Skip to 0 minutes and 9 seconds A regional hospital recently needed to expand due to an increase in the population that it services. The hospital is slightly landlocked, in that it sits on a corner block on a well-established street. Around the hospital, there are mainly office buildings, except next door to the hospital is a small establishment - an ice cream shop. The hospital management approached the neighbouring property’s owner, wanting to buy it. It’s not a large property, but large enough to build an extension of sorts to the hospital. Management were considering the construction of a new low-rise building, that could house the practises of some of the specialist doctors. The shop owner saw dollar signs in front of him. This is my dream come true.
Skip to 1 minute and 4 seconds I can charge what I want, he thought. And because the hospital needs to expand, they will just have to come to the party and pay what I’m asking for it. Regrettably, after much negotiation, toing and froing between valuers, real estate agents, accountants, and solicitors, the deal fell through. The ice cream shop is now vacant. The tenant moved out because they just couldn’t make it work, and no one, as yet, is interested in leasing the premises from the owner. The hospital managed to source another block of land across the road - larger so it allows for more growth and it was not developed.
Skip to 1 minute and 48 seconds While the hospital is arranging architects to design, planning permits, and building approvals, the land is being used to generate revenue. The hospital is leasing the land out as a car park. Cost refers to the construction cost of the improvements, plus the land. In this case, we might assume that the land was acquired years ago and the construction was also done years ago. Let’s assume that the historical cost of this ice cream shop on the land was $300,000. Costs can sometimes also refer to replacement cost, which is a theoretical cost to re-establish the asset. Price refers to a price that a willing buyer might buy at or a willing seller might sell at.
Skip to 2 minutes and 35 seconds So a willing buyer might be interested in paying $800,000 for the land and the buildings. And a willing seller might also be happy to accept $800,000 in an arm’s length transaction, where the parties acted knowledgeably, prudently, and without compulsion. This agreed upon price is known as the market value. The fact that the hospital has a special purpose in mind for the property creates a value, which might be higher than market value. This is known as the investment value. Even though investors may be willing to pay higher than a market value for a property, owners of property may need to be realistic about how much these investors might be willing to pay.
Skip to 3 minutes and 20 seconds Unfortunately, for the ice cream shop owner, their expectations of price were unrealistic.
Cost, price, value - what is the difference?
A property’s value can be different to the price that a willing buyer and a willing seller may agree to be paid for it, or indeed different to how much the property might cost.
What is the difference between cost, price and value? Basically, cost refers to the historical construction cost of the improvements plus the land. (Cost can also sometimes refer to the “replacement cost” which is the theoretical cost to re-establish the asset.)
The price refers to a price that a willing buyer might buy at or a willing seller might sell at. So a willing buyer might be interested in paying $800,000 for the land and the buildings and a willing seller might also be happy to accept $800,000 in an arms length transaction where the parties acted knowledgeably, prudently and without compulsion. This agreed-upon price is known as the “market value”.
The fact that an investor has a special purpose in mind for the property creates a value which may be higher than a market value – this is known as the “investment value”.
Sometimes, the value you place on a possession is very different to the value someone else places on the same item. Click on the video at the top of the page, and listen to this story. In the example above, the land the ice cream shop occupied was highly desirable, but to a particular investor…
Reflect on what you would have done if you were the Ice cream shop owner, when you were approached by the Hospital.
Explain what steps you would take to help you make a decision on what to do.
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