Market value is an essential concern of both buyers and sellers alike. Most people do not understand what “market value” truly means. Buyers and sellers have the same goal: to transact the property for a fair price. Obviously, buyers will want to grab a steal, and sellers will want to make a killing. But, neither party wants to get screwed.
Now, it is true that most buyers and sellers are real estate beginners who may only do three transactions in a lifetime. How are these relative newbies supposed to know what market value is? Even experienced investors looking to buy in a new area run into this question. “How can I trust that I’m not getting ripped off?”
Fair Market Value
Market value is the amount of money that a typical buyer will reasonably pay for a home given the current conditions. This assumes two things. First, that the transaction is at “arm’s length”, meaning that buyer & seller do not know each other. Second, neither party is forcefully requiring the transaction to take place. This is to say, the transaction is not “under duress”.
Family to family transactions are not arm’s length, because we know the buyer and seller know each other. They are not very helpful in determining true market value. Often, family-family sales are usually done via a Quit Claim Deed (QCD), which would not show in the MLS, or any third-party sites. This information is usually in the public record. If possible, family-family transactions should not be factored heavily into the analysis of market value because they don’t represent a “typical” buyer.
Trust a Human, Not a Machine
Third party sites like Zillow, Realtor.com, Trulia, etc., will give their estimates of what a home is worth. Behind the scenes in the real estate industry, it is our joke that these estimates are always wrong. Do not use them! They are simply algorithms that compile a list of homes within a radius of the subject and do not take in to account any differences in upgrades and/or property condition. Since the algorithms put so much emphasis on each day’s sales, they are inaccurate. In reality, property value is determined over seasons, and not day-to-day. That is not to say, that the algorithm is always grossly incorrect either. With that said, sometimes I see estimates that are spot on. However, those good estimates are cookie-cutter subdivision homes that usually are identical in features, location and price. Most locations or properties will not fit these criteria.
As a buyer or a seller, what options do you have to determine a professional’s opinion of fair market value? There are two types of price opinions that you can encounter: an appraisal or a comparable market analysis (abbreviated “CMA”). Only licensed appraisers can conduct accurate appraisals. However, licensed Realtors and brokers, like me, may conduct CMAs. Costs and level of detail will depend on the analysis & the professional who is conducting it. An appraisal is usually a few hundred dollars surcharge, while a CMA is generally included in the commission you pay to your Realtor. In this area, a standard appraisal will cost you about $300-500. If there are two options, which is best for you? It really depends on your role in the transaction.
What kind of market value analysis do you need?
Seller
Usually, a seller can get by with just a CMA from their Realtor to decide a listing price. On the other hand, you might want an appraisal if you’re selling for sale by owner. These sellers don’t have a Realtor to consult for a CMA. However, some sellers who work with a Realtor will also choose to purchase a second opinion with an appraisal. If your buyer is using financing, like a mortgage, the lender usually requires a third-party appraisal. The lender will not accept the previous appraisal or the CMA. An appraisal is not required for cash buyers.
Buyer
When purchasing a home, a quality buyer’s agent, like myself, will provide you with a CMA prior to placing an offer. As mentioned above, if you are using a mortgage, the lender will also require an appraisal to be completed at buyer’s expense. The pre-offer CMA by the Realtor is used to predict the appraised value by the lender-issued appraisal. Honestly, the CMA does not always predict the appraised value exactly, but a Realtor with strong pricing skills often comes very close. At the end of the day, that’s all an appraisal is—ONE person’s opinion of market value.
Importantly, no two appraisers or Realtors will complete an appraisal or CMA the same exact way. As with many types of analyses, the product is only as good as the data going in. While the processes used to form price opinions differ between Realtors and appraisers, in general they both rely heavily on the pricing information in the local Multiple Listing Service (MLS). The data used are called “comps” which is short for comparable homes. Comps must be carefully selected for their relevance to the subject property, and not used to “justify” a seller’s preferred listing price.
My Guide to Finding Great Comps
Both Realtors and appraisers undergo extensive education to accurately price real estate. But, you can learn some of our tools. Here are some of the most important aspects to consider for selecting comps:
- Location
- The area should be as close as possible to the subject property, preferably in the same subdivision. If the subject is an HOA-managed neighborhood, you should not select comps from elsewhere.
- For condominiums, you should only select comps from the same building or complex.
- If property is on a lake or body of water, only similar properties should be considered.
- Comps should also not cross any major roads even if they are close & nearby.
- If property backs up to or is situated on a busy road or near commercial property, similarly located properties should be used.
- Do not rely on a radius (i.e. within 0.25 miles or 1 mile of subject property).
- If subject property is on the border between two cities, comps should only be used from the subject city.
- Property type
- The architecture style should be the same – ranches should not be compared to colonials or split levels.
- Both homes should have similar square footage with the range as tight as possible. Generally, a range of a few hundred square feet is acceptable.
- Homes with full basements should not be compared to homes on a slab or with a crawl space. It is okay to compare a home with a finished basement to one with an unfinished basement (see “Adjustments”)
- Presence and type of garage is also a factor. The size of the garage (1 car vs. 2 car) could be adjusted for. However a home without a garage should not be compared to one that does. Same with attached garages.
- Acreage should be considered. A home with a 0.25 acre yard should not be compared to one with 5 acres.
- Rental properties or “fixer-uppers” should be compared with move-in ready owner occupied homes and vice versa.
- Sold type
- Unless purchasing a home on foreclosure or short sale, these “distressed properties” should not be used as in the comparable analysis.
- Homes that were purchased with cash are not very applicable as their price was not verified by an appraisal. They should only be used with caution.
- Selling season
- Keep in mind that in some areas, there will be a significant difference between a winter and summer market. Comps selected from the summer market may be artificially high if listing in the dead of winter, and homes from winter may be cheaper than the competitive summer market is.
- Adjustments
- Appraisals will rely heavily on adjustments for the features that differ between homes. Adjustments are commonly used for a different number of bathrooms, garage size, and basement finishing.
- However, Adjustments are not used for dollar-for-dollar improvements in property (i.e. $20,000 kitchen remodel does not equate to a $20,000 valuation increase). Although, the condition of the property can be adjusted for.
If You Read Only One Thing:
In summary, quality comps choose from homes with similar or identical:
- Architecture style
- Number of bedrooms
- Garage and basement (present/absent)
- Square footage
- Location
- Acreage
Then, you should adjust for these items:
- Number of bathrooms
- Finished basement vs unfinished basement
- 1 car garage vs. 2 car garage
- Condition/updates: great vs. fair
Hopefully, whether you are a buyer or seller, this guide has given you the tools necessary to understand the types of pricing strategies to make sure that the property is sold for a fair market value.
Recent Comments