Sunday, August 19, 2007

Location, Location, Location

In real estate you hear the refrain that the only three things that matter are "Location, location and location." This seems counter-intuitive sometimes when you are improving your home, whether it is installing new appliances, remodeling a bathroom, or just generally painting and installing new carpet. Certainly these improvements are adding value, right?

In the high-end real estate magazine that drops by my house periodically two houses here dramatically tell a story. Let's compare the amenities:

- both houses have 5 bedrooms
- one has 4.1 baths and the other has 5 1/2 baths (I'll leave it to the real estate pros to tell the difference between a .1 bath and a 1/2 bath)
- one has a three car garage and one has a two car garage
- both have spa / sauna and theater amenities

So I can say that generally, the houses are roughly equivalent, with the bottom house (and smaller ad) having an extra bathroom and an extra spot in the garage. And yet... one house is selling for $920,000 and the bottom house is selling for $3.495 million - almost four times the price for roughly the same quality and amenities! Why the disparity? One is in upscale Lincoln Park and the other is on the south side.

Another interesting element is that since the two houses are roughly equivalent, you can see how much the cost of land impacts the total cost of the house. Let's assume that the amenities cost roughly the same to construct; thus you could figure that it costs maybe $600,000 to BUILD a house like this and the remainder of the south side house would be split between the cost of land and profit to the builder. Thus the cost of land alone on the Lincoln Park house is probably $2 - $2.5M, JUST FOR THE LOT. This type of analysis may be impacted by the fact that the south side house may be selling at a loss; sometimes what it costs to build it and what the market will bear are out of synch; but assuming that it isn't selling at a loss this is a relatively sound analysis.

Don't forget that the lion's share of your houses' value if you are in an upscale neighborhood is actually in the land and not in your improvements; for more modestly priced homes a better proxy is the cost of construction plus profit and a bit for the lot.

Location, location, location.

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