Market Value

(This is the 2nd of a 3-part article | Part 1 | Part 3)

(by David Maloney) Market value is an all-encompassing general concept that is based on a market perspective (as opposed to a user’s perspective) and on what marketplace participants view as typical and normal market conditions.

The public’s expectation that a market value appraisal reflects only the perspective of the marketplace, and is not affected by such other criteria as an intended user’s objectives, is important. Meeting this expectation serves to foster and promote public trust in professional appraisal practice, a fundamental purpose of the Uniform Standards of Professional Appraisal Practice and one that applies to all work performed under USPAP. (USPAP AO-22)

Why is market value such an important type of value? Because it refers to a price that a seller can expect to receive from a buyer in an open and fair transaction. Knowing the market value of a property allows a would-be seller to determine an asking price. Without knowing the market value, the seller might price their property too high or too low, either of which could have negative financial results (possibly on the seller as well as on the buyer).

While its focus is on market value, USPAP does not mandate market value appraisals though it does require that the type and definition of whatever value used be identified in the report.

Though it focuses only on market value, USPAP does not define market value, per se, but it does describe it as a general concept. The definition of any value used in an appraisal analysis and report involves a set of assumptions about the market in which transactions regarding the subject property might occur. Thus, the definition of value becomes the basis for the appropriate market and, subsequently, for selecting comparable data for use in the analysis. These assumptions will vary from value type to value type, but for market value and market value types (such as fair market value, fair value (for business assets and liabilities), marketable cash value and orderly liquidation value) they generally fall into three categories as reflected in USPAP’s description of the concept of market value:

MARKET VALUE: 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.

Comment: Forming an opinion of market value is the purpose of many [real/personal] property appraisal assignments, particularly when the client’s intended use includes more than one intended user. The conditions included in market value definitions establish market perspectives [emphasis added] for development of the opinion. These conditions may vary from definition to definition but generally fall into three categories:

the relationship, knowledge, and motivation of the parties (i.e., seller and buyer);

the terms of sale (e.g., cash, cash equivalent, or other terms); and

the conditions of sale (e.g., exposure time in a competitive market for a reasonable time prior to sale).

Appraisers are cautioned to identify the exact definition of market value, and its authority, applicable in each appraisal completed for the purpose of market value. (USPAP)

Market value is characterized by ideal market conditions and reflects the most probable buy-sell price within an open and competitive market, i.e., the amount of money a buyer would probably pay and a seller would probably accept for an item of property in an open and competitive market without undue stimulus (i.e., an arm’s-length transaction).

Market Value: Definition of

Market value is simply the typical price for which something will trade hands between knowledgeable market participants within a reasonable period of time. In a normal or average real estate market, “reasonable” means one to three months. For personal property, however, “reasonable” time might extend from one week for common household goods sold at a local, weekly auction, to six to nine months for items sold through an international auction house, to a year or more for items placed on consignment in a retail gallery.

While USPAP does not define market value (the closest it comes is to describe it as a general concept as noted above), USPAP’s Advisory Opinion 22 Scope of Work in Market Value Appraisal Assignments (as you will learn in Chapter 7, Advisory Opinions are, technically, not part of USPAP—they serve only to “advise”) does include the following widely-accepted definition of market value that has been adopted by several federal regulatory agencies. Being based on the market perspective and on the premise of what is “typical and normal” is what makes market value appraisals distinct from appraisals using other types of value. These criteria result in fundamental market value conditions which are illustrated in the following definition. (As you read this definition of market value, keep in mind the scenario to which it is commonly applied—the appraiser developing an opinion of market value to aid a client in establishing a fair asking price for a property the client intends to sell.)

Market value means 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 own 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 in 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. (USPAP AO-22)

Note that a market value appraisal is based on the above market conditions which are considered as normal and typical as of the effective date of the appraisal. If market conditions are not what would be considered as “normal and typical” (such as would be the case in a forced liquidation appraisal), then the use of the term “market value” alone and without a modifier (such as “fair” market value or “orderly liquidation” market value) would be inappropriate.

Supplemental reading: USPAP Advisory Opinion 22 Scope of Work in Market Value Appraisal Assignments

Market Value: Fundamental Conditions for

It is important to understand the above five fundamental conditions associated with the definition of market value. These value definition conditions must be satisfied (or assumed to be satisfied) by all comparable sales being considered for use by the appraiser in developing an opinion of market value. These conditions must also have existed at the time of sale of the comparable property in order for that comparable sale to be considered as a basis for an opinion of the market value of a subject property.

Buyer and seller must be typically motivated and without duress, compulsion or pressure to act. Both parties should be acting for typical reasons such as the seller disposing of a property to help pay for a child’s college education and a buyer purchasing to enhance his or her collection. An example of an atypical motivation would be the seller attempting to avoid bankruptcy by liquidating assets quickly (i.e., a forced liquidation sale) in order to pay debts. Be forewarned, though—it is not always apparent what the motivations were for the comparable sale being considered. But if there are found to have been atypical motivations, then that data does not qualify for use as a comparable sale when determining market value of a subject property.
Both parties must be well-informed (or well-advised by another). Both buyer and seller should be knowledgeable of all the relevant facts in order to be able to make an informed, self-serving decision. An example of an uninformed buyer is a neophyte collector who attends a flea market and purchases a folk art copper weathervane purported to be 19^th century but which is, in fact, a 20th century reproduction. Although acting in his or her own self-interest, the buyer is not well-informed and pays too much. A future appraiser would be unable to make use of this data as a comparable sale if determining market value for either a genuine weathervane (or even for a replica weathervane, for that matter) because the sale was made to an ill-informed party.
Reasonable market exposure time. The property must be on the open market and properly marketed for an amount of time considered reasonable for sales in that market. The amount of time will vary from local market to local market and from item type to item type. For common items, a reasonable time might be considered to be 30 days. For more sophisticated and expensive items, a reasonable time might be considered to be 60 to 120 days. It would be improper for an attorney to direct an appraiser to estimate “market value” of a property within a marketing period of only 7 days if it would normally take 60 to 120 days in that market to effect an orderly liquidation sale that would satisfy the “reasonable market exposure time” test of market value. Some types of property, such as Native American Indian artifacts, can only be sold effectively and in an orderly fashion via infrequently-held specialty auctions or high-end dealer shows. These lengthy requirements for market exposure time must be taken into consideration when appraising such items. Past sales of comparable properties requiring completion in less than a reasonable market exposure time are invalid sales data and must not be used as a basis for market value of a subject property. (For an extended discussion, see the section entitled “Exposure Time and Marketing Time” later in this chapter.)
Payment in cash. Estimating market value of a subject property requires the use of comparable sales in which payment was made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto. While real estate transactions might include a special arrangement such as throwing in a vacation cruise and a golf club membership in order to entice a sale, such considerations are not normally involved with personal property transactions. In almost all cases, past comparable sales of personal property being considered as a basis for market value are sold for cash only.
Normal consideration. Market value also requires the price to represent the normal consideration for the property sold—unaffected by special or creative financing or sales concessions granted by anyone associated with the sale. While real property transactions might at times make use of payments affected by creative financing (such as a note being taken back by the seller), such transactions are rare when buying and selling personal property. Regardless, past sales in which creative financing or sales concessions were involved are not good candidates for use as comparable sales on which to base an opinion of market value.

Non-market-value types such as “forced liquidation value” or “replacement value” are based on the user’s (e.g., a buyer’s or seller’s) perspective and needs and not on the perspective of the market. By definition, these non-market-value types have conditions which are characterized by atypical market conditions, i.e., market conditions which are defined by the needs of intended users as opposed to what is normally and typically expected by most marketplace participants in an open and competitive market under conditions requisite to a fair sale. These non-market-value types have their own defined marketplace conditions that are established by the definition of value that is developed by the appraiser. For instance, non-market-value definitions might reflect that exposure time is be limited (such as in a forced liquidation sale), or that there might be a need to use only the market in which the insured customarily shops, regardless of the price that will be encountered (such as doing a replacement value appraisal for acquiring insurance or settling a damage or loss claim).

Define the Type of Value Used in the Appraisal

USPAP requires that for every appraisal, the type of value used needs to be identified and defined based on the report’s intended use as well as on those applicable conditions that impact on the assignment such as the needs of the intended users (user perspective), or the expectations of market participants (market perspective), or on legal or other mandates that serve to define value such as the IRS definition of fair market value. Here are a couple examples.

Market value. As noted earlier, USPAP only describes market value as a general concept but does not definemarket value. Market value is defined by either a specific jurisdiction (e.g., a court, regulatory body, or an agency empowered with legal authority) or by a client group such as Fannie Mae or Freddie Mac (for real estate appraisals). As an example, below is Maryland’s definition of market value which follows closely the above AO-22 definition:
- Market value is the most probable price which a specified interest in property is likely to bring under all of the following conditions:
  - Consummation of a sale as of a specified time.
  - Open and competitive market for the property interest appraised.
  - Buyer and seller each acting prudently and knowledgeably.
  - Price not affected by undue stimulus.
  - Buyer and seller typically motivated.
  - Both parties acting in what they consider to be their best interests.
  - Adequate marketing efforts made and a reasonable time allowed for exposure in the open market.
  - Payment made in cash in U.S. dollars or in terms of financial arrangements comparable thereto.
  - Price representing the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale
Value definitions other than Market Value. Definitions for other types of value such as “fair market value,” “liquidation value,” “forced liquidation value,” or “replacement value” could originate from any number of sources such as U.S. tax regulations, appraisal textbooks, legal jurisdictions, regulatory agencies, insurance policies, recognized appraisal associations, or even an assignment engagement letter from the client in which the client himself provides the required value definition. Below is Maryland’s definition of liquidation value. This liquidation value reflects a situation where there is a forced sale. For an interesting contrast, compare the below definition to the above definition of “market value” in which the sale is not under compulsion.
- Liquidation value (forced) is the most probable price which a specified interest in property is likely to bring under all of the following conditions.
  - Consummation of a sale within a severely limited future marketing period specified by the client.
  - Current actual market conditions for the property interest appraised.
  - Buyer acting prudently and knowledgeably.
  - Seller under extreme compulsion to sell.
  - Buyer typically motivated.
  - Buyer acting in what he/she considers his/her best interests.
  - Limited marketing effort made and limited time allowed for completion of sale.
  - Payment made in cash in U.S. dollars or in terms of financial arrangements comparable thereto.
  - Price representing the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

As noted earlier, if the definition of value being developed by the appraiser establishes market conditions that are different from what marketplace participants consider as “normal and typical,” then the use of the term market value is inappropriate. For example, in the above Maryland definition of, the market condition requires the use of the term forced liquidation value to reflect the abnormal and atypical condition caused by the seller’s compulsion to sell. In other words, the overriding marketplace condition (consummation of a sale within a severely limited period of time) is not consistent with what is considered “normal and typical”—a condition which is a necessary in order for the assignment to be referred to as a market value appraisal.

Market Value Types

The above-mentioned five fundamental conditions of market value found in USPAP’s AO-22 apply to market value itself as well as to the various “types” of market value of which those most commonly encountered are listed below and include fair market value, fair value (for business assets and liabilities), orderly liquidation value, marketable cash value, salvage value and scrap value.

Like market value, each of the additional market value types is defined only from the market perspective. i.e., what market participants expect as being normal and typical given the “specific conditions set forth in the definition of the term identified by the appraiser as applicable in the appraisal.”

Differences between market value and the six types of market value hinge on the market selected in which to conduct research, on time-to-sale, and (for marketable cash value) on the costs associated with the sale.

Market value is an opinion of the amount of money, as of a specific date, that would be realized if the property was sold in a market that is “open and competitive;” in which all parties act prudently, are knowledgeable of all relevant facts and are acting in their own best interests; in which both parties are typically motivated and neither is under compulsion to act; in which reasonable market exposure time is allowed (for example 60 or 120 days); and in which a sale will take place and title will change hands by a date certain.
Fair market value is the price, as of a specific date, at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of the relevant facts. Fair market value makes use of the market in which the item is most commonly sold to the public with the sale being hypothetical, i.e., the sale does not, in fact, occur; rather, ownership is retained and title is not transferred.
Fair value (for business assets and liabilities). Statement of Financial Accounting Standards 157 (issued by the Financial Accounting Standards Board in 2006) provides guidance about how entities should determine fair value estimations for financial reporting purposes. SFAS 157, which broadly applies to measuring fair value of corporate financial as well as nonfinancial assets and liabilities, defines fair value as:

“the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

Orderly liquidation value is an opinion of the amount, as of a specific date, that would be realized if the property was sold in an orderly fashion in an “orderly liquidation market” (such as an auction or estate sale) in which an adequate marketing effort is made and a reasonable exposure time is allowed to properly market the property prior to sale.
Marketable cash value is simply orderly liquidation value minus costs associated with the sale.

Salvage value is an opinion of the amount, as of a specific date, that would be realized for the whole property or a component of the whole property that is retired from service (perhaps because of obsolescence or damage) and for which refurbishing or repair is neither desired, possible nor economically feasible, i.e., the cost to do so would exceed the item’s worth; assumes a market in which typical buyers of salvage participate.
Scrap value is an opinion of the amount, as of a specific date, that could be realized for the property if it were sold for its intrinsically valuable material content and not for a productive use (e.g., the gold content in damaged jewelry); assumes a market in which typical buyers of scrap participate.