What is Market Value?

Market Value Dissected

There are different definitions of market value but today I’m going to discuss the one that appraisers use in their appraisal reports.

A Look At Market Value

Here is the definition of market value that is included in every appraisal report:

The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:

  1. buyer and seller are typically motivated;
  2. both parties are well informed or well advised, and each acting in what he or she considers his or her own best interest;
  3. a reasonable time is allowed for exposure in the open market;
  4. payment is made in terms of cash in U. S. dollars or in terms of financial arrangements comparable thereto; and
  5. the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

Now let’s dissect this to see exactly what it means.

The appraiser’s main goal is to provide a professional opinion as to what the most likely value of a property would be in a competitive and open market but what does this mean. A competitive market is one in which there are other houses available for sale that compete with the subject property.

An open market is one in which anyone can participate. It is not limited to certain people but to everyone who wishes to take part.

Those buyers and sellers that do engage are assumed to be doing so in a manner that benefits themselves. Most homeowners would not sell their home for a lower amount than what another similar home could be sold for.

The same goes for buyers. They would not pay more for a home than they could buy another similar one for.

Both buyers and sellers enter the market with a certain amount of knowledge of what a property is worth. If they don’t have sufficient information in the beginning most people will find out what they need to know so they don’t buy or sell a home for more or less than what it is worth.

There are situations that may create an undue stimulus that could affect the price. Examples of this are divorce, foreclosure, or the need to move quickly due to a job transfer among others.

For buyers, the need to have a place to live can also create a strong motivation to pay a certain price. If you are moving in from out of town due to a job transfer you may be willing to pay more than the list price to have a place to live.

In today’s ultra-competitive market homes do not stay on the market for long. In a more normalized market exposure time takes longer and any irregularities in the list price may be ironed out.

What this means is that in a balanced market a home that is priced too high will most likely not get snatched up as fast as it would be if it were priced to the market. It may experience price reductions until it is in equilibrium with the market and then it will sell.

The metric for this is the sale price to list price ratio. For the Birmingham real estate market this is typically 95-99% which means that the sale price will be 95-99% of the original list price.

In today’s market, it is not uncommon for this to be over 100% due to the high demand and low inventory. This is not true for every market area or every price range but is occurring in high-demand areas.

The payment for a property can also affect the price. If payment varies from either cash or financing not equivalent to cash the appraiser must determine if this affected the sale and if it did adjustments must be made. If a boat was thrown in on a lake property, or a tractor with a piece of farmland, it may affect what the final price was and this must be accounted for.

Lastly, if creative financing was used this may also affect the final price. For example, if a higher or lower than market interest rate and loan terms that vary from the norm are used will this result in a price different than if market rates and terms were used? It very well could.

Going back to the beginning of the definition we also see that it states that it is the most “probable price”. This does not mean a price that one or two people might pay but rather what the majority of people in the market might pay.

One person may pay over market value for a home that meets all of their requirements but would the majority of other buyers? Probably not.

In the appraisal, a minimum of three comparables are required but in reality, it could be 6-10, including active listings and pending sales. This provides a range of possible values for the property. Within that range, the appraiser must reconcile a value that they believe reflects the most probable value or one that the majority of people would pay given current market conditions.

Market Value vs Market Price

Sometimes people confuse market price with market value. I have heard many people state that a home is worth what someone is willing to pay for it.

While this is true the price may not always reflect market value, but it could. The price could reflect a possible value but maybe not market value, which is the value that the appraiser is estimating.

The appraiser’s job is to provide an educated and professional opinion as to what the majority of people would pay. If you have ten buyers and 9 would pay the price in question then that would reflect market value, however, if only one would pay the price out of ten that is market price.

In the end, we must not confuse the highest possible selling price with the most probable selling price.

Question

Do you have any comments or questions about what market value or market price is? If so please leave a comment below and as always thanks for reading.

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Comments

  1. The market today is very reminiscent of the frenzy during the mid-2000’s; the factors driving it are certainly different, but the mindset of buyers is quite similar.

    I will take issue with the first sentence of your blog regarding the quoted definition being the one “that is included in every appraisal report.” It is certainly most common, because most appraisals are prepared for purposes of mortgage lending, but there are a multitude of other definitions of market value and fair market value that apply to assignments other than mortgage lending – civil litigation, eminent domain, estate valuation, assessment/tax appeals and financial reporting, to name a few.

    And the definitions that apply to these types of assignments are quite different, even though they all purport to define the concept of market value. For starters, not all use the term “most probable price” – some use the term “highest price” and others have no qualifier associated with the word “price.” And most other definitions do not contain the long list of normative conditions that apply to the lending definition found in Title 12 of the Code of Federal Regulations (that’s the one you cited).

    The fact that there are a plethora of market value definitions that can sometimes be used to generate different numbers is, IMHO, a problem, something I addressed in my article on the topic of market value that was published in The Appraisal Journal in 2018:

    https://coastlinerealtyadvisors.com/wp-content/uploads/2018/10/Market_Value.pdf

    Is what is happening now really market value? Might depend on what definition of the term is being used. One important caveat to appraisers who venture outside the realm of mortgage lending – check the applicable definition of market value for whatever type of assignment you are doing; I guarantee that the proper definition will NOT be the one used for lending purposes.

    • Michael, thanks for your response. You are right, I should have noted that the market value definition I included is the one for mortgage lending. Since that is mostly all I do I had my blinders on and was thinking along those lines. Thanks for bringing to light the other definitions. I also question whether what is going on now is market value. It will be interesting to see what direction things will take and how property values and prices trend in the months and years ahead.

  2. Jim Fike says

    Privity, what in the world is that? Do Realtors rely on this to escape liability from future buyers and home sellers? What is the definition of privity? All parties involved in a Real Estate appraisal should confirm their standing before PAYING for an appraisal thru their Lender. It’s complicated & interesting!

  3. Mark Ziegler says

    Hey Tom,

    Excellent (and timely) post in current times. It’s wild how many times as of late I’ve had to point out the definition (most probable, not most possible) for a sales transaction. I recently had an AMC request a detailed explanation (which existed already, were they to take the time to read the report and view the statistics supplied) as to why the property didn’t appraise for the contract price. Imagine that…haha.

    I recently did an appraisal for a purchase of a vacation home the seller’s were using as a rental. The property was never exposed to the open market and a local agent who knows the owner brought a buyer and drafted a contract. The property appraised for approximately 10% less than the contract price. The AMC sent over an amended contract, asking me to change the sales price as the seller and buyer had agreed upon a sales price 5% over the appraised value (which I didn’t). Work was backing up and I didn’t pay total attention, but I called to schedule an inspection for a refinance on a waterfront property in the same area that’s the primary residence of the seller’s of the vacation home. I had a rather lengthy discussion with the owner (husband) regarding his property and my experience with these type properties in the area and we scheduled a time to conduct the inspection. Afterward I had to run out of the office on a quick errand, so I didn’t bother to take my phone. I returned to a message on my phone from this property owner who remarked: “You’re an idiot, a hack, have no idea what you do for a living and you cost me over $25k. You’ll never be allowed on any property I own.” I thought about contacting him to discuss the difference between most probable price as opposed to most possible price, which was obviously what the lender had requested, but then I thought better and didn’t return the call. Certainly not ironic the lender (nor the buyer or agent for that matter) didn’t contact me to complain about the report.

    • Wow! I also hear agents and other make comments that show that they are confusing the most probable and highest price, which is why I thought this topic would be helpful. It’s probably a good thing that you did not pursue that second appraisal as I am sure it would have been more of a headache than what it was worth. Thanks for sharing.

  4. It’s a wild market out there Tom. I find it often feels like auction value lately…

    • I agree. Will that now be considered “market value” since a majority of buyers are standing in line to pay over the list price? We are in unchartered waters.

  5. Lawrence Fenimore says

    Good luck figuring this [hypothetical nightmare out?] pending do not divulge the sale price remember so there fire are showing possible upper limit but not necessarily. To many moving parts, don’t you feel this way. We appraisers are up against impossible odds since nothing can be nailed down in the debacle.

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