The fair market value of a home, which is based on the price a potential buyer would be willing to pay for it, is an important factor for both sellers and buyers. You’ll often see it abbreviated as FMV.
What is fair market value in real estate?
Fair market value is the price that a willing buyer would pay a willing seller for a home in an open market, without current supply and demand conditions being present, explains Tim Garrity, partner and broker at Copper Hill Real Estate in Philadelphia. Although Garrity is not an appraiser, he is an experienced listing agent and brokerage owner.
In other words, both parties would have enough knowledge to proceed with the sale, but outside factors would not be relevant to the negotiation of price and terms.
“Basically, it is what the buyer audience perceives the home to be value-wise,” says Cara Ameer, a real estate agent at Coldwell Banker Global Luxury in Los Angeles.
How fair market is calculated
Whether an agent is preparing a comparative market analysis (CMA) or an appraiser is completing an appraisal report, fair market value is often calculated by taking the value of three or more comparable homes, or comps, that have recently sold and obtaining an average, Garrity says.
For an appraisal, an appraiser examines this group of homes and factors in any positives or negatives to each based on certain features. For example, if the home in question were 1,500 square feet and one of the comps were 1,250 square feet, it could be a plus for the comp, but a minus for the home being appraised.
“This process helps paint a more accurate picture of what a home’s value is, as most homes are different from one another,” Garrity says.
What fair market value estimations are used for
Real estate agents typically use fair market value to determine a price or price range at which a home will sell when working with a seller or buyer to devise a listing or offer strategy.
Appraisers also consider fair market value in an appraisal report, which is completed during the home-buying process when financing is involved, or when a homeowner refinances. Although the appraised value of a home — the opinion of a single appraiser — is not always the same as fair market value, the appraisal report is still the most common way to find it, Garrity says.
Outside of a real estate transaction, attorneys, government officials and insurance companies also consider fair market value in various scenarios, such as divorce, death, eminent domain and loss from a natural disaster.
For both agents and appraisers, there are many ways to narrow down a list of comps. Ameer researches active, under contract and sold properties, similar in size and age, from the past 90 to 180 days. These days, the more recent the sale, the better.
“Given the current pace of sales in many markets, looking back 180 days right now may show data that is too old as prices have dramatically increased in many markets from where they were six to three months ago,” Ameer says.
She then chooses the most relevant homes closest in style and location to the one she’s pricing, and makes adjustments for various factors such as:
- Square footage
- Type of garage
- Pool vs. no pool
- Number of bathrooms
- Fireplace vs. no fireplace
- Type of lot (privacy, proximity, view)
These adjustments are based on a generally accepted range of values in CoreLogic’s Marshall & Swift Residential Cost Handbook.
“For example, the value of a pool may be around $15,000 to $30,000 depending on the size and features, a third car garage bay may be valued around $5,000 to $7,000 and a full bath may be worth $5,000 to $7,000,” Ameer says.
Appraisers utilize the handbook more so than real estate agents, but agents often consult with appraisers to stay current on adjustments.
After adjustments are made, the agent or appraiser typically has a “very good idea of what the value is for the property,” Ameer says.
Other common methods to determine FMV
Aside from the comps strategy, appraisers sometimes use what’s called the cost approach to determine fair market value, especially when the home is unique and there aren’t many comps to weigh it against. In the cost approach, an appraiser considers the previous sale price of the lot and estimates the cost of construction to replace the home on the property, factoring in depreciation and subtracting that from the value.
A lesser-used third method is known as the income capitalization approach, which is generally reserved for income or rental properties, and is based on how much income can be generated from the home.
Fair market value in today’s market
The comps strategy is a popular way to determine a home’s fair market value, the price a buyer is willing to pay in a given market.
However, in many markets today, there are homes selling above fair market value, so using comps to craft an offer strategy may not result in a successful outcome for buyers in multiple-offer situations.
“Many sellers throughout the country are pushing their asking prices to see what the market will bear, given the low supply/high demand market we are currently experiencing,” Ameer says. “This approach does not work as well in a slowing market, where inventory levels are building and afz seller is often competing with a lot of options in their price range, including new construction.”
Under more balanced conditions, though, agents and appraisers often rely on the comps method, and sometimes the cost or income utilization approaches, to estimate fair market value. If you’re curious about the fair market value of your home, either formula would be a good place to start.
Real estate agents typically use fair market value to figure out a price or price range a home will sell. It’s used to come up with a listing or offer strategy. Fair market value is usually determined by taking the average of three or more comparable homes.