Wealth Opportunities in Commercial Real Estate: Management, Financing, and Marketing of Investment Properties

Fair Market Value and Capitalization Rate: What's It Worth?

A property's value is often a crucial factor in buying, selling, or obtaining financing. What the property is worth obviously becomes relevant if you are a potential buyer or seller. Similarly, if you are considering originating a loan secured by the property, it is important to understand the property's value. One of the main tests in loan origination is to limit the debt to a percentage of the property's value. If a lender miscalculates the property's value it may extend credit far in excess of its intended ratio, resulting in little equity remaining in the property and, hence, a smaller cushion for error.

Fair market value (FMV) is essentially the price at which a willing buyer and a willing seller agree to buy or sell the property. According to the Uniform Standards of Professional Appraisal Practice, implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under the following six conditions.

1. The buyer and seller are acting prudently and knowledgably and are typically motivated.
2. The buyer and seller are not affected by undue stimulus.
3. Both parties are well informed or well advised, and acting in what they consider their best interests.
4. A reasonable time is allowed for exposure in the open market.
5. Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto.
6. The price represents the normal consideration ...