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The Penny…A Classic Example of Cost Not Equaling Value

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What do you do with your pennies? Some put them in a large glass or plastic carboy or some other clever containment system. I have a wooden container on my desk. I put my change in it, most of which consists of pennies. When it’s full, I treat myself to a new bottle of Scotch. Not too shabby! What else are you going to do with a bunch of pennies?

Did you know one penny costs approx. 1.5 cents to create? By some estimates, in 2017 the US Mint lost nearly $70 million dollars minting pennies in 2017 alone. It wasn’t always that way. In the year 2000, minting pennies was still less expensive than their value.

 

Penny Loss Chart
Chart is from www.theatlas.com

What happened? Why is it now more expensive to mint a penny than it’s worth? Will the government continue to mint the penny? What does this have to do with real estate?

The primary reason for the penny’s value being less than its costs to mint, has to do with inflation. Inflation is defined on Dictionary.com, as “a persistent, substantial rise in the general level of prices related to an increase in the volume of value of currency.” Put more simply, it is a decrease in the purchasing power of currency.

For instance, in 1920, if you had one penny, it had the purchasing power of 13 cents, by today’s standards. If you had $100 back in 1920, you would have the buying power of $1,329 by today’s standards.

Remember your grandparents telling you about all the things they could by for a nickel? Now, most people wouldn’t bend over to pick up a nickel off of the ground. How much more so a penny? Clearly, currency has lost value over time. For fun, you can go to a cool inflation calculator at www.dollartimes.com. Play around with it. It’s interesting!

PRICE VS VALUE

According to bestcoin.com’s Coin Values Pricing Guide, “there are at least three values of a coin.”

1. “The price the owner thinks it’s worth.”

2. “The Value based upon a coin price guide, or a pricing book lists it as.”

3. “The actual price you can sell it for to a dealer, buyer or at an auction.”

Interestingly, that is true of real estate also. Let’s talk about price vs. value in real estate. In real estate, there’s the price the homeowner thinks their home is worth. Price is also the agreed upon amount in a contract. There’s the cost to replace or reproduce a property. Then, there’s what a property is most likely to sell for in an open market value under certain conditions. That is market value. By the way, there are many different definitions of value.

RESIDENTIAL NEW CONSTRUCTION

In real estate valuation, there are three approaches to value. The Sales Comparison or Market Approach which utilizes sales of comparable properties to develop an opinion of value. There is the Cost Approach which utilizes either replacement or reproduction costs to develop a value. (Traditionally replacement costs are used for residential lending purposes) The third approach to value is the Income Approach, which utilizes income in order to develop a value.  There are times when all three the same. This is called equilibrium. However, this is not always the case.

Often, the market value of a new home is similar to what it costs to build it. Otherwise, it wouldn’t make sense to build it. The cost of building materials has increased rapidly in recent years, which has led to major price increases in new construction.

Are there times when the market value of a proposed home is less than the builder’s construction costs (price)? Yes.  Certain upgrades that a homeowner may desire, may not translate into a dollar for dollar return, even in new construction.

Buyers have to be careful that their potential dream home doesn’t become a home that is over-improved for their area.  A couple of years ago, I was appraising a multi-million dollar proposed construction home. I had very comparable new construction home sales that I used. They all had similar amenities. However, the construction costs of the proposed home I was appraising were considerably higher than what the market would bear, at least based upon the data that I analyzed. This was primarily due to the proposed upgrades.

In this case, the builder adjusted the construction price by removing some of the proposed upgrades from the plan. I remember one of the reductions was to remove some of the proposed kitchen upgrades, resulting in a price reduction of $100,000. Yeah, it was an incredible kitchen, even without the upgrades that the owner originally wanted!

That’s why it’s good to have an independent third- party appraiser, appraise your property before it’s built. Especially if you’re not going through a bank for lending. Appraisers can appraise your proposed home as though it was already built. We do this all the time! We can also appraise your home as though some amenity was already completed, like an in-law suite, a pool or some other major improvement.

In reading through many construction contracts over the years, most of them state that there is a chance that the proposed home will not appraise for the amount of the construction contract price. Read your contract carefully. Be aware that if your proposed home does not apprise, that may not in itself, release you from your construction contract. I’m not a lawyer. So, I would advise speaking with a real estate attorney if you have a question about the contract, before you sign it.

Of course, sometimes buyers are aware of the fact that they may not receive a dollar for dollar return on a particular upgrade and proceed anyway, like the government continuing to mint pennies, even though it is at a loss. Some homeowners and buyers put more value on a home, or a particular amenity, than the market will bear. They just want the new home and don’t care what it costs. Especially if they can afford to bring cash to the table. That’s a form “intrinsic” value. Intrinsic value is a perceived value which can vary depending on viewpoint. Like coins, there is the price the owner thinks their home is worth.

For the penny, while the government takes a loss every year minting them, thus far, it has been easier to take the loss than to remove the penny from circulation, which would  create other challenges.

According to cashmoneylife.com, “The US Mint announced”, on April 4th, of this year, “that they will phase out the production of new pennies beginning in late 2019, and mint the last batch of pennies on April 1, 2020.” It will be interesting to see if this happens.

MAJOR HOME REPAIRS AND RENOVATIONS

One of the first things appraisers learn in the classroom is that cost does not equal value. What does that mean?

If you spend $30,000 adding an in-ground pool to your home, it may or may not add $30,000 to the value to your home. A homeowner is not likely to get a dollar for dollar return on an improvement. Even a nice one! Since price does not equal value, it should be stated that some improvements may actually add more value than the cost of installing the amenity. This might be the case if the amenity you are installing is in high demand. It depends on the amenity and a lot of other factors. However, usually, amenities bring less market value than what they cost to install.

That being said, usually, a homeowner is going to renovate their property to enhance its functionality and enjoyment factor for their benefit. So, it may be worth doing for that reason. The intrinsic value of the improvement may be higher than the market value.

But what about a major repair that may be needed?

Let’s say that you have some foundations issues. You spend $50,000 to make necessary repairs to your foundation. Since the market expects your foundation to be sound, you may not see any appreciable market value for making that repair. The market doesn’t usually care about how much a homeowner spends on the improvement. When looking at two homes, if one homeowner spent $50,000 to make foundation repairs, and the other homeowner didn’t because their foundation never needed repairs, to the buyer, there is no reason to spend $50,000 more when both homes are generally comparable.

In this scenario, what if the homeowner decided not to make the repair? Then buyers are going to expect a hefty discount. They will likely expect the seller to discount the price of their home enough to cover the expense of the repair. Additionally, buyers usually want an additional discount for their having to deal with the problem themselves. That’s called entrepreneurial incentive, or profit. Ultimately, having this needed repair is going to hurt the market value and marketability of the home, potentially causing the seller to take a greater loss than if they made the repair.

Either spend the money to make the repair knowing that there will probably be any return on the investment or, don’t make the repair and take the larger hit, but not have to deal with the work. It’s a hard pill to swallow. It’s a lose-lose situation. The choice is going to come down to the situation and motivations of the homeowner.

IN THE END, REMEMBER THAT COST DOES NOT EQUAL VALUE

When it comes to pennies, homes or home amenities, remember that cost does not equal value. If you’re thinking of making a major improvement like adding an enclosed porch, a deck, an in-ground pool, or if you’re thinking of finishing your basement, or any other improvement, go for it!  But remember that while it may increase the market value of your home, it will not be dollar for dollar.

Before making an improvement, why not contact a local appraiser in your area? Ask them about the value of the improvement you are thinking of making. If it’s a large improvement, have your home appraised as if the improvement were already made. Then you will be more informed about what you can expect.

Whatever you decide to do, enjoy it! May all your improvements add value to your home. Be it market or intrinsic, but hopefully both!


Looking for a qualified real estate appraiser in your area? Go to www.FindMyAppraiser.com

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Are you a consumer looking for information on real estate? Go to www.ConsumerHomeValue.com

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The Cleveland Appraisal Blog Podcast is now Home Value Stories with Jamie Owen

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If you’ve enjoyed my Cleveland Appraisal Blog Podcast, then you may have heard that I have started a new podcast called Home Value Stories with Jamie Owen. I used the first podcast to get my feet wet in the podcasting arena.

Phil Crawford of Voice of Appraisal and the Find My Appraiser Network and Gynell Vestal of Consumer Home Value, are my sponsors of this new podcast. The goal is the same! Fun and timely information for consumers!

I am currently working on broadcasting this to your favorite podcast player. If my show is not on your favorite site yet, it should be soon. In the meantime, feel free to listen on my podcast player on here or on my other website at www.AspenAppraisalServices.net or at www.ConsumerHomeValue.com.


Here are some links to other articles and videos I enjoyed recently! I hope you will also…

Voice of Appraisal Welcomes Gynell Vestal!!! – Voice of Appraisal with Phil Crawford

Dinosaurs Go Glamping as Suburban Homeowners Heave Sigh of Relief – Housing Notes by Jonathan Miller

5 Reasons Buyers Overpay For Homes – Birmingham Appraisal Blog

When sellers care too much about the Zestimate – Sacramento Appraisal Blog

Price Validation: A New Service? – George Dell’s Analogue Blog

Newz; Appraisal Waiver Train – Multiple Offers – Secret Doors – APPRAISAL TODAY

Time To Take Your Meds! – Real Value Podcast

A Large Driver For the 1004P’s – The Appraiser Coach Podcast

We Don’t Need No Stinking Bifurcates…Do we? – Tim Andersen’s The Appraiser’s Advocate

 

 

 

 

 

 

5 thoughts on “The Penny…A Classic Example of Cost Not Equaling Value”

  1. Nice job here Jamie. So it’s probably offensive to say ” a penny for your thoughts” these days…. Let’s be real, we need to replace pennies with Bitcoin. I’m kidding. On a serious note, cost really isn’t the same as value. In my market there is a home that just sold for literally half the cost of construction (highly custom). I know of a different property that is currently listed about 40% below its cost to build. Tract homes of course likely pencil out much better. But this underscores the issue at hand.

    1. Thanks Ryan! LOL! That thought crossed my mind when I was writing this article. I am totally on board with replacing the penny with Bitcoin. 😂 It is tricky situation. Even tract homes can be problematic at times. I have seen some tract home developers pushing the envelope of value by jacking up lot prices above market value. Not all builders are doing this, but I have seen a couple doing this in my area.

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