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Value: more than ever, in your eye.

From the conversations going on in boardrooms and back rooms around the country, it is clear that the concept of market value needs yet another round of discussion by the committees of the Appraisal Institute. The problem with the usual definitions, people are saying, is that they don't mean anything anymore. Transactions are too few, sellers too unwilling, buyers too greedy, and financing too scarce or peculiar for the market to satisfy the conditions described in The Appraisal of Real Estate, ninth edition:

The most probable price...for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress.(1) (Emphasis added.)

The notion of market value, as I pointed out some years ago,(2) tacitly assumes that enough transaction evidence exists to indicate convincingly how much the property will bring in an "adequate" market. Now, not for the first time, appraisers are routinely faced with situations in which no such evidence is available. Most investment property markets are dormant or nearly so; few sellers are willing to accept the prices available unless they are under duress; few buyers are willing or able to pay the prices being asked, which are generally keyed not to actual market conditions but to what the property used to be worth when conditions were completely different. Sellers and buyers alike are waiting on the sidelines for their respective counterparts' numbers to become more realistic.

Such a set of circumstances generally results in no deal, no transaction evidence, and thus no "market value" in terms of the standard definitions. The following disagreeable question remains: What is an honest appraiser to do--fake the value estimate by pretending that the market is still viable, or withdraw from the game until conditions change?

Appraisers aren't the only ones concerned with this question. It is also of crucial importance to the real-world players who pay their fees and wages. The entire financial system depends for its survival on the value of its assets, many of which take the form of real property. The problem for those banks, thrifts, insurance companies, and pension funds that own a lot of real property, whether as investments or as REO (real estate owned), is that the prices they can get on liquidation, as well as the cash income they can expect to derive meanwhile, have fallen much lower than they can afford to admit. An honest write-down to hard cash value would threaten the solvency of the institutions, their dependents, and the financial system as a whole. Because such a situation would be intolerable for the politicians who pay the regulators, for the owners and businesspeople who pay the taxes, and for the appraisers who depend on them for fees, obviously something else will have to be done.

In "The Market in Market Value," I commented with acerbity on previous attempts to evade the issue:

Some of the most convoluted thinking associated with the idea of market value occurred in the 1930s, a time when the world economy was deeply depressed. Lenders, borrowers, and assessors had an interest in maintaining the fiction that properties have market value regardless of actual market conditions. Only if value were somehow intrinsic and only if properties retained their value despite the world-wide collapse of the real estate market could lenders avoid writing down their assets, borrowers avoid adding collateral, and assessors have enough wealth to tax.

The fiction had obvious appeal. It also had practical consequences. Owners of depressed properties, hoping that the values of the properties would some day return, held real estate off the market in anticipation of better times. Sales forced by economic necessity were treated as distress sales, not to be used as indications of fair market value. People felt better, believing that their assets were really unimpaired even though they could not be converted to cash without deep discounts.

Not surprisingly, this syndrome reappears frequently in slow markets. What has to be remembered is that the value described by those who fall victim to it, or who benefit from its pervasiveness at such times, is not market value.(3)

These observations remain especially pertinent in the current regulatory climate. Federal and state officials, anxious not to crush the weaker participants in a shaky financial system and equally anxious to avoid exposing to public scrutiny the fragility of the institutions they oversee, have been just as eager as those institutions to avoid damaging their teeth by biting bullets. They see no reason why real properties should be valued in terms of a temporarily depressed market, or why they shouldn't be carried on the books at figures reflecting their "true value" rather than what they would actually bring for hard cash.

The standard definition of market value presumes that the property will be offered "in a competitive market under all conditions requisite to fair sale." My 1984 article argued that this definition, as embellished over time, requires an "adequate" market, that is to say

a market, identical or congruent to the market in which the property will be traded, that offers to a competent observer enough representative transaction evidence, in the form of prices stated in cash or translatable into cash, to display a clear pattern. To do so the market must offer, at known and reasonably frequent intervals, enough free, informed, and competent buyers for its reasonably fungible goods to assure competition for any property offered, and enough sellers to assure competition for the buyer's money. The market must be open to qualified participants, or at least to goods and funds from other markets channeled through such participants, and transaction knowledge must be widely available. Finally, prices and participants must be free of government or other constraints such as price controls that unduly interfere with the operation of the market.

These are for all practical purposes the "conditions requisite to a fair sale" of the hornbook definitions.(4)

The trouble is that these ideal conditions are seldom, if ever, met in the investment real estate markets of today. When there are too few ready, willing, and able buyers to assure competition for the available properties, and when sellers are likely to sell only under duress, the market is clearly inadequate in the terms of the old definitions.(5) As a result, they just don't work anymore.

Value in the absence of a market?

That there is no market evidence, or that a market is inadequate, does not necessarily mean no market exists that will satisfy other legitimate purposes, provided that the usual definitions of value and market are set aside. For most properties, the market is potentially there, although stagnant, and the term market value, adjusted for this deficiency, can still have meaning. It is the price, positive or negative, at which a transfer of the property from the most willing (or least unwilling) seller to the most willing able buyer, under duress or not, would probably occur, thus clearing the market; call it hard cash value. The difficulty is, as we have seen, that for many classes of property, the people and institutions most directly concerned--regulators, lenders, owners, assessors, and the courts--are unwilling to accept such a value as fair.

The courts have faced similar situations in the past when determining value in eminent domain and other cases. As is their won, they have muddied the waters considerably. A lawyer, Bradford White, comments that:

The courts have looked at market values in different types of "abnormal markets"--depression market, boom market, and the wartime market. In evaluating the effect of depression prices upon compensation to an owner in eminent domain cases the courts seem to have drawn a distinction between depressions which are temporary in character and those which have attained some degree of permanency. In the case of the former, the cases indicate that the courts are inclined to disregard the effects of the depression....

Thus it has been held improper to take into account, instead of considering the pre-depression conditions, (the actual prices obtainable in the market), thereby relieving the owner of the temporary adverse pressure on the value of his property. In fact, in a case litigated in the early days of the Great Depression, the jury was instructed that the "actual value of the land means the fair market value of the land, upon a fair market, upon fair advertisement, and a fair sale at normal times; that it does not mean any value in times of great depression." (Howell v. State Highway Department, 166 S.E. 129.)

In a permanent depression the courts have been divided in their reaction to the depressed value as a measure of just compensation. One view follows the holdings of those cases in temporary depressions: "Since by reason of economic dislocation, there are no buyers in fact, resort must be had to the fictitious willing buyer who, unlike the actual nonexistent buyers |sic~, would not be averse to paying the predepression price." The second approach rejects the predepression value as impractical of application and unsound. Courts are also split evenly in cases taking place during boom markets.... The cases are not clear who makes the distinction between temporary and permanent depressions and booms, and how those distinctions are made.(6)

Truth or consequences?

In light of the lack of meaningful guidance from either the marketplace or the courts, an honest appraiser has in practice two choices: 1) to estimate actual market value or hard cash value--the price at which the property would actually sell within a reasonable time (i.e., three to six months) to an actual cash or cash-equivalent purchaser--and face an irate client; or 2) to estimate something else that more nearly resembles the seller's idea of market value and the judicial notion of actual value (as used in Howell), which is what the property might have sold for under the right conditions a few years ago when things were better--or might sell for a few years from now when the good old days return. The first of these options would make most clients (and regulators) too unhappy for serious consideration. Thus, only the second option will be examined here.

The appraiser's dilemma arises from the fact that the fair market value to be found under option 2 bears no necessary relation to the price actually obtainable in the marketplace. How are appraisers to maintain any degree of intellectual honesty without exposing themselves to undue danger of bodily harm or worse at the hands of irate clients and regulators? The plain truth is that, under the constraints imposed by the standard definitions of value, they cannot.

Somehow, appraisers must develop new definitions of value that respect the actual state of the market. We do, after all, use other value definitions for a variety of purposes: investment value, insurable value, book value, hammer value, exit value, and many more. With a small expenditure of creative energy, we should be able to come up with one or two that can help us out of our current pickle.

Wishing to leave the ultimate selection of an answer to a higher authority, I therefore propose not one or two but three new value definitions. Each squarely faces the realities of the barely existent marketplace. The first two, for which I feel a special fondness, but which may be of less practical use than the third, offer great freedom to appraisers. They also have the advantage of reflecting the uncertainty, the wishfulness, and the extraterrestrial character of value opinions based on anything other than adequate earthly evidence. This is not to say that they will prove useless in the real world of hard-headed businesspeople and white-collar criminal prosecutions. We live by many fictions; why not these?

Ibo logic

My first two solutions are based on hints provided by an Ibo tribesman from Nigeria who is currently making his living as a taxi driver in Chicago. Mr. Okoro is well educated, widely traveled, and speaks three languages. He thus enjoys a broader frame of reference than is common among real estate appraisers, and thanks to his tribal culture is able to make good use of Ibo logic, a pragmatic system of intellection that depends more on the lessons of daily experience and common sense than on the carpe diem and other-worldly philosophies often used by non-Ibo Nigerians in reaching their decisions. Better informed than most native-born Americans about both amusement-arcade games and the capabilities of the English language as they relate to actual thought, Mr. Okoro was in an excellent position to draw on this expertise in assisting me toward the answers I had been seeking.

Solution 1: Subjunctive value

The first of his suggestions was based on the moods used in English verb forms to convey the speaker's intentions or feelings about what is being said and its relationship to reality. These are

* The indicative (also called the declarative), used to state the way things are (e.g., "She is going to the tavern").

* The imperative, used to demand that the hearer do what is asked (e.g., "Go to the tavern and get me some beer).

* The subjunctive, used to express the speaker's hopes, wishes, doubts, or fears about what is being said (e.g., "I recommend that he go to that store").

Though still common in such languages as French and German, this last mood is no longer much used in spoken English except in subordinate clauses, as in the above example, and in a few stock expressions heard occasionally among the literate--for instance, "be that as it may," "far be it from me," "I wish it were over," "if it please you," "had I the power," "that it were so," "money be damned"--but survives more widely in the written language, especially the high-toned kind, as in "unless action be taken," and "that she love me."

It was Mr. Okoro's mention of the subjunctive mood in this connection that first gave me a key to the problem. Obviously the mind-state of an appraiser delivering an opinion of value would under current conditions be more often hopeful, wishful, fearful, or doubtful than merely indicative. Applying my own abilities and those of my appraiser son Noah, who happened to be in the cab with us at the time, I quickly arrived at the concept of subjunctive value, which can be defined as:

That value which the relevant parties, hope, wish, fear, or suspect might be equal to market value, but which all recognize is not necessarily so.

A few words of explanation may be in order, because few are as familiar with the subjunctive and its uses as they are the other moods. Those who use it feel free to say, for example, "I wish (that) that were (not was) the case" or "I doubt that it be (not is) true," indicating by their choice of verb form that in fact it is not.

A century or so ago, when the subjunctive was more commonly applied in conversation, people also said "I doubt that he believe" or "that she go" to indicate skepticism about the person in question's belief, candor, or intentions. This is precisely the mood in which appraisers who must operate in an environment that lacks market evidence should be expressing their opinions of value. It explicitly tells a reader or listener that the statement is conditional, volitional, or questionable and must be taken with a certain amount of salt.

Unfortunately, most appraisers are not accustomed to the subjunctive and do not think about using it in their reports. They are trained to talk about value as though it existed only in the indicative mood: "This is what it is." Mortgage brokers, would-be borrowers, and asset managers anxious to protect their fees, on the other hand, are more inclined to use the imperative: "This is what it has to be." These moods have their uses in real estate valuation, or, rather, had them until the real estate depression rendered them generally obsolete. It is the subjunctive, though, that is clearly most relevant to current market conditions.

Solution 2: Virtual value

The second Ibo-logic solution is based on the new arcade games that place the players into a computer-created, four-dimensional alternate universe. There, by wearing a special helmet, they gain the power to maneuver at will in a three-dimensional world where spaceships and Star Wars-type characters can be made to shoot, shout, and blow up. The games are enormously popular with violence-loving citizens, young and old, who might blanch at the thought of committing actual mayhem, as the players can fire rockets and ray-guns in any direction without hurting anybody.

The universe where this occurs is called virtual reality. Its analogs can be found in any computer. They can also be found in the real estate world we have been discussing, where the only transactions that occur may be imaginary and the only available buyers lack the means to close. I therefore propose as a second solution to the appraiser's dilemma the concept of virtual value, defined as:

The hypothetical analog of market value in a universe where no actual transactions are occurring because no actual people are doing anything.

The universe referred to is the one where "Things are the way they used to (or ought to) be and might be again someday." To get there, all an appraiser has to do is put on the right helmet.

Solution 3: Nu value

The third of my suggestions is called nu value in honor of the Yiddish expression "Nu?" (rough translation: So? What then? How is that relevant to the price of fish?). This expression of skepticism is the only possible answer to the complaints "But I paid a lot more for it than that!" and "No way you'll get that much from me!" The word "nu" has the additional benefit of echoing words that share many relevant connotations as well as the same initial phoneme, though not the same linguistic root, such as gnu, new, news, nude, novel, noodle, nuisance, nugatory, and nudnik (another Yiddish word).

Nu value can of course be defined in many ways: what the seller thinks, for example, or the buyer, the lender, or the regulators, or what the neighbors say when discussing the problem over a plate of chopped liver. A more workable and acceptable definition of nu value might take the following form.

Value as determined by a committee of experts sitting at a round table with all pertinent facts at hand in a locked room from which they will not be released until they have reached agreement; the committee members to be selected by _____ (fill in the blank as desired).

Notice that in this definition no market is presumed and no special characteristics are required of buyers or sellers. The only relevant fact is the collective opinion of the committee, which will of course be influenced by the decor, the air conditioning, the identity of the committee members, and what they are given for lunch. One is entitled to hope that these influences will be similar to those affecting actual buyers and sellers in a living market.

Certain serious questions remain to be answered: Who is to select the nu committee members? Under what rules are they to operate? What happens if they are unable to agree? These and similar issues can safely be left to the wisdom of another committee, and so on ad infinitum. If necessary, there is always the The New York Times, The Forward (another New York paper), or the Supreme Court to serve as the final authority.

The advantages of nu value over market value should be apparent: no more entanglement in questionable facts, no more hypothetical conditions, and clear answers reachable in the course of a single meeting. Equally apparent is its realism. Something similar is already being done by the Internal Revenue Service (IRS), which appoints panels of experts from other parts of the country to review the appraisals used by taxpayers to support the deductions claimed for charitable donations of art objects and the like. The IRS may or may not be the ideal chooser of such panels, but the system seems to work; few reputable fine arts appraisers find it impossible to live with, and they have reason to care, being subject to penalties if their valuations diverge too much from those of the panel. It helps, of course, that out-of-town panel members are used, which tends to prevent local ties from interfering with their objectivity. A similar restriction should probably be attached to nu value committees.

Does the nu value concept really make sense? I maintain that it does, if only for the reason that it will get real estate appraisers out of the swamp in which they are presently mired. Besides, "what the experts think" has always been a better definition of value than the ones to which we certify in our USPAP-certifiable reports. What should an appraisal designation stand for if not the ability to arrive at an informed opinion of value even in the absence of verifiable facts? If one appraiser is good, why shouldn't several be better? If the outcome is a lawsuit, why not have a few colleagues around to help pay for the lawyers?

Honest again?

Once one or more of these new concepts acquires currency, those of us who engage in real estate valuation on a regular basis will find our lives made easier, our worries reduced, and our incomes improved. Everyone will be happier, including clients and appraisal reviewers who are now forced to wade through reams of mostly irrelevant factoids in their efforts to glean a few scraps of truth.

Best of all, appraisers can become honest again, notwithstanding the ongoing efforts of the government and the Appraisal Foundation to make wordy liars of us all. Real estate appraising will revert to something resembling what it was in days past, when it was neither the thickness of a report nor its conformity to a regulator's requirements that mattered, but the source of the value opinion. A good appraiser in those days was one who knew the right answers and told the truth. Maybe, with the help of a little creative thinking, appraisers can begin to enjoy once again the freedoms and the credibility of an honorable profession.

Jared Shlaes, MAI, has long been active as an appraiser, counselor, developer, and author. A frequent contributor to The Appraisal Journal, he was co-recipient of the 1974 Louise and Y. T. Lum Award for his articles in the field of development rights transfers, and in 1984 received the Robert H. Armstrong Award for his article "The Market in Market Value."

1. American Inst. of Real Estate Appraisers, The Appraisal of Real Estate, 9th ed. (Chicago: American Inst. of Real Estate Appraisers, 1987), 9.

2. Jared Shlaes, "The Market in Market Value," The Appraisal Journal (October 1984): 494-518.

3. Ibid., 498.

4. Ibid., 510-511.

5. Often, in fact, it is inadequate even under favorable market conditions. In the real world of investment real estate, buyers seldom have full knowledge of the properties they are interested in purchasing, and sellers may be almost equally ignorant. Real estate is not a fungible good, but rather one that is by its nature unique, so that there are seldom enough similar properties being offered for sale to assure buyers a reasonable choice. Even the requirements that the parties be prudent and free from government constraints are more often honored in the breach than in the observance.

6. Letter dated March 14, 1992, from Bradford White of Clarion Associates to the author.
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Author:Shlaes, Jared
Publication:Appraisal Journal
Date:Jan 1, 1993
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