Market value is an opinion of the price that a willing seller and willing buyer would probably agree on for a property at a given time if:
- the transaction is a cash transaction
- the property is exposed on the open market for a reasonable period
- buyer and seller have full information about market conditions and about potential uses
- there is no abnormal pressure on either party to complete the transaction
- buyer and seller are not related (it is an “arm’s length” transaction)
- title is marketable and conveyable by the seller
- the price is a “normal consideration,” that is, it does not include hidden influences such as special financing deals, concessions, terms, services, fees, credits, costs, or other types of consideration.
Another way of describing market value is that it is the highest price that a buyer would pay and the lowest price that the seller would accept for the property.
The market price, as opposed to market value, is what a property actually sells for. Market price should theoretically be the same as market value if all the conditions essential for market value were present. Market price, however, may not reflect the analysis of comparables and of investment value that an estimate of market value includes.
The appraisal and its uses
While most appraisals seek to estimate market value, any of the types of value described earlier may be the objective of an appraisal. An appraisal is
distinguished from other estimates of value in that it is an opinion of value supported by data and performed by a professional, disinterested third party. Appraisers acting in a professional capacity are also regulated by state laws and bound to standards set by the appraisal industry.
Broker’s opinion of value. A broker’s opinion of value may resemble an appraisal, but it differs from an appraisal in that it is not necessarily performed by a disinterested third party or licensed professional and it generally uses only a limited form of one of the three appraisal approaches. In addition, the opinion is not subject to regulation, nor does it follow any particular professional standards.
Uses. The appraisal itself is used in real estate decision-making to estimate one or more types of value, depending on the kind of decision to be made. Appraisals may be ordered and used by mortgage lenders, government agencies, investors, utilities companies, and real estate buyers and sellers.
An appraisal helps in setting selling prices and rental rates, determining the level of insurance coverage, establishing investment values, and establishing the value of the real estate as collateral for a loan.
Appraisals may be developed and reported in a narrative format or on a prescribed form with attachments. The most commonly used form for residential appraisals is the “Uniform Residential Appraisal Report” (URAR) promoted by the Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC) (known as Fannie Mae and Freddie Mac, respectively).
Steps in the appraisal process
A systematic procedure enables an appraiser to collect, organize and analyze the necessary data to produce an appraisal report.
Purpose. The first step in the process is to define the appraisal problem and the purpose of the appraisal. This involves
- identifying the subject property by legal description
- specifying the interest to be appraised
- specifying the purpose of the appraisal, for example, to identify market value for a purchase, identify rental levels, or establish a value as collateral for a loan
- specifying the date for which the appraisal is valid
- identifying the type of value to be estimated
Data. The second step is to collect, organize and analyze relevant data about the subject property. Information relevant to the property includes notes and drawings from physical inspection of the subject, public tax and title records, and reproduction costs. Relevant information about the market includes environmental, demographic, and economic reports concerning the neighborhood, community, and region.
Highest and best use. The third step is to analyze market conditions to identify the most profitable use for the subject property. This use may or may not be the existing use.
Land value. The fourth step is to estimate the land value of the subject. An appraiser does this by comparing the subject site, but not its buildings, with similar sites in the area, and making adjustments for significant differences.
Three approaches. The fifth step is to apply the three basic approaches to value to the subject: the sales comparison approach, the cost approach, and the income capitalization approach. Using multiple methods serves to guard against errors and to set a range of values for the final estimate.
- weigh the appropriateness of a particular approach to the type of property being appraised
- take into account the quality and quantity of data obtained in each method
Report. The final step is to present the estimate of value in the format requested by the client.