Fair market value: What it is, how it’s calculated

A home’s fair market value, or FMV, is an important piece of the real estate puzzle, no matter which side of a sale transaction you’re on. Sellers might use it to help figure out how to price their home for the market, while buyers can use it to help inform how much they will offer. It’s also used by home appraisers, attorneys, insurance companies and more. But what exactly is fair market value, and how is it determined? Read on to find out more.

What is the fair market value of a home?

In real estate, a home’s fair market value is the price that a willing buyer would pay a willing seller for the 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. 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.

In a way, FMV is a measure of buyer demand. “Basically, it is what the buyer audience perceives the home to be, value-wise,” says Cara Ameer, a real estate agent at Coldwell Banker in Laguna Beach, California.

How fair market value is calculated

There’s no absolute formula for calculating fair market value. But 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 a home 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 is 1,500 square feet and one of the comps is 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.

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. The more recent the sale, the better, she says: “Looking back 180 days may show data that is too old, as prices have dramatically increased in many markets.”

Ameer 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
• Number of bathrooms
• Type of lot (privacy, proximity, view)
• Whether or not it has a fireplace
• Whether or not it has a pool

“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.

These adjustments are based on a generally accepted range of values in CoreLogic’s Marshall & Swift Residential Cost Handbook. 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 ways to calculate 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 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.

What is fair market value 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. Agents may also use this information when preparing a comparative market analysis for a client.

However, in many markets today, homes sell for 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 a seller is often competing with a lot of options in their price range.”

Home appraisers evaluating a home also consider fair market value in their appraisal report. Appraisals are required by lenders when a homebuyer is financing the purchase, or when a homeowner is refinancing, to verify that they’re not loaning more than the home is worth. (Keep in mind that the appraised value of a home is the opinion of a single appraiser and is not always the same as fair market value.)

There are also uses for fair market value information outside of a real estate transaction. For example, attorneys, government officials and insurance companies might also consider FMV in various scenarios, such as divorce, death, eminent domain decisions and insurance claims. It’s also smart for homeowners to stay on top of their home’s current FMV, since it’s likely to be one of their biggest assets and a big part of their overall net worth.

Bottom line

Fair market value is usually determined by taking the average of three or more comparable homes. It helps both buyers and sellers get a sense of how much home is worth. Real estate agents typically use it to figure out a price or price range in which a home will sell — listing agents use it to come up with an appropriate asking price, and buyer’s agents use it to help determine their offer strategy.

FAQs

• What factors impact the fair market value of a home?

  The fair market value of a home is impacted by various factors, including location, size, usable space, age, condition and amount of upgrades or updates. The local housing market and comparable houses nearby (neighborhood comps) are all significant factors in determining FMV, too, as is the nature of the neighborhood and its amenities. (For example, is there public transportation nearby? Are local schools well regarded? What is the crime rate? How convenient is it to retail areas/commercial businesses?
  

• Is fair market value the same as assessed value?

  No. Fair market value is an estimation of a property’s worth, typically determined by a real estate professional based on factors such as condition, location and the market value of comparable properties in the same area. Assessed value, on the other hand, is the worth placed on a property by a local government (via an individual property assessor) for the purpose of taxation — specifically, property taxes. The market value and assessed value of a property do not necessarily have to match, and in fact often don’t, with assessed values lagging current market values.
  

• Is fair market value the same as appraised value?

  No. A home’s appraised value is the opinion of a licensed, objective appraiser. This professional assessment is typically used by the buyer’s mortgage lender as a kind of safety precaution, to make sure that the home is worth the loan amount. Appraised values are often lower than fair market values.