Pick Your Poison: Fair Market Value, Orderly Liquidation Value or Forced Liquidation Value

Includes: AF, COF, HCBK, HVB, VLY
by: Jeffrey Bernstein

This article was first published January 9, 2009.

I'm a certified machinery and equipment appraiser (CMEA), one of my lesser-known talents. In machinery and equipment appraisal there is a concept called market exposure; my business partner who is a trained commercial real estate appraiser, reminds me that the same concept also applies to real estate appraisal. Market exposure, loosely speaking, is the amount of time a property, company or piece of equipment would be expected to be on the market in order to produce a full price sale. A "full price sale" is generally defined as Fair Market Value (FMV).

An appraiser has several ways of estimating Fair Market Value. In residential real estate they generally stick to the Sale Comparison Approach, or comps, for short. A sale of property with a normal period of market exposure should produce a price near appraised "Fair Market Value" based on comps. Just set aside for the moment that in a significantly declining market comps get stale quickly (as Noah has written about, appraisers have a strategy for addressing this called time value adjustment).

When an entire company or a piece of machinery and equipment has to be sold more quickly than through "normal market exposure", an appraiser will look at two other potential values: Orderly Liquidation Value (OLV) or Forced Liquidation Value (FLV). These would be the values expected to be produced if the company or machinery and equipment had to be disposed of much more quickly, say, over 90 days in the case of OLV, or at auction (essentially immediate liquidation) in the case of FLV. These market exposure situations generally result because of a need to repay debts.

So what does this have to do with New York City real estate? As I said earlier, in the case of a Fair Market Value sale, value is generally expected to be 100 cents on the dollar vs. comps (in the case of real estate it would be time-adjusted comps). In the case of orderly liquidations of machinery and equipment, the rule of thumb is that the assets generally bring about 50 cents on the dollar of OLV vs. FMV. Forced Liquidation is assumed to result in recovery of about 25 cents on the dollar of Fair Market Value. I know from my Wall Street days that the orderly liquidation of a company is usually thought to bring 50 - 70% of book value, depending on how much of that value are things like receivables that can be sold at small haircuts and how much is land or machinery and equipment that must be liquidated at bigger discounts.

Real estate appraisal only has one definition for "distressed"-type sales.

According to the Dictionary of Real Estate Appraisal 4th Edition "Liquidation Value" is:

The most probable price that a specified interest in real property is likely to bring under all of the following conditions:

1. Consummation of a sale will occur within a severely limited future marketing period specified by the client.
2. The actual market conditions currently prevailing are those to which the appraised property interest is subject.
3. The buyer is acting prudently and knowledgeably.
4. The seller is under extreme compulsion to sell.
5. The buyer is typically motivated.
6. The buyer is acting in what he or she considers his or her best interest.
7. A limited marketing effort and time will be allowed for the completion of a sale.
8. Payment will be made in cash in U.S. dollars or in terms of financial arrangements comparable thereto.
9. The price represents the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

From what I understand, there is no rule of thumb for the markdown required to move property with less than "normal" market exposure, but I am already seeing busted condo developments where investors are valuing the property at the 50 cents on the dollar OLV level. They get there not by valuing them as condos, but by falling back on the value of the units as rental apartments, because no one even wants to think about having to sell new condos in this environment.

We have not yet seen Forced Liquidation Value type blowout sales and maybe we won't in commercial real estate. But I would not be surprised to see some OLV type residential real estate sales as we are seeing in commercial. For those who have been asserting that NYC residential real estate values could fall 50%... there is actually a pretty decent theoretical basis for their argument (although my official prediction is 40%), since we are all coming to understand that weak-handed sellers and vulture buyers set pricing in markets where normal buyers fear to tread. Orderly Liquidation Value is the watchword for now. I would be curious to know what Forced Liquidation Values look like vs. peak prices in places like Florida and Nevada where they actually are having auctions; 75% off seems too steep a hit even for these horrendous markets.

Companies with significant exposure to NYC residential real estate include HCBK, AF, COF, VLY and HUVL.OB.