Determining the Fair Market Value of a Home

When you’re looking for the right house, it’s good to know the fair market value. This article helps you determine the fair market value of the properties you’re interested in.

Believe it or not, houses are like Red Delicious apples. Most houses are green and need more time on the real estate tree before they’re ready to pick. A few are ripe for picking right now. The trick is knowing which is which, because houses don’t turn red as they ripen.

That’s one reason you must understand fair market value and know the asking prices and sale prices of houses comparable to the one you want to buy. Smart home buyers know which houses are green and which are ripe.

The basics of a helpful CMA

The best way to accurately determine a home’s fair market value is to prepare a written comparable market analysis (CMA). A competent real estate agent can and should prepare a CMA for a home that you’re interested in before you make your purchase offer.

Every residential real estate office has its own CMA format. No matter how the information is presented to you, the tables below show you what good CMAs contain.

These are facts. The CMA’s “Recent Sales” section helps establish the fair market value of 220 Oak — your dream home that’s currently on the market — by comparing it with all the other houses that:

• Are located in the same neighborhood
• Are approximately the same age, size, and condition
• Have sold in the past six months

These houses are called comps, which is short for comparables. Depending on when you began your house hunt, you probably haven’t actually toured all the sold comps. No problem. A good real estate agent can show you listing statements for the houses you haven’t seen, take you on a verbal tour of the properties, and explain how each one compares with your dream home.

Communicating well with your agent about subjective terms such as large, lots of light, close to school, and so on is critically important. You must understand precisely what the agent means when using such terms. Conversely, your agent must understand precisely what you want, need, and can afford.

If you and your agent were to analyze the sale comps in our example, you would find that houses comparable to the home you want to buy — 220 Oak, in the “Currently for Sale” section — are selling for slightly over $200 per square foot. Putting the sale prices into a price-per-square-foot basis makes comparisons much easier. As you can see in the “Currently for Sale” section, anything that’s way above or below the norm really leaps out at you.

The “Currently for Sale” section of the CMA compares your dream home (in this case, 220 Oak) with neighborhood comps that are currently on the market. These comps are included in the analysis to check price trends:

• If prices are falling: Asking prices of houses on the market today will be lower than sale prices of comparable houses. This may be due to an increase of distressed property sales.
• If prices are rising: You’ll see higher asking prices today than for comps sold three to six months ago.

If you’ve been looking at houses in a specific area for a while, you’ve probably been in all the comps currently on the market in that area. You don’t need anyone to tell you what you’ve seen with your own eyes. However, you do need an agent’s help to compare the comps you’ve seen with comps you haven’t seen, because some houses sold before you began your house hunt.

As the “Currently for Sale” section shows, your dream house appears to be priced very close to its fair market value based on the actual sale price of 210 Oak (in “Recent Sales” section). Given that 220 Oak has 1,880 square feet, it’s worth $392,920 at $209 per square foot. Factually establishing property value is easy when you know how.

Your CMA must be comprehensive. It should include all comp sales in the past six months and all comps currently on the market. Getting an accurate picture of fair market values is more difficult if some parts of the puzzle are missing, especially in a neighborhood where homes don’t sell frequently.

Like milk in your refrigerator, comps have expiration dates. Lenders usually won’t accept houses that sold more than six months ago as comps. Their sale prices don’t reflect current consumer confidence, business conditions, or mortgage rates. As a general rule, the older the comp, the less likely it is to represent today’s fair market value.

Six months is generally accepted as long enough to have a good cross section of comp sales but short enough to have fairly consistent market conditions. But six months isn’t carved in stone. If a major economic calamity occurred three months ago, for example, then six months is too long for a valid comparison. Conversely, if homes in a certain area rarely sell, you may need to examine comparable sales that occurred more than six months ago.

Sale prices are always given far more weight than asking prices when determining fair market value. Sellers can ask whatever they want for their houses; asking prices are sometimes fantasy. Sale prices are always facts — they indicate fair market value. The best proof of what a house is worth is its sale price. Don’t guess — analyze the sale of comparable homes.

Be sure that the comparable sales information factors in price reductions or large credits given for corrective work repairs (for example, a $5,000 credit from the sellers to the buyers to replace a broken furnace).

The flaws of CMAs

CMAs beat the heck out of median-price statistics for establishing fair market values, but even CMAs aren’t perfect. People can use exactly the same comps and arrive at very different opinions of fair market value. Discrepancies creep into the CMA process if you blindly compare comps without knowing all the following details of the subject properties:

• Wear and tear: No two homes are the same after they’ve been lived in. Suppose that two identical tract homes are located next door to each other. One, owned by an older couple with no children or pets, is in pristine condition. The other, owned by a family with several small kids and several large dogs, resembles a federal disaster area. Your guess is as good as ours when figuring out how much it’ll cost to repair the wear-and-tear damage in the second house. A good comparable analysis adjusts for this difference between the two homes.
• Site differences within a neighborhood: Even though all the comps are in the same neighborhood, they aren’t located on precisely the same plot of ground. How much is being located next to the beautiful park worth? How much will you pay to be seven minutes closer to the commuter-train stop? These value adjustments are a smidge less precise than brain surgery.
• Out-of-neighborhood comps: Suppose that in the past six months, no homes were sold in the neighborhood where you want to live. Going into another neighborhood to find comps means that you and your agent must make value adjustments between two different neighborhoods’ amenities (schools, shopping, transportation, and so on). Comparing different neighborhoods is far more difficult than making value adjustments within the same neighborhood.
• Distressed property sales: Foreclosures are easy to spot; short sales aren’t. A house, for example, may come on the market as a normal owner-occupied property sale. However, sometime while it was being marketed or after an offer had been accepted but before the sale was completed, the house became a short sale because the owners didn’t keep up their loan payments. A good agent continually checks the Multiple Listing Service to determine if any properties you’re using as comps became short sales or bank-owned properties. If so, they may not be good comps because they sold under duress.
• Noncomp home sales: What if five houses sold in the neighborhood in the past six months, but none of them were even remotely comparable in age, size, style, or condition to the house you want to buy? You and your agent must estimate value differences for three- versus four-bedroom homes, old versus new kitchens, small versus large yards, garage versus carport, and so on. If the home you want has a panoramic view and none of the other houses has any view at all, how much does the view increase the home’s value? Guesstimates like these don’t put astronauts on the moon.

These variables aren’t insurmountable obstacles to establishing your dream home’s fair market value. They do, however, greatly increase the margin of error when trying to determine a realistic offering price. You can minimize pricing problems created by these variables if you and/or your agent actually tour comparable homes inside and out.

A valid comparison of your dream home to the other houses is impossible if you and your agent have only read about the comps in listing statements (brief data sheets about houses offered for sale) or seen the properties on a website. Here’s why:

• Most listing statements are overblown to greater or lesser degrees. You don’t know how exaggerated the statement is if you haven’t seen the house for yourself. You may consider the “large” master bedroom tiny. That “gourmet” kitchen’s only distinction may be an especially fancy hot plate. The “sweeping” view from the living room may exist only if you’re as tall as LeBron James. Of course, you won’t know any of these things if you only read the houses’ puff sheets instead of visiting them in person.
• Floor plans greatly affect a home’s value. Two houses, for example, may be approximately the same size, age, and condition, yet vary wildly in value. One house’s floor plan flows beautifully from room to room; the rooms themselves are well proportioned with high ceilings. The other house doesn’t work well because its floor plan is choppy and the ceilings are low. You can’t tell which is which just by reading the two listing statements.
• Whoever controls the camera controls what you see. Remember when viewing those stunning color photos or the video footage of a house advertised on a website that you’re permitted to see only what the person who took the pictures wants you to see. You certainly won’t get a peek at less desirable things, such as worn areas on the living room carpet or graffiti sprayed on the garage door of the house next door.

Eyeball. Eyeball. Eyeball. Eyeballing — personally touring houses and noting important details both inside and out with your own eyes — is the best way to decide which houses are true comps for your dream home.

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