‘Too big for the street.’
‘Overbuilding.’
‘The white elephant.’
When a particular situation has a number of descriptions that all mean about the same thing, you know that it’s probably a common situation. That is what we’re talking about with the above terms, all used to describe a less than ideal condition. It’s a home that doesn’t fit in to the local value perspective, whether it’s too nice, too big, or both. Put another way, the home’s value is beyond what a buyer would be willing to pay for it.
What is a Market Cap?
Here’s an example. You have a subdivision filled with mostly colonials, all with decent yards, all running about 3,000 square feet. On average, buyers paid between $250,000-300,000.
But one person bought two lots in that subdivision and planted a 6,000 square foot home with an in-ground pool, the finest details throughout, a three-car garage. They spent $700,000 to build it. Could they sell it for that much? What do you think?
The market cap is more or less the organic ceiling on home value. People aren’t likely to pay more than that for a house in that neighborhood, no matter how cheap it might be compared to the same house in another community. Some market cap violations are minor and perhaps easier to digest. Other violations are insanely problematic, like the one I just cited.
But the question is: how do you find a market cap when you’re considering an infill opportunity or a major renovation?
How Do You Find a Cap?
There is no easy answer to this question. There is a little bit of science to it, but probably just as much art. Agents, though, with strong experience and a thorough knowledge of the markets in which they work can become quite adept at defining the market cap.
As I’ve said many times before, the Multiple Listing Service (MLS) is the most valuable resource in terms of data. It’s got it all: age of the home, square footage, features, construction information, and then information about geography, price history, and much more. This is the best place to look for outliers in the market.
Take a look at the chart below about the Lee Davis High School District. It shows how long a property is on the market and what the seller got versus what she asked for. When the asking price breaks through the $500K mark, the time spent marketing soars AND the percentage of the asking price that the buyer receives goes way down. This radical change suggests some information about a market cap. And the news gets worse the higher the original ask goes.
Let’s compare Lee Davis to Midlothian High School — you see a gradual softening in demand become far more pronounced in the middle $500’s.
And finally, to Deep Run High School. The market holds pretty firm until you reach $700,000 and then it starts going soft.
I hope this makes it clear that geography plays a huge role in the market cap. Each of the markets described has this organic roof beyond which buyers show a lot more hesitation.
Why Do Caps Matter?
Well, let’s look at the examples we already laid out.
Would I buy a home for $800k in the Lee Davis HS District? Not unless I felt pretty sure it was going to be the last house I ever bought.
How about the prospect of investing $200,000 into a Salisbury home that cost me $400,000? That I think I would do.
If I’m going to develop some land in Deep Run HS District, would it be smart to build brand-new million dollar spec homes? No, that would not be smart.
The market cap is an important number, one we should all try to suss out. It will help us make smart investment decisions that don’t have anything to do with appraisals or the price per foot. Because when you’re buying or building something, you have to keep your eye on the day you’re going to put the For Sale sign up.
Be aware.
Raise Your Virtual Antennae
