[Perishable] What On Earth Is Market Value?
Posted by Jonathan J. Miller -Wednesday, November 16, 2011, 12:38 PM
5 Comments
Like the term “sale” in discount retail stores, the term “market value” in valuation gets misused on a regular basis. In fact I’d characterize some of the misuse as manipulation.
I think of market value in housing as some sort of perishable fruit or vegetable. It has a limited shelf life of reliability.
Here’s an obligatory definition of market value as presented on the Fannie Mae single family appraisal report form, by far the most widely used report in residential valuation:
The most probable price which 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, knowledgeably and assuming the price is not affected by undue stimulus.
Then of course there are many other uses that are thrown into the same caldron of confusion:
- Appraised value – the value on an appraisal report
- Investor value – value of the property is to a specific individual or entity – not necessarily market value
- Fair market value – an accounting term, “old school” market value name and commonly used within the legal system
In layman’s terms let’s talk about how “market value” is being misused.
When a home is properly exposed to the market (listed so buyers can see it in a reasonable period of time), it sells in the marketplace for its value as of that moment.
Market value isn’t precise
Hence my problem with a Zillow “Zestimate” where the presentation is an exact number for the value of a home i.e. $257,532. Perhaps that’s why this tool has long been buried in their web site after being so prominent on their home page after launch. I have never heard of a housing market today that has that kind of precision. If I appraise something for $500,000 and it sells for $505,000 or $495,000, I was spot on the money so to speak.
I see market value of a home as some sort of “range of gray” that I am comfortable with given what I know about the housing market that the property sits within and how its amenities are considered in that market.
One sale does not make a market
As crazy as it sounds, we appraised a Manhattan transaction a long time ago where the buyer was in a 5 way bidding war of a multi-million dollar listing and offered $2M above list “to avoid the stress of a bidding war and get the property they wanted.” They knew they over paid but it was worth it to them. Was this sale price a new benchmark for market value? Of course not yet it was what someone was willing to pay. That’s investor value to the buyer, but not an establishment of market value. It was worth it to them, not the market (wouldn’t we all love to be the seller in that situation?).
During the dot com boom more than a decade ago, there was a townhouse in downtown Manhattan that was purchased by a newly minted dotcom type for $12M, about 2x the market level at that time as I recall (and that was generous). That sale actually seemed to slow down the high end market for a few years within the neighborhood as sellers continued to point to that sale as establishing “market value.” As a result, many overpriced listings sat for extended periods of time until reality sank in. The sale’s impact on the market eventually dissolved and the market returned to sanity.
One sale does not make a market – in other words, market value is a product of multiple data points.
Theory of relativity
My problem with the interpretation of market value as a benchmark is how much is left out of the story when describing it.
There was an article in HousingWire the other day that said: “Freddie Mac sells record-number REO at 94% of market value” The inference in Freddie Mac’s press release is to say that “we are doing a great job, since conventional wisdom suggests that foreclosures usually sell for 15%-20% below market value.” Forgetting that type of PR manipulation for a second, I think many also would followup that initial thought with:
Freddie Mac gave away an average of 6% of the actual value of every home they sold. However in reality, they sold the property for what the market would bear. Foreclosures involved added hassle and a certain amount of unknown pertaining to the condition of the property and probability of some hidden defect because the prior owner was under financial duress. No free lunch.
Often this “foreclosure discount” is quantified by two different data sets such as comparing the prices of non-reo home sales and REO home sales. However in many cases those housing stocks are very different. We see this in Miami where the average square footage of non-distressed properties are much larger. Condos were 27% larger and single family homes were 38.4% larger in 3Q 2011.
In other words, foreclosures don’t sell at a discount. Foreclosures generally sell for market value once you factor in everything.
Foreclosures often sell for a discount from some idealistic-if-this-property-were-not-in-this-situation value but that is NOT market value.
Money on paper loss
I get the same feedback with people who think their property is inherently worth what it was at the peak of the market. When selling the property today, after proper exposure and selling at 20% below the peak, it was described as some sort of discount from its “true” market value to move on with their lives. Wrong. It sold at market value. It did sell at a discount from market value in another time but that’s apples and oranges (i.e. rotten bananas).
Extended definitions and gobbledygook aside, to most consumers and real estate professionals, market value is really a reasonable number arrived at by two parties who are fully informed.
Everyday home sellers and even entities like Freddie Mac are not in the business of philanthropic endeavors (in theory).
The Elliman Report: Miami Sales 3Q-2011 [Douglas Elliman Florida]
Freddie Mac sells record-number REO at 94% of market value [HousingWire]
Jonathan, simply great analysis, great picture too, thanks.
Thanks Howard – it sure gets tiresome in the days of “mark to market” and screaming headlines of 60% discounts off of peak in Miami to see the term “market value” get such an extended beating.
A related point: many people think an appraiser determines or sets the market value, when in fact a valuation is defined as an opinion of value. Some opinions (such as a thorough appraisal done by a local professional) are more informed and well-considered than others (AVMs, Zestimates, etc.).
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