Liquidation Values:Moving Towards a More Empirical Analysis

Within the lending world, it is common for a client to request that the appraiser estimate the liquidation value of a particular property. The liquidation value is defined as the most probable price that a specified interest in real property should bring under the following conditions:

  1. Consummation of a sale will occur within a severely limited future marketing period as 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.

Oftentimes, the appraiser’s first line of attack will be to conduct a direct survey of market participants, gathering their thoughts and experiences with liquidation scenarios in the local market. This is certainly an important step in the process and should not be discounted. However, it is possible that market participants may give biased or otherwise unreliable answers for a variety of reasons. It would be helpful to bring in empirical market data evidencing market activity as a test of reasonableness. Unfortunately, this is generally a difficult adjustment to observe in the market, as identifying and analyzing sales in a dislocated market can be problematic.

One approach to observe the problem is to analyze sales of REOs, or bank-owned properties. REO sales generally fit the liquidation definition, with a motivated seller not interested in holding onto the property for an extended investment period. These listings often require a shortened marketing time and may allow for only limited due diligence by prospective buyers.

During a recent appraisal assignment, we solved this problem by analyzing REO sales of retail properties throughout southern California over the prior ten years. Sales data for both REO sales and non-REO sales was aggregated into annual value indications. The 10-year time period reflects changing market conditions from a distressed recession-era market to a recovering market and then an expanding market. The results of the study are presented as follows.

Several observations can be gleaned. As REO/distressed sales take up a larger percentage of the market, the discount for REO/distressed from “typical” non-distressed sales increases. This is likely due to several intertwining factors, including general weakness in the market leading to depression in values across the sector, typical supply/demand dynamics (when there are more REO properties available, prices should decline accordingly), and the relative leverage of buyers in a down market to extract the maximum discount possible in a distressed sale scenario. The converse of this is also true, with the REO discount generally declining as the market improves and these types of deals become comparatively rare. As the overall market finds positive growth and health, the number of REO properties declines and the discount required by a buyer shrinks. We can note this as the trend lines of median sale prices converge from a relatively widespread in 2010-2012 (on the order of 40-50%) to a much narrower spread in 2020.

As the COVID pandemic continues, we would expect to see an increase in REO sales, particularly in the retail sector, unless lenders elect to re-negotiate loan terms, rather than foreclose outright. Therefore, while current liquidation discounts should be minimal, a glut of REO properties hitting the market would likely portend increased liquidation discounts.

In the meantime, if we can be of any assistance, please reach out to us for any of your appraisal or analytical needs. Stay healthy and stay safe.

Wishing you all the best,

Michael Kearns, MAI, ASA & Colin Langeveld

Kearns & Langeveld LLC

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