Market value of property is defined as the value that the property would command given that it is marketed for a reasonable time and that the buyer and the seller are fully informed about the property, are acting prudently and there are no undue pressure to complete the transaction.
The purpose of any property valuation is to estimate the
market value of a property at the time of valuation. From an investment point of view though, the buyer is interested of course in not paying more than the market value, but the most important consideration is that the purchase price is such that will allow him/her to achieve his/her
minimum required profit.
For example, the market value of property may be $500,000. Just to simplify things completely, we will assume that the investor will hold the property for one year and will sell it at the end of the year. During that year, he/she expects that the net rental income (or more commonly net operating income) of the property will be 7% of the market value (500,000 x 0.07 = 35,000) and that the value of the property will increase by about 2.06%, which allow capital gains of about 2%.
Thus, taking into account the future income that the property will earn and the resale price, the investor concludes that at this price, the return that will be achieved will be only about 9%. However, taking into account the risk of this investment, he/she concludes that his/her required return is 12%. In this case, the market value of property does not allow an expected return equal or greater than the investor’s required return, in which case the investor will not be interested in purchasing it at that price.
Given the above rationale, the estimation of the market value of a particular income-producing property needs to go beyond the sales comparison approach and calculate also the value that an average investor in the market would be willing to pay given his/her required rate of return and the income-earning capacity of the property. The estimation of such price is typically carried out using the discounted cash flow (DCF) model.
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