Have you purchased a property that wasn’t publicly marketed?
I have. My husband and I own the Shoe House in York, which we purchased directly from the seller, an acquaintance who didn’t want a lot of publicity and chose to sell privately.
Many investors earnestly seek the “off market” deal in order to obtain desirable pricing and terms. Sometimes they may be getting better deals, but mostly they are limiting the competition, which can help secure better terms when they have open conversations with the owner. But who really determines the “fair market value” of a property, and are you really getting a better deal if you buy off market?
Is an appraisal the definition of value? I’ve seen many appraisals that are spot on, and many that are not. This is especially true in commercial real estate, where what makes sense on paper may not hold true in the open market. Read on for my reasoning.
The Foundation: Defining Fair Market Value
At its core, fair market value (FMV) represents the price at which a property would change hands between a willing buyer and a willing seller, neither being under compulsion to buy or sell, and both having reasonable knowledge of relevant facts.
This definition, though seemingly straightforward, encapsulates a multitude of factors that collectively determine a property’s worth.
First, FMV isn’t static; it’s a fluid concept influenced by the ebbs and flows of the market. Economic conditions, supply and demand dynamics, interest rates, and even geopolitical events all sway the perceived value of real estate assets. What constitutes fair market value today might differ tomorrow, reflecting the ever-shifting landscape of the real estate market.
Second, the notion of willing buyer and willing seller is pivotal. In an ideal scenario, both parties enter the transaction voluntarily, with no external pressures dictating their decisions.
The concept of reasonable knowledge underscores the importance of transparency and information symmetry in real estate transactions. Both buyers and sellers must have access to pertinent data regarding the property, including its physical condition, location, comparable sales, and market trends.
Sometimes a seller or buyer may not understand other market dynamics, which can lead to an uneven transaction. I’ve seen and heard stories that involve things like:
- An investor buying land to develop, without understanding the challenges of development.
- A house purchased at auction without an inspection that turned out to have a cracked foundation and termite damage.
- A property purchased for a change in use, where the investor didn’t realize that even a permitted change (like converting office space into apartments) can trigger costly code-required changes, such as adding sprinklers.
Full knowledge is what facilitates fair market value.
Unraveling the Determinants of Fair Market Value
While the definition of FMV provides a conceptual framework, the actual process of determining it involves an examination of various factors. One of the primary determinants is the property’s characteristics: size, location, condition, age, architectural style, and amenities.
Market comparables play a crucial role in assessing FMV. Most houses are fairly easy to compare, since many similar properties usually exist, with current sales setting a benchmark for future sales. In commercial sales (five or more units of apartments), comparable data becomes harder to obtain, and this challenge increases if there is a lack of sales within a market. During periods when investment sales slow — often driven by supply and demand shifts and rising interest rates — comparable sales become much harder to find.
The sales that do trade may also be influenced by factors like assumable financing, a highly motivated 1031 exchange buyer, or a sale resulting from settling an estate. Even if you have two sales that were exactly the same in unit count, location, and amenities, factors like these can affect the outcome.
While an appraisal provides a backward-looking view of value, it’s limited in looking at forward-facing value and predicting what the current market will do. This is why placing a property on the market often reveals its true value better than an appraisal does — the forward-looking view is what buyers are looking at, while appraisers are looking at a mostly rear-facing view.
Anticipating What’s to Come in Value
Real estate value is always shaped by the tension between buyers and sellers reading the market differently. When interest rates are elevated, buyers tend to press on price, while sellers who see a strong rental market often stand firm on theirs. As rates eventually ease, more buyers typically enter the market, competition increases, and rental rates tend to accelerate as well, helping buyers find that sweet spot of positive leverage again. Understanding where we are in that cycle is a key part of determining true fair market value at any given time.
Conclusion: Fair Market Value — Who Decides
As we’ve discussed, fair market value is the meeting of buyer and seller on open market terms, without duress. Market cycles will always shift the number of willing buyers and sellers reaching that meeting of the minds, but transactions continue as market dynamics shape the returns investors seek.
Recent market dynamics have caused many investors to sit on the sidelines or exit. We provide detailed knowledge of the market to help move you toward growing your wealth. Contact us for an opinion of value or to locate your next acquisition today.
