In order to ensure that different commercial real estate appraisers are applying the same logic and reasoning to valuation assignments, it’s important that they all operate under the understanding that “Market Value” has a universal definition.
While Appraisers have different experience, opinions and resources available, applying a similar definition of Market Value to every appraisal problem will result in consistent valuations within an acceptable range of values.
In this article, we’ll explain the definition of market value and talk about what all five parts mean for a commercial real estate appraisal.
The Definition of Market Value
The definition of market value as set forth in 12CFR banks and banking part 323 as published in the federal register is as follows:
The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. 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 conditions whereby:
- Buyer and seller are typically motivated.
- Both parties are well informed or well advised and acting in what they consider their best interests.
- A reasonable time is allowed for exposure in the open market.
- Payment is made in terms of cash in U.S. dollars or terms of financial arrangements comparable thereto; and
The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.
Essentially, for a sale to be considered at “Market Value,” the sale must ascribe to the stated definition of market value.
Various authorities define “Market Value” in their own way, therefore appraisers need to indicate which definition of Market Value they are relying on and cite the source. This allows the intended users of the report clearly understand the focus of the appraiser
Now, let’s examine some of the relevant points when considering this definition and how it applies to a commercial real estate appraisal.
1. Participants in the Sale Must Act in Their Own Best Interest
Neither the buyer nor seller may be under any duress or pressure to sell that might impact the negotiations and/or purchase price.
Some examples of duress or special circumstances for a seller might include:
- A pending foreclosure
- A business spilt
- A divorce
For a buyer, duress or special circumstances might include:
- Divesting himself of property to avoid taxes
- May be outgrowing the current space and need to leave for a bigger space quickly
- The current lease is expiring and there is no option to renew
Both parties to a transaction must be knowledgeable about the property, value and process of entering into a purchase agreement. Often, buyers and sellers will enlist the services of a broker and/or lawyer to represent them in the process, to ensure fairness and understanding on both sides.
Both parties must be acting in a way that ensures a fair outcome to oneself, not conceding too much. When the parties come to an agreement in which they are each working toward their own best interests, fairness is more likely.
2. “Market-level” Sales Must Have Adequate Exposure to the Open Market
Typical marketing and exposure times of closed commercial real estate transactions are readily available to brokers and real estate appraisers.
- A property that sells too quickly compared to other, similar properties that have sold, may be selling at a price below current market levels
- Properties that linger on the market beyond a reasonable period may have asking prices well above the current ranges
- Properties that sell within a reasonable amount of time, as compared to other similar properties, are more likely to have sold at market value
An appraiser must research the conditions of every sale of their comparables to ensure that appropriate adjustments are applied to any sale that is not considered Market-level.
3. Payment Must be Made on a Cash-Equivalent Basis
Payment must be in the form of U.S. dollars or in some form that can be related to the U.S. dollar. The U.S. dollar is the standard used for comparative analysis. Properties may trade for like properties, or for shares of stock, for example, but these means of payment must be able to be cross referenced to their value in U.S. dollars for the sake of consistency.
4. The Sale Must be “Straight-forward”
Lastly, the price must be for the specific stated property and cannot be subject to alteration due to concessions by the seller or buyer. For example, it’s not uncommon for a buyer to pay a lower price in return for paying higher rent and remaining as a tenant in the property. Appraisers need to be aware of such conditions and make appropriate adjustments to the sale or exclude the sale.
While it’s not a part of the definition of Market value, there is another important consideration for an appraiser when completing a commercial real estate appraisal:
5. Ensuring Comparable Sales Ascribe to the Definition of Market Value
Appraisers look to the market to find recent sales of comparable properties for use in their analysis. When analyzing a sold property, the appraiser must have confidence that the sold property adheres to the Definition of Market Value. In this way, the appraiser can be assured that she is utilizing a comparable sale that is truly reflective of Market Value. Sales that are not considered to be Market Level transactions may be excluded from an appraiser’s consideration or adjusted to account for any factors that are not consistent with the Definition of Market Value employed by the appraiser.
The Bottom Line
For a sale to be considered at market value, the buyer and seller must be knowledgeable or represented by a knowledgeable party, the sale price cannot be affected by any duress or particular motivation, or incentives and the property must be exposed to the open market for a reasonable amount of time. When these factors are met, an appraiser can be confident that the sale meets the definition of market value and can be utilized in the appraisal process without adjustment or consideration of atypical characteristics. When these factors are not met, the appraiser must decide if adjustments will result in a credible comparable sale, or if the sale must be excluded from consideration.
The appraisers at Standard Valuation Services understand the need for applying the most appropriate definition of market value in every commercial real estate appraisal. This ensures consistency from appraisal report to appraisal report and from appraiser to appraiser. If you have any questions about what market value is, or how Standard Valuation Services experienced and educated staff can help you attain your real estate investment goals, please reach out to us today.