All Kinds of Value

Mr. Appraiser, what is my house worth? Every appraiser has been asked that question at one time or another. In one sense, it is like asking a doctor whether or not you are going to die. If he is brutally honest, the doctor will say "Yes", since everyone must die someday. If he is thinking about the very immediate future, and you are healthy, he may say "No". Regardless what he says, he is both right and wrong. The appraiser is caught in a similar bind.

Aside from the fact that the appraiser might simply tell the homeowner that he cannot say anything about the value (depending on who his client is), there are so many kinds of value that an off-the-cuff answer may be very wrong. Most homeowners, when they ask The Question, are concerned about what price they might be able to get if they put their home on the market. They are not always aware of the relationship between, or the difference between, price and value.

Price is the amount of money, in a specified currency, or in terms of trade goods, that is actually exchanged for an item. You walk into an automobile dealership and buy a used car, paying a price in dollars. That tight feeling as you take the keys in hand comes from wondering whether or not you paid "too much". You drive it off the lot, and go to the house of Joe, your buddy, to show it off. As you pull into his driveway, you see a car just like yours sitting there. It turns out that Joe has just purchased an identical vehicle, in the same color, with the same mileage, and in the same condition, as yours. He did not pay the same price. In fact, one of you paid $5,000 more than the other. What is the value of your cars?

To the layman, price and value appear to be about the same. Price is a hard number. Value, however, has some conditions attached. It is subjective and can change very quickly depending on external conditions. Some other terms need to be understood about when we speak of value.

One of these terms is arm's-length. An arm's-length transaction is one where the two parties are not related and will not be doing each other any favors. Transactions between family members, close friends, or even mortal enemies, are not at arm's-length, because the price arrived at would be totally different if a stranger were involved.

Another factor is the concept of prudence. You may be able to come to an agreement with someone, but if that person is not mentally capable, or is intoxicated, or angry, or in any number of conditions where they are not functioning rationally (or maybe you are in that condition?), the price will not be the same as the value.

A third factor is that of similar knowledge. It is easy to steal candy from a baby. I frequently hear people brag about how they bought something very cheaply because the seller did not realize the value of the article. It amazes me that these same people could be so angry at someone who made a pile of money through insider trading on the stack market, without understanding that they have done exactly the same thing in a different market.

A fourth consideration is market exposure. Jack might agree over lunch to sell Jill a bag of rocks for X dollars, with neither of them concerned at the moment what would happen if other people were allowed to participate in the transaction. This is the eBay phenomenon, where one man's junk is another man's treasure, but only if the other man does not live next door. Market exposure will quickly tell sellers and buyers whether the asking price is correct. Because money has a time-value, some appraisal problems call for close attention to the anticipated market time.

A final factor is willingness. Distress sales can never be considered to have occurred at market value, since the seller is under compulsion to sell. Similarly, the buyer who is moving to town and has to have a house in one week's time will frequently pay more than market value simply because he needs a roof over his head in a hurry.

As a result, the definition of market value found on standard (FNMA) appraisal report forms used by lenders states that market value for the purpose of determining the loan collateral is "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, 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: (1) buyer and seller are typically motivated; (2) both parties are well informed or well advised, and each acting in what he or she considers his or her own best interest; (3) a reasonable time is allowed for exposure in the open market; (4) payment is made in terms of cash in U. S. dollars or in terms of financial arrangements comparable thereto; and (5) 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."

"Market value", which is an appraisal term, should not be confused with "fair market value" or "fair value", which are accounting terms (and also legal terms, since lawyers and the tax collectors are generally not disinterested parties where value is concerned). Let us consider a share of stock, which is a piece of personal, as opposed to real, property. Perhaps the corporation issues one million shares, which are traded on the stock market. At any given time that the market is open, the fair market value of a single share can be determined, since there is no difference between it and the next share of the same stock. If you know the price of one share, you know the price, for that given moment, of all the shares of the corporation's stock.

Real property, however, is very different from personal property. While you may have one million pieces of personal property that are exactly alike in the right to ownership and a share of the profits, there are no two pieces of real property that are exactly alike! This is because there are no two parcels of land that are identical, and as a result, just because you can determine a value for one parcel does not mean that all parcels of the same size or in the same town or the same subdivision are of the same value. It is not possible to arrive at a "fair market value" for real estate, regardless what you may be told by bean counters or legal sharks.

This causes untold misery for most home buyers, who were never introduced to economics or to real estate studies in high school. In a new subdivision, the most important selling points will revolve around the size of the house and the fixtures in it. It will not be until the new homeowners settle in that they will fully realize that their home is no different (despite the color of paint they used) than the one next door, except in location. It is very rare that the buyer of a new home in a new subdivision pays a market value price for that home.

It is for this reason that the most significant factors that influence market value are listed in order of importance on the FNMA appraisal grid, starting at the top : sales concessions, date of sale, location, property rights, site area, and view. Those factors are the most difficult to completely compile and analyze, but are critical in understanding why two houses of the same design and size can sell for very different prices.

There are other types of value besides market value, but they are suited to different purposes than determining the possible selling price of a property, and we can examine them at a later time.