A recent article questioned the use of forced liquidation values in relation to current “market” sales based on the premise that, given the current state of the market, nobody who can afford to hold onto an asset would sell it right now. Fingers are pointing to appraisers, implying that the appraisers are a significant part of the problem currently affecting bankers and borrowers, during the worst economic environment since The Great Depression. Specifically, there have been claims that appraisers are trying to force banks and developers to change their historic relationships with short-term fixes on long-term assets and that this will only continue to depress real estate values, decimate developers, and erode bank capital.
A fee appraiser, if he/she does his/her job correctly and ethically, remains completely independent of the interests of the parties in a transaction and produces a report that opines on the most probable price that a property would change hands between a willing buyer and seller. Given the “most probable price” assumption, an appraiser is supposed to clearly indicate when true comparable sales are unavailable to form a conclusion through a market/sales comparison approach to value. The appraiser is certainly supposed to have completed all of his due diligence on any possible comparable sales that will be utilized in the final appraisal, and this diligence includes an understanding of the form of sale of the property. For example, was the sale the result of an auction or liquidation process or an “arms-length” negotiation? While there is no question that, especially over the past twelve months, the residential, commercial and industrial markets have been flooded with properties being offered at prices significantly below historical highs, one needs to look back at how a combination of economic factors brought us to this point, what the short term predictions are, and why an appraiser cannot ignore these facts when a lender is relying on these conclusions.
Let’s start by boiling it down to facts that are irrefutable: over the past three decades the American economy has slowly transitioned from one that was “industrial” dominated to one that is “service” dominated. Service-oriented businesses thrive when consumers consistently spend a significant portion of their disposable income. As a result, corporate revenues generated through consumer spending remain healthy enough to support the commercial real estate market as retail and office vacancies remain at manageable levels. With industrial spending down significantly (and, thus, industrial vacancies increasing), a turnaround in the U.S. economy is now highly dependent on a substantial return in consumer spending. However, this appears to be a major challenge over the short term for the following reasons:
One must then look at how this loss of disposable income and the psychological effect of equity losses on the consumer effects retail businesses:
These issues and the overall recessionary environment have already caused the following distress in each the following real estate market sectors:
Additional facts regarding the distress in the current environment can be summarized as follows:
The factual evidence presented indicates that the decline in the economy and its effect on the value of real estate has been consistent and precipitous over the past 7 quarters. Because core factors remain weak in major market sectors, an appraiser has no choice but to consider these facts directly in every appraisal. The argument can also be made that in certain markets, where distressed sales are the only form of sale, that those sales do establish current market value.
Appraisers want nothing more than a healthy economy. A healthy economy means a market where new construction projects, mergers and acquisitions, property occupancy and consumer spending thrive. This scenario is the desire of everyone; however, the current facts and short-terms indicators have shown that none of these economic drivers is on the upswing, and real estate values are affected accordingly.
¹ The Shepherd Investment Strategist, October 16, 2009, a service of JASMTS, Inc.
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