Real estate appraisals can be used to serve a wide range of purposes: selling, buying, refinancing, or settling an estate. However, the most common goal of an appraisal is to establish the market value of a property. Although the concept of market value (sometimes also called Fair Market Value) is frequently mentioned in the real estate business, it is not always understood. It is type of value opinion among others definitions of value. It is essential to define what market value represents to understand its relevance to an appraisal.
What Is Market Value?
Market Value has multiple definitions and varies by state and region. The one most commonly used by appraisers is given by Fannie Mae, but USPAP encourages appraisers to “identify the exact definition of market value, and its authority, applicable in each appraisal completed for the purpose of market value.” Generally speaking, market value assumes several conditions:
- A buyer and seller who are well informed, act in their own interest, and not under duress
- The property is exposed for a reasonable period on the open market
- The payment is made in cash or equivalent, excluding cash or non-cash incentives
These conditions are not always met in real life, which is why the price a property might reach on the market is not necessarily its fair market value. For example, a seller may need to move out of the area by a specific date and sell the property for a price lower than it might have reached had it stayed on the market longer.
The market value of a property is not a price opinion or a price prediction. It is an opinion of value that typically falls within a range. Therefore, the market value of a property may differ from one appraiser to the next.
As the market (and the condition of the property itself) may change quickly, the market value can also evolve. The market value given in a report is a snap shot in time, which is why appraisal reports are only valid for a limited time. The effective date of the appraisal is traditionally the date an appraiser visited the property, but not necessarily. For example, if the appraisal is ordered to settle an estate, the effective date would be the date the owner passed away.
For most non-commercial properties, appraisers assess the market value by comparing the subject property to similar buildings comparable in location, features, age, etc., that sold recently. However, such comparables are not always available, and the appraiser may have to adjust the different properties used to match the subject.
The appraiser may also be confronted with a changing market (appreciating or depreciating) that sometimes affects the market value of the property. An influx of comparable properties in foreclosure or short-sale could lead to a declining market, while property prices might increase artificially in a bidding war in an area in demand. In this case, the appraiser must conduct a thorough market analysis and adjust the comparables accordingly.
Market Value: One of Many Types of Valuation
Even though establishing the market value of a property is the most common purpose of an appraisal assignment, especially if the report is to be used by several parties, it is far from being the only one. Market value is occasionally confused with other opinions of value, which are often more specialized.
The tax assessed value of a property is calculated by the municipality, for property tax calculation purposes. It is determined by the assessor using various methods, from market value to computerized models and assessment rates, depending on the jurisdiction. The after repair value (ARV) of a property is a projection estimating the market value of a property after renovations have been completed. Thus, comparables are not the properties in similar condition to the subject in the present, but after the projected improvements.
If the property is distressed, the purpose of an appraisal may be to determine the value of a property if it was to be sold quickly rather than after a customary exposure period on the open market (disposition or liquidation value). For an income-producing property, an investor might be more interested in its value based on cap rate than in its market value.
Interpreting the Report
Defining market value is a crucial part of any appraisal assignment as the price a property may sell for is not always its fair market value. In order to prepare an accurate report, it is important to keep in mind the purpose of the assignment, as values differ according to intent and usage. For the recipient of the appraisal, understanding the definition of market value will assist in interpreting the report and why the valuation may vary depending on the scope of the appraisal.