Why there's always a disconnect between property value, actual price

Knight Frank Kenya Chief Executive Mark Dunford probably holds what could be one of the most befitting explanations why these two aspects of the property market are immiscible. "Valuation is an academic exercise and is a snapshot of time," he said during the recent 10th Annual East Africa Property Investment (EAPI) Summit held in Nairobi.

Mr Dunford recognised how Covid-19 disrupted the market and had an influence on the value of assets.

He noted that there were assets that were not valuable pre-Covid, only to be valuable after the pandemic while there were others that had more value before and shot down after the pandemic.

One thing that can alter the value of property, he said, is infrastructure. Once this lands in an area, the value of that land exponentially changes over time.

"If you go back when Tatu City began, and where the project was being slated, a lot of people were like 'this is a white elephant', you know, land there was never going to be the kind of value we are talking about. Now, if you look at how many times the initial value has increased, it is incredible," he pointed out.

He noted that the property value versus price is an age-old divide in the sector. And possibly, this debate is as old as mankind. A detailed explanation by Morris Southeast Group, a commercial real estate firm that folded in April 2022 after 35 years in the US, describes value as a human construct.

"People with a vested interest in a product, be it an item at the grocery store or a commercial building on Brickell Avenue, assign value to it. If you want to own that item, you will have to pony up the money to meet a price that matches this perceived value," reads the detailed explanation titled, Why Perception Creates a Disconnect Between Price and Value in CRE (commercial real estate).

The article poses this question: Is a piece of commercial property in downtown Miami genuinely worth more than a similar-sized building in Davie (a town in Florida)?

"It will cost more, but that doesn't mean it has more value to a specific investor or tenant. However, since Miami is a more prestigious location, it's perceived as being more valuable and, therefore, is more expensive," it explains. It adds that even the same properties can fluctuate, significantly, in price based on their perceived value. It notes that real estate speculators are partly behind this perceived value as they buy property and flip them (reselling) to a market that actually cannot afford.

"When investing in commercial real estate, it might tempt you to jump at properties in a prestigious location with a higher price, assuming that they're the most valuable. And choices like this can certainly pay off. However, it's important to remember that the narrative assigns some of those numbers. And the underlying aspects of a location and your individual needs are what should drive decision-making," the firm advises.

Demand dynamics

Jiten Kerai, General Manager of Purple Dot International, a local real estate firm, opines that supply and demand dynamics play a crucial role in determining the extent of the valuation gap in the property market.

"When demand for property exceeds the available supply, the valuation gap tends to widen. This is often observed in areas experiencing high population growth, limited land availability, or a surge in economic activities. Conversely, when supply outstrips demand, the valuation gap may decrease or even become negative," he stated.

Like Morris Southeast Group, he noted that the location-specific factors also influence the valuation gap. Ideally, certain areas with high economic growth or substantial development projects often have wider valuation gaps due to increased demand for properties in those locations.

How likeable some neighbourhoods are, access to amenities and proximity to transportation hubs can also affect the valuation gap.

"Luxury properties and those in need of repair often have wider valuation gaps due to their unique characteristics and limited market demand. These properties may have higher valuations due to their potential or intrinsic value, but the actual market price may not align with these valuations," he said.

These gaps however can be corrected. One such solution is to address the supply-demand imbalance.

"Increasing the supply of properties through new construction or repurposing commercial spaces into residential units can help narrow the valuation gap. Conversely, decreasing demand by implementing measures such as higher interest rates or stricter mortgage regulations can also be effective in correcting the gap," said Mr Kerai.

Government intervention, he added, is another avenue to rectify the valuation gap. This is through policies such as tax breaks for home buyers or subsidies for new construction projects.

These interventions, he noted, can stimulate demand, increase affordability, and reduce the valuation gap, fostering stability in the real estate market.

"However, it is important to carefully consider the potential implications of correcting the valuation gap. Swift corrections could lead to sudden decreases in property values, potentially causing financial instability for homeowners," said Mr Kerai. "Moreover, excessive government intervention may result in increased public spending, potentially straining fiscal resources."