How do I Know How Much My House is Worth?

Confused by the different estimates you are finding online for your house? Well, here is an insider’s look at how professionals determine the fair market value of real estate.

The most common reason homeowners want to know the fair market value of their homes is because they are considering selling and want to know how much money they can reasonably expect to gain from the sale. But that is not the only reason. Maybe you are considering applying for a home equity loan or a refinance to drop the Private Mortgage Insurance from your existing home loan. Whatever your reason for valuing your home, you want to get it right (and no, your Zillow Zestimate® is not accurate!). This post will help you understand how much your home is worth.

The Trouble with Fair Market Value in Real Estate

What exactly is “fair market value”? Fair market value is the amount a reasonable buyer is willing to pay for your house at any given point in time. Before we launch into the process of establishing your fair market value, let’s quickly talk about two significant complications:

1. Each property is unique.

2. The market is constantly fluctuating.

Even if you own a tract home surrounded by other homes like yours, your house has a unique geographic location. No other property is located at your longitude/latitude coordinates. And in a world where the three most important factors are location, location, and location, your property’s unique geographic location makes it a snowflake.

And, of course, it is difficult to establish a value when you are comparing unique products. Luckily, your property is probably similar to other properties in your area, so we will be able to use those to at least help us gauge the value of your house.

Complication #2 is that real estate markets are always in a state of fluctuation. Sometimes the market changes are hard and fast, and sometimes they are slow and smooth, but they are perpetually present.

This means the fair market value of your property is constantly changing. It could be one value today and a different value a month from now.

So as we walk through the process for determining your property’s fair market value, remember that no property is the same as yours, and real estate values are constantly fluctuating.

This means your fair market value is probably not an exact dollar value but rather a range.

The Fair Market Value Process

To find the fair market value of your property, we need to find similar properties that sold recently, then adjust the sale prices of those properties to account for the differences between those properties and your property. Believe it or not, the process to find the fair market value of your property is just three steps:

● Step 1: Find Comparable Properties

● Step 2: Make Value Adjustments

● Step 3: Calculate a Weighted Average

Easy, right?

Well…

Each step has its own complexities. Let’s take a closer look at these steps and how, exactly, to complete each of them.

Step 1: Finding Comparable Properties

To get a good idea of the fair market value of your home, you want to compare it to multiple other properties. Choose between 3 and 5 comparable properties (“comps” for short) to calculate a correct value.

What constitutes a good comp? With all the criteria making a property unique (new appliances, renovated kitchen, added garage, square footage, view, etc.), how do you decide which properties would make the most accurate comps?

First, use sales, not listings, as your comps. Anyone can list their house at any price they want. It does not mean buyers will pay that amount. But with sales, you know that there was a buyer willing to purchase at that price.

Having said that, there are five factors to consider when deciding on your comps:

1. Similarity

First, you need your comps to be as similar as possible to your house in terms of square footage, the number of beds and baths, year built, lot size, quality of construction materials, etc. These features do not need to match exactly, but the closer, the better. For example, a 2-bed, 2-bath could be similar enough to your 3-bed, 2-bath to be used as a comp. But comparing your 3-bed to a 1-bed? Probably not close enough. This “similarity” factor will be easy in some markets. If you are in the suburbs where your neighboring homes were built at the same time, in the same style, and often by the same builders, you should have lots of similar properties to choose from. But in some city and rural markets where there is not much consistency to the neighborhoods, you may have a harder time finding similar comps.

2. Location

Location is an interesting factor because a “comparable location” out in the country could extend for miles and miles, but in the city, it could just be a block or two. See, in the city, you may have hundreds of condos packed in tightly. And the neighborhood vibe can change from one block to the next. But in the country, you may only have a few dozen properties in a square mile, all of which share a similar environment. The general rule-of-thumb is to focus on comps within the following ranges: · Cities: ½ mile · Suburbs: 1 mile · Country: 5 miles

3. Special Features

You should also consider any features that make your property special. Do you have a pool? A barn? A spectacular ocean view? These make a big difference in fair market value. Try to choose comps that share these special features.

4. Timing of the Sale

We have already touched on the importance of the constant fluctuations in real estate markets. You need to compare your home to recent sales. But “recent” means something different in a slow-moving market than in a fast-moving market. When values are changing quickly, sales from 6 months ago might be completely different from sales in the last month. The faster your local real estate market is changing, the more recent your sale dates need to be to make the sale prices relevant. As a very general rule, six months is a reasonable timeframe for a not-too-fast market. When markets are moving slowly, and not many properties are selling, you might need to go back a whole year to find comparable sales.

5. Fair Transaction

The final factor in selecting your comps is to make sure the sale was a fair transaction. This means that neither the buyer nor the seller was under extraordinary pressure to complete the transaction. Foreclosures, for example, are usually not fair transactions. The sellers are forced to transfer the property to the bank. Exchanges between family members are another common example of transactions that do not indicate fair market value. Families may transfer properties for far less than the market value to keep the property in the family. Most sales are fair transactions, but you want to give your selected comps a second look to make sure that is the case before relying on the value of that transaction to help determine the value of your property.

What to ignore in your comps

The one thing you should not consider when deciding on your comps is the sales price. Do not ignore a potential comp because the sales price seems high or low at first glance.

The purpose of finding comps is to see how much homes like yours are actually selling for. Not to substantiate a value you already have in mind.

So if you are going to disqualify a property from being a comp, disqualify it because of one of the five factors we just covered. Not because of the sales price.

Ranking Your Comps

Now, how do you prioritize these criteria? Do you choose a property located closer to yours that sold six months ago? Or should you choose a property that sold just last week but is miles away?

That is the art of valuation.

That is why people pay hundreds of dollars for an appraisal when the appraiser follows the same basic process we are examining in this post.

The short answer is, it entirely depends on the specifics of each individual micro-market at a singular point in time. How highly do today’s buyers rank a specific school district? Would local buyers trade a spare bedroom for an amazing view in this economy? Are buyers suddenly clamoring for the neighborhood in the midst of gentrification?

This is one of the reasons it’s so helpful to have a Realtor® in your corner. Real estate agents live and breathe the ever-evolving market. We know which factor buyers are valuing most highly at any given time. And we know how much more critical that single factor is than all the other factors.

But whether you have an Agent or not, once you select three-five “good comps” (they’re fairly similar, are located withinthe general location guidelines, have similar special features, were sold within the last 6-ish months, and were fair market sales), you’re ready to move on to Step 2!

Step 2: Making Value Adjustments

You may see a pretty wide range of sale prices for your comps. And that’s completely fine and normal at this stage. Don’t even worry about it.

Part of the reason for the large discrepancy in prices is that we’re currently comparing apples to oranges. You may be comparing a two-bed to your three-bed. Or a house with a panoramic mountain view to your home with a mountain “peek.”

In this step, we will make adjustments to the values of those comps to simulate an apples-to-apples comparison.

It is best explained with an example.

Let’s say you have a three-bedroom home. Three of your comps are three-bedroom homes, but then you also have a two-bed comp and a four-bed comp. How would we adjust the comp values?

1. The three-bed homes already match your house in terms of bedrooms, so no adjustments need to be made to those comps based on the number of beds.

2. But for the two-bed comp to really compare to your three-bed, we need to pretend it has a third bedroom. We want to know what the sale price for that home would have been if it had a third room. So we need to add the value of an additional room to the sales price of that comp.

3. And for the four-bed: we want to know what the sales price would have been if that house had only had three bedrooms. So we need to subtract the value of a bedroom from the sales price of that comp.

The problem we quickly run into is: how do we know the value of a bedroom? And this is a complex problem to address because the answer (like everything in real estate!) is a moving target.

In family-friendly neighborhoods, extra bedrooms could be worth a lot of money, maybe $25,000. But in urban condos, additional rooms may be seen as a waste of space and money, so they may only be worth $10,000.

And, again, markets are constantly changing. So an extra room in a specific neighborhood may have only been worth $15,000 five years ago, but now it is worth $18,000.

Then consider that we are only addressing one factor at this point: bedrooms. We still need to make value adjustments for all the other factors: baths, lot sizes, building materials, interior finishes, views, special features, year built, etc.

This is why it is so difficult for homeowners (and for the nation-wide websites!) to calculate the fair market value of a property. When you are not dealing with real estate pricing all day, every day, it is challenging to determine these adjustment values.

I hate to keep saying, “call a Realtor®!”, but really, you might want to call a Realtor®...

A good one will do all this for you, so you know what your home is worth. And a great one will walk you through the comps they chose (and why!) and explain their adjustment values to you.

If you are determined to calculate the fair market value of your property yourself, you could try to find two recently-sold properties that are near-identical in every way except the number of bedrooms. Then assume the difference in their sales prices is the value of the added bedroom.

Then repeat that process for each of the other factors for which value adjustments must be made.

Or you could just call a Realtor ;)

Either way, you will adjust the value of each comp to account for any material differences (differences significant enough to affect the value), and you will arrive at an “adjusted value” for each comp. This is the hypothetical value the comp would have sold for if it had actually been much more like your property.

Step 3: Calculating a Weighted Average

With all your value adjustments made and your adjusted values calculated, you are finally comparing apples to apples!

While selecting your comps and adjusting their values, you may have noticed that one or two properties were more similar to your property than the rest. And that fewer adjustments were needed on these properties. That should not be ignored!

Instead of simply averaging the adjusted prices of all your comps to find the fair market value of your property, you should “weight” your comps.

Say you have three good comps. Weighting them all equally would mean they all factor into your final value by 33.3%(100% divided by three comps). But if one comp stands out as being more similar to your property than the others, you could assign it a 50% weight and change the remaining comps to 25% each (so the total still equals 100%).

Time for another example.

Let’s say you have three good comps, with values as follows:

● Comp #1: $235,000

● Comp #2: $210,000

● Comp #3: $225,000

The average would be $223,333.33 ((235,000+210,000+225,000)/3).

But what if Comp #1 is more similar to your property than Comps #2 and #3. So you decide to weightComp #1 50%, and the other two at 25%.

● Comp #1: $235,000 (x 50% = $117,500)

● Comp #2: $210,000 (x 25% = $52,500)

● Comp #3: $225,000 (x 25% = $56,250)

The weighted average would be $226,250 (117,500+52,500+56,250).

In our example, the weighted average of $226,250 is likely more accurate than the unweighted average of$223,333. So we know that $226,250 is in the fair market value range for our hypothetical property. Give or take a few thousand for minor factors; we can reasonably estimate the property between $220,000 and $230,000.

And that is it! That is the professionals' process to accurately estimate fair market values in real estate.

I hope you found this explanation of fair market values helpful.

When you are ready to sell your house, please contact me. I would be happy to provide you with a custom valuation for your property based on up-to-date market conditions and tell you about the many services I offer as a Listing Agent. Can’t wait to hear from you!