Market value

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Market value or OMV (Open Market Valuation) is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with open market value, fair value or fair market value , although these terms have distinct definitions in different standards, and differ in some circumstances.

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Definition

International Valuation Standards defines market value as "the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently, and without compulsion". [1]

Market value is a concept distinct from market price, which is "the price at which one can transact", while market value is "the true underlying value" according to theoretical standards. The concept is most commonly invoked in inefficient markets or disequilibrium situations where prevailing market prices are not reflective of true underlying market value. For market price to equal market value, the market must be informationally efficient and rational expectations must prevail.

Mocciaro Li Destri, Picone & Minà (2012) [2] have underscored the subtle but important difference between the firms’ capacity to create value through correct operational choices and valid strategies, on the one hand, and the epiphenomenal manifestation of variations in stockholder value on the financial markets (notably on stock markets). In this perspective, they suggest to implement new methodologies able to bring strategy back into financial performance measures.

Market value is also distinct from fair value in that fair value depends on the parties involved, while market value does not. For example, IVS currently notes fair value "requires the assessment of the price that is fair between two specific parties taking into account the respective advantages or disadvantages that each will gain from the transaction. Although market value may meet these criteria, this is not necessarily always the case. Fair value is frequently used when undertaking due diligence in corporate transactions, where particular synergies between the two parties may mean that the price that is fair between them is higher than the price that might be obtainable in the wider market. In other words "special value" may be generated. Market value requires this element of "special value" to be disregarded, but it forms part of the assessment of fair value. [3]

Real estate

The term is commonly used in real estate appraisal, since real estate markets are generally considered both informationally and transactionally inefficient. Also, real estate markets are subject to prolonged periods of disequilibrium, such as in contamination situations or other market disruptions.[ citation needed ]

Appraisals are usually performed under some set of assumptions about transactional markets, and those assumptions are captured in the definition of value used for the appraisal. Commonly, the definition set forth for U.S. federally regulated lending institutions is used, although other definitions may also be used under some circumstances: [4]

"The most probable price (in terms of money) 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 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: the 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 United States 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."

In the US, licensed or certified appraisers may be required under state, federal, or local laws to develop appraisals subject to USPAP Uniform Standards of Professional Appraisal Practice. The Uniform Standards of Professional Appraisal Practice requires that when market value is the applicable definition, the appraisal must also contain an analysis of the highest and best use as well as an estimation of exposure time. All states require mandatory licensure of appraisers.

USPAP does not require that all real estate appraisals be performed based on a single definition of market value. There are frequent situations when appraisers are called upon to appraise properties using other value definitions. If a value other than market value is appropriate, USPAP only requires that the appraiser provide both the definition of value being used and the citation for that definition.

Other definitions

Market value is the most commonly used type of value in real estate appraisal in the United States because it is required for all federally regulated mortgage transactions, and because it has been accepted by US courts as valid. However, real estate appraisers use many other definitions of value in other situations. [5]

Liquidation value

Liquidation value is the most probable price that a specified interest in real property is likely to bring under all of the following conditions:

  1. Consummation of a sale will occur within a severely limited future marketing period specified by the client.
  2. The actual market conditions currently prevailing are those to which the appraise property interest is subject.
  3. The buyer is acting prudently and knowledgeably.
  4. The seller is under extreme compulsion to sell.
  5. The buyer is typically motivated.
  6. The buyer is acting in what he or she considered his or her best interest.
  7. A limited marketing effort and time will be allowed for the completion of the sale.
  8. Payment will be made in cash in U.S. dollars or in terms of financial arrangements comparable thereto.
  9. 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.

Orderly liquidation value

This value definition differs from the previous one in that it assumes an orderly transition, and not "extreme compulsion". [6]

Federal land acquisition

For land acquisitions by or funded by U.S. federal agencies, a slightly different definition applies: [7]

"Fair market value is defined as the amount in cash or terms reasonably equivalent to cash, for which in all probability the property would be sold by a knowledgeable owner willing but not obligated to sell to a knowledgeable purchaser who desired but is not obligated to buy. In ascertaining that figure, consideration should be given to all matters that might be brought forward and reasonably be given substantial weight in bargaining by persons of ordinary prudence, but no consideration whatever should be given to matters not affecting market value."

Going concern value

When a real estate appraiser works with a business valuation appraiser (and perhaps an equipment and machinery appraiser) [8] to provide a value of the combination of a business and the real estate used for that business, the specific market value is called "going concern value". It recognizes that the combined market value may be different from the sum of the separate values: "The market value of all the tangible and intangible assets of an established operating business with an indefinite life, as if sold in aggregate." [9]

Use value

Use value takes into account a specific use for the subject property and does not attempt to ascertain the highest and best use of the real estate. For example, the appraisal may focus on the contributory value of the real estate to a business enterprise.

Some property tax jurisdictions allow agricultural use appraisals for farmland. Also, current IRS estate tax regulations allow land under an interim agricultural use to be valued according to its current use regardless of development potential. [10]

Economic value and investor confidence

Stability and economic growth are two factors that international investors are seeking when considering investment options. A country offering economic value amongst its other incentives attracts investment funds. A political unrest situation can be the cause of not only loss of confidence, but a reduced value in currency, creating transfer of capital to other and more stable sources.

In the event of a government printing currency to discharge a portion of a significant amount of debt, the supply of money is increased, with an ultimate reduction in its value, aggravated by inflation. Furthermore, should a government be unable to service its deficit by way of selling domestic bonds, thereby increasing the supply of money, it must increase the volume of saleable securities to foreigners, which in turn creates a decrease in their value.

A significant debt can prove a concern for foreign investors, should they believe there is a risk of the country defaulting on its obligations. They will be reluctant to purchase securities subject to that particular currency, if there is a perceived, significant risk of default. It is for this reason that the debt rating of a country; for example, [11] as determined by Moody's or Standard & Poor's is a crucial indicator of its exchange rate.

Currency values and exchange rates play a crucial part in the rate of return on investments. Value for an investor, is the exchange rate of the currency which, contains the bulk of a portfolio, determining its real return. A declining value in the exchange rate has the effect of decreasing the purchasing power of income and capital gains, derived from any returns. In addition, other income factors such as interest rates, inflation and even capital gains from domestic securities, are influenced by the influential and complex factors, of the exchange rate.

The case of Luxmoore-May and Another v. Messenger May Baverstock [1990] 1 W.L.R. 1009 shows us the legal interpretation of market value: "The measure of damage in this case is, I conclude, the difference between what the foxhounds in fact realised consequent on the defendants' breach of contract and what was their true open market value at that time. What better guide could there be to that value than the price at which these paintings happened to be knocked down at Sotheby's so shortly afterwards? The price which the international art market was willing to pay was surely prima facie the best evidence of the foxhounds' value." Also the equilibrium of the qualibrium is hard to distinguish between.[ clarification needed ]

Related Research Articles

This aims to be a complete list of the articles on real estate.

Real estate appraisal, property valuation or land valuation is the process of assessing the value of real property. Real estate transactions often require appraisals because every property has unique characteristics. The location also plays a key role in valuation. Appraisal reports form the basis for mortgage loans, settling estates and divorces, taxation, and so on. Sometimes an appraisal report is used to establish a sale price for a property.

<span class="mw-page-title-main">Revaluation of fixed assets</span> Financial action

In finance, a revaluation of fixed assets is an action that may be required to accurately describe the true value of the capital goods a business owns. This should be distinguished from planned depreciation, where the recorded decline in the value of an asset is tied to its age.

An ad valorem tax is a tax whose amount is based on the value of a transaction or of a property. It is typically imposed at the time of a transaction, as in the case of a sales tax or value-added tax (VAT). An ad valorem tax may also be imposed annually, as in the case of a real or personal property tax, or in connection with another significant event. In some countries, a stamp duty is imposed as an ad valorem tax.

A real estate contract is a contract between parties for the purchase and sale, exchange, or other conveyance of real estate. The sale of land is governed by the laws and practices of the jurisdiction in which the land is located. Real estate called leasehold estate is actually a rental of real property such as an apartment, and leases cover such rentals since they typically do not result in recordable deeds. Freehold conveyances of real estate are covered by real estate contracts, including conveying fee simple title, life estates, remainder estates, and freehold easements. Real estate contracts are typically bilateral contracts and should have the legal requirements specified by contract law in general and should also be in writing to be enforceable.

The fair market value of property is the price at which it would change hands between a willing and informed buyer and seller. The term is used throughout the Internal Revenue Code, as well as in bankruptcy laws, in many state laws, and by several regulatory bodies.

Comparables is a real estate appraisal term referring to properties with characteristics that are similar to a subject property whose value is being sought. This can be accomplished either by a real estate agent who attempts to establish the value of a potential client's home or property through market analysis or, by a licensed or certified appraiser or surveyor using more defined methods, when performing a real estate appraisal.

Business valuation is a process and a set of procedures used to estimate the economic value of an owner's interest in a business. Here various valuation techniques are used by financial market participants to determine the price they are willing to pay or receive to effect a sale of the business. In addition to estimating the selling price of a business, the same valuation tools are often used by business appraisers to resolve disputes related to estate and gift taxation, divorce litigation, allocate business purchase price among business assets, establish a formula for estimating the value of partners' ownership interest for buy-sell agreements, and many other business and legal purposes such as in shareholders deadlock, divorce litigation and estate contest.

Just compensation is a right enshrined in the Fifth Amendment to the U.S. Constitution, which is invoked whenever private property is taken by the government. Under some state constitutions, it is also owed when the government "damages" private property.

Closing costs are fees paid at the closing of a real estate transaction. This point in time called the closing is when the title to the property is conveyed (transferred) to the buyer. Closing costs are incurred by either the buyer or the seller.

<span class="mw-page-title-main">Arm's length principle</span> Parties to a transaction are on an equal footing

The arm's length principle (ALP) is the condition or the fact that the parties of a transaction are independent and on an equal footing. Such a transaction is known as an "arm's-length transaction". It is used specifically in contract law to arrange an agreement that will stand up to legal scrutiny, even though the parties may have shared interests or are too closely related to be seen as completely independent.

The sales comparison approach (SCA) is a real estate appraisal valuation method that relies on the assumption that a matrix of attributes or significant features of a property drive its value. For examples, in the case of a single family residence, such attributes might be floor area, views, location, number of bathrooms, lot size, age of the property and condition of property. This method is in contrast to the two other main pricing methods for real estate which are cost approach and income approach.

<span class="mw-page-title-main">Commercial property</span> Buildings or land intended to generate a profit, either from capital gain or rental income

Commercial property, also called commercial real estate, investment property or income property, is real estate intended to generate a profit, either from capital gains or rental income. Commercial property includes office buildings, medical centers, hotels, malls, retail stores, multifamily housing buildings, farm land, warehouses, and garages. In many U.S. states, residential property containing more than a certain number of units qualifies as commercial property for borrowing and tax purposes.

A lease option is a type of contract used in both residential and commercial real estate. In a lease-option, a property owner and tenant agree that, at the end of a specified rental period for a given property, the renter has the option of purchasing the property.

<span class="mw-page-title-main">Real estate investing</span> Buying and selling real estate for profit

Real estate investing involves the purchase, management and sale or rental of real estate for profit. Someone who actively or passively invests in real estate is called a real estate entrepreneur or a real estate investor. In contrast, real estate development is building, improving or renovating real estate.

An appraised value or mortgage valuation (Australia) pertains to the assessed value of real property in the opinion of a qualified appraiser or valuer. It is usually a pre-qualification & risk-based pricing factor related to the issuance of mortgage loans by a financial institution.

Intellectual property valuation is a process to determine the monetary value of intellectual property assets. IP valuation is required to be able to sell, license, or enter into commercial arrangements based on IP. It is also beneficial in the enforcement of IP rights, for internal management of IP assets, and for various financial processes.

Liquidation value is the likely price of an asset when it is allowed insufficient time to sell on the open market, thereby reducing its exposure to potential buyers. Liquidation value is typically lower than fair market value. Unlike cash or other available liquid assets, certain illiquid assets, like real estate, often require a period of several months in order to obtain their fair market value in a sale, and will generally sell for a significantly lower price if a sale is forced to occur in a shorter time period. The liquidation value may be either the result of a forced liquidation or an orderly liquidation. Either value assumes that the sale is consummated by a seller who is compelled to sell and assumes an exposure period which is less than market normal.

In the field of real estate appraisal, extraordinary assumptions and hypothetical conditions are two closely related types of assumptions that are made as predicating conditions of an appraisal problem. Under the Uniform Standards of Professional Appraisal Practice (USPAP), they are two of the assignment conditions on which an appraisal assignment is predicated, the others being general assumptions, laws & regulations, supplemental standards, jurisdictional exceptions, and other conditions affecting scope of work. Making the distinction between the two is important when compiling or reporting appraisals in the United States or other jurisdictions where USPAP is considered the professional standard because USPAP has different specific disclosure requirements for each in an appraisal report and specifies different conditions under which each can be made.

In the valuation theory department of economics, the Transactional Asset Pricing Approach (TAPA) is a general reconstruction of asset pricing theory developed in 2000s by a collaboration of Russian and Israeli economists Vladimir B. Michaletz and Andrey I. Artemenkov. It provides a basis for reconstructing the discounted cash flow (DCF) analysis and the resulting income capitalization techniques, such as the Gordon growth formula, from a transactional perspective relying, in the process, on a formulated dynamic principle of transactional equity-in-exchange.

References

  1. ↑ IVS 1 - Market Value Basis of Valuation, Seventh Edition
  2. ↑ Mocciaro Li Destri A., Picone P. M. & Minà A. (2012), Bringing Strategy Back into Financial Systems of Performance Measurement: Integrating EVA and PBC, Business System Review, Vol 1., Issue 1. pp.85-102 https://ssrn.com/abstract=2154117.
  3. ↑ "Exposure Draft of Proposed Revised International Valuation Standard 2 - Bases Other than Market Value, June, 2006" (PDF). Archived from the original (PDF) on 21 June 2007. Retrieved 6 January 2018.
  4. ↑ Federal Register Vol. 55, No. 163, August 22, 1990. This definition has also been adopted by the International Association of Assessing Officials for tax assessment purposes.
  5. ↑ Dictionary of Real Estate Appraisal, 4th ed. (Chicago: Appraisal Institute, 2002)
  6. ↑ Valuing Machinery and Equipment: The Fundamentals of Appraising Machinery and Technical Assets, 2nd ed., (American Society of Appraisers, 2005)
  7. ↑ Uniform Standards for Federal Land Acquisition
  8. ↑ "What is Machinery and Technical Specialties?". www.appraisers.org. Archived from the original on 7 May 2010. Retrieved 6 January 2018.
  9. ↑ The Appraisal of Real Estate, 12th ed., (Chicago: The Appraisal Institute, 2001)
  10. ↑ Timberland Appraisal Timberland Appraisal Archived 2010-06-16 at the Wayback Machine
  11. ↑ "Credit Ratings". Standardandpoors. Retrieved 6 January 2015.
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