In ever-changing markets, there are many valuation methods available, for a buyer or seller of land and commercial real estate, from which to choose. However, which one is really the fair market value?
When working with both buyers and sellers of land and commercial real estate, usually the first topic discussed is “what is the market value of the property?” While every real estate transaction involves many other important business topics (for example: the period-of-time until settlement, repairs to the property prior to settlement, the ability of the buyer to obtain funds to purchase the property, etc.), the sales price of the property tends to be the most important issue to both buyer and seller.
Each party will likely rely on one, or more, estimates of market value to determine what they feel is a fair price. Some of the most common estimates of value, which may come into play, include the “assessed value”, “appraised value”, “comparative market value”, and computer-generated estimates of value. Knowing some basic information about each of these estimates is useful.
A property’s assessed value is determined by the local tax assessment office and is used as a basis to determine property taxes. In Maryland, assessments are performed every 3rd year so the assessed value lags the actual market, and the lag can be substantial, when real estate prices are changing rapidly.
The tax assessor uses public information (e.g. building permit data and basic information from recent sales) to evaluate each property – the assessor does not perform a tour of the interior of the property. Each tax assessor has thousands of properties to evaluate each year and does not have time to scrutinize each property carefully.
In some cases, the assessed value is kept below fair market value purposefully, for example, a property that is in the Agricultural Use Assessment program. In my experience, assessments are typically lower than market value and are often NOT a good indicator of market value.
A property’s appraised value is established by a privately licensed appraiser who is hired by someone with interest in the subject property. Some property owners will have their property appraised to determine their equity or in preparation of marketing the property for sale.
If a loan is used by a buyer to purchase a property, the lender will typically require an appraisal as a condition of the loan. If the buyer doesn’t need a loan to purchase the property, the buyer may decide to obtain an appraisal to ensure that they are not ‘overpaying’ for the property.
Licensed appraisers are highly trained to evaluate the large number of factors, which determine market value. The appraiser will perform a significant amount of research into the material facts of the property and conduct an inspection of the property. The appraiser will use this objective information as a base but will have to make highly informed but subjective adjustments to estimate the property’s value.
Appraisers have a high level of responsibility, and it’s not an easy task. The more unique a property is, the more subjectivity the appraiser has to apply in determining the appraised value. It should be noted that an appraisal is simply one person’s opinion of market value, and the appraised value can change depending on who the appraiser is. I sold a property, a couple years ago, for an estate, which obtained two appraisals prior to listing the property for sale – the ‘low’ appraisal was less than 60% of the ‘high’ appraisal.
Comparative Market Value
Real estate professionals (“REPS”) typically estimate the market value of a property by comparing the subject property to recent sales and current listings of comparable properties. For better or worse, REPS typically use a bit more latitude to inject subjective criteria into their evaluation compared to appraisers. For example, if prices have been rising by 5% over the past year, but the real estate professional senses that prices are currently rising faster than 5%, the REP may factor that into the value estimate whereas an appraiser may not.
Real estate professionals can also factor in the potential to increase the property’s market value through repairs, renovations and improvements – the appraiser is limited to evaluating the existing situation.
Web-based analyses have become popular ways to obtain estimates of value. Most of us are familiar with Zillow’s “Zestimate” as an example. These computer-generated value estimates are derived using whatever public information is available to the computer as input. Since there are lots of attributes of any individual property, which the computer can’t know, the resultant value estimate is a good first guess at best. For example, the computer probably will know that a property contains 3,000 square feet of improved space, but it won’t know if the layout is functional or obsolete, or if there is a terrible odor present.
Computers are powerful at crunching numbers and can analyze sales prices of vast numbers of properties, so it’s likely that their use in estimating market value will continue to increase over time. The National Association of Realtors developed a highly sophisticated computer program known as Real Property Resource, which will help Realtors better evaluate a large number of attributes, which can be used to estimate a property’s market value.
The goal of each method discussed above is to determine a property’s “Fair Market Value”. In simple terms, Fair Market Value is the price that a knowledgeable, willing, and unpressured buyer will pay to a knowledgeable, willing, and unpressured seller. Fair Market Value is a nice concept but it’s theoretical in nature. In practice, sellers want to receive maximum price (or more), and buyers want to pay as little as possible (or less). As you might expect, for any given property, the estimated values can vary significantly. Having an experienced real estate professional on your team is critical to sorting through all the conflicting information and helping to bridge the gap between the expectations and desires of the buyer and the seller.
A few years ago, I was involved in the sale of a property, which illustrates the disparity between several estimates of market value. The property owners contacted me and asked me for my opinion of the property’s market value. After touring the property, carefully evaluating its potential and researching recent sales and listings of similar properties, I provided them with my estimate of the property’s current market value. In order to conceal the parties involved, instead of using dollar amounts I will describe the market value estimates in terms of percentages based on my original estimate. My estimate of the property’s market value was 100 in its current condition; if the owners would invest another “4” toward some minor improvements, the market value would increase to 112. The assessed value of the property, at that point in time, was 82. The owners informed me that they recently had the property appraised and the appraised value was 96 “as-is”. The owners agreed to both list the property with me and to perform the recommended improvements.
Several months later, when the improvements were finished, I updated my estimate of the market value – the market had improved, and my new estimate was 121 – the owners and I agreed to list the property at 128.
After several showings, two parties made offers on the property. The terms of the two offers were very similar except for the price. The ‘low’ offer was based on a Zestimate of the market value which was 88; the ‘high’ offer came in at 115 and after negotiations, the parties agreed on a final price of “118”. Both the buyer and seller were satisfied that the final sale price reflected Fair Market Value.
Having an experienced agent with a good “feel” for the market can be very useful. If you’re interested in the current market of property you currently own, or property you may be interested in buying, please feel free to give me a call for a no-cost consultation. It could be a valuable discussion.