Posted on September 25, 2008 by Eric S. Solotoff

THE VALUE OF REAL ESTATE - PROBLEMS IN THIS EVER CHANGING MARKET

I just finished a day of trial yesterday taken up be competing real estate experts regarding the value of the marital home.  It was certainly a reminder of the problems with the values of real estate in a rapidly changing market.

We first have to start with the basic premise of using the appropriate valuation date.  The case law is clear that a marital home is valued as of the date of the trial.

That caused some interesting issues in this case. The Complaint for Divorce in this matter was filed in September 2006.  The original appraisal of the home was done in April 2007.  While the market had already started to decline, both experts testified yesterday that their profession was resisting making adjustments for time (that is, if the comparable sales they were using were months prior, they were not adjusting for the decline in the market between the time of the sale of the comparable and the home they were appraisal), prior to early 2008.

Because this case is in a county that is hard to get trial time, the trial had been adjourned several times.  The original appraiser, who was a joint appraiser, updated his report in January 2008 and it should come as no surprise the the value had decreased.  It should also come as no surprise that the person that wanted to be bought out of the house objected and got his own appraisal.  This appraisal was in April 2008 and used comparables from the last quarter of 2007.  No adjustments for time were made.  The original appraiser updated his report for trial in September 2008.  Given what is going on with the real estate market, it is no surprise that the value has gone down again.

In fact, the appraiser believes that at this point, values are going down at a rate of 1/2% to 1% per month.  He also anticipates this to continue.

This case illustrates several areas for concern:

1) Best practices, which is court policy that dictates the time line of cases, will inevitably force appraisals to be done several months before the trial date.  In this market, is that not forcing the parties to get at least one more appraisal given the time delay between the end of discovery and the end of a trial? 

2)  In the event that there is a trial, some times it takes many months to get a decision.  Assuming you have a fresh appraisal report as of the trial date, in this market, if there is a several month delay, is the value as of the trial date a fair assessment of value for equitable distribution?

3)  Does it make sense in this market for one party to keep the house and either buy out the other spouses interest from the equity or offset the other side's share of the equity against other non-real estate assets?  With the prognostications regarding the continued decline in the market, would it not be most fair to sell the house so that the pain is shared equally and then divide the rest of the assets, in-kind?  I suppose it depends on how long the person getting the house plans to stay there.  If it is a long time, maybe it makes sense to keep the house.  If it is a short time, probably not so much. 

The equitable distribution statute requires a court to look at the income producing aspect of the assets received in equitable distribution.  While you don't see this done too often, how should a court look at an asset that is expected to continue to decrease in value for the foreseeable future. 

What this all means is that we need to think our prior thinking about what to do with the marital home in this declining economy.

 

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Posted on March 27, 2008 by Eric S. Solotoff

IS UNIFORMITY IN BUSINESS VALUATIONS UPON US? - THE NEW AICPA BUSINESS VALUATION STANDARDS

            On June 21, 2007, the American Institute of Certified Public Accountants, “AICPA”, released the Statement on Standards for Valuation Services No. 1 (SSVS No. 1) – Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset (“Standards”). These standards are effective for all valuation engagements accepted on or after January 1, 2008. The purpose of these Standards is to improve the consistency and quality of practice among CPAs that perform valuation services. The Standards were developed because Congress, government agencies and regulators have recently focused their attention on valuation issues, as well as the increasing demand for valuation services over the past 20 years. 

            The Standards specify two types of engagements: valuation engagements and calculation engagements. Valuation engagements would typically be the one required in a divorce matter.

            In determining whether the valuation engagement can reasonably be expected to be completed with professional competence, the standards require that the valuation analyst consider, at a minimum, the following: (a) the subject entity and its industry; (b) the subject interest; (c) the valuation date; (d) the scope of the valuation engagement (including the purpose of the engagement, any assumptions or limiting conditions that are expected to apply to the valuation, the applicable standard of value (i.e. fair market value or fair value) and premise of value (i.e. going concern), the type of report to be issued, the intended use and users and the restrictions on the use of the report); and (e) any governmental regulations or other professional standards that apply to the entity to be valued or to the valuation engagement.

            Additionally, in understanding the nature and the risks of the valuation services to be provided, the standards require that the expert should consider: (a) the proposed terms of the engagement; (b) the identity of the client; (c) the nature of the ownership interest, including control and marketability issues; (d) the procedural requirements of the valuation and whether they will be limited by either the client or circumstances beyond the client’s control; (e) the use and limitations of the report and the conclusion or calculated value; and (f) any obligation to update the valuation.

           

          Under the Standards, the accountant is permitted to rely on the work of a third party specialist, such as a real estate or equipment appraiser and has the option of appending the specialist’s report within their valuation report.

           In performing a valuation engagement, the standards require the CPA to analyze the subject interest (considering many of the factors previously addressed); consider and apply appropriate valuation approaches and methods and prepare and maintain appropriate documentation. The analysis of the subject interest should include financial information for the relevant period such as historical and prospective financial information, comparative summaries of financial statements, comparative common size financial statements, tax returns, information on owners compensation and key man life insurance, advantageous or disadvantageous contracts, contingent or off balance sheet assets or liabilities and information regarding prior sales of the entity. Additionally, non-financial information must be considered such as the nature, background and history of the entity, the facilities, the organizational structure, the management team, classes of equity ownership interests and the rights attached thereto, products or services, or both, the economic environment, the geographic markets, the industry markets, key customers and supplies, competition, business risks, strategy and future plans and the governmental and regulatory environment.

          In performing the valuation, consistent with past practices for a typical valuation, the accountant should consider the three most common valuation approaches: the income approach, the asset approach and the market approach. While using the capitalization of benefits method (an income approach), the accountant should consider normalizing adjustments, non-recurring revenue and expenses, taxes, capital structure and financing costs, appropriate capital investments, non-cash items, qualitative judgments for risks used to compute discount and capitalization rates and expected changes in future benefits. When performing a discounted future benefits analysis (also an income approach), the accountant must consider forecast/projection assumptions, forecast/projected earnings or cash flows and the terminal value. When using the asset approach, the assets and liabilities must be identified, the assets and liabilities must be valued and the liquidation costs must be considered. In using the market approach (i.e. looking for comparable sales), the accountant must consider qualitative and quantitative comparisons, whether the data reflects arms-length transactions and prices and the dates and relevance of the market data.

        The accountants are also required to consider valuation adjustments such as discounts (lack of marketability or lack of control) and premiums. Though consideration of these adjustments is seemingly required, it will be interesting to see how this is applied in New Jersey since discounts are disfavored in matrimonial valuations.

        Subsequent events that were not known or knowable as of the valuation date are not to be considered. This is significant as there was considerable debate in the valuation community about the appropriateness of using subsequent events. 

         The Standards, in large part, comprehensively state what the more skilled accountants have been doing for some time. However, another benefit of the Standards, aside from uniformity, is the creation of a road map to use both to be sure that your valuation expert’s report is as unassailable as possible, and to provide fodder for cross-examination of the adverse expert.

          For a full version of the Standards from the AICPA web site, click here.
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