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Market value: the elusive standard.

The concept of market value has been defined and discussed by the courts, by government regulators, and throughout appraisal literature. Despite this widespread attention, however, adoption of an industry standard has remained an elusive goal. The authors trace the history of market value and offer a definition that applies to all real estate activity.

First presented at the Appraisal Institute's "Under the Microscope" program at the January 1992 national meeting in Palm Desert, California, this article introduces a new, ongoing feature in The Appraisal Journal. Two other articles on market value will appear in the October 1992 issue. Papers on the cost approach presented at the July 1992 national meeting in Boston will be published in a future "Under the Microscope" column in The Appraisal Journal.

The current recession, the sharp decline in real estate values throughout the country, and the increased regulation of the banking and insurance industries underscore the need for a commonly accepted definition of market value. The intense debate concerning this issue, which raged during the mid-1980s, is once again at the forefront.

An acceptable definition of market value should realistically reflect the diverse activity in the real estate marketplace. It should apply equally to lending, investing, periodic asset valuation, litigation, and all other situations. It should satisfy the needs of the general public, regulators, market participants, judges, and analysts. In short, it should facilitate real-world solutions to real-world valuation problems.


The modern concept of market value evolved primarily from court decisions and appraisal literature. A review of the role each has played in the development of the market value concept provides the foundation for resolving the current debate.

Court definitions

The most widely quoted court definition of market value, which arose in the case Sacramento, etc., R.R. Co. v. Heilbron, is:

The highest price estimated in terms of money which the land would bring if exposed for sale in the open market, with reasonable time allowed in which to find a purchaser, buying with knowledge of all of the uses and purposes to which it was adapted and for which it was capable of being used.[1]

This definition was used widely in the 1950s and 1960s during the great boom in condemnation appraisals for highway construction. While the term "highest price" occasionally caused some arguments, there was little debate on the concept of market value. In the context of providing for just compensation based on cash valuations of fee simple real property interests, this definition was fair and equitable, and it functioned well.

According to another frequently quoted court definition, which resulted from Reservation Eleven Associates v. District of Columbia, fair market value is:

The price which a willing seller, who is not obliged to sell, would be willing to accept and the price which a willing buyer, who is not obliged to buy, would be willing to pay for the property. This . . . assumes that the buyer is knowledgeable and that the seller is knowledgeable . . . of all the present or potential elements of value involved . . . Fair market value . . . is based upon the probabilities as they appear to the willing buyer and the willing seller.[2]

This definition stresses that both parties to the transactions are "willing" and neither is obliged to buy or sell. A cornerstone assumption (sometimes unstated) of any market value definition, this concept caused no controversy.

Court definitions, while useful and appropriate in solving legal problems, are of limited relevance in most valuation assignments. Court decisions generally involve and appropriate in solving legal problems, are of limited relevance in most valuation assignments. Court decisions generally involve valuations of fee simple real property interests. Unless it is an issue that is being litigated directly, jurists tend to avoid the question of the value of leased fee and lease-hold estates.

Courts have also manifested an astonishing indifference concerning the impact of financing on value. As a result, most court decisions involve only cash interpretations of market value in fee simple situations. The danger of such narrow interpretations is that they do not relate to the bulk of real estate transactions or properties as they actually exist. Most commercial properties are leased and the vast majority are financed. Financing does have an effect on many real property interests that are sold, and appraisers are often asked to value those specific interests.

Aside from these weaknesses, legal decisions present other problems because they are accorded publicity disproportionate to their significance. Lay people fail to realize some simple truths. Courts are limited to what is presented at trial. Because judges are prohibited from going beyond the bounds of the evidence, value definitions are often predicated on limited facts. Further, while judges are learned in the law, many are not well trained in real estate valuation theory. Most important, market participants make value, not judges. Like all other observers, judges merely interpret market phenomena.

Court-derived market value definitions still have relevancy in condemnation or tax appeal cases, however, or in any situation in which fee simple cash valuations are required.

Appraisal literature

The impact of appraisal literature on the concept of market value greatly outweighs the impact of court definitions. This results, in no small part, from the wide dissemination of appraisal textbooks and related articles in professional journals. Early appraisal literature defined market value as:

The quantity of other commodities a property will command in exchange; specifically, the amount expressed in terms of money which a purchaser would be justified in paying for a property as of a certain date, assuming he were to acquire thereby all of the rights and benefits to the equivalent extent possessed by the owner.[3]

Value is the present worth of all the rights to future benefits arising from ownership.[4]

The reference to "rights and benefits . . . possessed by the owner," and "rights to future benefits arising from ownership" (which were unfortunately dropped from the 1975 definition that follows) are critical concepts.

In 1975, market value was described in Real Estate Appraisal Terminology as "the highest price." Payment was limited to "cash or its equivalent."

The highest price in terms of money which a property will 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.

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:

1. Buyer and seller are typically motivated.

2. Both parties are well informed or well advised, and each acting in what he considers his own best interest.

3. A reasonable time is allowed for exposure in the open market.

4. Payment is made in cash or its equivalent.

5. Financing, if any, is on terms generally available in the community at the specified date and typical for the property type in its locale.

6. The price represents a normal consideration for the property sold unaffected by special financing amounts and/or terms, services, fees, costs, or credits incurred in the transaction.[5]

The term "highest price," taken from the Heilbron case, was introduced for the first time into a market value definition published by a national appraisal organization. A cash value is required (condition 4) but "financing. . . on terms generally available" (condition 5) is also allowed. A controversy ensued concerning whether seller financing (generally available) at below-market rates reflected market value. In the subsequent edition of Real Estate Appriasal Terminology, "most probable price" was substituted for "the highest price."[6] There were no other changes to the definition.

Some of the most profound developments in the evolution of market value were incorporated in the definition that appeared in 1983 in the eighth edition of The Appraisal of Real Estate.

The most probable price in cash, terms equivalent to cash, or in other precisely revealed terms, for which the appraised property will sell in a competitive market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress.

The fundamental assumptions and conditions presumed in this definition are:

1. Buyer and seller are motivated by self-interest.

2. Buyer and seller are well informed and are acting prudently.

3. The property is exposed for a reasonable time on the open market.

4. Payment is made in cash, its equivalent, or in specified financing terms.

5. Special financing, if any, may be the financing actually in place or in terms generally available for the property in its locale on the effective appraisal date.

6. The effect, if any, on the amount of market value of atypical financing, services, or fees shall be clearly and precisely revealed in the appraisal report.[7]

This definition marked a watershed because it acknowledged that value could be reported in terms of cash, its equivalent, "or in other precisely revealed terms." While many appraisers were routinely reporting market values of real property interests "subject to specified financing," this was the first opportunity to use a relevant market value definition promulgated by a national appraisal organization. It caused an immediate and heated controversy. The main objection centered on the concern that appraising "subject to below-market rate financing" would inflate values. Although this was never the object of the proponents of this new definition, the issue nonetheless tainted the definition and adversely affected its acceptance as the industry standard.

Although much of the opposition to reporting value "in other precisely revealed terms" was overcome with the adoption of Standard Rule 1-2(b) of the Uniform Standards of Professional Appraisal Practice (USPAP) and Guide Note 2 of the Standards of Professional Practice of the Appraisal Institute, many continue to resist this alternative--most notably federal regulators--on intellectual and philosophical grounds. Standard Rule 1-2(b) requires an appraiser to clearly indicate whether a market value estimate is in terms of 1) cash, 2) financial arrangements equivalent to cash, or 3) in such other terms as may be precisely defined. This standard also provides that if a value estimate is based on submarket financing or on financing with unusual conditions or incentives, the terms of such financing must be clearly set forth, their contributions to or negative influence on value must be described and estimated, and the market data supporting the valuation estimate must be described and explained. Guide Note 2 explains how to communicate the required analysis.

Throughout the 1980s, the real estate industry continued to seek a definition that would reflect the realities of the modern marketplace yet appeal to all constituencies. It was in this environment that the authors articulated the following market value definition.

The price in cash and/or other identified terms for which the specified real property interest is expected to sell in the real estate marketplace under all conditions requisite to a fair sale.[8]

With two possible clarifications, this concise definition best captures the essence of market value. Its strength lies in its simplicity and in its universal applicability. When proposed, it represented a departure from several traditional beliefs. According to Austin J. Jaffe and Kenneth Lusht in "The Concept of Market Value: Its Origins and Development," "This definition is important on three counts. First, it departs from the 'all cash or typical financing basis' underlying other definitions. Second, it differs from the fee simple focus by referencing the 'specified real property interest.' Third, it suggests the 'expected price' as the criteria of market value."[9] The elements of this definition and suggested clarifications will be discussed in greater detail later in this article.

Two other definitions are significant. One was prepared by Jaffe and Lusht; the other was mandated by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). Both adhere to the "cash-only school." The former definition of market value, from a comprehensive unpublished study of market value completed in 1985, is:

The expected selling price of the specified real property right, for cash or terms equivalent to cash, based on observed selling prices of reasonably comparable property rights.[10]

As a result of the passage of FIRREA and its interpretation by various bank regulating agencies, the debate on the market value definition reignited. The definition mandated for use in federally regulated transactions is as follows:

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. Implicit in this definition is consummation of a sale as of a specified date and passing of title from seller to buyer under conditions whereby:

1. buyer and seller are typically motivated;

2. both parties are well informed or well advised and each acting in what he considers his own best interest;

3. a reasonable time is allowed for exposure in the open market;

4. payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and

5. 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.[11]

Thus, the concept of a cash value is again brought to the forefront.


As a solution, the authors offer a modified version of their earlier definition of market value. All revisions are in italics.

The price in cash and/or other identified terms for which the specified real property interest is likely to sell as of the effective date of appraisal in the real estate marketplace under all conditions requisite to a fair sale.

The form of a definition is of vital importance. It should not be expansive. Rather, it must be precise and easy to understand. Elements of the definition and any implicit assumptions or underlying theories should not be included. They are superfluous appendages that are more appropriately addressed in textbooks or journals.

(Expected) price

Most of the early definitions held that market value should be expressed as the highest price. This was the result of court decisions that undoubtedly sought fairness for litigants. Emphasis on the highest price was viewed as an assurance that this objective would be achieved. However, there are obvious problems. As Harold Albritton notes in Controversies in Real Property Valuation, "Literal interpretation of highest price is judged to be no more logical than estimating lowest price and labeling it market value. The appraiser typically seeks to estimate fair market value, and the estimation of highest or lowest price would be unfair and not market value at all."[12]

In recognition of this problem, "most probable price" was used as a substitute. One of the first widely accepted definitions to use this phrase was the one that appeared in the 1981 edition of Real Estate Appraisal Terminology.[13] Even before its widespread use, however, most probable price had developed a specific meaning in appraisal literature. Largely as a result of the writings of Richard Ratcliff, one of its earliest and most fervent proponents, most probable price became synonymous with the mode, which is how he described it in "A National View of the Appraisal Function."[14]

Equally significant, this term ignores the willing buyer/willing seller concept in the sense that it includes all sale data even if some transactions are not arm's-length. Duress and motivations of the parties are not considered. In short, most probable selling price has a narrow, specific meaning.

The proposed definition intentionally rejects the notion of most probable price because of its rigidity. In selecting a final estimate, an appraiser exercises judgment in a deductive process through which an informed estimate is derived, based on a combination of observed phenomena and an appraiser's background and expertise rather than the mere mechanical process of selecting the mode. Clearly, the term "most probable price" is unsatisfactory.

The proposed definition uses "price," which simply means the price that the property is likely to command. In the interest of clarity, such modifiers as "highest," "most probable," and "fair" were avoided.[15] Jaffe and Lusht somehow interpreted "the (expected) price" to be equivalent to the mean.[16] This misunderstanding is symptomatic of a larger gap between academicians and practitioners. Notwithstanding that real estate appraisal is not an exact science, academicians frequently seek to impose the discipline of mathematics on the entire valuation process, which tends to make it arcane. Practitioners, on the other hand, acknowledge the usefulness of certain mathematical applications; however, they also contend that there is no substitute for sound reasoning, judgment, experience, and simple common sense. Practitioners acknowledge that real estate markets are inefficient and that they do not always lend themselves to precise mathematical explanation.

Other identified terms

The phrase "other identified terms" acknowledges that value can and does vary depending on financing and the real property interest appraised.[17] Most important, it expresses recognition of the fact that clients sometimes need to know the market value of a real property interest subject to possibly atypical existing or proposed financing, and that this is a legitimate need. Many pension funds require their leveraged assets to be valued on a "subject to" basis to be posted on the asset side of their financial statement. Including the current debt balance on the liability side of the statement results in the proper accounting of their equity value in the asset. To preclude appraisers from estimating market value in such situations would be unrealistic and without merit--a disservice to everyone concerned and to the public at large.

The potential for abuse in such situations is eliminated by Standard Rule 1-2(b) of the USPAP and the Appraisal Institute's Guide Note 2, which were discussed previously. Proper adherence to standards ensures that no misunderstanding occurs and that all interests, including third parties and the general public, are protected.

The important principle is that appraisers should be permitted to report market value in other terms if there is a legitimate need to do so, if such a need is precisely revealed, and if there is compliance with all ethical requirements.

The proposed definition, in addition to providing for the legitimate need of "subject to" financing valuations, also provides for the needs of regulators, litigants in condemnations, and property taxing authorities, all of whom require cash-only valuations. The flexibility of the definition recognizes the varied needs of the marketplace.

Specified real property interest

Real estate appraisers do not value real estate. Rather, they value interests in real estate such as the fee simple, leased fee, or leasehold estates. Further interests are created if these estates are fragmented (i.e., partnership or corporate shareholders interest) or if they are encumbered by mortgages.[18] Just as deeds and leases create certain rights and restrictions, so do mortgage encumbrances. It is indisputable that mortgages further fractionalize the bundle of rights by giving a mortgagee an interest in a property, if only under certain circumstances. Thus, real property interests include equity and debt interests in fee simple, leased fee, and leasehold estates (see Figure 1).

James E. Gibbons summed up this issue best in a letter written in February 1992.

The bundle of rights concept is of utmost importance and misunderstandings about it cause many appraisal confusions. In commercial real estate today it is not unusual for a project to comprise a fee interest that has been mortgaged once or twice, a long-term leasehold that has been mortgaged to create leasehold improvements, and a variety of operating leases. The bundle has been divided into many parts owned by diverse parties. While a value estimate covering the total property rights is not likely to answer their individual questions and might even contribute to confusion it might satisfy some statutory or regulatory mandate.

We worry about matters such as creative financing's influence on values. But if you examine a simple case of such a mortgage and look at it solely in terms of the equity and mortgage interests, several interesting facts seem clear. If the equity position has the benefit of light debt service and may have it for 25 years, what does that say about the market value of the equity? It is enhanced and any sale of it in a fair market transaction will demonstrate this contention. What about the property's other component--the mortgage? It is owned and controlled by a mortagee, not by the equity owner. What does this financing do to the market value of the mortgage? It will suffer diminution--in any sale of the lien, the mortgagee will have to discount it to reflect current mortgage yields. It would not be correct to say this component has a market value equal to its face amount.

This little example heightens the importance of the bundle of rights. These two property rights, mortgage and equity, each have a market value, those values are influenced by the financial arrangements, and the market will deal with them only on that basis. So the cogent issue is: Which of the property rights is the subject of appraisal? When that is clear, its market value can be separately estimated. Putting the two components together seems to generate the confusion. The parts are owned by different parties who have separate aims and objectives.

If the so-called owner of the property, the equity investor, wishes to sell, he or she does not have full control of the mortgage. If it is assumable, the benefit can be passed on to the new equity owner and the mortgage position continues to suffer. If the mortgage profits to the extent of the difference between the lien's former market value and its face amount. The impact of leasing is the same. Does a lease favor fee or leasehold and to what extent? A lease and a mortgage are quite similar--they are encumbrances that divide, distribute, and limit the various rights and benefits in the bundle. (Emphasis added.)[19]

Is likely to sell

An appraisal is an estimate or an opinion rather than an absolute assurance that a property will sell for the estimated value. Because "will sell" implies certainty, it was modified. Because "expected" has become synonymous with the mean in statistics, "likely" has been substituted.

Conditions requisite to a fair sale

The phrase "conditions requisite to a fair sale" embodies the concepts that a knowledgeable, willing buyer and seller are both acting prudently and without duress, and that the property has been exposed to the market for a reasonable time. It is concise and also implicity rejects the use of most probable price, because in appraisal literature most probable price encompasses all transactions including those that are not arm's-length.

As of the effective date of appraisal

With the introduction of a marketing period reporting requirement by the bank regulatory agencies and the use of the term "fair value" by the Office of the Comptroller of the Currency, confusion has emerged recently concerning the date on which an appraised value is effective.

Without commenting directly on the logic of fair value or that it is equivalent to market value in accounting terminology, several points are worth mentioning.

Standard Rule 1-2(a) of the USPAP requires an appraiser to identify the effective date of appraisal. Standard Rule 2-2(e) states that every written or oral appraisal must "set forth the effective date of the appraisal and the date of the report." The effective date of the appraisal is the date on which the hypothetical sale of the subject property is assumed to occur. If the effective date is current as opposed to some time in the future, which is the case in the vast majority of appraisals, marketing efforts are viewed as historical rather than prospective. This has been the traditional assumption and is reflected in the valuation process itself. For example, the first day of a discounted cash flow analysis is normally the effective date of the appraisal. Value is measured from that day forward. The same principle applies to the sales comparison approach. Value is measured from the closing date of each sale property to the hypothetical closing date of the subject property (i.e., the effective date of appraisal). Just as the time and effort required to market the sale properties were historical to their respective closing dates, any efforts to market the subject property are assumed to be historical to the effective date of appraisal. This assumption is clearly the basis on which the valuation process operates in every situation that requires a current value estimate.

To clarify the meaning of "reasonable exposure time" in market value definitions, some appraisers include the following statement in their reports.

The specified date as contemplated by the market value definition is the date of value indicated in this report for the real property interest appraised. The "reasonable time allowed for exposure in the open market" refers to the marketing time leading to the valuation date. Hence, the value estimate presumes a sale on the date of value.


The need of regulators and other clients to know the price that a property is likely to command at the end of a typical marketing period is legitimate and the appraisal profession must respond accordingly. Fortunately, the response is easy and sensible. Once a client outlines the scope of the assignment, the appraiser can provide the prospective market value at the termination of a typical marketing period. This principle is no different than those of the prospective market value upon completion of construction or the prospective market value upon reaching stabilized occupancy. Obviously, any conclusions relative to the length of the marketing period require support, and the persuasiveness of that support will depend on its timeliness. Marketing period is currently defined by regulators as "the term in which an owner of a property is actively attempting to sell that property in a competitive and open market."[20]


The search for a universally accepted definition of market value continues. Some contend that the task is nearly impossible.

The term "market value" is understood in many ways: as a symbol, norm, opinion, inference, expectation, prediction, event, ideal. Out of this thicket of meanings no unifying idea has emerged despite years of effort by the appraisal profession and the courts. The official definitions are clumsy, lax, unrealistic, and self-contradictory, obviously the products of tired committees and overworked jurists. If there is a single concept common to all of them, it has yet to be articulated.[21]

Others are more optimistic. The definition proposed here is concise, simple, and applicable to all real estate activity. It is no substitute for ethical regulations, which are found in codes of conduct, or for theoretical discussions, which are found in textbooks and professional journals. The proposed definition does, however, provide a reasonable and practical framework for reporting market value that best satisfies the needs of the general public, shareholders and depositors of lending institutions, government regulators, borrowers, the real estate industry, market analysts, and the courts. The proposed definition applies equally to the fee simple estate of an industrial building in Topeka, to the leasehold estate of a service station in Cincinnati, and to the leased fee estate of strip stores in Little Rock. It also applies with equal validity to the leased fee interest of an office tower in San Francisco subject to existing financing or to the leasehold estate of a regional mall in Chicago. Therein lies its strength.

[1]. Sacramento, etc. R.R. Co. v. Heilbron (1909) 156 C. 408, 409, 104 P979, 980.

[2]. Reservation Eleven Associates v. District of Columbia, 420 F.2d 153, 155 (C.A.D.C. 1969).

[3]. American Inst. of Real Estate Appraisers, Appraisal Terminology (Chicago: American Inst. of Real Estate Appraisers, 1935), 55.

[4]. American Inst. of Real Estate Appraisers, The Appraisal of Real Estate (Chicago: American Inst. of Real Estate Appraisers, 1951), 37.

[5]. American Inst. of Real Estate Appraisers and Society of Real Estate Appraisers, Real Estate Appraisal Terminology (Chicago: American Inst. of Real Estate Appraisers and Society of Real Estate Appraisers, 1975), 137.

[6]. American Inst. of Real Estate Appraisers and Society of Real Estate Appraisers, Real Estate Appraisal Terminology (Chicago: American Inst. of Real Estate Appraisers and Society of Real Estate Appraisers, 1981), 160-161.

[7]. American Inst. of Real Estate Appraisers, The Appraisal of Real Estate, 8th ed. (Chicago: American Inst. of Real Estate Appraisers, 1983), 33.

[8]. Peter F. Korpacz and Richard Marchitelli, "Market Value: A Contemporary Perspective," The Appraisal Journal (October 1984): 485-493.

[9]. Austin J. Jaffe and Kenneth M. Lusht, "The Concept of Market Value: Its Origins and Development," (University Park, Pennsylvania: December 1985), 5-18.

[10]. Ibid., 802.

[11]. Federal Financial Institutions Reform, Recovery and Enforcement Act of 1989.

[12]. Harold D. Albritton, Controversies in Real Property Valuation (Chicago: American Inst. of Real Estate Appraisers, 1982), 9.

[13]. Real Estate Appraisal Terminology, 1981, 160-161.

[14]. Richard U. Ratcliff, "A National View of the Appraisal Function," The Appraisal Journal (October 1965): 169.

[15]. Korpacz and Marchitelli, 490-491.

[16]. Jaffe and Lusht, 7-5 to 7-7.

[17]. Peter F. Korpacz and Richard Marchitelli, "Market Value: Contemporary Applications," The Appraisal Journal (July 1985): 437-445.

[18]. Peter F. Korpacz, Richard Marchitelli, and Mark I. Roth, "Back to Basics: Specified Real Property Rights," The Appraisal Journal (October 1987): 604-607.

[19]. Letter dated February 13, 1992, from James E. Gibbons to A. Scruggs Love, Jr.

[20]. Interagency Policy Statement on the Classification of Commercial Real Property Loans, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, Washington Federal Reserve Board, Office of Thrift Supervision (Washington, D.C.: November 7, 1991), 17.

[21] Jared Shlaes, "The Market in Market Value," The Appraisal Journal (October 1984): 496.
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Title Annotation:Under the Microscope: Winter 1992
Author:Marchitelli, Richard
Publication:Appraisal Journal
Date:Jul 1, 1992
Previous Article:Estimating value diminution by the income approach.
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