What is Fair Market Value: definition, conditions, and methods of calculating
Fair market value, or FMV, is a price a willing, knowledgeable, unpressured buyer is willing to pay to a willing, knowledgeable, and unpressured seller. Fair market value is most often used in real estate, investment, legal, and stock market realms, but it can be applied to any buyer/seller market.
Understanding fair market value
The term fair market value is purposefully distinct from similar-sounding terms such as market value or appraised value, as it considers the economics of free and open market activities, whereas the term market value is simply the price of an asset or product in the marketplace.
So, while a home’s market value can easily be looked up in a listing, the fair market value has more intricacies to determine. Similarly, the appraised value refers to an asset’s value in the opinion of a single appraiser, thus not immediately qualifying the appraisal as a fair market value. However, in many cases where a fair market value needs to be determined, an appraisal will usually suffice.
Given the thorough definition of the term “fair market value”, it is often used in legal settings. For example, the fair market values of real estate and property are frequently used in divorce settlements in order to calculate compensation.
Again, fair market value is most regularly used in dealing with the assets in the real estate, investment, legal, and stock market realms, but the buyers and sellers of any products and services use the concept when deciding prices.
Ways to determine fair market value
All things that can be sold, traded, or bartered have a fair market value. If you are selling a used car, the amount a buyer is willing to pay for it will determine its fair market value. Fair market value can be decided in many other ways, some common ones listed below:
- Comparative analysis
When real estate is being sold, real estate agents conduct a comparative market analysis, in which they compare the property to other similar properties. The same can be done for other assets (such as cars, jewelry, rare collectibles) and products. All you have to do is find another item like yours and see the price at which it sells, then go from there in pricing your product, item, or property.
- Professional appraisal
Having certified experts in your field, with their training and experience at hand, appraise an item, product or property can help determine the market value. Though do note that it is important to work with an appraiser who regularly assesses the worth of whatever it is you are trying to find the value of. For example, if you want to know the fair market value of a rare book, hire an appraiser who works with rare books, not just any antiques dealer.
The fair market value of publicly traded stock is calculated by averaging the highest and lowest selling prices of the day. So, if the highest is $15 and the lowest $5, the fair market value for that day would be an average of $10. This can be applied to other fields too in order to find the best free market value of a product.
What affects fair market value
Unfortunately, there is no equation to determine fair market value. Determining a fair market value for your asset, item, or product requires looking into the fair market value of similar products, a professional appraisal, or determining average market value.
However, there are things that can affect the fair market value beyond these. Therefore, adjust your fair market value according to relevant factors, such as:
- Previous purchase price of your asset or service
If you are evaluating an asset not long after it was originally purchased, the price you paid can be a good indicator of its current fair market value.
- Past sales price of similar asset
This is relevant when the sale of an item was very recent and the asset that was sold is similar to the item being valued.
- Replacement cost of asset or service
The cost to replace the asset or service may be relevant, especially the going price of an identical item or service.
Having said that, there may be many other factors that set your assets and services apart from others on the market, so you may not always end up comparing apples to apples.
Besides, fair market value is not even always completely fair. In some instances, fair market value gets totally derailed. For example, let’s imagine a famous rapper teams up with a famous shoe company to release limited edition designer sneakers. Expectedly, this rapper’s fans are completely willing to forgo what would be the fair market value and will pay exorbitantly more for the shoes than they are worth, even when they know a sneaker is not truly worth $500 or more. In this kind of scenario, the fair market value is inflated to reflect the price the consumer is willing to pay.
Why fair market value is so important
Simply put, fair market value is a financial concept related to the price a buyer will be willing to pay and a seller will be willing to sell for, with reasonable knowledge about the item in the open market, free from pressure.
The fair market value process offers many advantages. In its broadest economic sense, fair value represents the potential price or value assigned to an asset, product, or service, taking into account its utility, supply and demand for it, and the amount of competition for it. Knowing the fair market value leads to being able to price a product in a range that people will be willing to pay for it, while not underselling yourself.