Transactional Adjustments: Conditions, Concessions, and Market Trends

Chapter: Transactional Adjustments: Conditions, Concessions, and Market Trends

This chapter delves into the intricacies of transactional adjustments within the sales comparison approach, focusing on conditions of sale, concessions, and the impact of market trends. Understanding these adjustments is crucial for accurately reflecting market value and avoiding biases in appraisal analyses.

1. Conditions of Sale: Unveiling Motivation and External Influences

Conditions of sale refer to the circumstances surrounding a transaction that may influence the agreed-upon price, independent of the property’s inherent attributes. These conditions can stem from motivations of the buyer or seller, or from external factors affecting the transaction.

• 1.1 Non-Arm’s Length Transactions:

  • These occur when parties are not independent and may have pre-existing relationships (family, business partners) that can skew the price.
  • Scientific Principle: Game theory can provide insights. In an arm’s length transaction, both parties aim to maximize their individual utility. However, in a non-arm’s length transaction, the utility function might incorporate the well-being of the other party, leading to price deviations from market equilibrium.
  • Example: A parent selling a property to their child at a discounted price. The parent’s utility function includes the child’s financial well-being, influencing the sale price.
  • Data Analysis: Analyzing sale prices between related parties versus unrelated parties can provide data to support or refute the influence of the relationship on sale prices. Statistical tests (e.g., t-tests, ANOVA) can be used to determine if the difference is statistically significant.

• 1.2 Distressed Sales:

  • Sellers facing financial hardship may be compelled to sell quickly, accepting lower offers than they might otherwise receive.
  • Economic Theory: The “reservation price” concept is relevant. A seller’s reservation price is the minimum price❓ they are willing to accept. Distressed sellers often have a lower reservation price due to their urgent need for liquidity.
  • Example: A foreclosure sale where the lender aims to recover outstanding debt, potentially accepting a below-market offer.

  • Mathematical Representation:

    Let:

    • P_m = Market price (estimated without distress)
    • P_d = Distressed sale price
    • D = Discount factor (reflecting the degree of distress)

    Then:

    • P_d = P_m * (1 - D)

    The discount factor D would range from 0 (no distress) to 1 (severe distress). Determining D requires market research and analysis of similar distressed sales.
    * Experiment: Review foreclosure sale data and compare those prices to sales of comparable properties. Calculate the average discount for foreclosure sales.

• 1.3 Unusual Tax Considerations:

  • Transactions structured to minimize tax liabilities (e.g., 1031 exchanges) can influence prices.
  • Financial Theory: tax incidence❓❓ examines how the burden of a tax is distributed among economic actors. Tax incentives or avoidance strategies shift these burdens, potentially altering transaction prices.
  • Example: A buyer in a 1031 exchange might be willing to pay a premium to acquire a qualifying property, as they avoid immediate capital gains taxes.
  • Empirical Analysis: Conduct a matched pair analysis. Find properties sold with a 1031 exchange and compare them to comparable properties sold without a 1031 exchange. Calculate the price differential and use this to develop an adjustment factor.

• 1.4 Lack of Exposure on the Open Market:

  • Sales not widely marketed may not attract the highest possible price.
  • Marketing Principles: Effective marketing broadens the pool of potential buyers, increasing competition and driving up prices. Limited exposure reduces competition.
  • Example: A private sale between acquaintances where the property was never listed on the open market.

• 1.5 Eminent Domain Proceedings:

  • Sales under threat of eminent domain (government taking of property for public use) can involve negotiated settlements that differ from market value.
  • Legal Framework: Eminent domain laws dictate compensation standards, often aiming for “just compensation,” which may be subject to legal interpretation and negotiation.

• 1.6 Important Considerations:

  • Any adjustment for conditions of sale must be thoroughly supported with market data and clearly explained in the appraisal report.
  • If adequate support is lacking, the sale should be discarded or used with extreme caution and extensive commentary.
  • The direction of the adjustment (upward or downward) may be difficult to determine in some cases, but the reasoning should be documented.

2. Concessions: Incentives and Hidden Price Adjustments

Concessions are financial payments, special benefits, or non-realty items included in a sale contract to incentivize a buyer. They effectively alter the true price paid for the real property.

• 2.1 Types of Concessions:

  • Financial Incentives: Seller contributions to closing costs, mortgage buy-downs, payment of buyer’s mortgage payments.
  • Non-Realty Items: Inclusion of personal property (furniture, vehicles, tickets) in the sale.
  • Creative Financing: Seller-financed mortgages with below-market interest rates.
  • Lease-Related Concessions: Free rent months, landlord paying moving costs.
  • Points Paid by the Seller

• 2.2 The Effect of Concessions:

  • Concessions inflate the stated sale price❓❓ above the actual market value.
  • They can distort financing terms, making it appear that a buyer can afford a higher-priced property.
  • Failure to account for concessions leads to inaccurate appraisals.

• 2.3 Identifying and Quantifying Concessions:

  • Verification is Key: Thoroughly examine sale contracts and interview parties involved to uncover all concessions.
  • Cash Equivalency: Determine the cash equivalent value of each concession (e.g., the present value of a mortgage buy-down).
  • Adjustment Calculation: Subtract the cash equivalent value of the concessions from the stated sale price.
  • Mathematical Illustration:
    Let:
    * S_P = Stated Sale Price
    * C₁, C₂,… C_n = Cash Value of Concessions
    * A_S = Adjusted Sale Price
    Then:
    * A_S = S_P - ( C₁ + C₂ +… + C_n)
  • Example: A house sells for $300,000, including $5,000 in seller-paid closing costs and a $3,000 furniture package. The adjusted sale price would be $300,000 - $5,000 - $3,000 = $292,000.
  • Experiment: Analyze sales data for properties with and without concessions. Using regression analysis, determine the relationship between the type of concession and the increase in sale price. This can help develop a reliable adjustment factor.

• 2.4 Avoiding Double-Counting:

  • Be careful not to adjust for a concession under both “conditions of sale” and “financing terms.” The label is less important than compensating for the effect once.
  • Adjustments for concessions should not be based on a mechanical, dollar-for-dollar basis but must reflect the impact on what a typical buyer would pay.

3. Expenditures Made Immediately After Purchase

These are costs buyers anticipate and factor into the offer price.

• 3.1 Examples:

  • Costs to cure deferred maintenance (roof repair, HVAC replacement)
  • Demolition and removal costs.
  • Costs to petition for a zoning change.
  • Environmental remediation costs.
  • Large capital improvements needed at the time of sale

• 3.2 Quantifying Adjustments:

  • Focus on the expenditure anticipated by the buyer and seller at the time of the sale, not the actual cost incurred later.
  • Positive adjustments are made to comparable sales. If the subject property requires some expenditure immediately after the purchase to reach its full utility, the adjustment amount is subtracted from the sale prices of all comparable sales.

• 3.3 Example:
  * Comparable property sold for $850,000.
  * Buyer expected to spend $65,000 to install an overhead door and loading dock.
  * The adjusted price for that comparable property would be $915,000 ($850,000 + $65,000).

4. Market Trends: Capturing Value Changes Over Time

Market trends reflect changes in property values over time due to macroeconomic factors, shifts in supply and demand, or other market forces.

• 4.1 The Impact of Market Conditions:

  • Comparable sales that occurred under market conditions different from the subject property’s effective date require adjustments.
  • These adjustments account for general increases or decreases in property values since the transaction date.
  • Changes in income tax laws, building moratoriums, the availability of financing, employment, interest rates, and fluctuations in supply and demand

• 4.2 The “Time” Adjustment Misconception:

  • The adjustment is not for time itself, but for the market conditions that change over time.
  • If market conditions remain stable, no adjustment is needed regardless of the time elapsed.

• 4.3 Measuring Market Trends:

  • Paired Sales Analysis: Analyzing two or more sales of the same or similar properties over time indicates the percentage of price change.
  • Resale Analysis: Sales and resales of the same properties provide a direct indication of market changes. This must be approached with caution because it is possible that a resale of a property involved nonmarket conditions.
  • Statistical Analysis: Regression analysis can be used to model the relationship between sale price and time, controlling for other property characteristics.
    • Mathematical Representation:
      • SP = Sale Price
      • t = Time (e.g., months since the base date)
      • β = Coefficient representing the monthly percentage change in value
      • SP = α + βt + ε
      • Where α is a constant, and ε represents the error term.
        The coefficient β would be the adjustment for the Market Conditions. For example, if β = 0.01, the adjustment for the Market Conditions would be 1% per month.

• 4.4 Applying Market Trend Adjustments:

  • The adjustment is usually expressed as a percentage of the comparable sale price.
  • Adjust the comparable sale price to reflect its value as of the effective date of the appraisal.
  • Example: A comparable property sold six months ago for $200,000. Market analysis indicates a 1% monthly increase in value. The adjusted sale price would be $200,000 * (1 + (0.01 * 6)) = $212,000.

• 4.5 Challenges in Declining Markets:

  • Finding recent, non-distressed sales is difficult in depressed economies.
  • Older sales must be used with caution, as they may not reflect the current economic challenges.
  • Shifts in rent, lease terms, or land values can provide insights into market activity when sales data is limited.

5. Conclusion: Mastering Transactional Adjustments for Accurate Valuation

Accurately analyzing and adjusting for conditions of sale, concessions, and market trends is essential for developing credible and reliable appraisals. This chapter has outlined the principles, methodologies, and considerations involved in these adjustments, providing a foundation for sound valuation practices. By understanding the motivations behind transactions and the dynamics of the market, appraisers can provide informed opinions of value that reflect the true worth of real property.