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.