Fair Market Value: Definition & Calculator

Key Takeaways


Fair market value, sometimes abbreviated as FMV, is of massive significance for real estate investors and homeowners. For investors, the fair market value of home real estate establishes a baseline. If you expect it to go up, you invest; if not, you don’t. For homeowners, it lets you know how much you can expect to sell your home for.

So, what is fair market value? In this guide, we’ll talk about fair market value, why it’s important, and how to determine fair market value for your property. Let’s get started!

What Is Fair Market Value?

In a nutshell, fair market value is defined as the price for which you would list a property when placing it on the market. However, there are a few stipulations on that. After all, if you could set whatever price you wanted, you could sell a small suburban home for millions of dollars. Clearly, there’s more to fair market value. To begin with, the following must be true:

  • The buyer and the seller must have full knowledge of the property, including any defects

  • Both parties are acting in good faith, both in the legal and the ethical sense

  • Neither party is under undue pressure (i.e. you need to sell your home immediately, or your buyer is desperate to buy)

  • Both parties have an agreed-upon timetable for transacting the sale

If all these conditions are met, the agreed-upon price will be the fair market value. Typically, you can estimate this by having the property appraised, but the appraised value is not always the fair market value. An appraisal is based on cold, hard economics, while FMV takes other factors into account.


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fair market value calculator

Fair Value vs. Market Value

When talking about fair market value, it’s easy to get confused with two other related terms: market value and fair value. Appraised value is another factor altogether, but it can still be confusing. When the numbers are different, which one is your fair market value?

The short answer is that it’s a combination of all three. In general, the average of these values will give you a good ballpark number. The long answer is that there are several factors, which we’ll talk about in our fair market value calculator. Here’s a quick breakdown of fair value vs. market value vs. appraised value.

Market value: Sometimes known as Open Market Value (OMV), market value is the estimated cost of a property. There are a couple of assumptions built into this cost. First, both the buyer and the seller must be acting freely and conducting the transaction immediately. Second, both parties must be operating with full knowledge of the property’s condition.

Fair value: Fair value is similar to market value, but it takes into account the individual circumstances of the buyer and the seller. For example, you may have spent a small fortune installing a huge, in-ground pool. Depending on where you live, this could be a major selling point, but if the buyer is afraid of water, they’re not going to care. For them, it will just be an unnecessary added expense.

Appraised value: This is the value assigned to a property by an independent appraiser. It’s usually the same as fair market value, but not always. For instance, a neighborhood might be gentrifying, which could factor into fair market value but not the appraisal. Too low an appraisal can be bad for buyers and sellers alike since most lenders won’t approve a loan if the asking price exceeds the property’s appraised value.

How to Determine Fair Market Value

To calculate the fair market value, you need to have the right information. As we’re about to discuss, there are several factors you need to take into consideration. But as with any calculation, the phrase “garbage in, garbage out” applies. If you don’t have the correct information, you’re going to come up with a wildly inaccurate estimate of the property’s FMV. You can find some of this information on the public record. You’ll need to consult a real estate agent, the owner, or even neighbors who know about the property for other information.

Another thing to consider is that the real estate market is constantly in flux. Fair market value will go up when there’s a lot of demand and down when there’s less. If there’s a significant change in the market, it can potentially change overnight.

Fair Market Value Calculator

For many real estate calculations, you have an exact number. You can calculate the number of square feet in a house, or the number of bedrooms, with relative ease. Unfortunately, there’s no set formula for determining the fair market value of a property. Supply, demand, and individual circumstances will all affect how much a home can sell for. Every situation is unique. That said, a few factors will pop up any time a real estate deal is transacted. Here’s a quick rundown.

Property Cost/Selling Price

One good indicator of fair market value is the amount the last buyer paid for the property. Of course, this only works if the previous sale was relatively recent. If the current owner has been in the house for ten years, their purchase price will not tell you very much.

Property Comparables

A property comparable, or “comp,” is the value of similar properties in the same geographic area. Real estate agents use it to get a quick ballpark number for fair market value. However, this number is not always accurate because it can be hard to determine which properties are comparable. Most people will think about square footage, location, and the number of bathrooms, but there are other factors to consider. For example, is the property in good condition, or does it need a lot of work? How big is the backyard? How old is the house, and is it “charming” old or “creepy” old? These factors and many more need to be factored into your comparable properties.

When real estate agents calculate a property comp, they’ll look for at least three homes in the same area that have sold recently (within the past three to six months). Ideally, these homes will be in the same neighborhood as the one being comped, but that’s not always possible. The nice thing is that home sale prices are a matter of public record, so the numbers are at least easy to find. At that point, the agent will need to factor in any differences. If one house has fewer bathrooms, for example, that needs to be factored into the equation. Then, they’ll create an adjusted average value, which is the comp value for your property.

Replacement Cost

Replacement costs are different from fair market value because replacing a house doesn’t cost the same as buying one outright. It might be more or less, depending on the conditions. For example, the materials used in the old building may not be in use, and you may have to use different materials. You’ll also have to pay for labor, overtime, and inspections. Keep in mind that replacement costs only count for replacing a building of the same quality and usefulness. Upgrades, changes to conform to code, and demolition don’t count.

Replacement cost is not as important as the other factors for most people. That said, it’s vital to insurance companies, who use it to calculate your premium. The IRS also considers replacement cost when determining fair market value.

Expert Consultation

A professional appraiser can help to determine the value of a property by performing an on-site inspection. They’ll learn all about the structure of the house, its condition, and all the amenities. Of course, they’ll also consider the usual factors like bathrooms and square footage. Larger investors may even hire a full-time appraiser to assess different potential investments.

Importance of Correctly Calculating Fair Market Value

Fair market value is essential first and foremost for determining the correct value of a property. That said, there are several other reasons it can be important. In addition to buying and selling, FMV is necessary for tax purposes, loans, refinancing, portfolio management, divorce, bankruptcy, and insurance claims. In all of these cases, knowing the correct value is crucial.

For example, suppose you have a house fire, and the home is a total loss. The insurance company is going to consider the fair market value when determining how much to reimburse you. Another good example is taking out a home equity loan; the lender will want to know how much the property is worth before letting you use it as collateral. When real estate agents get their education, they need to understand all these issues.

Tax benefits: If you pay property tax, you’re being taxed based on the value of your property. If your home is overvalued, getting a new appraisal could lower your tax liability.

Appreciation profits: Accounting for appreciation requires you to know the fair market value, both at the moment and when you bought the property.

Smart investment decisions: You wouldn’t buy a stock without knowing the spot price or knowing a little bit about the company. Along the same lines, you wouldn’t want to invest in real estate without knowing what it’s worth on the open market.

Summary

As you can see, calculating fair market value isn’t as complicated as it might sound. With knowledge of your local market, a reliable appraisal, and a helpful real estate agent, you can quickly determine a fair price. This price is significant for many of the financial aspects of real estate investing and will help you make wise decisions.


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