Basic elements of Value – Demand, Utility, Scarcity, and Transferability
Following are the 4 essential elements to consider when determining the value of real estate: S.T.U.D. Elements of Determining Real Estate Value
- Scarcity: Even if a thing has utility, it is not valuable unless it is scarce. Air is certainly useful for breathing but is so plentiful and easy to access that it has no value. When a property is scarce, investors are faced with conducting their own cost-benefit analysis. If a property is in high demand but has low supply, it will likely be expensive. Hence Scarcity is a relative term and must be considered in relation to effective demand and effective supply and the alternate uses, present and/or prospective, to which asset can be put to.
- Transferability: Even if a thing has utility and scarcity, it must be transferable to have value. If a commodity cannot be transferred from the buyer to the seller, value cannot exist. If the owner of a property cannot be determined, it cannot be transferred. Without a legal owner, there can be no buyer. Transferability is a legal concept that must be considered in the determination of the value of a property/ asset. If an asset is not transferable, in whole or in part, it will not have value in the market.
- Use (Utility): For a commodity or service to have value, it must be useful. Utility (usefulness) means it will satisfy some want, need, or desire of the potential buyer. Real estate has utility for many reasons. The utility can be defined as the power of a good or an asset to satisfy human needs. Since Value is dependent on the degree of satisfaction of need according to the perception of an individual, it is subjective and varies from person to person.
- Demand: Demand is the desire and ability to buy (or lease) goods and services. Desire alone is insufficient to create demand. The ability to buy must also be present. A Rolls Royce is certainly desirable, but demand is small. The ability to buy is synonymous with purchasing power. Some factors that have a tendency to affect demand are population, demographics, government, employment, and wage levels. Demand implies not only the desire to possess a thing in view of the presence of need but it must also be supported by efforts to acquire a thing in terms of monetary power. Thus demand must be effective demand and if any of the two i.e. either desire or efforts is lacking, there is no demand
How the Different Elements Interact
Analyzing the S.T.U.D. elements are essential in determining the value. It can be very helpful to have a realtor guide you through the process and help analyze how the different elements interact. For example, a property may be scarce, but if it has limited utility, there will be limited demand for it. To have utility value, real estate should have the ability to provide shelter, income, amenities, or whatever use is being sought.
Scarcity is the present or anticipated supply of a property 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 property cannot acquire it.
Real estate cycles cause fluctuations in the four elements of value. For example, when interest rates increase, fewer buyers are able to qualify for loans. This in turn reduces demand for real estate. This may lead to an over-supply of properties for sale (or a lack of scarcity).