by James R. MacCrate, MAI, CRE, ASA
In the current unstable real estate market, we hear reports from the National Association of Realtors and many economists that the real estate residential housing market is stabilizing. This is based on several factors including recent price increases in several metropolitan markets, an increase in pending contracts of sale, and increase in overall residential market activity. This may very well be a temporary illusion that has been caused by an increase in incentives, concessions, and the federal tax credit. The Wall Street Journal reported that Toll Brothers, Hovnanian Enterprises and Lennar Corporation have provided below market financing and other incentives to increase the number of sales. If adjustments are made to the transaction prices for these incentives, concessions and federal tax credit, one would clearly see that the market value as defined by the Uniform Standards of Professional Appraisal Practice has not really increased at all.
The typical definition of market value as defined in appraisal reports for federally regulated institutions is summarized as follows:
“The most probable price which a property should bring in a competitive 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 each acting in what they consider their 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 unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.”
Source: 12 C.F.R. Part 34.42(9); 55 Federal Register 34696, August 24, 1990, as amended at 57 Federal Register 12202, April 9, 1992; 59 Federal Register 29499, June 7, 1994.
In the above definition, the fourth and fifth bullets are extremely important. If builders are providing below-market financing, even adjustable-rate mortgages, this may have an impact on the purchase or transaction price that the appraiser must consider. In addition, the American Recovery and Reinvestment Act of 2009 authorizes a tax credit of up to $8,000 for qualified first-time home buyers purchasing a principal residence on or after January 1, 2009 and before December 1, 2009. In most real estate markets, it has been reported that the increase in market activity is directly related to the first-time home buyers.
The Uniform Standards of Professional Appraisal Practice specifically states in Standards Rule 1-2 (c) (iv) if the opinion of value is to be based on non-market financing or financing with unusual conditions or incentives, the terms of such financing must be clearly identified and the appraiser’s opinion of their contributions to or negative influence on value must be developed by analysis of relevant market data. These Standards are very clear in that the appraiser must make an adjustment to estimate market value unaffected by any financial incentives, concessions, or abnormal financing. This may very well include the tax credit indicated in the American Recovery and Reinvestment Act of 2009.
On the Appraisal Institute’s web site, the Guide Notes to the Standards of Professional Appraisal Practice of the Appraisal Institute include Guide Note 2 which specifically addresses cash equivalency in valuations. The concessions, tax credits and/or abatements and the favorable financing that are being offered today must be valued separately because these items may not be available in the future. If the tax credit disappears or tax abatements do not continue, the market value of a residential property will be negatively affected in the future if all other factors remain unchanged. In effect, one may be paying more than market value today and suffer a loss tomorrow.
The effect of these factors on sales or transaction prices can vary with the dollar amount of the actual savings and may affect prices differently in various markets. The adjustments should reflect the difference between what the comparables actually sold for with the sales concessions, incentives, favorable financing and tax credits and what they would have sold for without these items so that the dollar amount of the adjustments will approximate the reaction of the market to these factors. These factors do influence the price that buyers pay and must be properly reflected to estimate market value. Many builders, realtors, appraisers, government officials and most importantly home buyers do not fully understand how these factors impact pricing and the future selling price of the property when the property is resold. All these gimmicks do not improve the transparency of the residential home market for buyers because the average market participant has not been trained in financing, economics and marketing.