Chapter 36
The Broker’s Competitive Market Analysis Technique
Introduction
This chapter is a follow-up to Chapter 35 entitled The Appraiser’s Sales Comparison Approach. In Chapter 35, the discussion focused on the nature and substance of the sales comparison approach as used by an appraiser and not the Competitive Market Analysis discussed in Chapter 34 as used by a licensee in pricing property. It is important for the appraiser and the customer of the appraisal assignment to understand the definition of value and to be able to choose from several alternative definitions according to what is needed by the customer to answer his question. This is especially true in disrupted markets where normal market activity exists alongside foreclosure-related transactions. These definitions must be read very carefully and literally to align the target definition with the client’s intended use for the appraisal product.
Value definitions
Appraisers must consider an array of value definitions. Each of the following subsections presents a discussion of one of those value definitions.
Market value
In addition to the market value definition provided in Chapter 35 there are other market value definitions that the appraiser must consider. They are presented below:
The most widely accepted components of market value are incorporated in the following definition: The most probable price that the specified property interest should sell for in a competitive market after a reasonable exposure time, as of a specified date, in cash, or in terms equivalent to cash, under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, for self-interest, and assuming that neither is under duress.
Market value is described in the Uniform Standards of Professional Appraisal Practice (USPAP) as follows: A type of value, stated as an opinion, that presumes the transfer of a property (i.e., a right of ownership or a bundle of such rights), as of a certain date, under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal. (USPAP, 2010-2011 ed.) USPAP also requires that certain items be included in every appraisal report. Among these items, the following are directly related to the definition of market value:
(a) Identification of the specific property rights to be appraised.
(b) Statement of the effective date of the value opinion. Specification as to whether cash, terms equivalent to cash, or other precisely described financing terms are assumed as the basis of the appraisal.
If the appraisal is conditioned upon financing or other terms, specification as to whether the financing or terms are at, below, or above market interest rates and/or contain unusual conditions or incentives. The terms of above- or below-market interest rates and/or other special incentives must be clearly set forth; their contribution to, or negative influence on, value must be described and estimated; and the market data supporting the opinion of value must be described and explained.
The following definition of market value is used by agencies that regulate federally insured financial institutions in the United States:
The most probable price that 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:
(a) Buyer and seller are typically motivated;
(b) Both parties are well informed or well advised, and acting in what they consider their best interests;
(c) A reasonable time is allowed for exposure in the open market;
(d) Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
(e) 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. (12 C.F.R. Part 34.42(g); 55 Federal Register 34696, August 24, 1990, as amended at 57 Federal Register 12202, April 9, 1992; 59 Federal Register 29499, June 7, 1994)
The International Valuation Standards Council defines market value for the purpose of international standards as follows: The estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently, and without compulsion. (International Valuation Standards Council , Glossary (as of December 2011)
Market value is the amount in cash, or on terms reasonably equivalent to cash, for which in all probability the property would have sold on the effective date of the appraisal, after a reasonable exposure time on the open competitive market, from a willing and reasonably knowledgeable seller to a willing and reasonably knowledgeable buyer, with neither acting under any compulsion to buy or sell, giving due consideration to all available economic uses of the property at the time of the appraisal. (Uniform Standards for Federal Land Acquisitions) For further discussion of this important term, see The Appraisal of Real Estate, 13th ed. (Chicago: Appraisal Institute, 2008), 22–25.
Assessed Value
The assessed value of the property is its taxable value based on market value, as determined by the tax assessor of the local government in which the property is located.
In Georgia fractional assessment is used, and the market value determined by the local tax assessor is multiplied by an assessment rate of 40%. So, if the fair market value of the property is $200,000 and the mandated assessment rate is 40%, then the value of the property for assessment purposes is $200,000 times 40% equals $80,000. The millage rate is applied to this assessed value of $80,000.
Insurance value
The value of all on-site improvements for purposes of casualty insurance, usually based on replacement construction cost estimates.
Investment Value
The value of a property interest to a particular investor or class of investors based on the investor’s specific requirements. Investment value may be different from market value because it depends on a set of investment criteria that are not necessarily typical of the market.
The maximum price an investor is willing and able to pay for a property.
Liquidation Value
(a) Liquidation value is the net amount that would be realized if the business is terminated and the assets are sold piecemeal. Liquidation can be either “orderly” or “forced.”
(b) Liquidation Value is the value of assets estimated with regard to specific circumstances under which the assets are sold. Liquidation value describes a situation where a group of assets employed together in a business are offered for sale separately, usually following a closure of the business. Although associated with forced sale, these terms have distinct meanings. There is no reason why assets cannot be liquidated by an orderly sale following proper marketing.
(c) Liquidation value is the most probable price that a specified interest in real property should bring under the following conditions:
1. Consummation of a sale within a short time period.
2. The property is subjected to market conditions prevailing as of the date of valuation.
3. Both the buyer and seller are acting prudently and knowledgeably.
4. The seller is under extreme compulsion to sell.
5. The buyer is typically motivated.
6. Both parties are acting in what they consider to be their best interests.
7. A normal marketing effort is not possible due to the brief exposure time.
8. Payment will be made in cash in U.S. dollars or in terms of financial arrangements comparable thereto.
9. 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.
This definition can also be modified to provide for valuation with specified financing terms. See also disposition value; distress sale; forced-sale price.
Disposition value
Disposition value is the most probable price that a specified interest in real property should bring under the following conditions:
1. Consummation of a sale within a future exposure time specified by the client.
2. The property is subjected to market conditions prevailing as of the date of valuation.
3. Both the buyer and seller are acting prudently and knowledgeably.
4. The seller is under compulsion to sell.
5. The buyer is typically motivated.
6. Both parties are acting in what they consider to be their best interests.
7. An adequate marketing effort will be made during the exposure time specified by the client.
8. Payment will be made in cash in U.S. dollars or in terms of financial arrangements comparable thereto.
9. 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.
This definition of disposition value can also be modified to provide for valuation with specified financing terms. See also distress sale; forced-sale price; liquidation value; market value. Source: Appraisal Institute, The Dictionary of Real Estate Appraisal,
5th ed. (Chicago: Appraisal Institute, 2010).
Distress sale
A distress sale involves a seller acting under undue duress. See also disposition value; forced sale; liquidation value. Source: Appraisal Institute, The Dictionary of Real Estate Appraisal, 5th ed. (Chicago: Appraisal Institute, 2010).
Forced-sale price
A forced sale price is paid in a sale in which a reasonable time was not allowed to find a purchaser or the purchaser was forced to buy. See also disposition value; distress sale; liquidation value. Source: Appraisal Institute, The Dictionary of Real Estate Appraisal,
5th ed. (Chicago: Appraisal Institute, 2010).
Going Concern Value
1. The market value of all the tangible and intangible assets of an established and operating business with an indefinite life, as if sold in aggregate; more accurately termed the market value of the going concern.
2. The value of an operating business enterprise. Goodwill may be separately measured but is an integral component of going-concern value when it exists and is recognizable.
The value of a company as an ongoing entity. This value differs from the value of a liquidated company’s assets, because an ongoing operation has the ability to continue to earn profit, while a liquidated company does not.
Value of a firm as an operating, normally functioning business to a buyer. It results from advantages such as a good reputation, trained workforce, established and successful procedures, tested systems, operational equipment, and necessary licenses and permits. This value is almost always more than the sum of the market (liquidation) value of the firm’s assets. The excess value is recorded in accounting as the firm’s goodwill.
Some appraisal practitioners take the position that the phrase ‘Going Concern Value’ is a poor construction, and what is usually meant is the combination of a value definition (from the above) with one of the defined interests in real property, such as fee simple, or leasehold. An assignment to provide an opinion of the Market Value of the Fee Simple estate of a subject property would be preferable to its ‘going concern value’.