What is market value?
Ask a lender, agent, and appraiser to define this, and you'll likely get three different definitions. Today we'll look at why the real estate industry, 1) generally, uses the Fannie Mae definition, 2) sometimes needs to know a different definition of value.
Fannie Mae includes the following definition in their 1004 UAD Form:
Market value is 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 considers his 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.
Before we look at this value definition deeper, let's look at some alternatives that may be requested by lenders.
Disposition Value - what would the property most likely sell for after a limited marketing time.
Liquidation Value - what would the property most likely sell for after an extremely limited marketing time.
These values are often sought by lenders to understand 1) how quickly an asset can be removed from their books, and 2) what potential loss might be suffered in the process.
In addition to these "value" definitions, others might include:
Highest possible price - this differs from the market value and seeks to understand what "might" happen if the "right" cash buyer came along. Agents when listing a home will likely explore this possibility in their analysis, but should also be grounded to the actual market value.
Market value in eminent domain cases - this is the source of a great deal of tension. The "value" determined by the government in a case of "taking" a property by eminent domain is not what the property is worth before the "taking" action, but after. For example, if the government takes the 100 ft of your property that fronts a road, and moves the road, such that your land is now divided - the value the government would offer is not that of the 100 feet before the road is built, but the value of it after the road is built (which will likely be severely lower).
With this understanding that there are many definitions of "value" that someone might have, let's perform a thought experiment to understand what "market value" really is.
Imagine for a moment a rich man traveling in a desert, alone, without water, and with $10,000 in his pockets. The man is becoming delirious when a child comes along and sees the man. The man looks up to the child, and sees his water jug, and reaches out in need. The child recoils in suspicion. The man reaches into his pockets and throws the money at the child's feet, with hands begging for the water. The boy throws down the jug, gathers up the money, and runs back to his home in the desert.
The child runs home, draws up another jug of water and now offers it to the residents... for a mere $10,000, and the boy scratches his head... What is the market value of a jug of water. Let's suppose that water sells for $1 per jug in the town on a typical day.
Did the sale of one jug for $10,000 change the market value of "water" in the town?
Will anyone ever again get such a price under normal circumstances?
Was the rich man in the desert "typically motivated?"
Was the rich man "well informed?"
The answer to all of these questions is of course, No. One sale at an outrageous price does not change the market as a whole. Markets, when they are healthy, move slowly over time in keeping with supply and demand. One unknowledgeable sale (much less, merely an offer) doesn't change the value.
If your sale is going to have a lender involved, and government underwriting (conventional, FHA/USDA/VA), understand that the market value definition above is the only definition that matters. You might find a desperate soul willing to pay more than that... but you better make sure they have the cash upfront.