What is a Market Cap?

For the past few years, the Richmond real estate market has been performing exceptionally well. Houses all over the metro are appreciating quickly, and if you invested in a home even just a few years ago, you’ve likely made some good money on it already.

In a climate of rising prices and bidding wars, our clients on either side of the equation often forget to take into consideration a very important concept: the market cap.

What is a market cap, exactly?

To put it simply, a market cap is the maximum value a particular market (a specific neighborhood, zip code, etc) will sustain, regardless of what the home looks like.

Imagine you’re walking through a neighborhood filled with one story, 1500 SF homes, with a noisy highway not 50 yards away from the outermost street. Most of the homes go for around $120,000 - $150,000. Now imagine someone builds a new home or expands an existing home in this same neighborhood to be three stories, 3000 SF, with an outdoor pool, complete with all new premium materials and finishes.

In terms of material costs, this second home should be worth more than double the neighborhood average, right? It’s twice as big, it has more amenities, and it’s sleek, modern, and updated inside.

Well, not exactly. What this individual didn’t take into consideration was the market cap. This neighborhood, regardless of how amazing the new home is, would likely have a market cap much lower than the $300,000 - $350,000 the seller expects to get for it. Because of any number of factors - the size of the other homes, access issues, noise concerns, school district, safety, etc - a home’s value is a reflection of not just its physical makeup, but of the market it exists within.

Long story short, this builder, renovator, or owner, just spent a lot of money that he or she might never be able to make up for during the resale.

How do we know what that number is?

Whether you’re a buyer trying to assess how much you’re willing to pay for a home, or a seller budgeting for renovations that might help yield a better sales price, there’s one, main way we can help you figure out what the market cap in your area is.

Please note that this is not an exact science, it’s just a prediction of buyer behavior and anything can happen! But by comparing the sales prices of any particular neighborhood to the average discount and/or marketing times at those prices, we can get a feel for where the market ‘breaks’, or where that market hits it’s cap.

For example, if you see that homes in a particular neighborhood sell in about 3 - 5 days, on average, until you hit the $400,000 mark, where marketing times shoot up to 10 days or more, that’s a good clue that the market cap sits around that $400,000 mark. And if the average seller discount also shoots up at this price, that’s another indicator.

This sharp change in buyer behavior at this price point doesn’t necessarily mean a home never sells above $400,000, but it does mean that above and beyond that price, a seller isn’t likely to get his or her value out of additional size, improvements, upgrades, etc.

How should you use this information?

If you’re a buyer, it can help guide decisions about what to buy and where. Resale, even if you plan on staying in the home for quite some time, should always be a consideration when making a home purchase. So if you’re buying close to or above that ‘market cap’, keep in mind that you may have trouble reselling it down the line.

As a seller, this is especially important in both deciding what renovations or improvements to take on before selling and how to price your home. We always take these statistics into consideration when recommending upgrades and determining what we feel is the appropriate market value for when your home goes on the market.

A home is an investment, so use all the data you can.

Ultimately, whether you’re buying, selling, or are happy in your current home and plan on sticking around for a while, it’s wise to keep up on this information and protect your investment. Houses are expensive (I hope you didn’t need us to tell you that…), and you want to make sure you get your money’s worth - or more! - in the long run.

Not sure where to start? Let us help you sort through the numbers!

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