Insights: Series 2
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What Is The Fair Market Value of a Home?

Both home buyers and sellers should know what fair market value means – and what it doesn’t – and how its determined to ensure accuracy.

Fair Market Value (FMV) Defined

One of the most important aspects of real estate is understanding the concept of fair market value (FMV) and how a home’s price can reflect its worth.

In real estate, the FMV of a home can be defined as the price it would sell for on a free and open market in an arm’s length transaction.

In addition, the transaction must be between a willing buyer and a willing seller, both of whom are informed of the relevant facts and neither is under any compulsion to buy or sell.

This may sound complex but when taken in its parts, understanding FMV is simple. Let’s take a closer look.

What’s an Arm’s Length Transaction?

Key to the definition of FMV is the inclusion of the phrase “arm’s length transaction.” This describes a transaction in which the buyer and seller act independently and have no relationship to each other.

In real estate transactions, when the seller and buyer are at an “arm’s length” it implies a level of separation or independence from each other. To illustrate this concept more simply, we can use the following example scenario.

Example: A parent wants to sell their home to one of their children, and the child wants to buy it. Here we have a willing seller and a willing buyer. So far so good.

Next, they agree on a price together, during a family dinner, and decide to save some money on closing costs from the title company by using a quitclaim deed (instead of a warranty deed) to transfer the title.

Are the seller and buyer at an arm’s length in this example?

The answer is clearly ‘no’ since it’s easy to recognize that the seller and the buyer have a close relationship with each other. It’s also obvious in this situation that the selling price of the home would likely not reflect the price it would sell for in a competitive market. Therefore, the price paid for the home would not represent it’s true FMV.

Remember, both parties in an arm’s length transaction are always acting in their own self-interest and are not subject to any influence, pressure or duress from anyone else (familial or otherwise).

Next we’ll look at how to calculate your home’s FMV.

How Fair Market Value Is Calculated

At this point you might be wondering how to calculate the FMV for your home, but similar to many other valuations, FMV doesn’t have one specific formula or function.

The reason for this lies in the definition of FMV as we noted above. Homes are bought and sold on a free, open and competitive market. This type of market is hyper-local, fluctuates with the seasons, and is heavily influenced by emotion, trends and even personal whims, just to name a few.

As a result, the tried and true method for calculating the current FMV of any home uses a comparative sales approach. While not perfectly scientific, this approach is the most reliable and impartial way to find a home’s current FMV.

Using Comparative Sales

In very simplistic terms, a comparative sales analysis identifies and compares recent sales of similar properties that are located nearby the subject property. This results in an informal (verbal or written) or formal (always written) estimation of a property’s value.

In a more formal and written form, a home value report is often referred to as a comparative market analysis (CMA). While both real estate agents and appraisers use this method to compare a subject home/property to similar homes/properties that have recently sold in the general area, the CMA in an appraiser’s report is going to be much more technical.

Either way, remember that a CMA is never going to be perfect. In fact, there are plenty of times where an accurate estimation of FMV can be done “back of the napkin.” However, even an informal CMA will give you a good sense of current sales numbers for similar properties. In a lot of situations that is good enough.

Where to Get the Fair Market Value of Your Home

There are two primary sources where property owners can get the FMV of their home (sorry, Zillow’s ‘zestimate’ just isn’t one of them). These include a real estate agent and a home appraiser.

Real Estate Agents

Almost any real estate agent can provide a very accurate valuation of a home or other type of property, whether or not they perform a formal CMA. Keep in mind, however, that asking an agent for their opinion of value usually implies that you’re going to work with them going forward.

A good way to ensure that you get the most accurate FMV estimate from an agent is to make certain that they work or even live (or have lived) in or very near to the area where the subject property is located. This is important for two basic reasons:

  1. The best market data is going to come from the local MLS. If your agent doesn’t have access to the local MLS (through their paid membership), it’ll be difficult for them to find accurate sales data.
  2. A home’s specific location is a huge influence on its FMV. If an agent spends a lot of time in your area, professionally and/or personally, they’re going to know more about it than those who don’t.

Licensed Home Appraisers

If you’re looking for a much more detailed and very technical analysis of your home’s FMV, you can get a professional home appraisal report for a few hundred dollars from a local licensed appraiser.

A licensed home appraiser will conduct a visual inspection and analyze sales data (similar to a real estate agent) to provide a detailed (but hard to read) appraisal report. Since these reports are the same appraisals used by mortgage lenders, you can feel confident that it will reflect the same valuation their underwriter will place on the property.

How Fair Market Value is Used

Fair market value is used in many different ways in real estate. Home sellers may use FMV to set their asking price, buyers use it when making offers, and real estate agents use FMV on both sides of the deal.

However, mortgage lenders and underwriters are arguably the most significant and prolific advocates for FMV. Banks and other lenders use FMV as an important metric in determining how much to lend.

More specifically, mortgage lenders rely on reports from professional appraisers that include a determination of FMV to assure them that a home is sufficient collateral for the amount of the loan.

It’s important to know, however, that while an appraiser’s opinion of FMV isn’t the last word on the matter, their valuation will often suffice for lenders. Therefore, when you’re buying a home with financing, the appraiser’s estimation of FMV will be crucial as it supports how much your lender will allow you to borrow. Without a supporting FMV, a home loan likely won’t get underwritten.

Likewise, when you sell your home, being mindful of FMV will help you set the best listing price that attracts the most buyers. While your real estate agent is usually the best resource to use when determining listing price, using an appraisal also can be helpful.

Other Uses for Fair Market Value

While fair market value is used primarily when buying and selling residential real estate, it has many other practical applications. Here are the most common:

Homeowners Insurance Policies

When writing a homeowners policy, insurance companies use FMV to determine the cost to replace a home. This, among other things, has a big influence on the price of the policy.

Estimating Net Worth

When calculating your personal net worth, one of the largest assets and biggest liabilities listed will likely involve real estate owned. As part of any personal financial statement, you’ll provide the amount of your home’s FMV as an asset and any mortgage balance as a liability.

Estate Planning

The fair market value of a home is a metric used in many facets of estate planning and inheritance. Since your estate is everything that comprises your net worth, FMV is used to put a value on any real estate owned by you. And if you’re inheriting a home, FMV will be used to determine your basis for tax purposes.

Fair Market Value Isn’t The Same as Selling Price

Even when a home is priced at or near its fair market value, it still may sell for a much higher price for a variety of reasons.

In Northern Michigan, this sometimes happens when popular or rarely sold condos hit the market. This is especially true when the property is located near Little Traverse Bay, walking distance to town, or have highly desirable amenities like a private beach.

But even when a home sells for an elevated price, it doesn’t necessarily mean the price paid reflects its FMV.

Example: A rare waterfront condo gets listed at $750,000, an amount that reflects its current FMV as determined by the seller and an appraisal they ordered.

Immediately, this listing attracts several highly motivated cash buyers with substantial financial resources. Each knowing it’s their only chance to get the prized condo, a competitive bidding war ensues.

Each competing buyer offers well above the asking price and don’t concern themselves with the FMV. Ultimately, the condo sells for $1,000,000, a full 33% above FMV.

This is why financed buyers, who are constrained by FMV, often don’t have as good of a chance to compete in such situations. Here, if they qualified for a loan based on FMV, they’d have to come up with at least another $250,000 just to have a seat at the table.

Remember, if a buyer is using financing for their purchase, their lender will require an appraisal of the property to determine the FMV, which in turn sets the upper limit of how much the buyer may borrow.

On the other hand, as in the example above, a cash buyer is not constrained by FMV. Instead, it’s up to them how much they “overpay,” and they’re only limited by their will and available cash.

Fair Market Value vs True Cash Value

Here in Michigan, “true cash value” is used for property tax assessments when determining taxable value (upon which taxes are levied) each year. So while it may sound familiar to many, true cash value (TCV) is not the same as fair market value (FMV), and sometimes their differences can be substantial.

True cash value is the “usual selling price” for a property at that location in a private sale at the time of assessment. It considers factors like location, zoning and soil quality, but excludes things like repairs, replacements and maintenance.

For example, upgrades such as a new roof, renovated kitchens or bathrooms, and replacement windows and doors would be excluded from TCV calculations.

On the other hand, FMV, typically used in real estate transactions and appraisal valuations, is mostly based on recent sales of comparable properties. Most importantly, FMV considers what a property is worth on a free, competitive and open market. FMV takes into account all aspects of a property’s value inside and out.

Also, given that FMV is heavily influenced by comparable sales, it can be swayed by rapid market fluctuations. However, TCV, which is assessed just once a year in Michigan, remains relatively immune to such short-term market dynamics. This stability renders TCV a more fitting metric for an “equitable taxation” system, while FMV is perfectly suited to reflect value in a continually shifting open market.

For a complete legal description of true cash value and how it’s interpreted in Michigan law, see MCL 211-27.

Is Fair Market Value Just an Opinion?

In a sense, yes, a determination of fair market value is just an opinion. Even when professional appraisers are used by commercial banks and lenders, they literally deliver an “opinion of value.” You can see this for yourself just by looking at an appraisal report.

However, when a competent appraiser or real estate agent provides their opinion of a home’s FMV, it should be supported with documentation that shows how they arrived at the price. Both professionals will use their experience, knowledge of the local market, and recent comparative sales data of similar homes nearby to determine their valuation.

Why Fair Market Value is Important

Fair market value in real estate is most often a topic of discussion when you want to determine how much a home is really worth.

When you want to make an offer on a home, you’ll need some sense of its value relative to the market. After all, you certainly don’t want to overpay.

On the other hand, when you’re selling your home, you’ll want a good idea of your property’s market value before coming up with its listing price. Pricing your home too low could cost you money, and pricing it too high could discourage buyers.

While FMV has many more applications, understanding what it means and how its used in residential real estate can help everyone involved save time, money and frustration.

All content on this website is for information purposes only. Any information contained herein is not intended to provide legal or financial advice, nor does it create an agency relationship. All information is made available without any guarantee, warranty, or representation of any kind. It is your sole responsibility to seek the services of your own legal, financial, accounting, and real estate professionals prior to any such related decisions or transactions.

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