Is That an Arm’s-Length Transaction?
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USPAP does not define the term arm’s-length transaction. Fannie Mae also lacks such a definition. Yet, both of them call for the appraiser to use only arm’s-length transactions as comparable sales…
How often do we appraisers get into the mode where we think we know it all? Occasionally, do we need to step back and look at the way we do things, just to make sure we are not missing something? Is what we know to be true and correct really true and correct? I raise this issue relative to the concept of what an arm’s-length transaction is. Are we truly aware of its definition and its application?
I thought such a transaction was one where the buyer and seller were traditionally motivated; there was no coercion, no bias; no relationship between the parties. In other words, it was a typical market transaction. This is how this concept was taught to me when I took my original appraisal classes, oh so long ago. This is what my mentor taught me. However, was that correct? Let’s go to USPAP to see what it says.
Surprisingly, USPAP does not define the term arm’s-length transaction. Fannie Mae also lacks such a definition. Yet, both of them call for the appraiser to use only arm’s-length transactions as comparable sales (which is what the definition of market value assumes). Now, consider a situation in which a tenant in a duplex is the contract grantee. Your client gives you a copy of the tenant’s current lease, as well as a copy of the signed and executory purchase and sales agreement. With those data only, how do you conclude if this is an arm’s-length transaction?
Let’s assume, for the purposes of this discussion, that some analysis on your part reveals that this property was never offered for sale via the local MLS. Further, the tenant as the contract-grantee might have had some “sentimental” reasons to purchase the property (although I can’t imagine about how anybody could get sentimental about a duplex property), thus may have other-than-market motivations to purchase. Therefore, based on this analysis, at one time I would have concluded this was NOT an arm’s-length transaction.
In all candor, however, I can’t say this question would be so cut-and-dried to me now. For example, what if the seller offered the property for sale as a FSBO? True, there was no exposure via the local MLS, but why does a property need to be offered for sale via the MLS just to qualify as having been “…offered for sale on the open market…”? Next, where is it written that a tenant-purchase of a duplex cannot/does not meet the requirements of an arm’s-length transaction? Why assume that merely because the tenant is the contract grantee, the parties to the contract reached that sales price by other than free and open negotiations?
From the seller’s standpoint, in this scenario, is there any evidence the seller is under any undue influence to sell the property (to anybody, including the tenant)? So, if there is no undue influence to sell, as well as no undue influence to buy, and the parties arrived at the contract price via free and open negotiations, what is not arm’s-length about this transaction? Without reading any more into this scenario, nor reading anything out of it, I see this transaction as arm’s-length for these reasons. Could I change the scenario to make it a non-arm’s-length transaction? Yes. However, that’s not the point here.
Now, here is another question: who determines if the sale is arm’s-length? Consider this true story. A grandchild offers to purchase a grandparent’s property. Both the grandparents and the grandchild have the property appraised, and then from those appraisals negotiate a purchase price and terms. The grandchild will put 10% down, while the grandparents will not carry any paper. It’s the same deal as any buyer could make. The only difference is that a grandchild bought the property from a grandparent. Now, is that an arm’s-length transaction?
Some will say yes, whereas some will say no. However, the point is not whether it is or is not. The point is the appraiser cannot answer that question until after having completed the necessary analyses to determine its status. Frankly, I say it is an arm’s-length transaction but would understand if another appraiser, faced with the same circumstances, would say no. This is why we must confirm sales with other than MLS. It is only after the proper analyses that we can make this decision. Proper verification of this transaction is more work than we would normally do, frankly, since, typically, such a buyer-seller situation does not come up all that often. Nevertheless, to verify if this sale in a comparable will work we need to at least attempt to do. It’s our job to analyze any given transaction, and then decide if it is or is not arm’s-length. If the details of a specific transaction are too cloudy to make the decision, then we may decide to get another comp.
The purpose of this blog is not to define an arm’s-length transaction. Rather, its purpose to make sure we as appraisers know that determining this is part of what we do – the verification part. And because it is part of what we do, we have the freedom and responsibility to determine which comparable sales to use and which to reject. We do this, in part, by learning enough about a sale and purchase transaction to determine if it is or is not an arm’s-length transaction.
For more information on this subject, please download and listen to The Appraiser Coach Podcast Episode: 254 What Exactly IS an Arm’s Length Transaction?
An arm’s length transaction means, and has always meant, that the seller and buyer are not related by blood or association. Nothing more and nothing less.
Where did you get that from James?
I don’t know where I picked it up, but i know it to be true. The term speaks to extra consideration necessary in the analysis of a transaction. It has nothing to do with financing, price, contract considerations(personal property), or value it is simply a statement on the relationship of the participants. A Non-Arm’s length transaction can absolutely occur within the definition of market value as the term does not define the level of bias or motivation. Just because I sold my house to my brother does not mean I gave him a better deal. However, if you have a choice between two comparable sales, I would go with the arm’s length transaction over the non-arm’s length.
Non-arm’s length transactions are purchase transactions in which there is a relationship or business affiliation between the seller and the buyer of the property. Fannie Mae allows non-arm’s length transactions for the purchase of existing properties unless specifically forbidden for the particular scenario, such as delayed financing. For the purchase of newly constructed properties, if the borrower has a relationship or business affiliation (any ownership interest, or employment) with the builder, developer, or seller of the property, Fannie Mae will only purchase mortgage loans secured by a principal residence. Fannie Mae will not purchase mortgage loans on newly constructed homes secured by a second home or investment property if the borrower has a relationship or business affiliation with the builder, developer, or seller of the property.- FNMA Selling Guide, 12/04/2019
Arm’s Length Transaction: An Arm’s Length Transaction refers to a transaction between unrelated parties who are each acting in their own best interest. FHA Handbook,4000.1, 12/30/2016 page 4.
IF THEY ARE RELATED BY BLOOD OR BUSINESS IT IS A NON-ARM’S LENGTH TRANSACTION.
Too many weasel words, too much to interpret. Blood or business is a neat phrase but too disconnected.
The worth of the deal is in the parts, the financing, the discount points, the extra stuff, the sail boat in the garage, the golf cart, the prepaid HOA’s. What was the solar deal? Did the seller keep the solar, did they move the turbine generator to a new site, was the family cow a Holstein or a Guernsey, was the onion crop $harvest the sellers or the buyers?
Private financing offers lots of packages, Bankruptcy offers lots of reasons for high interest rate financing, the buyers have incentives. Also an appraiser will ALWAYS explain The standard (No more than 3 points discount for a 4% loan of 80% LTV). OR maybe an all cash deal is an unexplained bargain. What are typical sales terms in a 55 plus development?
You will find James’ definition in the dictionary of real estate appraisal, which by the way the author should have researched.
There may be several sides to the sale through family transactions. A friendly price based on the purchasers affordability, a more aggressive price for convenience of the buyer and/or sellers. Some other under the radar agreement nobody will ever be aware of. They will not disclose concessions, rentbacks, cash, gifts, or anything along those lines. On top of that what about the differential between sellers cash equivalence if they did not pay agency fees?
In some fsbo scenarios the home may become shared for a time. The buyer may be essentially funding their parents retirement. Inter family sales have very high potential to be problematic. One has to look at the broader market to see if that sale lines up well with typical market expectations. Why bother if there are represented sales instead. Only sometimes do fsbo’s get a legitimate appraisal before the price is formed. Quite often they’ll form the price from avm figures or personal financial goals. If you’re pulling comp data directly from county records or something along those lines, you may never even know if a property was family to family or not.
The premise of the question is unnecessary, arms length is at least loosely defined already. One may even go so far as to argue that the lending climate, the skill, experience, and leverage differences between agents themselves may create a non-arm’s length climate of sale conditions. When agents walk the buyers home into a highest possible price, agency costs are financed, and everyone holds hands.
One may ponder if commission based agency under current lending conditions nullify any notion of ‘arms length’ in the first place. Because the agency fees are financed and not paid out of pocket, it’s all too easy for participators in purchasing to overlook inherent conflict of interests in the structure of lending itself. Higher price, higher commission. Commissions and cash, not thrift, is the primary motivating factor in price when dealing with sales conditions which utilize financing. People learn how back patting works in short order, it is the easiest skill to acquire in real estate.
Imagine a climate where all parties held agencies to a higher standard. Where thrift had a place at the table because everyone had to write agents a check for their agency at closing, where representative costs were not financed. Where the agency commission did not have an actual cash equivalent cost which was much higher due to amortized interest. People in real estate throw a lot of defined terms around having become familiar with them through repetition. Far fewer participators actually grasp the inherent conflict of interests at every turn. Banksters set up all these rules for their own benefit, true masters of illusion. The rest of us just play along for a little cut of the action, lining up data, signing paperwork, pushing fiat paper left and right.
Arms length is when you count the dollars, every single last one of them. Very few transactions actually qualify as arms under strict expectations of full accountability and legitimate checks and balances. Lenders earn the equivalent of all agency combined, through the process of financed agency fees. It’s a great way to mask devaluing currency with a constant rake off the top. Those are the things I think about when I constantly report ‘arms length’, while being purposefully shielded from actual financing term data. Report it how you want to, none of it matters anyways. These are the theories behind the audit the fed argument and Article 1 Section 10 on sound currency, they’re not just clever slogans. Thank you for reading and I’ll see you around through the looking glass.
I think you are right Mark…I think the author likes to be “heard”….
“BLACKS LAW” is the premier which holds to the definitions we have to use in protecting ourselves. “blacks” is compiled from old and recent court decisions. Some of these definitions go back the before we were separated from England. Arms length means more than relationships, it also refers to the dingles hanging from these relations.
The judicially ordered F.M.V., the friendly M.V. between neighbors, The Vacation- escape neighborhoods where institutional financing is not available and Multiple listing is less than 50% make simple explanations unreliable. A lot of like to be heard because we see so much advice coming from emotion, and we feel some be better grounded.
Buying and selling R.E, backed paper notes “Trust Deeds”, was a major part of the industry until the financial institutions became so big with guaranteed financing. Government guaranteed financing is changing and all financing is not the same. Beware!!
That looks like a tough read Don but I’d bet you’ve read it. Will find time to buy it one of these days. Would make a great desk piece.
Oh look here, there is a definition just waiting to be read.
Beyond the reach of personal influence or control. Parties are said to deal “at arm’s length” when each stands upon the strict letter of his rights, and conducts the business in a formal manner, without trusting to the other’s fairness or integrity, and without being subject to the other’s control or overmastering influence.
Yeah, how exactly does that happen when the tenant is purchasing while currently being at the mercy or their selling landlord? Rent to own, not a situation I’d want to find myself in.
Dustin, your example conflates arms-length sale requirements for COMPARABLE SALES as also applying to the subject in the same manner.
1. There is no prohibition in FNMA Freddie Mac, VA or FHA in a seller selling to a related family member; business partner or tenant. It happens all the time. Mother and Father sell to children; spouses sell to spouses (divorces). As far as a subject goes, simple disclosure of the relationship and terms is usually all that’s required.
2. Having the above scenario in a comparable sale is not condoned. In #1 the lender has all the non-arms length information as part of the loan application and copy of the sale contract. In a comparable sale, it simply does not fit the accepted definition of market value. We do not normally have access to that contract nor reliable information on possible undisclosed discounts; inducements, special concessions, kicks backs, etc..
If the non-arms length sale was forbidden from being used as a comparable sale then why does the UAD have NAL as an option on the Sales comparison grid. I agree that most times a NAL sale does not meet the definition of market value and should probably be excluded from the comparison, but there may be times when the property actually sold between related parties at market value and is, therefore, a valid comparable. If it wasn’t then why is it part of the UAD formating?
Too many laws; too many sources. If we simply rely on the definition of market value as being an arm’s length transaction, all is reasonable. However, the definition of ANY sale without undue influence eludes me. Start writing down reasons to sell and reasons to buy, and then tell me which one of the hundreds you come up with could be considered just a random decision with no undue influence. Think about it. With enough digging, it is likely that nearly ANY purchase/sale could be disqualified as arm’s length.
Too many reasons to sell not enough buy, Except for the potential of profit, or reduction of losses. Seems a contradiction! Partnerships illustrate contradictions, some have reasons for a quick profit, some have reasons to preserve capital.
Once upon a time when sales were really slow I found the re-negotiating of seller sale most enlightening. The previous seller renegotiated rather than repoed. The pressure of a sale was equal on each of the parties; The purchase money trust deed holder v the over extended recent buyer. Theses negotiations exist, finding them is tough, but informative.
Painting a picture of the situation is MOST important, for the analysis.