Getting to value
Fair market value is the price that real estate would sell for on the open market without any unusual forces being involved. The definition is relatively simple but there are certainly different methods of determining what it is.
A homeowner could order an appraisal before they put their home on the market but would incur the expense of an appraisal and more likely than not, it won’t or can’t be used by the buyer or their lender. The advantage is that an appraisal is a professional approach by a disinterested party to establish value.
Licensed appraisers use three approaches to value: the market data, the replacement cost and the income approach. The appraiser can put more weight on one approach than another based on his/her assessment of what would be appropriate.
The replacement cost looks at what it would cost to rebuild the property today less the depreciation it has experienced by age and wear and tear plus the value of the lot.
The income approach uses a capitalization rate based on the net operating income of a property to determine value. It is more applicable to commercial properties than it is for homes used by homeowners and not rented.
The market data approach relies on recent sales of similar properties near the subject. The appraiser will make monetary adjustments for differences in the comparables that are used to create a more accurate comparison.
Real estate agents use a similar approach to determine fair market value by performing a Competitive Market Analysis, CMA. Like the market data approach of an appraisal, it looks at recent sales of similar properties, it also considers properties currently for sale and what homes were unsuccessful in their attempt to sell. This approach is sensitive to supply and demand and may be more reactive to rapidly rising or declining markets.
Both appraisals and CMAs have a distinct advantage because of the personal opinion as a professional compared to online website estimates using raw data and mathematical formulas. Regardless of which method is used, it is an estimate. Obviously, some estimates are more accurate based on the experience of the person making the estimate. A price is placed on the property by the seller but value is ultimately determined by the buyer when a final sale is achieved.