Have you purchased a property that wasn’t publicly marketed?
I have. My husband and I own the Shoe House in York, which we purchased directly from the seller, who happened to be an acquaintance of ours. The seller didn’t want a lot of publicity, which is why they chose to sell privately.
Many investors earnestly seek the “Off Market” deal, aiming to obtain desirable pricing and terms. Sometimes, they may truly be getting better deals. But mostly, they’re limiting competition, which can help secure better terms if a buyer has an open conversation with the owner. But who is really determining the “fair market value” of the property, and are you really getting a better deal if you buy “off market”?
Is an appraisal the best definition of value? I’ve seen many appraisals which are spot-on, and many that are… not so spot-on. This is especially true in commercial real estate, as many times what makes sense on paper may not hold true in the open market. Here’s my reasoning behind what I think constitutes a true fair market value:
The Foundation: Defining Fair Market Value
At its core, fair market value (FMV) represents the price at which a property would change hands between a willing buyer and a willing seller, neither being under compulsion to buy or sell, and both having reasonable knowledge of relevant facts.
This definition, though seemingly straightforward, encapsulates a multitude of factors that collectively determine a property’s worth.
Firstly, FMV isn’t a static figure; it’s a fluid concept influenced by the ebbs and flows of the market. Economic conditions, supply and demand dynamics, interest rates (the biggest influence right now in many cases), and even geopolitical events all can sway the perceived value of real estate assets. Thus, what constitutes fair market value today might differ tomorrow, reflecting the ever-shifting landscape of the real estate market.
Secondly, the notion of willing buyer and willing seller is pivotal. In an ideal scenario, both parties enter the transaction voluntarily, with no external pressures dictating their decisions.
The concept of reasonable knowledge underscores the importance of transparency and information symmetry in real estate transactions. Both buyers and sellers must have access to pertinent data regarding the property, including its physical condition, location, comparable sales, and market trends.
Sometimes a seller or a buyer may not understand other market dynamics, which can also lead to an uneven transaction. I’ve seen and heard stories that involve things like:
– An investor buying land to develop, when they did not understand the challenges of development.
– Buyers purchasing a house at auction without an inspection, not knowing it had a cracked foundation and termite damage.
– Property that was purchased for a change in use, but the investor doesn’t understand a change in use (even if permitted by zoning) may trigger many code-required changes. An example would be a renovation from office into apartments, which can trigger a requirement for sprinklers.
FULL knowledge is what facilitates fair market value.
Unraveling the Determinants of Fair Market Value
While the definition of FMV provides a conceptual framework, the actual process of determining the number involves an examination of various factors. One of the primary determinants is the property’s characteristics, including its size, location, age, condition, architectural style, and amenities.
Market comparables play a crucial role in assessing FMV. Most houses are fairly easy to compare, as many similar properties usually exist within current sales, setting a benchmark for future sales. However, in commercial sales (5 of more units of apartments), the comparable data becomes harder to obtain. This challenge can increase if there is a lack of sales within a market as well.
Over the course of the past year, investment sales have slowed considerably as interest rates have climbed. As a result, comparable sales are much harder to find. The sales that have traded may also be influenced by:
– assumable financing
– 1031 buyers, who are more highly motivated to make the transaction
– sales that are the result of settling an estate, with a higher motivation level for the seller
Even if you have two sales that were exactly the same in unit count, similar location, and comparable amenities – factors like these can also affect the outcome.
While an appraisal provides a backwards-looking view of value, it is limited in looking at forward-facing value and trying to predict what the current market will do.
This is why placing a property for sale on the market will determine a property’s value better than an appraisal, as the forward-looking view is what the buyers are considering, as opposed to an appraiser’s mostly rear-facing view.
Anticipating What Is To Come in Value
An interesting component of the investment real estate market right now is this: the housing market continues to remain very strong with elevated pricing. This results in many home buyers, especially in lower price ranges, being shut out of home purchases.
If interest rates decrease as we anticipate they will at some point this year, more buyers will enter the market, creating more competition and driving prices up even further. This results in more would-be homebuyers stuck in the rental housing market. And if the rental housing market is doing so well, why would any smart investor take less for their property?
This market dynamic is what we’re seeing right now – buyers who see the interest rate and are pressing back on prices, while sellers see a strong rental market and are standing by their pricing.
If rates do fall in the near term, expect an increase of investor activity as buyers and sellers find a meeting point again. Rental rates will likely accelerate as interest rates decrease, allowing buyers to find that sweet spot of positive leverage again.
Conclusion: Fair Market Value – Who Decides?
As we discussed here, fair market value is the meeting of the seller and buyer on open market terms, without duress. We have been in a time with limited “meeting of the minds”, but expect that a return to many more transactions will be coming as the market dynamics shape the returns that investors seek.
Recent market dynamics have caused many investors to sit on the sidelines or exit completely. We provide detailed knowledge of the market to move you towards growing your wealth. Contact us today for an opinion of value on your property, or to locate your next acquisition.
