Some Suggestions for Evaluating Virtual Real Estate
The beginning of creating appraisal standards
Guest blog by Jeran Miller — if you are interested in submitting your stories to WeMeta, please reach out!
At the time of this writing (the first days of 2022), The Metaverse is a foreign concept to most people. I enjoy telling friends how much a parcel of virtual land costs in The Sandbox, just to watch their reactions. It’s pretty universally laughter and disbelief, perhaps with a little mockery thrown in. I can understand it, but I don’t have any certainty myself of how much virtual real estate (hereafter “VRE”) should be priced. I recently wrote an article expressing my doubts that sufficient data exists for anyone to know what virtual real estate is worth. I stand by that assessment, but I’d also like to add something more constructive.
This article is my attempt to bring forward my first few thoughts on how VRE valuation should be done. I only have a few items, which is natural given how embryonic the whole field is at this point. Luckily, as early as it may be, we have many years of physical real estate appraisal practices to draw upon, and we can copy and paste some of them onto our new, virtual landscape. Digital assets are different, though, and they require some alterations to these methods. My hope is that, with more data and the entrance of seasoned property appraisers into this asset class, we will have more clarity and professionalism in the valuation of VRE. From there, perhaps more advanced methods of automated valuation could be devised so to reduce lagtime and bias, but that’s a topic for another day. On with the suggestions!
1.) Let’s treat virtual real estate more like commercial real estate and make use of the “income approach” where feasible.
It seems that most people purchasing metaverse real estate are money-motivated. Part of that may be just be the nature of the virtual experience. There’s no imperative for a having a residence, really. You log off to go eat or to sleep, after all. Nor are buyers are concerning themselves with typical, real-life homeowner worries when they purchase — the crime in the area, the quality of local schools, the quiet, or their proximity to work. Instead, people seem to be almost exclusively excited about the possibility of earning money with their property. This leads to us thinking of value in much more “commercial” terms.
Interestingly, though, the attempts made so far in valuation have all been exclusively via comparable sales. This is a focus on one appraisal method, and is more characteristic of residential real estate. To be clear, there’s nothing wrong with using “comps”. Commercial property appraisal makes extensive use of comparables, too. However, their full process is more complex, and appraisers tend to weigh the results of the comparable sales against those of the “the income approach”.
This approach is especially common for places like office buildings or apartment complexes. If we find a lot of leasing in VRE’s future, it might become the dominant method of valuation. Anyway, it makes use of a very simple formula to find the value of a property: value is equal to net operating income divided by the capitalization rate.
“Net operating income” is just the total amount of money the property makes in a year, minus the expenditures it has in its operation. The capitalization rate, for its part, is a percentage rate of return on a property’s value. This overview article is probably not the best place to go into too much depth, but once we have enough data reported from parcel owners on their capitalization rates, we can use that to get a good sense of a parcel’s worth to an investor.
It only makes sense that income data would be the key factor in VRE, right? If we come to find out that a piece of “savannah” in Axie Infinity is returning $1,000 a month, the value will inevitably skyrocket from the current $13,000-or-so floor price. If, on the other hand, we find that the savannah only generates $10 a month, the value will plummet. We just need to know what’s possible, financially speaking.
2.) Let’s make location less of a factor than in the real world.
Another huge consideration in physical real estate is the location of a property. In my experience, appraisers often won’t even consider a residential property “comparable” if it’s further than about a mile and a half from the home being sold. In VRE, a metaverse having the capacity for fast travel really changes the equation. When you can transverse the entire metaverse in a second, what does proximity really mean? And what’s the importance of location?
It’s hard to say for sure. There has to be some value in being right next to something attractive. But, in most cases, I have to imagine that one could draw comparable sales from further afield than one could do in physical real estate. We’re not yet able to review enough data to isolate the value of being close to this feature or that. So, I believe that in any world where teleportation is enabled, we should draw comparables from locations that are similar in terms of type rather than proximity.
3.) Let’s express all values in USD.
One of the unfortunate aspects of appraising virtual real estate is that prices and values are typically noted in cryptocurrency. I don’t believe I’m breaking any news here by saying cryptocurrencies are volatile, and that adds a whole extra fold of complication to expressing value. For instance, if you have one comparable sale for 1,000 ETH from three months ago, and another comparable sale for 1,200 ETH that happened just last week, one assumes that property values are appreciating. If ETH’s value happened to halve during that period, the opposite is actually the case: rising prices, but the value is dropping like a stone. The best practice until there’s a change in crypto’s stability is to make reference to a more stable currency, like the dollar.
4.) Let’s add in a multiple to adjust for time between comparable sales, at least for now.
The rate of growth in prices in the VRE space is just insane right now. Per Metaland, real estate prices across the various Metaverse platforms have risen 1,700% over the last five months.
This is crazy growth. Coincidentally, at the time of this writing, we are also seeing unprecedented growth in the United States’ physical real estate market as well. It’s up roughly 19% in a year. That rate of growth is (justifiably) enough to cause howling from the masses of first-time homebuyers. But, even still, appraisers that I’ve worked with have not been taking this growth into account when adjusting comparables. If a comparable sold six months ago, its value does not get adjusted upward to reflect the 10%+ growth in the our local market (Orlando, FL) during that period.
That approach just won’t fly in this context. Let’s imagine a VRE market in which prices have doubled in a year, which is totally possible at this point in time. If we’re considering buying an ‘estate’, and the closest comparable estate was sold four 4 months ago, we’re looking at a snapshot of a market that has since changed 33%(!). While we are experiencing growth of this sort, I believe we need to adjust values up to compensate for time between sales.
A recurring theme I’ve returned to in outlining each of these suggestions is that virtual real estate is still in its nascency. It’s so new that this article may actually represent one of the first times anyone has attempted to set any standards at all for appraising it. There aren’t much in the way of “best practices” yet, but they’re developing. And, while it makes sense to port over some things from physical real estate, there are adjustments to be made …appraisal pun intended.
