All’s Fair in Love and … Market Value? What is Fair Market Value Means in Real Estate

If one thing is certain about real estate, it’s that the concept of a “good deal” is highly subjective. Many factors are at play when it comes to buying a home, including your budget and what you’re looking for in terms of size, features, and the location of a property.

What feels like a great deal to you on a three-bedroom house with lake views in a quiet neighborhood may be someone else’s idea of far too expensive, which is why the concept of “fair-market value” exists in real estate.

As a buyer, understanding the difference between “fair-market value” and “market value” means that you’ll be better equipped to avoid overpaying for a house — or, if you’re in a situation where you love a property so much that you simply must have it and are willing to pay more in order to get it, you’ll enter the transaction with open eyes and be able to offer an amount that still feels fair to you.

Let’s dive into the world of market value and what makes it fair (or otherwise!).

What is fair-market value?

The International Society of Appraisers defines fair-market value as, “The price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.”

To put it more simply, fair-market value is the price that a home would sell for in an open market. Let’s look a bit closer at that definition:

• Willing buyer and seller: Both parties are entering into the transaction willingly and looking out for their own best interests. The seller is trying to get fair compensation for their home, and the buyer is hoping to pay a reasonable amount for that home. In a situation where one party is unwilling, such as a seller trying to avoid foreclosure by selling off the home, that could negatively impact the home’s price, and therefore not reflect fair-market value.
• Neither being under any compulsion: Neither party is under any undue influence — such as needing to move quickly — and both are willing to stay the course to meet their goals. A buyer who needs to move within two weeks for a new job, for example, may need to pay above fair-market value for a home due to their abnormally short purchasing timeline.
• Both having reasonable knowledge of relevant facts: In a fair-market transaction, both parties are going into the transaction with eyes wide open and with proper representation for their interests. If a buyer forgoes an inspection, for example, they may pay more than fair-market value for the home.

Fair-market value generally does not take into account the individual circumstances and preferences of buyers. For example, a home with an underground wine cellar that would be perfect for Buyer A’s cheesemaking hobby could be worth more to them than what Buyer B or Buyer C is willing to pay. The fair-market value isn’t necessarily what Buyer A is willing to pay in that scenario, but what an average buyer might pay.

Needless to say, pinning down fair-market value in real estate is not easy in any market, but when the market is especially hot (there aren’t many houses for sale) or cool (there aren’t many interested buyers), determining a home’s fair-market value becomes increasingly difficult.

What’s the difference between fair-market value, market value, and appraised value?

If it seems excessive for a home to have three different standards of valuation … well, it can be confusing, for sure — but that’s why we’re here to help.

Let’s break it down:

Fair-market value

At its core, fair-market value is what a home would hypothetically sell for on the market if neither the buyer or seller felt any pressure to accept a deal, and both had reasonable knowledge about the condition and features of the home. No frills!

Market value

Market value, on the other hand, is what a house will actually sell for according to current conditions of the local market. Is it a seller’s market, where buyers are lining up to make offers on every home because there are so few available, or is it a buyer’s market with lots of houses to choose from and no pressure to make a decision quickly (at least on the buyer’s side)?

Appraisal value

The appraisal process is an essential one if you’re using a mortgage to buy a home. Banks need to protect themselves, so a third-party appraiser will be sent in to evaluate a home’s value in relation to the amount you’re trying to finance.

Appraisers look at the general characteristics of a home, it’s overall condition, improvements to upgradeable areas like kitchens and bathrooms, the location of the property, and recent sales of comparable homes.

So, which value matters most?

The most important valuation is, ultimately, your own. What you are willing to pay for a particular home may be more or less than what the market calls for, and what an appraiser has to say may not be as relevant if you have a sizable down payment or are paying cash.

“There’s no exact science to it,” says Brian Beatty, a top agent in Charleston, South Carolina. “Real estate is and always will be an emotional process. People value different things, and that doesn’t always have to mean the upgrades or finishes or square footage in a home.”

When does fair-market value come into play in a real estate deal?

Fair-market value is used in real estate to assess what a home is worth for property taxes, in the event of an insurance payout, or during a legal dispute (such as a divorce).

Otherwise, if you’re buying or selling a home, you’re probably going to be working with plain old market value — especially in a hot market like we’ve seen in 2021.

Rudy Dudon, an agent based in Siesta Key, Florida, has a unique perspective on how fair-market value does (or doesn’t) work.

Siesta Key is a barrier island and holiday home haven just off the coast of Sarasota. This market is unlike most in that the majority of Dudon’s buyers are not first-timers or young families; they’re established folks seeking a second home for investment purposes, or they’re looking for a comfortable place to retire.

Often, these buyers are from out-of-state and, according to Dudon, it’s essential that an agent properly advise a buyer on local market value.

“What we need to educate buyers on is, what does $500,000 get you? What does $1,000,000 get you?” Dudon explains.“Just because a million dollars might get them a home in Indianapolis that’s one of the largest homes in the city, it’s not going to be the same down here.”

This is where a market analysis is particularly helpful. “The best way to determine the market value is to look at past sales, showing the customer what properties have sold for so they understand what their price point gets them. That’s the best way to start the process,” says Dudon.

Beatty echoes Dudon’s sentiments on the importance of working with an experienced local agent.

“When we represent buyers, our responsibility as agents is to determine what we believe a property is worth,” he says. “We ask, ‘What is market value?’ and then the conversation shifts to, ‘How much are you willing to pay?’

“The emotional side of real estate sometimes gets people into trouble.”

The ‘need’ factor

Speaking of which, there’s another all-important factor when it comes to home pricing. There’s also the emotional side of things; the “I want” or “I need” components of searching for a home.

A buyer who happens upon his childhood home for sale is likely going to feel the tug of sentiment, while someone who insists on a waterfront view in a specific neighborhood, or is very particular about having a three-car garage or a finished basement, may be willing to pay a premium for a house with those desired features.

Dudon notes that historical or architecturally significant homes tend to turn up the “need” factor, too.

“Sarasota has a high following of mid-century modern homes,” he says, “so depending on who built the home, who designed the home — people will pay additional just because of the name behind it.”

Other scenarios that may entice a buyer to pay more include:

• • A true home office. Anyone can turn a spare bedroom or an unused formal dining space into a comfortable place to work, but if a house has an actual office, and you’re someone who works from home on a regular basis? You’re probably going to be tempted by those French doors, built-in bookshelves, strategically located electrical outlets, and caster-wheel-friendly flooring.
  • Luxurious amenities. It may be true that not everyone sees an in-ground pool as a benefit — but lots of people do! The same goes for features like a wraparound porch, finished basement, lush landscaping, or a wet bar.
  • Move-in readiness. A move-in ready home is just that — as soon as it’s yours, you can start moving in. With a fixer-upper, on the other hand, you may need to make repairs or updates to the home before it’s comfortably livable. Projects can be fun, but they can also be costly and take longer than expected.

Whether you “need” any of these desirable qualities or not is something only you can determine, but do be mindful of the difference between must-haves and nice-to-haves as you’re searching for your next home. 

Can high demand bring about a new fair-market value?

It stands to reason that if enough people are willing to pay a premium for a historical home with a sea view, the shifted market value actually becomes the new fair-market value — right?

Maybe not.

“You’re going to have people who will overpay, or pay what they want to pay, because they have the ability. That will help increase the value across the board, but it’s not dollar for dollar,” Dudon says. “Just because someone got $1,500 a square foot for a home, that doesn’t mean everybody’s going to get $1,500 a square foot for theirs.”

If scarcity is a factor — such as in the case of a historic or architecturally significant home — then fair-market value may not be an adequate measure of what the home is truly worth. The rarity and special attributes of this one specific property have inclined interested buyers to pay more — but that doesn’t mean the same is true across the board for properties that are comparable in size and location. (Remember that for market value to come into play, there needs to be an actual market in which to act.)

What are the challenges of assessing a current fair-market value in real estate?

Because there are so many variables with every home and every buyer, there’s no avoiding the complications of trying to determine fair-market value. But even beyond wants versus needs, emotional attachments, and disparate financial means, the parameters of what defines fair-market value present their own challenges for assessment.

Pocket listings

A pocket listing is when a real estate agent is working with a seller who has a house that is technically for sale, but it’s not listed on the open market. Other agents won’t find pocket listings on the MLS, there won’t be a “for sale” sign in the yard, and you definitely won’t find it by Googling homes for sale in your city.

If a house isn’t on the market, it can’t factor into comparative analysis, nor will it even be an option to most buyers because they simply won’t know that the home is available in the first place. And that might make it more difficult to pinpoint the fair-market value of a similar home.

Defining ‘reasonable knowledge’

Because the definition of fair-market value includes all parties having reasonable knowledge of the asset — see also: the house — we have to understand what constitutes “reasonable knowledge” in the first place.

By default, you as the buyer won’t know as much about a property as the seller does. As a responsible buyer, of course you’ll have a thorough home inspection completed, but even with this report in hand, sometimes you just can’t know what you don’t know.

Understanding undue pressure

In this context, undue pressure is most likely to mean either that the seller is in a financial position where they need to sell as quickly as possible — such as in a pre-foreclosure or short sale situation, for example — or the buyer is in a rush to find somewhere to live.

Maybe a rental contract is about to expire, maybe their current home is under contract, or something else is going on to where it’s essential for the buyer to make a move quickly.

Time is often of the essence in a real estate transaction, yes, but ideally neither party is on such a tight deadline that any delay or mishap would be cause for alarm. When one party is on such a deadline, it can skew the pricing of the home beyond fair-market value range.

Acting in one’s own best interests

Few sellers are willing (or able) to cater to a buyer’s every demand, and vice versa — but that doesn’t mean every buyer or seller always acts in their best interests, at least financially speaking.

Maybe a first-time buyer is dealing with excessive input from parents and is ready to sign anything just to get the homebuying process over with, or maybe a seller decides to take an early lowball offer because they’d rather finish the task today than ensure they’re fetching the top price for the property.

Now, if you ask that buyer or that seller, they might tell you that a speedier transaction is exactly what’s in their best interest, but that need for speed will probably land them outside fair-market value.

Sometimes it’s best to step back, take a breath, and make sure that what you’re pursuing is actually the right decision.

Defining ‘reasonable amount of time’

One person’s idea of a reasonable amount of time in which to sell their home might be 45 days, while an uneasy buyer may have 90 days in mind.

Your real estate agent can help you determine the norm for your market, but these details are usually smoothed out in negotiations. A purchase agreement can only go back and forth with negotiations so many times before one party has had enough and backs out, and once a contract is fully signed, there’s a specified period of due diligence in which inspections must be completed and financing must be secured.

Let’s play: Is this a fair-market value scenario?

To really drive home the essence of fair-market value in a real estate transaction, let’s examine a few different situations:

Scenario #1: An adult child purchases a home from a parent

This is most definitely not a fair-market value scenario, nor even a market-value scenario. There are exceptions, yes, but in most cases, a parent is not going to charge their own child the full market value of a property.

The discount may not be as deep, but the same “hey, we’re family!” favors tend to apply when purchasing from a grandparent, aunt, uncle, cousin, and so on. Plus, in a family transaction like this, the home is unlikely to even go on the open market.

Scenario #2: A buyer purchases his or her childhood home from the current owners

Now, there may not be a personal relationship between buyer and seller in this scenario, but there is something special about this particular home. Emotions are already running high when it’s time to buy a house, so imagine what it’s like when the home in question is one with deep nostalgic value to the buyer. One of two things are likely to happen:

• • • The emotionally attached buyer is willing to pay whatever it takes to ensure the house isn’t sold to someone else.
    • The seller will be charmed by the tale and generous with their negotiation, whether with the list price, covering closing costs, or any extras that might be included in the sale.

Either way? We’re not dealing with fair-market value (or market value) in this case.

Scenario #3: A buyer purchases an investment home from his or her boss at work

At this point, you shouldn’t be surprised to learn that this is likely not a fair-market value situation.

Although a buyer’s boss isn’t likely to cut as sweet a deal as their own mother, it’s still quite likely that favorable terms will be offered.

Perhaps the boss has priced the property low enough to entice the employee into taking action as a buyer, or perhaps the buyer is helping to ease the stress of selling by purchasing the home before the boss even has to formally list the house on the market.

Depending on the employee-boss relationship, the buyer may also have further information about the history of the house and its repairs or renovation process that wouldn’t be as readily apparent to outside perusers of the market.

Scenario #4: A buyer with a very specific hobby or interest purchases a home already outfitted for that hobby/interest

So, this one can be tricky.

As discussed earlier, people are often willing to pay for what they really want. A car collector who enjoys wrenching on the weekends may very well be happy to fork over additional funds to buy a house that has ample garage space with a built-in workbench and tool rack, while a burgeoning homebrewer may light up over discovering a home for sale with a finished basement complete with custom bar and beer taps.

Though the buyer and seller may indeed be strangers pursuing their own best interests, what skews the fair-market value in a case like this is the buyer’s increased interest in this specific home.

The stakes are higher; we’re no longer dealing with a matter of simply finding another four-bed, two-bath home with a yard. Someone who sees a home as perfect for their hobby is no longer representative of an average/reasonable buyer, and thus this is not a fair-market value scenario.

Scenario #5: A buyer and seller who don’t know each other are connected by a real estate agent before the home hits the market, and they’re able to negotiate a deal

This may be the most difficult scenario yet. On the one hand, we have a buyer and a seller who have no prior relationship, and we can even go ahead and assume that there is no compelling emotional nor recreational pull to this particular house — seems like fair game, right?

Except, it’s not, because the house never had the chance to go to market. Sure, a good agent will have performed their due diligence and examined comparable sales to have a starting price point in mind, but by connecting a seller with a potential buyer before listing the property, there’s no way to know what someone else may have offered or how long the house would have sat on the market.

This is not an example of fair-market value (or market value) because a connection was facilitated between buyer and seller that would not have happened otherwise.

Only you, the buyer, can decide what you’re willing to pay

Risks of voluntarily overpaying may include having to put down a larger amount of money to avoid appraisal issues when it’s time to secure the mortgage, and you may not see as great a profit — and in some cases, perhaps not even a full return — on your investment if you later decide to sell. For many buyers, the right home is worth the price.

The best way to buy smart is to have a great real estate agent on your side through the whole process, and a top local agent will be well-qualified to advise you on fair-market value and beyond. Happy house hunting!

Header Image Source: (Binyamin Mellish/ Pexels)