A property's value may seem a straight-forward calculation.

But the general public and the industry's professionals often bring conflicting -- and usually unstated -- assumptions to their understanding of value.

If we narrow our focus to market value alone, exclusive of values for insurance, taxation, or accounting purposes, there are still sufficient complexities and subtleties that can affect the resulting numbers.

The Standard Definition

Are we interested in the property's value-in-use (its value as a component in an operating enterprise), its liquidation value (forced or orderly), or its fair value, fair salable value, or fair market value, or some other provision on the theme?

The classic market value definition within the appraisal profession, based on language originally drafted by the Appraisal Institute, defines a property's market value as:

"The most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms for which the specified property rights should sell after reasonable exposure 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."

One of the most troublesome sources of confusion is the built-in conflict between the two important groups involved in using real estate valuations: the Federal Deposit Insurance Corp. and the Financial Accounting Standards Board.

Following the practical experience of appraisers in the field, FASB understands "market value" as defined in a normal marketing period, which can be as much as two years or more.

Restricting the Time Frame

Banks, on the other hand, partly as a result of pressure from FDIC, want value defined on a shorter-term basis, up to 12 months. The problem is that time itself is a component of value -- though an often overlooked one.

For the appraiser, the way to gauge the "reasonable market exposure" for a sale is to look at comparable sales that have taken place in the market. The regulatory agencies are now requesting the inclusion of "listings" to assist in measuring current marketing periods.

If we have eight comparables, and investigation shows they were on the market an average of 18 months before a sale was consummated, then 18 months is the normal marketing period for that area and type of property.

If you want to induce a sale within a 12-month period, it will be necessary to reduce the price; that lower price then becomes the market value for a 12-month marketing period.

Other Approaches Preferred

The Office of the Comptroller of the Currency recently issued a memorandum reducing the reliance on the market approach (since in most markets, recent sales have been sparse) and stressing instead the importance of the cost approach, and especially of the income approach.

This is the point in conflict. Many financial institutions want a market value assuming a 12-month marketing period. In fact, this seemingly small step actually undermines the entire rationale of "value." This is because the concept of "the property being exposed for a reasonable time in the open market" is intended to allow the market itself to determine what period is reasonable.

Once we as appraisers place a time limit on the expected marketing period, the value conclusion becomes subjective rather than objective.

Though directed primarily at the savings and loan industry, the Financial Institutions Reform, Recovery, and Enforcement Act of 1990 attempted to legislate appraisal requirements.

Interpretation Is Open

But Congress, in effect, pulled its punch by not putting down specific rules in black and white. The result: it is left to everybody to interpret them, and they are all interpreted differently by different financial institutions.

The FIRREA guidelines are generic, requiring each financial institution to come up with its own guidelines. At the same time, they include direction as to definitions of market value, fair sale, and myriad other concepts that go into value.

One element of value is the marketing period, and banks, urged to this position by the FDIC, have generally focused on 12 months. This may or may not be equal to what is found in the mythical "market." How long does it take to sell a property? Obviously, if you drop the price, it will sell faster.

The intention of FIRREA is to enforce a conservative approach, and in many cases -- for example, in a market where the normal period is only nine months -- the 12-month limit would have no impact on a property's value. If the normal marketing period is more than 12 months, the value starts going down.

A Mixed Outcome

This is good for the banks because it provides more security; but it is bad for existing loans, because it may force the banks to increase their loss reserves.

The 12-month value basis may also lose out in a competitive financial situation. If one financial institutions is using a market value based upon a 12-month sale and another is using the classic market value definition, the borrower will tend to go where he or she can borrow more money.

More important, once a time limit has been imposed, the fundamental concept of market value is seriously compromised. As one valuation consultant has objected, "You really aren't estimating market value any longer. You are estimating something other than market value -- by the very act of restricting it to a period other than that determined by the market's actual behavior."

To ensure its collateral is not at risk, every bank has its outstanding loans appraised periodically. How could the conflicting value definitions affect the process?

Value Could Be Slashed

Assume that the original appraiser had estimated a market value for a collateralized property (using the classic "normal marketing period") of $10 million. Assume further that the bank put a loan on the property at 80% ($8 million).

If, on reappraisal, the bank now asks the appraiser to base "market value" on a 12-month marketing period, the value may fall to $9 million, bringing the appropriate loan amount down to $7.2 million. With its margin no longer covered, the bank may decide to call the loan, or federal regulators may require the institution to increase its loan loss reserve.

I should emphasize that I don't agree with this handling of the situation -- at least, not on an "automatic" basis. If the loan is performing, and payments are being made, the mere fact that the loan balance is high should not, in my opinion, make it a non-performing loan and require a reserve.

My viewpoint is somewhat jaundiced; when transactions fail because the numbers are too low, the would-be borrower tends to blame the appraiser, not the bank.

Suggestions for Loan Officers

With reasonable care, the risk of such misunderstandings can be minimized or eliminated. For bank loan officers, we offer three communications:

* Be fully knowledgeable about your institution's guidelines.

* Advise any prospective customer of the exact criteria upon which the institution is prepared to make a loan. Using the term "market value" generically can and does make for confusion. In an inactive market, confusion on this issue can easily become a major problem for lending institutions.

* Once a loan is established, a prudent system for monitoring the loan should be in place, including periodic review of the assets' value. "Value" here may refer to any of the measures mentioned earlier -- market value, liquidation value, value-in-use, etc.

Above all, the need is for consistency in defining value. Clearly, many forces are impacting real estate values today.

When the large service industries cut back, for instance, they set a downward spiral in motion. Reduced demand for office space results in oversupply; building owners then cut rents to induce tenants to occupy their buildings; when they reduce their rents, they diminish the income-generating capacity and consequently lower the value.

Stability Comes First

Until prices stabilize and a suitable equilibrium is restored, property values in major cities across the country will remain relatively low compared to their 1989 peak.

Likewise, recession-induced cuts in the industrial base mean that factory orders are down, there is little or no new industrial construction, rents go into a downward spiral, and the whole economy stagnates, as it has done since the end of the 1980s.

Though not in the same league, the failure of the financial community to establish a consistent definition of market contributes to the market's current malaise. When the appraiser's work is suspect or discounted, the value conclusion is discounted accordingly; in an extreme case, of course, no loans are made.

In the final analysis, then, inconsistency in value definitions is dangerous because it impairs the market's ability to believe in appraisal reports. As long as people doubt or disbelieve valuations, it is impossible for values to stabilize. And if values do not stabilize, it will take that much longer before they can begin to rise again.

Mr. Atkins is an executive vice president in the Philadelphia office of Marshall & Stevens Inc., a national valuation consulting firm.

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