Market value, fair value, and duress
| DOI | https://doi.org/10.1108/14635781111150321 |
| Date | 12 July 2011 |
| Published date | 12 July 2011 |
| Pages | 428-447 |
| Author | John Dorchester |
| Subject Matter | Property management & built environment |
Market value, fair value, and
duress
John Dorchester Jr
Cushman & Wakefield of Arizona, Inc., Prescott, Arizona, USA
Abstract
Purpose – This paper seeks to consider a significant market misconception and related errors
commonly made by valuers, financial decision makers, and other users of valuation services. Its
purpose is to focus on the importance of relating the explicit requirements of market value and fair
value definitions to the evidence required for a supportable opinion of either.
Design/methodology/approach – The paper provides conceptual foundations for the terms
“market value” and “fair value” and reviews their meanings and applications in a historical context.
Business cycles and the recent recession are used as foundations for illustrating how prices, such as for
real estate, vary with cycles, but are not always directly indicative of either market value or fair value.
The latter term has a long history, but has undergone recent definition and revision by the US
Financial Accounting Standards Board (FASB) that are shown to closely align fair value with market
value. A current controversy over the use of transactions as prima fascie, or perhaps the only
indication of market value is discussed and the “market” of “market value” is examined.
Findings – The paper offers a new look at market evidence concepts that are time-honored, yet have
been largely lost or forgotten. The principal finding is that duress is not consistent with conventional
definitions of market value or fair value, yet significant market evidence exists that duress is often
ignored or improperly considered in valuations and financial decisions. The paper also concludes that
the FASB’s focus on “market participants” (sellers and buyers) as the prime source of Fair Value
evidence is akin to the rules which have applied to market value for many decades. The paper
concludes with a discussion of why transactions may be evidence of “a market,” but are not
necessarily representative of the “market” or of fair value.
Originality/value – Market Value is a market protection against fraud, misrepresentation, and
misunderstanding. Valuations must be performed in accordance with that definition – not as it is
interpreted for personal gain or for any other interpretations of convenience, misunderstanding, or
special purpose.
Keywords Market value, Fairvalue, Market price, Real estate valuation,Valuation,
Financial decisionmaking, Duress, Market transactions and value
Paper type Research paper
Introduction
Confusion, doubt, and questions characterize continuing concerns of individuals,
companies, countries, and the world as they review recent economic woes and look to
the future. Questions abound. “How did we get here, anyway?” “What do we do now?”
“When and where is all this going to end?” Many search for lifelines to weather the
continuing storm. While each is a serious question, the concerns are echoes of similar
ones expressed worldwide and in the USA since before we were a country. This paper
will make brief reference to historical examples of troubled US economies as a
foundation for understanding current market issues and related professional valuation
questions addressed herein. Specifically, these questions deal with the terms and
concepts called “market value”, “fair value”, “market price”[1], and their ingredients.
We will bring what we discuss into focus for today and tomorrow.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1463-578X.htm
JPIF
29,4/5
428
Received December 2010
Accepted March 2011
Journal of Property Investment &
Finance
Vol. 29 No. 4/5, 2011
pp. 428-447
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635781111150321
For individuals who have been around since the days of the Great Depression it is easy
to understand how those who have been in the appraisal industry the shortest time
(hereafter I will generally refer to “valuation” instead of “appraisal” and usually save the
word “appraisal” for its more colloquial use in today’s business world: a report containing
a market value or other defined value opinion) often have the least appreciation for the
cycles that economies go through. Our parents and early mentors said the same about us.
Historical considerations and other references to the past in this paper may sound
esoteric, but they are not. If we look back to the panic of 1907, we can see that the US
has endured about 20 recessions of various magnitudes over a 100-year span, or about
one every five years. Of course economic downturns such as what is now called the
Great Recession[2] do not happen with that regularity, but valuers must recognize that
markets bounce – sometimes erratically and unpredictably. Despite the analyses
contained in many appraisals, the value ascribed to such valuable items as real estate
or the revenues it produces does not always “increase at three percent per year” or
“decrease at five percent per year” over time. They simply vary. Trends occur, and
disappear. Short-term trends can become mid-term or longer-term trends, in any
direction. Meanwhile, valuers are to reflect the markets for which they are investigative
reporters, and must reliably analyze and report market behavior when they derive
professional opinions of that behavior called market value.
More recently, the term fair value has gained traction and has developed significant
attention in the financial world. Although fair value has been an element of US
Generally Accepted Accounting Principles (US GAAP) for many decades, it seems that
few investors (and some would say few accountants) considered the importance of the
term. Ironically, the Financial Accounting Standards Board’s (FASB) clarification of
the concept and definition of the term in 2006[3] nearly created a Panic of 2007. Closer
to home for our purposes, FASB’s attempts to clarify and make financial reporting
standards more understandable encountered the Law of Unanticipated Consequences
in the confusion that followed. Confusion and concern leaked into the real property
valuation world, affecting valuers whether they performed fair value valuations or not.
Perhaps more importantly, and aided by the dramatic changes that were occurring
in real estate markets and what has happened since, fair value and market value have
been compared, contrasted, and confused. Importantly, these served to force real
property valuers to take fresh looks at market value and its component elements as a
concept, an activity controlled by a definition that is essentially recognized throughout
the world in business and professional disciplines, and a commodity that is frequently
bought and sold in the market in the form of an appraisal that is used for purchase,
sale, lending, or related uses.
Professional and aspiring valuers in today’s still troubled economy come from
varied backgrounds, experiences, education, geographic locations, and professional
tutelage. Some, but not all, exhibit what founders of the American Institute of Real
Estate Appraisers (AIREA)[4] called “fair weather appraisal traits” [5]. By that they
meant that some could perform valuations in economic times that had the “sunshine”
of many market transactions, but had less understanding or training in how to respond
in the changing or foul weather of unique properties or uncertain market conditions
such as they responded to at the time of the Great Depression. It is clear, however, that
valuers are required to professionally develop and report market-based value opinions,
and to be independent, in any type of economic weather.
Market value
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