As we are all well aware, residential real estate prices have been in a general decline for several years. By now most appraisers have become accustomed to appraising in a declining market. But what constitutes a declining market? How does an appraiser define it? And what is required to arrive at the best possible value faced with this type of market? These questions and many others have been addressed in an advisory released by the Appraisal Practices Board (APB) on May 7, 2012. The APB is the Appraisal Foundation’s newest board, established in July 2010, and is responsible for developing voluntary guidance in the form of Recognized Valuation Methods & Techniques.
Below are a few excerpts I found interesting, but I recommend that you read the entire document as it addresses eight main questions related to appraising in a declining market. Remember, the guidance in the document is voluntary. But it is great advice offered by a panel of expert appraisers and produced to give you various options for successfully completing your assignments. The Board’s goal is to provide additional guidance and information on generally accepted methods and techniques used to solve very real appraisal challenges.
The first question the APB tackles is a very useful one that addresses a core issue: How should an appraiser define a declining market? The board provides the following guidance:
When providing residential appraisal services, appraisers may be required to determine what constitutes a declining market in order to produce credible assignment results. When determining the status of a market, issues of concern include the following:
Recognizing the characteristics of a declining market – Most appraisers can identify the indicators of a declining market. However, many have trouble interpreting the indicators and then deciding when the indicators lead to a conclusive identification of a declining market. Some characteristics of a declining market are as follows:
In most cases, one of these characteristics alone is not an indication of a declining market, but the presence of several indicators may be a strong indication that the market is in decline.
Defining a declining market – It could be said that all markets are increasing if you go back in history far enough. If an appraiser looks only at the last two quarters, would this be a reasonable time period to say whether prices are going up or down? Would it be better to say in the last 90 days? Would it be better to analyze and read the current market on an annual basis because of the impact of normal seasonal differences?
It is quite logical to say “Declining; compared to what?” It is important for an appraiser to not only state whether they believe the market for the subject is increasing, decreasing or in balance, and to also state what baseline was utilized to arrive at that conclusion. The appraiser should tell the intended users what the comparison is based on (e.g., “The subject’s market is considered to be increasing compared to the same market a year ago,” or “This market is considered to be declining because the database shows a decline in median prices for three out of four quarters in the last year.”)
Just stating “increasing,” “declining” or “stable” without commenting on the time period covered is inadequate.
One recurring theme throughout the advisory document is that of an appraiser’s definition of market value. Question #3 asks: What are some Alternative Value Definitions? This section also addresses questions about using distressed sale properties as comps. Here is an excerpt from their full answer that will be useful to keep in mind:
Market Value: The Public Perception – It is important to understand that most real estate owners, lenders, investors and government officials believe that the term “market value” reflects a gross sale price that an owner of the subject would receive if the subject were put on the market as of the effective date of appraisal. This assumes exposure time has already occurred. However, it is widely recognized (including in USPAP) that market value definitions assume a hypothetical sale of the property as of the date of the appraisal according to the standards of the definition of market value utilized in the appraisal.
In most definitions, market value assumes a sale to the most probable buyer within the highest and best use opinion. This means the definition of the term is based on a sale from the current owner to a new owner. When an appraiser is asked for a “Market Value Opinion,” the public perception would be that the appraiser will tell the client how much they can sell it for. If so, this necessitates an understanding by the appraiser and the client that the value is a future value. This also necessitates an opinion of “the most probable type of buyer.”
Because comparable sales are used to develop opinions of market value, the comparable sales must be compliant with the defined value or be adjusted to those requirements. There are many parts to the popular definitions of market value including the condition that “buyer and seller are typically motivated.” Some appraisers consider that this condition in the defined value precludes using comparable sales that were bank owned properties, short sales, or even corporate relocations. While this may be possible in some markets, this cannot be done in many other markets. There are markets where nearly all sales are bank-owned, short sales or other financially distressed sellers. To say these are excluded fails in two ways:
This is why communication with the client about the intended use and scope of work is important to ensure the appraiser does not answer the wrong question.
Finally, here is a list of items to keep in mind when appraising during a period of declining markets:
This is all good advice and probably matches what many appraisers are doing today in the face of declining markets. It is good to see the APB logic laid out in such an organized way, so appraisers can look at what they are doing today and identify areas where they may want to fine-tune their practice.
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