What Is Fair Market Value?

Fair market value (FMV) is the price at which a property would sell in an open, competitive market where buyers and sellers have all relevant information and enter the transaction willingly, without any undue pressure.
This figure is important for homeowners listing their property for sale and homebuyers looking to make a wise investment. It may also be used in property taxes, estate planning, divorce settlements, and property insurance.
Fair market value can be calculated by comparative market analysis (CMA), which compares recent sales prices of similar properties, cost approach, which determines the expense to rebuild from the ground up, or income approach, which explores the revenue generated by an investment property.

Whether buying a new home, selling a property, or managing assets, understanding fair market value can help you make better financial decisions.

FMV principles apply to all assets of value, but the term is most often associated with real estate. Property values play a crucial role, not just in real estate, but in taxation, insurance, estate planning, and your financial health.

This article will explain exactly what FMV is, how it’s calculated, and why it matters to you.

What Is Fair Market Value in Real Estate?

Fair market value is the price at which a property would be expected to sell in a competitive, open market where:

Both the buyer and seller have all the relevant information about the property
Both parties enter the transaction willingly, without any undue pressure
The transaction is conducted at arm’s length, meaning that there is no special relationship between the buyer and seller, and each party is acting in their own best interest.^[1]

Why Fair Market Value Matters

Fair market value has many important applications across real estate, taxation, estate planning, lending, insurance, and legal situations as follows:

Buying or selling real estate. FMV helps sellers set a competitive asking price and helps buyers determine an appropriate offer price.
Property taxes. Many local governments use FMV to calculate property taxes, basing the tax amount largely on the property’s current value.^[2]
Estate planning and inheritance. The FMV of an asset is used when dividing inheritance among heirs and calculating inheritance taxes.
Divorce settlements. FMV is critical for equitably dividing marital assets, including real estate, in divorce proceedings.
Secured loans. Lenders need to know the FMV of any asset used as collateral for secured loans. In mortgage lending, for example, lenders must confirm the value of the property to determine how much the buyer can borrow for the purchase.
Insurance coverage. Because an asset’s value changes over time, owners should periodically estimate FMV to make sure their coverage matches the asset's value in case of damage or loss.
Financial reporting. Businesses need to know the FMV of owned real estate and other significant assets to generate accurate financial statements.
Investment decisions. Investors use FMV to calculate return potential.
Eminent domain claims. FMV determines fair compensation when the government acquires private property for public use.^[3]
Charitable donations. When donating property or assets, FMV is used to calculate appropriate income tax deductions.^[4]

How To Determine Fair Market Value

There are three primary methods of valuing real estate:^[5]

1. Comparative Market Analysis (CMA)

This method calculates the FMV of a home by comparing the sales prices of recently sold comparables (properties nearby with similar sizes, conditions, and features). Real estate agents and appraisers typically use this approach when estimating the FMV of residential properties.

2. Cost Approach

This method calculates FMV by evaluating the cost of rebuilding the property from scratch, including construction and land costs, while accounting for depreciation. This method is often reserved for unique properties or those without many comparable sales.

3. Income Approach

Primarily used for investment properties, this method calculates FMV based on the income the property generates. You can divide the annual net operating income by the capitalization rate to determine the FMV of an income property.

Factors That Affect FMV

FMV is a moving target, constantly fluctuating with changing conditions.

Common factors that influence fair market values of real estate include:

Market conditions: The balance between supply and demand, as well as economic factors such as interest rates and employment levels
Economic and political factors: Broader economic stability, inflation, tax policies, government incentives for homebuyers, etc.
Location: Proximity to schools, transportation, and neighborhood amenities
Property condition: A structure’s age, build quality, and level of maintenance
Size: The square footage of the structure, size of the lot, and number of bedrooms and bathrooms
Additional features: Pools, garages, energy-efficient appliances, fireplaces, views, etc.

Fair Market Value vs. Other Valuation Metrics

Fair Market Value vs. Market Value

Fair market value and market value are closely related terms, often used interchangeably. The difference is that market value is a more general term. It is simply the price a property would currently sell for on the open market. It does not carry the fair market value requirements that both buyer and seller have full knowledge of the property and that both are acting in their own best interests, free from undue pressure.

Fair Market Value vs. Appraised Value

An appraised value is a licensed appraiser’s professional opinion of the value of a property.^[6] These experts are well-trained in real estate valuation, so an appraised value is often used as a fair market value for all intents and purposes, despite the difference in textbook definitions.

Fair Market Value vs. Assessed Value

An assessed value is a property tax assessor’s opinion of the value of a parcel of real estate for property tax purposes. This figure can be wildly different from the fair market value of a property for multiple reasons:^[7]

Limits on assessed value increases. Many property tax jurisdictions have limits on the amount of assessed value that can increase year-over-year. So, in periods of strong growth, a property’s fair market value may increase by 5% or more, while the assessed value may only increase by 1-2%, depending on the jurisdiction’s limits.
Formulaic assessed value increases. In many jurisdictions, it’s impractical for the tax assessor to evaluate individual properties every tax cycle (typically every year). So, they apply a formula to entire neighborhoods. For example, an assessor may calculate that average property values have risen by .5% in a given area since the last assessment cycle, so they apply a .5% increase to all properties in that area for the new assessment cycle. This leads to many inaccurate valuations, which is why many homeowners appeal their property tax assessments.
Assessors are often unaware of upgrades. Tax assessors typically watch for building permits so they can adjust their assessments to include substantial improvements. However, the assessor may be unaware of smaller upgrades that add to the value of your home, leaving the assessed value lower than the FMV.

The Bottom Line

Fair market value is a vital concept for anyone involved in real estate, financial planning, or asset management, even if your involvement is limited to your personal assets. Before purchasing a home, listing a property for sale, or investing in real estate, make sure you understand the role of FMVs.