Some ten years ago, we saw the start of the economic meltdown. Were appraisers to blame? Some tried to pin the blame that way. But was there a big lie underneath? The required (federally insured) definition of value has seven distinct elements. Were appraisers doing what they were told?
- Buyer and seller each acting prudently and knowledgeably.
- Price is not affected by undue stimulus.
- Buyer and seller are typically motivated.
- Both parties are well informed or well advised.
- A reasonable time is allowed for exposure.
- Payment is made in terms of cash.
- The price … [is] unaffected by special or creative financing or sales concessions.
Around 2010, I asked myself a question. Were any of these requirements of “market value” being ignored by the loan industry? The immediate answer seemed to be that maybe, just maybe one or two of these were not wholly true. My “abductive reasoning” as in the scientific method — said first organize the definition. The result was as above – seven bullet-point assumptions.
Seeking entertainment for my Stats, Graphs, and Data Science¹ classes, it seemed fun to see if these assumptions had not been religiously followed. This led to a PowerPoint slide entitled:
“Dell Operative definition of market value”
“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 speculatively with exuberance, and assuming the price is affected by universal euphoria. 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 avariciously motivated; biased
- both parties are uninformed and advised by commissioned salespeople 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 enabled by unrestricted special and creative financing provided by commissioned salespeople.”
I was astonished to discover that five of the seven assumptions were universally ignored. (Another case of social groupthink.) Recently, my assistant reminded me that “reasonable time” for exposure was also nonexistent at that time. People were lined up to overbid each other the day a listing hit the pages.
Six out of seven. But we got the “cash in terms of U.S. dollars” part right.
Groupthink, a term coined by social psychologist Irving Janis (1972), occurs when a group makes faulty decisions because group pressures lead to a deterioration of “mental efficiency, reality testing, and moral judgment.”
A big lie? Groupthink? What do you think? Stay tuned!
April 25, 2018 @ 5:45 am
Thanks George. Great points. On one of the larger national appraiser blogs I recently tried to make the point that under the current market conditions, where the lack of inventory is resulting in multiple offers with offering prices sometimes exceeding list price by as much as 15 to 20 percent, valuing property at contract prices may not conform to the FNMA definition of market value because the market is placing undue stimulus on buyers competing with many others for a single property. That comment was pretty much scoffed by the moderator who implied that the natural laws of supply and demand were at work here. All other things being equal, and assuming that a property is listed close to market value, a transaction resulting in a price that is 15 to 20 percent over market would surely imply that competing buyers were under some level of duress.
April 25, 2018 @ 7:13 am
Excellent excellent excellent, George! Except, No. 3: The deal is rushed by all parties. Offers are submitted immediately after listed. Little to no due diligence is performed by the principals, brokers, lenders, or third-party experts.
April 25, 2018 @ 7:17 am
Interesting points. Thanks George. I talked to an appraiser from Great Britain once (they are called valuers there), and he said that in GB the valuers assume an exposure time of 90 days. The consequence of this restriction is interesting, First, appraised value of homes are more volatile as appraiser raise mv estimates higher in buyer’s markets drop them lower in seller’s markets. This result dampens the impact of artificial stimulus like QE designed to help other sectors of the economy.
April 25, 2018 @ 4:19 pm
This issue here seems to be the fact that the market value definition used for federally-regulated mortgage lending attaches a bunch of hypothetical and idealized conditions to the market, essentially forcing the real world to conform to the “perfectly competitive market” of neoclassical economics. In this respect, the value definition used for lending purposes is far more restrictive than definitions used for litigation and other purposes. Decades ago, Richard U. Ratcliff argued that market value should reflect real, if imperfect, markets without artificial constraints, a position reiterated by many respected appraisal authors since. If the market is depressed and distressed sales comprise most of the activity, so be it; if the market is exuberant and euphoric, as in George’s tongue-in-cheek definition above, our valuation should reflect that as well.
We need to stop kidding ourselves that real estate markets should behave as the perfectly competitive market conceptualized by Alfred Marshall and the early neoclassical economists. The problem isn’t the market, the problem is an unrealistic definition of market value. Our job should be to reflect market conditions as they are, rather than how others might wish them to be.
May 10, 2018 @ 6:45 am
Well said.
May 10, 2018 @ 11:59 am
You’ve identified the problem but not offered a solution of value to the ultimate investor. What is the purpose of the appraisal? It is the same as all other risk management tools used in lending – e.g., credit analysis – the purpose is to ensure the investor gets paid back. Even if the borrower loses his or her job, or the couple get divorced, or for the scores of other reasons that loans go sour. Reasons usually unrelated to value, BTW. But our fundamental appraisal premise is that the appraisal is tied to a specific date, and so reflects the exuberance or distress as of that date. So what good did it do anyone in 2009 to know that a particular property had a market value of $500,000 in 2007? By 2009, the property might be worth $350,000. The lender was no longer secure, and was not going to get paid back in the event of borrower default. We have to either realize that an appraisal has limited utility – to identify flipping or other fraud, make sure the siding is on all four sides, identify uninformed buyers or non-market motivations – or develop some concept of “sustainable” or “long-run” value. However, bubbles are easy to identify after they’ve popped, not so easy when you’re in it. A sustainable value concept would have been very unpopular in 2007.
April 28, 2018 @ 8:08 am
Typically my definition of work/ scope of work was to describe the market and analyze the market, the good, the bad and the ugly. Right now I think that we are in “the ugly” phase. I struggle with the markets as we all do when they are either 2005, 2006, 2011 or 2017/2018, with an inventory that is not in balance and other market conditions such as low interest rates. I am not sure about Neoclassical economists as I am not smart enough, tall enough or good looking enough to be in that crowd. But I think what ever happened in the past and will again in the future it is up to the appraiser /valuer to reflect the market, describe it and provide the data to support your conclusions. Whether we in sync with the rest of the market contributors and whether they are reading our reports, wasn’t exactly in my job description. Course there are some very bright folks commenting on this blog including the originator who will probably be able to disclose how I just drove off the appraiser road.
May 10, 2018 @ 5:27 am
The rub here might be the much besmurked cost approach. Eight buyers may want it today but don’t ask me to support the market value with the cost approach.
May 10, 2018 @ 6:02 am
George, I believe that a new line should be added, solely for buildings in use, from residences to commercial and that is the insurability. A line should read, “the subject property should be capable of being insured at a normalized rate, without premium payments nor deduction of coverage.” (or better wording, but you get the idea).
If a house or building, in use, cannot obtain typical insurance or is rated, then that impacts market value. Insurance coverage should be part of every appraisal. Having left 30 years of appraisal as an active Realtor today, I insert an insurance clause into every offer I make for a buyer.
May 10, 2018 @ 9:05 am
Maybe the problem is the quest for a single definition of MV. How can there be a single definition of MV if markets are frequently if not typically segmented; e.g. strong in high end, average in low end, and fluctuating around the middle or vice-versa in any other combination? I have seen this play out in the SW in the late 80’s, late 90’s and during the Great Recession. I am impressed with the reasoning of both the author and “commentors” but don’t believe either has found the “holy grail” of a universally to be applied definition of MV or rationale for it.
Market Value or Other Value? - George Dell, SRA, MAI, ASA, CRE
March 15, 2023 @ 1:16 am
[…] see the Dell “Operative Definition of Market Value,” which describes how, up to the “great recession,” five of the seven assumptions were […]