Guest Author: Matt Cook, Torrance, CA
A poster to the Inland California appraiser's forum posed an appraisal problem regarding distressed sales.
He stated that the market for a particular residential assignment included 88% "distressed sales of one kind or another" and thought that perhaps by dominating the market, the distressed sales would exert downward value pressure on all the properties in the market.
He was wondering if and how to include these distressed sales in his analysis?
My response was:
If the distressed sales are truly making the market, then two comparable homes--one a distressed sale and one not--should sell for the same amount. Unfortunately, there is not a monolithic "distressed market;" there are vast differences in seller motivation. That is the difficult but essential factor that must be analyzed.
When you separate out the price ranges of the REOs, short sales, and "typical" sales, what do you see? If the REOs and short sales are ALL "distressed" sales (implying below market), you should see that their value ranges will be below the 12% of typical owner sales. On the other hand, if you see that the upper price ranges of the REOs and short sales are similar to the price ranges of the typical sales, that MAY indicate that there are REOs and short sales that are not being affected by poor condition, atypical seller motivations, or fraud, and can be used in support of your analysis and conclusion of market value.
Good news! If the ranges are not similar, this may be the first step in allowing you to derive an adjustment for distressed sales that can be used in your sales comparison analysis. Here are some other suggestions for ferreting out sales from that 88% that can still be used.
REOs: Often, distressed sales--especially REOs--are in poorer condition than typical owner-occupied, owner-sold properties, so they would have lower average sales prices. Sometimes they are also "dumped" at below-market prices. If you can analyze the REO sales and first separate out the ones that were in good or typical condition, then analyze these to separate out the ones that seem to have been sold without undue duress, you may have some REO comparables you can legitimately use.
Some clues that the REO sales MAY be below market are shorter-than-typical marketing times, sales prices above list prices, and out-of-area selling agencies. Short marketing times may indicate a quick sale at a discount price; sales above list price may mean that the listing agent listed the property below market to begin with, and out-of-area listing agencies often handle all of a particular lender's REOs and may not know the local market, or be as available as a local agent to do the marketing, showings, etc. necessary to ensure getting the best possible price.
If you set aside the REO's with those characteristics, after weeding out the ones that were in poor condition, you may be left with a pool of REO sales that have the potential to be market-value sales. Investigate these to be sure; agent interviews are a must here. You may find some REO sales that were in typical condition, sold in normal marketing times by a knowledgeable local agent at a typical discount from list price, verified by both listing and selling agents as being a normally-valued sale. Viola, a comparable sale!
SHORT SALES: Short sales by definition are only short sales because their MARKET VALUE is less than the mortgage balance, so if they are selling at that market value, they should have sales prices similar to otherwise comparable homes. Unfortunately, short sales often involve protracted negotiation and settlement times that can translate into discounted sales prices, as the pool of buyers willing and able to endure the delays is smaller and likely differently motivated than the general pool of buyers. Also, there is a lot of short-sale fraud going on so you have to be very careful.
Start by setting aside the short sales with long times in escrow, or the ones that have been in and out of escrow several times. These conditions MAY reflect unreasonable, unrealistic, or difficult-to-deal-with lenders that will drive "typical" buyers away and result in below-market sales prices. Again, set aside the sales with out-of-area listing agencies for the reasons above. Investigate what you have left, and you may find that some of the sales were sold at market value. A short sale with a reasonable, responsive lender, normal listing history, and an experienced local agent who markets the property correctly can result in a good, market value sale despite its being a short sale.
Finally, take a close look at the "typical" market, the 12% that are not REOs and short sales. If they are priced differently than the 88%, what does it take to get one of them sold? That is, if the "distressed" sales are selling in normal marketing times for their market but the "typical" sales have extended marketing times, or are selling with seller financing, concessions, or other conditions made necessary in order for them to compete with the lower-priced "distressed" sales, then you may want to rethink whether they are truly "market-value" sales.
AUTHOR: Matt Cook, Torrance, CA