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 real estate is best viewed through the lens of fair-market value.
As a buyer, understanding fair-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 overpay 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.
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 an average or reasonable buyer would spend on a house when there is no existing relationship with the seller, and no extenuating circumstances endearing the buyer to that particular house.
What exactly is an “average” or “reasonable” buyer? Well, it’s someone who knows what they’re looking for… and while they may be interested in that two-story home on a corner lot in a lakeside neighborhood, they’re also aware that they have other options, and they are ultimately willing to walk away.
This house is not the one in which they grew up, it’s not being sold by their best friend’s sister, it’s not already set up with an underground wine cellar that would also be perfect for the buyer’s cheesemaking hobby — in short, there is nothing extra-special about this property or the circumstances of its sale that would incline the buyer to pay more than necessary to find themselves at the closing table.
Fair-market value and the buyer-seller relationship
For fair-market value to truly come into play during a real estate transaction, there can be no prior relationship between the buyer and the seller.
The seller isn’t a friend, colleague, relative, congregation member, recreational acquaintance, or friend-of-a-friend of the buyer in any sense.
These are just a couple of good, old-fashioned strangers seeking an agreement that satisfies both parties. The seller is looking for a ballpark amount of money for their property, while the buyer is hoping to acquire a house that suits their space and location needs while accommodating their budget.
The relationship between buyer and seller matters because, let’s face it, someone buying a home from their own parents isn’t likely to pay the same price as the rest of us. Which — your own relationships aside — means that if the house you have your eye on today is sitting next to one that sold last year within the same family, that transaction could potentially skew the results of a comparative market analysis.
To learn more about how fair-market value can affect buyers from all walks of life, we spoke with Florida-based real estate agent, Rudy Dudon.
Dudon is based in Siesta Key, a barrier island and holiday home haven just off the coast of Sarasota. The Siesta Key market is unique in that most 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 is 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.
The ‘need’ factor
Human relationships aren’t the only determining factor when it comes to fair-market value. 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 their 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,” he says, “so depending on who built the home, who designed the home, people will pay additional just because of the name behind it.”
Can high demand bring about a new fair-market value?
It stands to reason that if enough people are willing to pay a premium, let’s say, for a historical home with a sea view, the would-be skewed fair-market value actually becomes the new market value, right?
“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 market 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.”
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
As we touched on earlier, this is most definitely not a fair-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.
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 in extras are included in the sale.
Either way? We’re not dealing with fair-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 not a fair-market value situation.
Although a buyer’s boss isn’t likely to cut as sweet as of a deal as their own mother, it’s still quite likely that something is working in someone’s favor.
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, 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 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)