Appraisers are not prognosticators; they apply professional judgment to available data. And what information is available? Transactions and market trends that occurred in the past. Looking to past market behavior after a crisis – be it financial, natural disaster, terror attack, or pandemic –may not provide useful data to support decisions regarding future behavior. This article discusses the issue with regard to property appraisals.
Using any of the three most common approaches to value presents the same problem. In the cost approach, the appraiser must determine the value of the subject land as if vacant based on the recent past sale prices of similar parcels of vacant land. The sales comparison approach depends on the recent past sales of physically similar properties. The income approach relies in part on the analysis of past rents for similar space and in part on the yield rates indicated by recent past sales of similar properties.
When markets are disrupted as suddenly and steeply as they have been during the COIVID-19 pandemic, how does relying on recent past transactions and market behavior support an opinion of current market value? How can an appraiser develop a credible opinion of market value in the aftermath of a disaster? Putting the human tragedy aside, business transactions and financial arrangements continue. How can appraisers provide value opinions and other analyses when markets are unstable at the least and more often downright chaotic? If appraisals are required during such times, the appraiser must do his or her best. It is up to the client and other users of the appraisal report to determine its reliability and usefulness as well as the durability of the value opinion.
What is required to determine market value of an interest in real property? Market value is defined as:
The most probable price that 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 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.
(12 C.F.R. Part 34.42(g); 55 Federal Register 34696, August 24, 1990, as amended at 57 Federal Register 12202, April 9, 1992; 59 Federal Register 29499, June 7, 1994). (emphasis added)
Following a crisis, how can sale prices not be affected by undue stimulus? In fact, after a disaster most if not all of the criteria of market value may be unmet. In the last year, we have seen hotel occupancies plummet if not disappear; office leasing has fallen drastically, along with rents. Cinemas, restaurants, even summer camps have not been exempt from plummeting revenues while property taxes, insurance premiums, mortgage payments and rent for those properties that are leased have remined the same. Owners of such properties often sold when they were desperate to get out from under the costs of ownership; they were not willing sellers as we normally understand that term.
If an appraiser is required to value a commercial property as of March 1, 2021, relying as it should on recent past transactions and market behavior, the appraised value most likely will be significantly lower than the appraised market value as of March 1, 2020. The 2021 valuation may trigger default provision of a mortgage or reduce the asking price for the property to something significantly less than the seller had expected to realize. It has been reported that appraised values of shopping malls nationwide were 65% lower than the appraised values of the same properties at the end of 2019. If the data were available, something similar would likely be seen for hotel and office properties. The appraisal for the same properties as of March 1, 2023 will likely indicate values closer to those in 2019, significantly higher than in 2021 and even in 2022.
If the appraiser takes the position that transactions that occurred during the pandemic are not reflective of market value and relies on pre-pandemic transactions, the value will reflect the actions of market participants prior to the date of value, rather than the market participants temporally adjacent to the subject transaction, and so over-value the property.
It must be recognized that appraisers are required to use the available data; appraisers cannot fabricate comparable transactions. It is up to the users of appraisal performed in tumultuous times to assess the reliability and durability of these value opinions.