Advanced Issues in Property Valuation. Hans Lind
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The underlying ‘problem’ is that transactions are voluntary and that the willingness to buy and sell depends on market conditions. Observed transactions are not the result of a random selection of properties that is put on the market. Given the economic conditions, institutional structure and the beliefs of the actors, a certain change in demand can lead to very different reactions on the market: In some cases, transaction volumes fall much and prices only a little, while in other cases, observed prices fall much but turnover only a little. The development during the financial crisis 2008 can illustrate this where observed prices for commercial property hardly fell at all in Sweden while they fell much and quickly in England (see Crosby et al. 2010 ) – even though the underlying fall in GDP was roughly the same.
It might not be necessary to make assumptions about turnover explicit in the definition of market value, but it could be an advantage to add a clause saying ‘given expected turnover’ in the definition. The relation between turnover and price, when there is a downward sloping demand curve, will, however, affect uncertainty in the estimation of market value. This will be returned to both in Chapter 4 on uncertainty and in Chapter 6, where we discuss exit prices in thin markets in the context of valuation for financial reports.
2.9 Highest and Best Use
Both IVSC (2019 ) and Appraisal Institute (2013 ) use the concept of ‘Highest and best use’. IVSC (2019 , p. 25) writes, ‘The market value of an asset will reflect its highest and best use’ and this is explained in terms of the use that maximizes its potential (given what is possible, legally permissible and financially feasible). Similar formulations can be found in Appraisal Institute (2013 , p. 42).
There are problems with this concept and our recommendation is that it should be used with a great degree of caution when market value is discussed. The requirements for empirically extracted ‘evidence’ should be high if, or when, this concept is claimed to have affected an estimated market value‐figure. As will be returned to in Chapter 8, the typical situation in a market is that actors have different knowledge, different expectations and different plans for a specific property. One actor may see possibilities that other actors initially are not aware of. An example discussed in Chapter 7 is that one investor sees that a certain building can be made green with a rather small investment. More theoretically, this can be described in terms of different views on the real options that a property has. In a market, actors typically gain by not giving away information and not telling others what their plans are. Investors may have plans that valuers are not aware of. If only one actor is aware of certain profitable opportunities that ‘highest and best use’ will not affect the bids of others are therefore not the price if the property is sold by a standard English auction, where bids are presented in ascending order until there is only one bidder left.
In a world of uncertainty, expectations are very important for what an actor is willing to pay. This means that even if a majority of investors and valuers believe that use A is the highest and best use, a very optimistic actor that believes that B is the highest and best might be willing to pay more.
These arguments imply that it may be questionable to say that the market price reflects the highest and best use, and the formulation does not add anything to the definitions discussed above. But it is very important to think about options when valuing a property and how this can be done is discussed in the next chapter.
2.10 Conclusion
Different countries have somewhat different definitions of market value, and valuers in the specific market have to follow the local practice in the interpretation of market value. The arguments above concerning clarity, conciseness and relevance, however, point in the direction of a simpler definition. The market value could be defined as
The most probable price, as of a specified date, in an arm's‐length transaction after proper marketing given current market conditions and the expected level of turnover.
Even if this proposed definition differs somewhat from the official IVSC and US definitions above, our belief is that valuers in practice actually follow this shorter definition. They estimate a market value on a property given current market conditions even if the competitiveness on the market is rather low. They do not investigate how rational buyers and sellers have been in earlier transaction, unless there have been extreme conditions of some kind. But if there have been extreme conditions in a certain transaction, such a transaction should in any case be given little weight when the market value is estimated as the definition refers to the most probable price.
Exercises
1 What value concepts are used in your local market? Is there any differences between the local definitions and the one in IVSC? How do local valuers look at conditions related to knowledgeable actors?
2 Company A just won a ‘closed’ bidding contest and acquired an investment property for 135 Cash Units (CU). However, after the acquisition, it was found out that other bids on the property was 100 CU, 98 CU, 101 CU, 99 CU, 96 CU and lower. Two weeks after the acquisition, Company A has to present an estimation of market value (could be, for example, for lending or financial reporting purposes). Can Company A claim 135 as a market value? If not, why?
Note
1 1 See Lind (1998) for a discussion about these criteria.
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