HOUSE BUYER

What is the Fair Market Value of Real Estate

Fair market value (FMV) is an estimate of the market value of a property, based on what a knowledgeable, willing, and unpressured buyer would probably pay to a knowledgeable, willing, and unpressured seller in the market. An estimate of fair market value may be founded either on precedent or extrapolation. Fair market value differs from the intrinsic value that an individual may place on the same asset based on their own preferences and circumstances.

Fair market value is the most probable price that a particular parcel of property should sell for in both a competitive and open market with all conditions for that market being met by the property itself, such as the buyer and seller acting on their own and the price not being affected by any undue outside stimulus.

Simplifying this concept even further, it is the most competitive price a buyer is willing to pay – and the lowest price a seller would be willing to accept. Fair market value is tied to the basic economic notion of supply and demand: if there are only a few properties for sale in a particularly desirable area, a property’s market value will go up because the price a typical buyer is willing to pay will increase due to demand.

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Since market transactions are often not observable for assets such as privately held businesses and most personal and real property, FMV must be estimated. An estimate of fair market value is usually subjective due to the circumstances of place, time, the existence of comparable precedents, and the evaluation principles of each involved person. Opinions on value are always based upon subjective interpretation of available information at the time of assessment. This is in contrast to an imposed value, in which a legal authority (law, tax regulation, court, etc.) sets an absolute value upon a product or a service.

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An eminent domain taking, in lieu of a property sale, would not be considered a fair market transaction since one of the parties (in this case, the seller) was under undue pressure to enter into the transaction. Other examples of sales that would not meet the test of fair market value include a liquidation sale, deed in lieu of foreclosure, distressed sale, and similar types of transactions.

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How Fair Market Value is Determined
There is no exact mathematical formula that calculates fair market value. However real estate appraisals, property valuations or land valuations and market conditions are the building blocks of developing an opinion of value for real property (usually market value). Real estate transactions often require appraisals because they occur infrequently and every property is unique (especially their condition, a key factor in valuation), unlike corporate stocks, which are traded daily and are identical.

The location also plays a key role in valuation. However, since property cannot change location, it is often the upgrades or improvements to the home that can change its value. Appraisal reports form the basis for mortgage loans, settling estates and divorces, taxation, and so on. Sometimes an appraisal report is used to establish a sale price for a property.

Three approaches to value
There are three traditional groups of methodologies for determining value. These are usually referred to as the “three approaches to value” which are generally independent of each other:

The sales comparison approach (comparing a property’s characteristics with those of comparable properties that have recently sold in similar transactions).
The cost approach (the buyer will not pay more for a property than it would cost to build an equivalent).
The income approach (similar to the methods used for financial valuation, securities analysis or bond pricing).

From the three approaches I can determine the highest and best value of real estate and thereby make the best offer to sellers while still making a profitable investment. I realize that these three concepts can be rather difficult to comprehend, so if you would like a further explanation of anything covered in this article, please contact me and I would be more than happy to discuss these items with you.

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ABOUT THE REAL ESTATE AUTHOR

In addition to buying houses Scott FladHammer, founder Housebuyer™, writes on real estate and business for Housebuyer™. Read more about Scott and his helpful articles for selling houses fast.