Liquidation Value

TLiquidation Value is different from Market Value. Liquidation Value is the value that is produced when a seller does not have time to prepare a property for its best advantage and time to sort through multiple offers. In a liquidation sale, the high bidder may not have time – usually, no more than 90 days – to arrange a loan, and, so, the buyer had better have cash. In liquidation, the buyers know only part of what there is to know about a property. They can see what there is to see from the street. Is the paint peeling? Is the place kept up? What they can’t see is what is behind the walls. Is it five or 50 years since the last renovation? How old is the heat system? Does a tenant have a claim to the space? Buyers are bidding largely sight unseen. They have no time, and they have no means to “kick the tires.”

Auctioneer Justin Manning indicates that, in some situations, bidders may be at risk that a property on which they bid may be subject to a lease that is unknown to them and that encumbers the property for a period of years, at unknown rent.

Liquidation doesn’t happen often. In a healthy economy, even a company that is in trouble, falling behind on its mortgage payments, usually has time to arrange an orderly sale of its property. The property owner is on the hook for the entire principal balance of a loan, and so the owner usually wants the highest possible return from the sale. Sometimes that happens. Other times, the seller’s problems are so large that they simply throw in the towel. Think of the trashed out houses that Christine and Tarek used to buy on their HGTV show “Flip or Flop.” Walking through the front door of their new acquisition was always an adventure. Was the rehab manageable? Or were there termites in the walls, a strange layout, or wiring that was not up to code? That happens in residential real estate. It happens in commercial property as well.

If there were a world of evidence of the prices that liquidation sales produce – the kind of market data that is usually there when an appraiser analyzes the value of a commercial property – then the appraiser’s task would be straightforward. The appraiser would simply make use of the data involving liquidation sales. But because the economy has been generally healthy in recent decades, market analysts do not have a large body of data concerning liquidation sales from which to draw direct comparisons. The last time we had a market with an abundance of foreclosure sales was in the early 1990s, when prices suddenly crashed, debt financing was scarce, and buyers who had cash could collect properties at distressed prices. That market is too far in the past – a past when distress pushed prices down to half what they had been just two years before – to help to know what happens in a liquidation situation today.

An appraiser wants to build an analysis on solid ground. The solid ground is comparable sales that are at market value. Estimating liquidation value then becomes a two-part process: first, to estimate the property’s market value; and second, to determine how much less than that the property is worth because of the liquidation situation.

Let’s say that the market value of a property is $1,000,000 when the buyers have time to secure a mortgage and when they can have full knowledge of the property. What tells appraisers the difference between Market Value and Liquidation Value?

The first important evidence is what can be known about the property. Is the property a building accessible to the public like a multi-tenant office building or a restaurant, where the buyers can go have lunch and size up the interior? Is it an industrial building where the build-out is not really important because the inside of an industrial building is usually largely un-finished? Or it is an apartment building where no one can see whether the kitchens are new or old? Some buildings are easily known. Others are not.

The most important evidence is what is likely scant evidence of what prices other properties that have been sold in liquidation have brought. Let’s say a retail building sold at foreclosure auction for $700,000, and then months later the buyer who acquired it re-sold it without doing much to it for $1,000,000. From those numbers, we can say that the distress conditions of the auction sale reduced the price by 30%, from $1,000,000 to $700,000. A good appraiser collects evidence of this kind involving sales of commercial properties from which to draw general conclusions about liquidation sale discounts. The evidence may not be entirely consistent. It may show no discount at all in one case and a 50% discount in another. But the evidence is the evidence. In an example with a building with a Market Value of $2,000,000, we might say that the most probable discount is 25%, and the Liquidation Value is $1,500,000. The appraiser’s estimate is evidence bound. The best appraisal would be the one that gives the client the full range of what the appraiser has found, including the Market Value and the range of the discount that produces the Liquidation Value.