Since the object to real estate investing is to make money, it’s important that real estate investors understand some basic information about investment property market value.

Obviously, the best real estate investment is being able to buy a rental income property you can make money on when you buy, as well as when you sell. In other words, you buy properties at or (preferably) below their market values. When you do this, you reduce risk and increase your chance for great returns.

Okay, but this tactic requires that you know what the term “market value” really means.

What is Market Value?

There are essentially three terms used in real estate to denote property value such as “appraised value,” “sales price,” and “market value”. These do not all mean the same thing, and it’s important for the real estate investor to understand the distinction.

• “Appraised value” could refer to an insurance appraisal, a property tax appraisal, an estate tax appraisal, or a market value appraisal.
• “Sales price” merely refers to the nominal price at which a property has sold. That sales price could equal, exceed, or fall below market value.
• “Market value” equals sales price when a property is sold according to five conditions: (1) Buyers and sellers are typically motivated (not acting under duress), (2) buyers and sellers are well informed about the market (they negotiate in their own interest), (3) the marketing period permits reasonable exposure of the property to potential buyers, (4) no unusually favorable or unfavorable terms of financing, and (5) neither the sellers nor the buyers offer any extraordinary concessions.

Let’s consider an illustration.

Say that two properties recently sold for $500,000 and $510,000 in a part of town where you’re interested in buying. Each of these was a four unit building consisting of two-bedroom, one bath units with around 840 square feet each.

Okay, so you locate a nearby four-plex of similar size and features priced at $475,000 and consider it bargain (below market value), but is it? It appears to be, but before you draw a conclusion, investigate the terms and conditions of the other two sales.

We’ll make up a couple of scenarios to show you why the so-called “market value” of the previously sold investment real estate might be flawed.

• The sellers of one of the four-plexes carried back a nothing down, 5 percent, 30-year mortgage for their buyers (i.e., favorable financing)
• One of the buyers purchased merely because it seemed like a steal to their real estate market (i.e., an uninformed buyer)
• The sellers of one of the four-plexes paid all of their buyer’s closing costs (i.e., extraordinary sales concessions)

Sales Price Might Not Equal Market Value

When you invest in real estate, it’s not enough to learn the prices at which other similar rental properties have sold. Also, learn whether the buyers or sellers acted with full market knowledge, gave any unusually favorable terms of financing, bought (or sold) in a hurry, or made concessions that pushed the sales price up or pulled it down. Remember, faulty sales price information can make bad deals look good (or vice versa).

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