A comparable land sale included the seller financing the purchase at below-market interest. What adjustment is required?
Correct Answer
B) A downward adjustment for the favourable terms
Why this is correct: The original explanation states that cheap financing causes a buyer to pay more, so the recorded price overstates a cash-equivalent transaction. The governing concept is that market value is based on cash or cash-equivalent terms. To use this comparable, its sale price must be adjusted downward to reflect what it would have sold for without the favorable financing. Why the other choices are wrong: An upward adjustment for the favourable terms would further inflate the price, moving it further from cash equivalency. No adjustment, since the price was still paid ignores the financing influence on price, violating the principle of cash equivalency. An adjustment only if the buyer later refinanced is incorrect because the adjustment is needed at the time of the sale analysis, not contingent on a future event. Exam tip: Remember: favorable seller financing = downward adjustment to the comparable's sale price to estimate cash-equivalent value.
Why This Is the Correct Answer
Below-market financing is a benefit the buyer paid for in the price, so the reported price is adjusted downward to its cash equivalent, estimated by discounting the payment stream at market rates.
Why the Other Options Are Wrong
Option A: An upward adjustment for the favourable terms
Favourable financing inflates the price, so the adjustment reduces it. An upward adjustment would compound the distortion.
Option C: No adjustment, since the price was still paid
The price was paid for real estate plus a financing benefit. Only the real estate portion belongs in the comparison.
Option D: An adjustment only if the buyer later refinanced
A later refinancing does not change what the buyer paid at the time of sale, which is what the analysis addresses.
Cash Equivalent, Always
Cash Equivalent, Always. Favourable financing raised the price, so take it back out.
How to use: Discount the payment stream at a market rate. The difference is what the financing was worth and what to remove.
Exam Tip
The adjustment is also made in the other direction. Financing worse than market depresses price and calls for an upward adjustment.
Common Mistakes to Avoid
- -Adjusting in the wrong direction
- -Ignoring financing terms because a price was actually paid
- -Estimating the adjustment without discounting the payment stream
Concept Deep Dive
Analysis
Market value assumes payment in cash or its equivalent, so a sale price influenced by financing on other than market terms must be converted back to what the property would have brought without that inducement. Below-market seller financing is a benefit the buyer receives on top of the real estate, and a rational buyer pays for it — the price is inflated by the present value of the interest savings over the loan's expected life. The adjustment is therefore downward, reducing the reported price to its cash equivalent, and the amount is estimated by discounting the payment stream at a market interest rate to see what the financing was actually worth. The reasoning is symmetric: financing on terms worse than market would call for an upward adjustment. What never applies is the argument that the price stands because it was paid; the price was paid for real estate plus a financing benefit, and only the first part belongs in the analysis.
Background Knowledge
Market value assumes payment in cash or its equivalent. Sales with financing on other than market terms require a cash equivalency adjustment, estimated by discounting the financing benefit at market rates.
Real-World Application
An appraiser finds a land sale with seller financing three points below market, computes the present value of the interest savings, and adjusts the price downward by that amount.
More land-or-site-valuation Questions
Under which condition is the land residual technique most applicable?
What is the appraiser's obligation when a site's legal description does not match its apparent physical boundaries?
Why can the same physical parcel carry different values in two assignments?
A site differs from land in that a site is best described as which of the following?
In a built-up area where no vacant land has sold for years, which approach to site value is the usual fallback?
How is entrepreneurial profit treated in the subdivision development method?
A land comparable sold 18 months ago in a market rising about 4 percent a year. What adjustment direction applies?
In a land residual analysis for a proposed office development, the appraiser estimates total annual net operating income (NOI) will be $1,250,000. The improvement value, derived via the cost approach, is $15,000,000. Market evidence indicates a 7.0% overall capitalization rate is appropriate for similar improved properties. What is the indicated land value?
A developer plans a 36-lot residential subdivision on raw land. Each lot is expected to sell for $85,000. Total development costs (excluding land) are $1,420,000, including $220,000 for entrepreneurial incentive. The developer requires a 12% annual yield on invested capital over a 3-year development period. Using the subdivision development method, what is the maximum price the developer should pay for the land if all lots sell at the projected price and timing?
In applying the land residual technique to a proposed subdivision, an appraiser estimates that the time required to fully absorb all lots will be 6 years. The developer requires a 10% annual yield on invested capital. Which discounting approach is most appropriate for converting future net proceeds to present value?
People Also Study
Valuation Principles & Procedures
25% of exam
Property Description & Analysis
20% of exam
Market Analysis & Highest/Best Use
15% of exam
Appraisal Math & Statistics
15% of exam
USPAP (Ethics & Standards)
15% of exam