As a real estate investor, market value is an important metric to keep in mind. Put simply, market value is an estimation of how much a property is worth in current market conditions.
Below is a quick guide to everything that you need to know about market value in real estate, including what it is, how it's determined, and how savvy investors use it as a tool to build their portfolios.
What is market value in real estate?
Also known as "fair market value," this term refers to how much a property would sell for on the open market under current conditions. Another way to say it is to call market value an educated estimation of how much the home is currently worth, given its features, condition, location, and current market conditions.
In real estate, market value has a lot to do with supply and demand. In hot real estate markets, for example, the sale price of nearly every property will likely be inflated because there are not enough available properties to satisfy buyer demand. In contrast, in buyer's markets, the market price of a property is likely to be lower because it will be harder to find a willing buyer.
How is the market value of a property determined?
There is no one way to determine a property's market valuation. A property's current market price is determined by how much money market participants, or interested buyers, are willing to pay for the property. There is no one, true intrinsic value to be found.
Real estate agents and appraisers are often tasked with coming up with a fair estimation of a home's market value. While a real estate agent is likely to use a comparative market analysis (CMA) to arrive at a fair asking price for the property, there are three different methods that an appraiser might use to find the appraised value.
Comparable sales approach
The comparable sales approach to an appraisal is very similar to a comparative market analysis. Here, the appraiser will compare the property to other, similar homes that have recently been sold in the area. They will look at the property's features, amenities, condition, size, and location in order to determine how much the property is worth.
The income approach is typically used to value investment properties. This approach to determining an assessed value is based on how much money the property is likely to earn in the future.
This approach looks at the amount of rent earnings that a property might be likely to generate in the current market. Alternatively, in the case of a fix-and-flip investment property, the appraiser might look at the anticipated sale price for the property once all the renovations are done.
Replacement value approach
As the name suggests, the replacement value approach looks at how much it would cost to replace the property from scratch, given the current price of building materials. Typically, this approach is most likely to be used with new-construction homes or with custom-built homes that aren't similar enough to any other properties on the market for comparable sales to be used.
The pros and cons of knowing a property's fair market value as an investor
Now that you know more about what a home's market value is and how it's determined, it's time to take a closer look at the pros and cons of utilizing this metric as an investor.
- It's more accurate than face value: While many investors swear that they can determine the value of an asset just by looking at it, determining the right valuation for a property often takes doing a significant amount of market research.
- It can help determine your purchase price: If you have a good idea of a property's current market valuation, you can easily determine how much it makes sense to offer as a proposed purchase price when you're thinking about buying a property.
- It can help you analyze potential investment opportunities: Purchase price aside, knowing a property's fair value can help you determine if a particular investment property is a good fit for your portfolio.
- It costs money: If you're thinking of having an independent appraisal done on a property, you'll need to be prepared to spend a few hundred dollars on the experience.
- It doesn't account for bidding wars: If you're in competition for a property, you may have to offer more than the fair market value in order to be the winning offer.
- It doesn't indicate future value: A property's current market price is a snapshot in time. Market conditions can change, so there is no guarantee that your property will appreciate with time or added sweat equity.
The bottom line on how investors should use market value
Real estate investors should use market value as a starting point in their research. It can help give you an idea of the current state of a particular market or tell you how much you should offer on a property. However, it is by no means the only metric you should be using. While this post can serve as a guide to market value in real estate, that metric should be just one tool in your real estate investment analysis toolbox.