For some it depends on whether you’re buying or
selling. But that’s not the way it
works. The definition given in real
estate school for FAIR MARKET VALUE is the following: What a seller and a buyer, each having access
to all the facts about the property and neither being under duress, agree
to. In a cash transaction this
definition will fly; if a lender is involved the lender could not care less
what the two parties agreed to and there is a fundamentally solid reason for
this. When a lender extends credit there
is an element of risk in the loan in that the lender may have to take the
property if the buyer defaults on the loan.
Consequently the lender has a major requirement before making the
loan. The lender is going to want
assurances that, if he has to foreclose the property and sell it himself, there
is a likely chance that he will be able to sell the property for what the
borrower paid for it. This is where
appraisals come in. Where a loan is
involved the purpose of the appraisal is to research recent (usually within one
year) sales of similar properties. If the
values of these prior sales support the
price that the buyer has agreed to pay, the loan will probably go through. If the prior sales do not support the price
the buyer contracted to pay, the lender is not going to make the loan unless
the seller reduces his price or the buyer agrees to pay the discrepancy. Both of these scenarios do occur. In a market of rising prices most prior sales
will be somewhat lower than the price of the current contract. Appraisers are allowed to use discretion when
coming up with values and may concede the higher price. Today much of the United States is in a
falling market and an appraiser would need to take that fact into consideration
so as not to expose the lender to inflated values.
It is not uncommon to see certain properties have an
appraised value that is significantly less than the cost to reproduce the
improvements. Many of the factories and
office buildings that have sold over the years in Jacksonville have sold for a
fraction of their reproduction cost because there was not a ready replacement
owner. Properties like these are
arguably purchased for a song but, if the seller and buyer agree, then fair
value has been established. Fine homes
in Jacksonville are often a tough sell at replacement cost because most local
buyers who can afford a fine home in Jacksonville will build their own. It is usually the out-of-town buyer who buys
the fine homes in our area......particularly buyers from higher price point
markets, such as California.
When a property is unique it is difficult to establish a
likely sales price because of the lack of available comparable sales. In instances like these an appraiser is
forced to make many adjustments, assumptions and disclaimers. Some lenders will not make a loan on a
property where it is difficult to establish a likely value unless the buyer is
very strong credit-wise and is perhaps making a significant down payment. The lender may even require additional
collateral. Sometimes a property may
have a unique improvement that cost many thousands of dollars and the appraiser
will give the improvement no value whatsoever.
A good example is a fountain located beside a fine home. Most buyers couldn’t care less about a
fountain and its presence would have no impact on a sale nor the purchase
price. Some improvements arguably add
negative value because they make a sale more difficult. A good example of this is a swimming
pool. A pool can kill the sale of an
otherwise desirable home.
Can property have more than one value? Yes. A
good example is a house that can be used as a personal residence or as
rental-investment property. A dwelling
used to generate income and a good return on investment can be worth more than
when used as an owner-occupied residence.
A lender will still, more than likely, go with the lower value in order
to exercise conservative lending practices.
A house in a commercial setting can have a commercial value that is
multiples of its residential value.
Several years ago we sold a 70 year old house on a 14,000 square foot
lot for $150,000.00. The house as a
house was worth no more than $25,000.00 but, in this case, the purchaser added
the land the house sat on to a lot on South Jackson and built a retail store. The house had no value for the purchaser and
it was sold for a modest amount to an individual who moved it off the
property. Did the buyer pay a fair price
for the property? He did for the use for
which he intended it; and he had no trouble getting his financing.
From time to time we hear the phrase mortgage fraud as it
relates to values. There have been
instances where buyers and sellers have conspired to execute a transaction for
values way in excess of likely market value.
This type of fraudulent transaction requires collusion among the buyer,
seller, lender and an appraiser who is willing to fudge on values. After the sale closes the excess funds
received by the seller are shared among all parties to the illegal transaction. With the recent runup in values over the past
several years a lot of this type activity took place. Then, as the market took its dive over the
past year and these properties were foreclosed and appraisers established true
values, many creditors were left with foreclosed properties with values that
did not come close to the prices at which they previously sold. Fortunately the Federal Government is working
on legislation to help reduce the likelihood of this kind of conduct in the
future.
The bottom line is that arriving at a fair price for real
estate is not as scientific as we would like it to be. If you ever plan on buying a property and you
want to be certain that you are paying a reasonable and fair price, have the
property appraised....................but DO NOT SHARE THE ASKING PRICE
NOR THE PRICE YOU HAVE AGREED TO PAY WITH THE APPRAISER.
