The transaction zone is a range within which a sale price might occur. Yet our definitions of value nearly all define a “most probable” price.
In prior issues, we have discussed how vintage appraisal practice is vulnerable to accusations of bias. The “appraisal process” is most vulnerable at the beginning of the analysis, wherein “good judgment” is substituted for reliable similarity models. That results in our first “impossibility theorem” of objective results:
Impossibility Theorem #1: You can’t get objective results from subjective data.
We now look at the end of our “appraisal process.” (Impossibility Theorem #2).
Current education for appraisers focuses on “modern” economic theory from the 18th to the early 20th century, resulting in a set of “recognized methods and techniques”. These are then embedded in a documented “body of knowledge” generally promulgated by the Appraisal Institute, then separately “enforced” through a rolling interpretation by 50 states and US jurisdictions.
The legislated appraiser economics training focuses on that historical value theory and valuation theory. Those theories include the agents of production: land, labor, capital, and entrepreneurship. They do not embrace (or recognize) the fifth modern agent of production: information.
This “recognized” theory also considers the four factors of value: utility, scarcity, desire, and demand (effective purchasing power). Value may or may not require an actual marketplace. If price is to be equal to value, then the goal is expected selling price.
But we have a problem. Most of the assumptions and theory of value taught is based on equilibrium as between buyers and sellers – all of whom are: typically motivated, well-informed or well-advised, and reasonable “marketplace” exposure time. [Equivocation of the word ‘market’ permeates the industry and its admonitions.]
The key words in the prevalent definitions are “most probable price.” (Some say “highest price.) Unfortunately, this number seldom, if ever, actually exists! Not in theory. Not in practice. It is yet another equivocation (and our second impossibility theorem of value).
Nearly all real property transactions do take place in the broader “marketplace.” However, the actual market (at a given moment in time) comprises a few buyers, and a few listed properties. This type of interaction is called “game theory.” In our case, this means a few buyers looking for some particular set of features and location. And a small set of properties actually “for sale” at that moment.
This particular class of game (say 3 buyers and 4 properties) does not have an equilibrium point! No “most probable selling price.” The buyers have a set of internal motivations and trade-offs. Each buyer is different. Each seller (or owner group) will also have different internal motivations, not necessarily rational. The result is that no number, no value is neither “most probable” nor “the highest.”
Impossibility Theorem #2: The most probable selling price does not exist!
At best, we may identify, or attempt to quantify a “transaction zone,” within which a probability of a sale price will occur. This we must do. Or regulations must require. Today’s non-acknowledgment of the transaction zone reality — creates yet a second major vulnerability for appraisal bias accusations.
Without recognition of the inherent uncertainty of valuation, the profession will continue to attempt to provide a fiction. An opinion. And continue to strive for believability in place of measurable reliability.
August 31, 2022 @ 6:18 am
So, what shall we call our indication of value and how should it be defined? Most of our clients are interested in some estimate of a likely sale price. I’ve been in the business long enough to remember when Fannie’s definition was “highest”. Maybe our analyses should reflect different conclusions each differently defined for different purposes? Perhaps a “loan value” for collateral use, a “base value” drawn from a depreciated cost analysis, or a “value in use” based on income? I agree that in any particular case the motivations of the small set of buyers and sellers might result in a price that diverges from the expected norm. The question is, is this knowable? Is it possible to separate the data to a granular level?
August 31, 2022 @ 7:48 am
In my market and the Work from Home idea of Covid has shown that the idea of well-informed or well-advised is just not real world.
Local Properties over the past 2+ years have been marketed ONLINE as a cheaper place to LIVE and WORK than those in the rest of the state. The out of town buyers flooded the market and pushed up the Asking Prices across the areas outside the cities. This happened in rural areas like Shingletown, Cottonwood and Happy Valley (Anderson).
The real issue was the Buyers were NOT Well-Informed or Well-Advised. As Out-of-Town Buyers many never saw first hand the properties until the week or two before the sales were to close. Some only After they signed and were loaded and pulled up to the new purchase with loaded trucks.
It was then that they would find that they had NO ACCESS to Internet and some times even Cell Service was unreliable in the area. With the reason for moving here being to work from home they were now stuck with a home that did not offer them this option.
YES, I saw a large number of SALES fall apart within days of the closing for just this reason.
There are MANY side to blame here. The Buyer for not knowing and/or learning about the market before making the offer to buy. The Agents for not informing the Buyer of the Limited or No Internet Access across many rural areas.
The whole idea of Well-Informed or Well-Advised comes down on the shoulders of the Agents involved. But, the real problem is that most Agents have little or can be held to little or no responsibility to Inform or Advise the Buyer or the Seller.
Over my 20+ years I have stacks of data that show Agents fail to do what t they should even after they are informed of the data.
Point in Case. Agent listed a property as 1,700 and include the following statement. Buyer to verify all data.
Listed as 1,700 sf at $525,000 and Sold at $525,000
Seller inherited the house after her mother died and lived out of state with little to no knowledge of the house.
Accepted that the Agent was correct listing it as 1,700 sf.
As an appraiser I knew just by walking in the front door it was not 1,700 sf. I taped it off on two different days and reported to the Agent that it was, are you real, 2,433 sf.
I contacted the Agent and even provided a sketch, but she did not care as she already had a BUYER and all she cared about was the CASH in her pocket for closing the deal.
It again Sold for $525,000 and was Appraised at $665,000.
SHOULD I HAVE contacted the Seller and informed her that she was SCR$$$$ED by her Agent? That she was NOT Well-Informed or Well-Advised and that she may have lost as much as $140,000 due to the Agent that was to be working for her?
Comments on this would be nice.
James Pratt
September 1, 2022 @ 5:33 am
Totally agree with all you said here. I would love to be able to advise the seller in this situation however you will open yourself up to all sorts of grief and possible litigation by butting in where you do not belong (that would be the Realtor’s response, not mine). BUT, I would for sure advise the Broker of that Realtor what happened and then you have done your good deed and it is up to the Broker to advise her Realtor’s accordingly. They are supposed to be working for the Seller and in this case the Realtor did the seller a real disservice. If indeed this Agent is a REALTOR because not all Agents are, then they are held to an even higher standard than licensed Agents. You can look up Realtors via the NAR (national association of Realtors website I believe).
October 25, 2023 @ 1:51 pm
So appraisers are supposed to produce “exact” results and no longer be producing our “opinion”? Because that is what it has always been is an “opinion” based upon factual data, analysis of historical data and trends, with an “opinion” applied to determine the results as of the effective date. No necessarily a future date. (unless a prospective value is requested and that is far from a typical assignment) Appraisers that are worth their salt already do these types of things by analyzing pending and active listings, interviewing agents from recent sales, actives, expired, and pending listings about how many offers, interests, etc in order to get a better feel for current market conditions. You want to have precise values and prices, then remove agent and LOS from the transaction or at least remove their commission status. There will new be an unbiased transaction as long as you have parties involved that have compensation that is based upon high high the sales price is. Appraisers are the only ones that are truly unbiased in these transactions, and the ones that are criticized the most.