Some Ground Rules (and House Rules , Too)

If you were to guess that buying a home is not like buying a parcel of land, you'd be right – and you'd also be wrong. Although the house purchase is different from the land transaction, it's actually the same in certain key respects. The reason is there are a couple of critical principles that apply to all types of property – houses, land, retail centers or whatever – and they can have a big impact on a property's value and its market appeal.

Location (Location, Location)

We've all heard that location is the most important thing about a property, but why is that true? You can demolish or add onto the house or maybe even pick it up and move it (although that's expensive and often not feasible), but you can't pick the land up and move it. It's the land that gives the property its location, and location is the only thing about a property that you can't change. It determines how the property can be used (zoning), visibility and accessibility to public utilities, and it has a positive or negative effect on value based on the surrounding properties.

Value Is Relative to Use

If the property matches most of your needs and wants, it will be more valuable to you. How often have you walked into a store and bought something you couldn't use or didn't really want only because you thought the price was ridiculously low? Would you have paid a lot more for it? Probably not.

A corollary of this principle is that the property's inherent value increases if the property can be used by many potential buyers or categories of buyers. Suppose you're thinking about buying a building lot that has a stream running through its front yard. Your builder tells you he'll have to put the house on the far side of the stream and the driveway (about 200′ long) will have to cross the stream. The cost for all of this work will be about $30-40,000. That driveway could cost you more than the initial $30,000 over time in maintenance, repairs and resurfacing. However, something even more important should make you hesitate. Someday when you try to sell the property, you could discover that most buyers won't want the property because of the stream and driveway or they'll offer you much less than you want for it. Now what's this property worth to you? When you sell, you'll probably have to discount the price or wait a long time for the “right” buyer to come along – or both.

Value = Price + Terms

Ultimately, buyers determine what a property is worth, but an offer is much more than just price. It's a set of scales with price on one side and terms and conditions on the other. The real value of any property is the price a buyer is willing to pay in exchange for terms and conditions. You want to buy that building lot with the stream running through it. Public water and sewer aren't available and the seller hasn't had the property tested to determine if some type of sewage disposal system would be approved by the county health department. You need to know if the lot is buildable. You don't want to spend the money for testing unless the seller accepts your offer and you don't want to have to buy the property if you can't get a building permit. What you might do here is give the seller an offer contingent on your being able to get the property approved for a certain type of sewage system and anything else you'd need in order to get a building permit. You'd be more likely to offer the seller a higher price if the seller would agree to these conditions than if the seller wanted to sell “as is.” Sellers who get the highest price usually have to give the buyer favorable terms. Buyers who want the lowest price will have to forego most if not all of their contingencies. The seller's willingness to assume some of the risk and give the buyer time to satisfy conditions is as important (and sometimes even more important) as price in development property transactions.

Buyers Are Sellers

Before you decide to buy a property, you should evaluate it as objectively as possible. Put it under the microscope and try to identify objections that buyers in the future might have when you go to sell. In short, when buying, think like a seller because some day you will be one. Whatever you buy should have appeal to the widest segment of the buyer market, and remember that there's no substitute for a good location. A good location is one that enhances the property's value relative to the intended use. For instance, when builders purchase development land, they take into account factors that will reduce the property's appeal in the eyes of the end users (homeowners), such as location on a busy street. On the other hand, if they want to develop the property into retail space, visibility and high traffic counts are critical.

Don't Over Improve

The value of residential property is generally defined by the uses and sale prices of neighboring “comparable” properties – those having the same characteristics as your property. Investment property value (including land) is tied to the income or profit that the property can produce, either immediately or down the road. Value won't increase in direct proportion to the cost of additional improvements if surrounding property values are equal to or less than the property's value without the additional improvements. For example, you live in a subdivision of homes that have two-car attached garages and sell for $250,000. Four years ago, you had a three-car detached garage built in your back yard because you wanted more garage space. Now you've got your property up for sale for $300,000. Even if you find a buyer willing to pay your price, the buyer's lender will have an appraisal done to make sure that the property appraises for the purchase price. The ideal buyer in this situation would be someone who wants mega garage space and can either pay cash or doesn't need a mortgage for more than 80% of the purchase price.