elsewhere lose big. Even in that extreme event, a Depression, that no one expects, your loss would be much less in dollar terms, and less in percentage terms, than would be the loss that real estate owners elsewhere would have.
