What is fair market value?
In real estate, fair market value is the price a buyer is willing to pay and a seller is willing to accept in an arm’s length transaction – assuming the property has been appropriately exposed to the marketplace. An arm’s length transaction means the buyer and seller were unknown to each other and there’s no reason why the seller might have sold the home for less than it was worth, such as to a grown child or a good friend.
Since each property is different, the market is always changing and each buyer and seller have their own means and motivations, we don’t know a property’s fair market value until after it sells. Your agent can’t tell you when you sign the listing agreement exactly what that number will turn out to be.
Understanding fair market value is fundamental to buying and selling real estate. Without it, we couldn’t give our buyers context around an offer price. We couldn’t advise our sellers on a listing price. In many ways, we measure our success in a negotiation by whether we’ve achieved or exceeded our clients’ expectations in relation to this value.
Fair market value: a case study.
Mr. Smith wants to sell his Main Street townhome and lists it with a boutique real estate firm. His agent presents a thorough comparative market analysis that suggests the property’s fair market value sits between $1.45 million and $1.525 million. Together, they decide to list the home for $1.5 million on a Monday morning.
The agent effectively markets the home: staging, designing beautiful brochures, hiring a professional photographer and videographer and engaging a measurement technician who produces an accurate floor plan. The agent buys Facebook ads, shares the listing on Instagram, holds an agent’s tour preview and two weekend open houses.
The agent also books private showings for agents during the week. They’ll accept offers on the following Tuesday – eight days after the home is listed. The buyer, Mrs. Anderson, doesn’t know Mr. Smith and views the home with her agent on the weekend. She loves it and writes an offer for $1.4 million on Tuesday. Luckily for her, there are no other offers. After some negotiation, Mr. Smith accepts Mrs. Anderson’s final counter offer of $1.485 million.
Case study questions.
Why does it matter whether the listing agent effectively marketed the property?
The definition of fair market value requires that the sale price is achieved after a property is appropriately exposed to the market. This means potential buyers have a reasonable chance to, most likely, see the listing online and book a showing or attend an open house. To ensure this, an agent has to list the home’s features and benefits correctly, create reasonably effective marketing materials and actively promote the listing by emailing it to other agents in their office, for example. An agent should also share and advertise it on social media and upload it to websites such as REW.ca and others.
Why does it matter that the agent hosted several showings, an agent’s preview and two open houses before reviewing offers?
If the listing agent had effectively marketed and advertised the property, but accepted an offer after just one showing, they wouldn’t know if other buyers were willing to offer on the home. Could a bidding war have driven up the sale price? By holding offers for a week, allowing private appointments, hosting an agent’s preview and two open houses prior to reviewing offers, both the agent and Mr. Smith knew that if only one offer materialized on Tuesday, there were likely no other qualified buyers ready, willing and able to write an offer on the home at that time.
What is an arm’s length transaction?
An arm’s length transaction means there were no special circumstances that could affect the price, such as a husband selling to his ex-wife or a deal between friends. In an arm’s length transaction, the buyer and seller are unknown to each other. If they are acquainted, it’s not a close enough relationship that the buyer might receive a price break, for example.
Usually the buyer and seller are represented by separate real estate professionals, each negotiating on their client’s behalf. If Mr. Smith had sold his home privately to a neighbour, data would show what it sold for, but the price would have no relation to fair market value. Agents wouldn’t use that price when estimating the value of another, similar property in the neighbourhood.
How does fair market value relate to list price?
The list price is rarely the final sale price or fair market value. Sellers and their agents set the list price based on a combination of the seller’s wishes, the agent’s advice about market conditions and the comparative market analysis, which we’ll cover in the next chapter. The combination of the seller, the successful buyer, both agents involved and broadly, other prospective buyers, determines fair market value – which we only know once the property has sold. In this case study, the list price was a little higher than the final sale price, but this isn’t always the case.
Did Mr. Smith, with the help of his agent, achieve fair market value?
Yes – based on the information provided. The case study indicates that the home was properly exposed to the market through advertising, professional marketing materials and buyers had many opportunities to view the home before the offer date. When an offer emerged, the listing agent negotiated with the buyer’s agent and the two parties reached an agreement. The buyer was willing to pay a figure the seller was willing to accept. The parties were unknown to each other and each represented by their own real estate agent.
*Did you know?
Fair market value has no relationship to BC Assessment value. The province assesses property values to determine annual property taxes, which can be found at BCAssessment.ca. It’s a rather crude calculation, which shouldn’t be confused with the price a home will sell for to a willing buyer in an arm’s length transaction.
Consider that the BC assessment is determined without an appraiser seeing the home or asking the homeowner about its condition, such as whether any renovations have been done. How could this value be reliable without that information?
Even if the province thoroughly inspected the property, values are determined annually in July, but not published until the following January. They’d still be out of date and, therefore, useless in determining a home’s value six months later. To analyze fair market value for both buyers and sellers, agents use the most recent comparable sales. Six months wouldn’t be considered recent in most instances.
A Q&A with Mary Cleaver, the author of You Can’t Live in the Ceilings.
Mary Cleaver recently published You Can’t Live in the Ceilings, a practical guide to everything about buying and selling real estate in BC. We sat down with her to ask why she wrote this book and what she hopes Homeseekers will gain from reading it.
