What is Market Value, anyway?

Matthew Moore is a commercial real estate appraiser, investor, developer, and founder of Moore Real Estate Group Inc., located in Southern California.

The bulk of my assignments as a commercial real estate (CRE) appraiser are to estimate Market Value. In a common case, Buyer and Seller have agreed to a price and entered escrow before I am ever hired. Most CRE acquisitions are financed with some combination of debt and equity, and the debt provider (i.e. the lender) may hire the appraiser during escrow to determine the Market Value.

Let’s stop here and understand that the Buyer is typically hoping to get a good deal, which we can interpret as less than Market Value, and that the Seller is hoping for a strong price, which means more than Market Value. The contract price at this stage might reflect Market Value, but Market Value is not necessarily the same concept as what one entity, “Buyer” has agreed to pay and what another entity, “Seller” has agreed to sell for. Let’s explore why not with a common definition of Market Value used by the Federal Deposit Insurance Corporation (FDIC), which insures deposits and regulates banking activities:

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;
• 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.

(Source: FDIC 12 CFR, Part 323 – Appraisals)

I have added my editorial comments to the definition in order distinguish market value from a given price in a particular real estate transaction. My notes are (parenthetical in blue).

Market Value is the most probable price which a property should bring (and not the exact price that the property always brings). 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 any 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; I touched on this above. Buyer should be motivated to get the lowest possible price and Seller should be motivated to get the highest possible price. This would be “typical.” Questions are often asked about the effect of Section 1031 tax deferred exchanges, which can provide significant tax shelter for real estate investors who are able to sell out of one property and buy another within a strict time frame. As tax consequences differ for each party depending on their individual investment basis, some of these parties may be atypically motivated. Capable listing agents are aware of this, and often try to find Buyers who are in a 1031 exchange period.

• Both parties are well informed or well advised, and acting in what they consider their own best interests; We frequently encounter transactions in which one party and their agent/advisor are deeply familiar with the local market, and the counterparty/agent is less so. Real estate is inherently local, and information is not all available to the public. As in many business transactions, parties with better information make better decisions.

• ) A reasonable time is allowed for exposure in the open market; T; These days, there are many online services that CRE owners and listing agents can use to publish their listings. One of the benefits is that these services will track the days on market for transactions that closed escrow. Common marketing periods might range from 3 to 9 months. If a property is sold in 30 days, does the price reflect market value? What if it was available for 30 months . . . and finally a buyer comes along who thinks this property is perfect? Is that a reasonable time? Is it a “typical” buyer?

• Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and We can usually check this box as we don’t often run into currency exchange arbitrage with real estate, but this is certainly a factor at play in market sectors that are more liquid.

• 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. Transactions that involve the sale of real estate and business often raise questions here as Buyers are motivated to allocate more of the price to the real estate in order to benefit from the advantageous terms offered on secure real estate loans versus business loans. Another common case is a long escrow that allows a developer buying land to secure development approvals before being committed to the land purchase. Is that Buyer paying normal consideration for the property, or is that Buyer paying for other rights that allow for the elimination of investment risk if granted by the Seller

I hope that this discussion helps you to understand some of the variance in prices for commercial real estate. Somewhere within the range is one price that might, most probably, under certain conditions, be Market Value. That doesn’t make it right, and it doesn’t make a Buyer and/or Seller wrong. It is just one answer to a very specific question in an exciting and ever-changing investment landscape.