Note Professor Newsletter

Fair Market Value (Continued)

We have the replacement cost approach, the income approach, and the "market" approach. These approaches will define FMV, right? Well, maybe?

We have all heard some definition of "fair market value". It usually goes something like "the price a willing buyer will pay, and willing seller will accept, where duress is not a factor". Here again, we are trying to define "market value" without defining "market". The purpose of this article is point out that you cannot separate the two. Value determines your market, and vice versa.

Let's define "market". Here is one definition that will illustrate that you cannot separate the market from price or value.

The organized exchange of goods, services, or resources between buyers and sellers with common interests, within a specific geographic area and during a given period of time.

Are you beginning to see how "fair MARKET value" takes on a different tone when we start applying the definition of "market". The first question that must be asked, is "WHAT MARKET"?

For example, let's say we have a house that has an ARV of $100,000. Here we will look at how this same house has different prices for different markets.

Does not the ARV imply an end user, or owner occupant market? According to appraisals, and other "logical" information, $100k is what this house will sell for, right? Not necessarily. I have given this as an example of one of the biggest mistakes that new rehabbers make, which is to take the ARV as the "market" price they will get for their property. They then become disillusioned as to why their expertly rehabbed property is not selling. The mistake they make is not determining "the common interests within a specific geographical area". In other words, the neighborhood is predominantly renters and they are trying to price an owner occupied house in a rental neighborhood. They have not matched the price with the target market.

To take this example a step further, since the ARV of the house is $100K, and it will take say $20K to get the property in "marketable" condition, is the house now worth $80K? If so, to whom? To answer this question, we have to go back to the definition of "market". To a rehabber the house might be worth only $50K because after he puts in all his costs, including holding costs; this will give him the profit margin he desires. I have heard many who will say if they bought this house at $50K, they bought it $50K under market value. This is not true because to a rehabber, his "market" value is $50K. If you bought it at $40K, then you bought it $10K under the rehabber's market, and you will be able to arbitrage the deal.

I used the word "arbitrage" to further explain markets, and why your market has to be defined. "Arbitrage" means buying in one market then selling simultaneously in another market to make a profit. Is this not what we call flipping? You purchase a house from a distressed seller, who is in one market, and sell it to a buyer who is in another.

In the next issue, I will discuss the definition of "market" further and examine how the element of time alone can affect a market.

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Go to www.DFWREIN.com for details. Or call Joele at (972) 671-7346