When investing in real estate, there are a lot of concepts investors need to know. Property valuation is one of these important concepts. Having a grasp on property valuation is necessary for selling and buying an investment property. In these cases, fair market value is a must-know. So, what exactly is fair market value in real estate?
What Is Fair Market Value in Real Estate?
Fair market value, or FMV, is a price estimate that a property would sell for on the open market. Specifically, FMV is the property’s price in an arm’s length transaction. An arm’s length transaction must meet the following conditions:
- The real estate deal is voluntary
- Both the buyer and the seller have equal bargaining power and a reasonable knowledge of the asset
- The parties are free of undue pressure and are given a reasonable time period for completing the real estate transaction
Real estate FMV depends on four important factors. These include:
- The selling price of the real estate investment
- The property prices of real estate comps
- The replacement cost of the asset
- Opinions from experts
Above all, fair market value is the objective assessment of an investment’s value. As a result, it is a vital piece of information to have when buying investment properties for sale.
How Is FMV Different Than Market Value and Appraisal?
It is important to note that FMV is different than market value. Market value simply refers to the price of real estate assets. Fair market value, however, considers the conditions of an arm’s length transaction, as mentioned previously, and the real estate marketplace.
A home appraisal, on the other hand, is similar to the FMV. An appraisal is a real estate asset’s market value based on a single appraiser’s opinion. Usually, however, an appraisal is enough to calculate fair market value.
What Are the Uses of Fair Market Value in Real Estate?
So, what exactly is FMV in real estate used for? There are three answers:
1. Transfer of Ownership
On the surface, a transfer of ownership sounds like a real estate purchase. However, it also includes other forms of real estate deals. An investment property involved in a divorce settlement, probate process, or eminent domain are also examples of transfer of ownership. Whatever the case, a property’s FMV must be clearly defined. By doing so, no party involved is taken advantage of, and the real estate deal becomes fair.
FMV isn’t only important for transactions in the real estate market. The fair market value of a home is also necessary for insurance companies. Based on an accurate fair market value calculation, an insurer has defined standards of property coverage.
The uses of FMV also extend to tax purposes. This is true when transactions take place, particularly for those that do not meet the conditions of arm’s length. In addition, municipal property taxes are usually assessed based on a real estate property’s FMV. As discussed previously, the difference in a property’s purchase price and FMV can be significant. Therefore, tax authorities are most interested in a property’s current fair market value.
How Is FMV Determined?
We can now move on to a very important question. How to determine fair market value of a home? Here are three, IRS-approved methods used to determine fair market value:
1. Comparative Market Analysis
A comparative market analysis is the main method used to determine FMV. A comparative market analysis, or CMA, uses real estate comps to determine an investment property’s FMV. Comps that have been sold during the last 2-3 months are the focus of CMAs. CMAs also use real estate comps that are similar to the property in question. Similarities in number of bedrooms and bathrooms, square footage, and type are all important factors when selecting comps.
How Mashvisor can help you with a CMA
Knowing how to find real estate comps is the biggest challenge of a CMA. With Mashvisor, however, real estate investors can find the most accurate comps in a matter of minutes. Mashvisor’s detailed investment property search tool analyzes comps on multiple levels. First, Mashvisor lists comps for the neighborhood in which you are searching for an investment property for sale. Then, an investor can view real estate comps specific to any listing on the platform. In addition, Mashvisor is able to find both traditional and Airbnb real estate comps for an FMV.
2. Selling Price
Using the selling price of a property is another common way to determine fair market value. If a real estate deal follows the conditions of arm’s length, then the selling price of the property is the same as the property’s FMV. Of course, this only applies when the property was recently sold. For instance, a property’s selling price of twenty years ago is not the same as its current fair market value. There are many reasons why this is the case. Various temporal factors, such as seasonality and real estate appreciation, can significantly alter an investment property’s FMV. Overall, using the selling price method is a temporarily accurate method of how to calculate FMV of real estate. This method becomes more unreliable with the passage of time from when the purchase occurred.
3. Real Estate Appraisal
Finally, a professional appraisal can be used to determine fair market value. Appraisals are conducted by real estate appraisers, who utilize many tools, such as a CMA, to estimate FMV. Appraisals are very reliable for FMV valuation. As a result, many mortgage lenders require FMV appraisals from qualified investors.
The Bottom Line
Fair market value is a vital component for investing in real estate. Transactions cannot be performed without it, and insurers and tax authorities require it. By learning what fair market value in real estate is, you’re now one step closer to finding the best real estate investments! Knowing this number will ensure you don’t overpay for an investment property and will help you find below market value deals.