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EconomicsWhat’s the difference between price and value?
Imagine a simple housing market where all property values are known with certainty. Even though values are not observable, all current prices would be “correct” (i.e., identical) and all future prices would be perfectly predictable. In such a market, price always equals value.
In the real world of real estate, with unique assets, various local market conditions, changing demographics and uncertainty about the future, property values are unknown. Values remain unobservable, so as before, we rely upon prices. This time, prices are not the same as values: price is merely an estimate of value.
This distinction is important but is often overlooked. Prices are used by market participants as indications of value because true values cannot be observed. Often supply and demand conditions in real estate markets change, sometimes quickly. In these cases, prices can diverge from values upwardly or downwardly, depending on the direction of the change.
For example, suppose housing prices are found to be rising faster than household income for an extended period. We know from experience that there is a relatively constant relation between house prices and household incomes. Yet, we sometimes see prices changing compared to incomes (e.g., consider most housing markets from the mid-1990s until about 2006). We cannot explain the rise in prices relative to incomes, yet it has occurred. Values are determined by the underlying long-term and complicated relationships set out in the past. In this case, prices diverge from values.
The debate over “prices” and “values” is a very old and famous one in economics, perhaps 250 years in the making. In the short run, it is quite possible to find prices higher or lower than values due to unusual events or rapid changes in market conditions. In the long run, price equals value due to market forces.
We make decisions in the short run. Therefore, it is possible that prices will exceed values (this is typically called “over-valuation”) or prices may be less than values (this is called “under-valuation”). If there were no differences between value and price, under- and over-valuation would have no meaning.
Researchers and analysts study markets in attempting to identify situations where there is over- or under-valuations. We can observe prices (as reported by MLS offices from actual transactions) but we cannot observe values. The latter must be estimated in careful studies by statistical analysis.
Are PA housing markets over-valued or under-valued? A major study of this precise question has just been completed and will be the subject of my next blog.
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Austin Jaffe, Ph.D. is PAR's Consulting Economist from the Smeal College of Business at Penn State University. |
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Great post–or as we teach students in Appraisal 101–Cost does not equal value; value does not equal price; and price does not equal cost. And, appraisers will tell you they see comparable sales with PRICES not substantiated by market data vis a vis VALUE.