What is an arm’s length transaction? The question seems simple enough, right? Just mentioning it on an appraiser blog creates a flurry of debate over what exactly is an arm’s length transaction. While doing research for this article, it evoked a lot of emotion from my peers. Everyone has an opinion and many believe their opinion is the correct one.
The Appraisal of Real Estate, 13th Edition, published by the Appraisal Institute, states that an arm’s length transaction is “a transaction between unrelated parties under no duress. The common definitions of market value usually set out the criteria for an arm’s length sale in detail (1).” On the page prior to this definition in this text, it reads, “Sales that are not arm’s length market transactions (in accordance with the definition of market value used in the appraisal) should be identified and rarely, if ever, used (1).”
In the new FHA/HUD Handbook the definition of arm’s length transaction is, “An Arm’s Length Transaction refers to a transaction between unrelated parties and meets the requirements of Market Value.” This is where the lines get blurred. Grandma can sell me her home at market value, under no duress, and it is not arms length but can be at market value. A property that sells for less than market value may occur because it is under duress, such as REO, but it is not between related parties. They can be mutually exclusive. They are not interchangeable terms.
Simple examples of a non-arm’s length transaction are buying a home from someone you have a relationship with (like a family member or a friend). More complex transactions typically involve builders, developers, “flip” transactions, properties being held in trusts or corporations and being sold to the trust or corporation owner. Other examples include real estate agents selling properties to themselves, etc. It is important to examine the relationship of the buyers and sellers to determine whether or not the transaction is arm’s length.
A good illustration of this involved a vacant land sale in Sedona, AZ that I discovered while researching sales for a vacant land appraisal. The sales price was $800,000 in a market of typically $200,000 properties. To add to the complexity of that sales price, the property backed to a highway and medical center, which would typically adversely impact market value, not add to it. Turns out the developer sold the lot to himself to create comparable sales.
To complicate matters, some State assessor’s offices list REO transactions as “non arms length” when they simply should be listed as REO. There are other influences on value aside from being between related parties.
This article is relatively short on a topic that can be written about at length (no pun intended). There is a lot more that can be said about arm’s length transactions but hopefully this has cleared up some of the ambiguity. I invite any constructive comments and feedback. As appraisal professionals, we all need to continue to evolve, grow and learn from one another in a positive arena.
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