I teach this in both Real Estate Economics and Beginning Real Estate classes. It is the economic basis of all real estate decisions and is often used intuitively by many sellers and buyers. However, it is far more beneficial when applied with complete understanding and awareness of the concept. Simply put, it stands for:
D = Demand
U = Utility
S = Supply
T = Transferability
Demand: We all know what demand is: How many potential buyers are there for the product? If I build apartments that I must rent for $5,000 per month, but the prevailing income in the market can only
afford $3,000 per month, I am going to have a very serious problem. Similarly, if I build a $1,000 per month product in a $5,000 per month market, I’ll also have a problem. (Or, a lot of profit if the product meets the demands of the market otherwise.) As a buyer of any type of income property, attention must be paid to the market and the pre-existing demand. When you intend to market a property that you own or plan to build, you must ask yourself, “who” will the property satisfy? The “who” are the potential buyers that want or need your property and have the ability to purchase it. Knowing and marketing to the “who” will bring the most return.
Utility: What benefits to a user will the property provide? It would seem that apartments should be a pretty straightforward purchase. People always need a place to live. Just how important is the configuration of the space? Is the market strong for three bedroom one bath units? Is there enough closet space? Are a washer and dryer important considerations in the particular market? Swimming pool? Common areas? Recreation room? There are many different questions that any prudent investor MUST consider BEFORE executing a purchase. The price one is willing to pay will depend on the answers to these types of questions.
What if the highest and best use of the property, which is a basis for valuation in any appraisal, is not allowed? A
while back I had a property for sale that was configured naturally for storage use. However, the zoning strictly prohibited that particular use. Whether these restrictions make any economic sense is not the issue. Unless one is prepared for a long and costly entanglement with the “system,” it is best to look elsewhere for your investment.
Check the zoning. Is there any redevelopment being considered? Are there any anticipated changes or external forces that could drive the value up or down?
Supply: Who are the competitors? How many similar properties exist in the market? How many other three bedroom one bath units are renting and for how much? Possibly, if there are no other three bedroom units in the market, such a property may satisfy a demand by some families. If there are a lot of three bedroom two and a half bath units how well will you compete? An important question that one must ask is: How many could be built in the market? Very simply, what are the barriers to entry?
Marin County is a prime example of prices being driven by the high barriers to entry. There is very little land available on which to build, and the restrictions to getting a permit to build are time consuming and expensive. As a result, the existing properties benefit from scarcity. Whatever you buy in a high barrier market, it is quite probable that very few similar properties will be built. At least anytime soon and at a price that can rival your purchase price.
Transferability: Does the seller of the property have the title and can the seller of the property deliver/transfer the title to a purchaser? What restrictions are there to changing the ownership, tenant, and uses of the property? Is the title held in trust? Are there any restrictions in the trust that would prohibit the intended use? Is there a condition subsequent that could cause the title to revert to the original grantor or another party named in the trust? If you cannot freely, or at least within a reasonable time frame, transfer the title to the property, it will have no value to you and you should move on. This is the most important aspect of value. Without transferability there is no value. So, remember D. U. S. T.
* Please note that the numbers used herein are for illustration only, and are not reflective of any current market.
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