Determining Fair Market Value

Natural disasters aside, every home will sell at the right price. That price is defined as its fair market value (FMV) — the price a buyer will pay and a seller will accept for the house, given that neither buyer nor seller is under duress. Duress can come from life changes, such as divorce or sudden job transfer, that put either the buyers or sellers under pressure to perform quickly. If appraisers know that a sale was made under duress, they raise or lower the sale price accordingly to more accurately reflect the house's true fair market value.

Fair market value is more powerful than plain old value. As a buyer, you have an opinion of what the house is worth to you. The sellers have a separate, not necessarily equal (and probably higher), opinion of their home's value. These values are opinions, not facts.

Unlike value, fair market value becomes a fact when buyers and sellers agree upon a mutually acceptable price.

When fair market value isn't fair — need-based pricing

Whenever the real estate market gets all soft and mushy, many would-be sellers feel that fair market value isn't fair at all. Don't let your highly developed sense of fair play make a sucker out of you. Sellers frequently confuse "fair" with "impartial." Despite its friendly name, fair market value can be heartless and cruel. Fair market value doesn't care about any of the following:

How much the sellers need because they overpaid for their house when they bought it.

How much the sellers need to recover the money they spent fixing up their house after they bought it.

How much money the sellers need to pay off their loan.

How much money the sellers need from the sale to buy their next humble abode, Buckingham Palace.

Fair market value is brutally impartial. It is what it is — not what buyers or sellers want it to be.

Median home prices aren't fair market value

Median sale prices for homes don't indicate fair market values either. The median-priced home is the one exactly in the middle of the prices of all the houses that sold during a given sales period in a particular geographic region, such as a city, county, or state.

You don't know how many bedrooms or baths the hypothetical median-priced home has. Nor do you know how many square feet of interior living space the house has, how old it is, or whether it has a garage or a yard.

If median-price information is so vague, why bother with it? Because it tells you two important things:

Price trends: If the median price of a home in America was $80,000 ten years ago and is $110,000 now, you know home prices in general are rising. You don't know why they are, just that they are.

Price relativity: If the median-priced home in Yakima, Washington, sells for $75,000 versus $300,000 for the median-priced Honolulu home, you know that you'll get a much bigger bang for your housing buck in Yakima. Honolulu has many redeeming qualities, but cheap housing isn't one of them.

Zero in on areas you can afford by comparing median home prices on a town-by-town and neighborhood-by-neighborhood basis. When median price statistics indicate that home prices are rising or falling sharply in an area, find out why by reading and talking to your real estate agent.

Comparable market analysis

The best way to accurately determine a home's fair market value is to prepare a written comparable market analysis (CMA). A competent real estate agent can and should prepare a CMA for a home that you're interested in before you make your purchase offer. Every residential real estate office has its own CMA format, but always includes "Recent Sales" and "Currently For Sale" data.

The CMA's "Recent Sales" section helps establish the fair market value of your dream home that is currently on the market by comparing it to all the other houses that

Are located in the same neighborhood.

Are of approximately the same age, size, and condition.

Have sold in the past six months.

These houses are called comps, which is short for comparables. Depending on when you began your house hunt, you probably haven't actually toured all the sold comps. No problem. A good real estate agent can show you listing statements, take you on a verbal tour of the houses you haven't seen, and explain how each one compares to your dream home.

The "Currently For Sale" section of the CMA compares your dream home to neighborhood comps that are currently on the market. These comps are included in the analysis to check price trends. If prices are falling, asking prices of houses on the market today will be lower than sale prices of comparable houses. If prices are rising, you'll see higher asking prices today than comps sold for three to six months ago.

Your CMA must be comprehensive. It should include all comp sales in the past six months and all comps currently on the market. Getting an accurate picture of fair market values is more difficult if some parts of the puzzle are missing, especially in a neighborhood where homes don't sell frequently.

Like milk in your refrigerator, comps have expiration dates. Lenders won't accept houses that sold more than six months ago as comps. Their sale prices don't reflect current consumer confidence, business conditions, or mortgage rates. As a general rule, the older the comp, the less likely that it represents today's fair market value.

Sellers can ask whatever they want for their houses, but sale prices indicate fair market value. The best proof of what a house is worth is its sale price.