A Look at Disposition Value & Liquidation Value

A common instruction in an engagement letter in these times might include wording such as:

"Please provide both the current market value and the disposition value based on a 9 month market period for the fee simple interest."

As compliance reviewers, my colleague, Richard Rexroad, SRA, and I have noted on numerous occasions what appears to be total confusion among the ranks of appraisers as to what exactly is meant by "disposition value". Certainly, the definition of disposition value is easily found for, and cited in, their reports, but the summary statements that include their opinions of disposition value may be of marginal use -- or worse, no use at all -- to the client.

To try to ascertain the resources available to appraisers for reference on the subject, a search was made of all media in the Appraisal Institute's Lum Library using the keywords "disposition value". The search returned one resource, Appraisal Institute Special Task Force on Value Definitions, June 1992 by Schultz, Featherston, Gibbons, LeGrand, and Parson. That work proposed definitions of disposition value and liquidation value, both of which appear to have subsequently been defined following their proposal. No further modern references could be located in the Lum Library.

Perhaps the best starting point for the discussion would lie in examining the Assignment Type and Intended Use of the report. After the highjacking of the URAR form by Fannie and Freddie in 2005, and the hardcoding of the Intended Use ("The intended use of this appraisal report is for the lender/client to evaluate the property that is the subject of this appraisal for a mortgage finance transaction."), most residential appraisers gave no further thought to that matter. For the most part, the assignments were for either purchases or refinances; no other discussion of the intended use was needed.

With the increase in inventory of REO properties and the periodic need to analyze the value of the collateral with a view toward asset disposition, lenders holding residential properties in their portfolios have been ordering large numbers of appraisals for the purpose of collateral analysis rather than mortgage finance. The AI Reports forms (which would be a much better choice for the task) have been ignored by the lending community. Appraisals for collateral analysis have been ordered, almost without exception, on the FNMA 2005 series of forms, most likely because that is what the lenders are most familiar with.

Because the FNMA/FHLMC forms are intended to be used for mortgage finance rather than disposition of the asset, the change in Intended Use is in direct conflict with the hard-coded statement in the report, and very few residential appraisers (even among those holding various designations from professional associations) have seen fit to add language in the addenda to the report which will supercede the hard-coded verbiage.

[Note: The forms do state that "Modifications, additions, or deletions to the intended use, intended user, definition of market value, or assumptions and limiting conditions are not permitted.", and then two exceptions are cited. However, that restriction applies ONLY to the use of the form for a FNMA/FHLMC mortgage transaction. The GSEs cannot prohibit the use of the form for other purposes; the key to their USPAP-compliant use in such situations is to adequately provide overriding verbiage in an addendum regarding the intended use, intended user, definition of value (and the source of the definition), assumptions, conditions, limitations, and certifications. ]

This discussion does not purport to address all forms of deviation from the hardcoded verbiage in the FNMA/FHLMC forms, but appraisers using those forms for other than a mortgage finance transaction need to keep the above factors under consideration.

When the assignment stipulates that the purpose is in the nature of collateral analysis for disposition of the asset, the client will frequently request either a disposition or liquidation value opinion along with the current market value opinion. In doing so, the client is first looking for the present value of the asset as though it had been offered on the open market at competitive terms with all other properties comparable to it. The typical exposure time for the subject must be analyzed and reported for the current market value. In that analysis, the appraiser will also be analyzing the market supply and pricing trends of competitive homes; all these factors are supposed to be summarized on page 1 of the FNMA report form.

Development of current market value is a straightforward process for most residential appraisers. Their major concern with the neighborhood market trend information is to develop adequate adjustments for the comparable sales, based on their distance in time from the effective date of the report. When the assignment adds the requirement to develop an opinion of disposition or liquidation value, however, there will be an application of the trends to the stated marketing period along with additional consideration of the motivation of the seller.

An examination of the definitions of these values is in order:

Market Value	Disposition Value	Liquidation Value
12 CRF 323.2(g)	Dict. of RE Appraisal (4th Ed)	Dict. of RE Appraisal (4th Ed)
Consummation of a sale as of a specified date.	Consummation of a sale will occur within a limited future marketing period specified by the client.	Consummation of a sale will occur within a severely limited future marketing period specified by the client.
Competitive and open market under all conditions requisite to a fair sale.	The actual market conditions currently prevailing are those to which the appraised property interest is subject.	The actual market conditions currently prevailing are those to which the appraised property interest is subject.
The buyer and seller each acting prudently and knowledgeably.	The buyer and seller each acting prudently and knowledgeably.	The buyer acting prudently and knowledgeably.
Assuming the price is not affected by undue stimulus, buyer and seller are typically motivated.	The seller is under compulsion to sell, the buyer is typically motivated.	The seller is under extreme compulsion to sell, the buyer is typically motivated.
Both parties are well informed or well advised, and acting in what they consider their own best interests.	Both parties are acting in what they consider their best interests.	The buyer is acting in what he or she considers his or her best interest.
A reasonable time is allowed for exposure in the open market.	An adequate marketing effort will be made in the limited time allowed for the completion of a sale.	A limited marketing effort and time will be allowed for the completion of a sale.
Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto.	Payment will be made in cash in U.S. dollars or in terms of financial arrangements comparable thereto.	Payment will be made in 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.	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.	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.

Standards Rule 1-2 requires that the appraiser identify the Intended Use of the appraisal. It seems to be a difficult thing for appraisers to ask clients, "What do you intend to do with my opinion?", yet that is critical to understanding how the problem must be approached. The appraiser cannot render a useful opinion of value without understanding the motivation of the participants in the market. We seem to clearly understand that a market value opinion will be used to make a decision regarding underwriting a mortgage loan. Sadly, there seems to be a failure to understand why a client would request a disposition or liquidation value; the client assumes we know, and we assume they understand what we are about to deliver.

Let us step into the shoes of the lender with an asset which needs to be sold. The lender first wishes to know what his collateral is worth today -- the current market value. That value assumes that the subject has been on the market for its reasonable exposure period. In studying that exposure period, the appraiser will note the change in the market from the beginning of the exposure period to the effective date of the appraisal; that market change information will be critical in making adjustments to the comparable sales.

Unfortunately for the client, he is holding the subject in his inventory today, without a sales contract. He realizes that in order to get a contract, he will have to market the property. He has certain parameters for market time. Let us assume that the market is slow and the reasonable exposure period for the subject might be 6 months. The client knows that it will take time to sell the subject; acting prudently (see the definition of disposition value) he is willing to extend the market time to a maximum of 9 months, and orders a disposition value based on a 9 month market period. What is he telling us he wants? Have we really learned the definition of the value type?

Perhaps the client tells us his intent is to know what the property will be worth 9 months from now by asking for a disposition value based on a 9 month market period. That is a prospective value opinion which the appraiser will need to develop by adjusting the current market value for any anticipated change in the market over the 9 month period, as well as his knowledge, perhaps gleaned from anecdotal evidence in talking with sales brokers, of typical discounts in the subject market when properties sell under compulsion. Similarly to forecasting in a relocation appraisal, the 9-month disposition value thus arrived at gives the client a far end of a range (current market value is the near end) within which he can hope to sell the property during that time period. If an offer comes in within that range, the client now has a tool he can use to judge the acceptability of the offer. As the 1992 Task Force noted, in a declining market, the disposition value opinion would probably be lower than current market value, but in a rising market, it possibly could be higher.

Development of a liquidation value opinion would follow the same general pattern, with a subtle difference -- the factor of extreme compulsion to sell, coupled with the facts that the marketing effort would be limited and the seller might not be acting prudently. In such a situation, the place to turn for the anecdotal market conditions would be the auctioneer who specializes in absolute auctions with no reserve. Such an opinion would need to be formed with the mindset that the specified market period for the subject would anticipate an absolute auction at its termination, with a view toward informing the client that any offer he received within that time period which fell into the range would likely be one to which serious consideration should be given.

Nevertheless, regardless the trend of pricing in the marketplace, the anecdotal evidence will be crucial to the development of either type of value. There simply is not enough reliable statistical information readily available to the average residential appraiser for this purpose. The subjective nature of anecdotal data should not be viewed as lacking validity; the decisions behind the motivation and actions of the typical seller in disposition or liquidation scenarios are similarly subjective and valid. The appraiser is not being misleading as long as full disclosure of the kind of data source is made.

What is not valid, and is indeed unethical, is to postulate an opinion of value without understanding the intended use of the appraisal, or acknowledging the conditions explicit in the definition of that value.