As a real estate appraiser, understanding whether a transaction is an arm’s length sale or a non-arm’s length sale is crucial. Therefore, when evaluating the current terms of a sale or analyzing past sales of the subject property or comparables, it’s essential to consider the nature of the sale to ensure a credible appraisal.
Before examining the conditions that define an arm’s-length transaction, let’s review some key definitions and address common questions such as, “What does arm’s length mean in real estate?” and “What’s the difference between an arm’s length and a non-arm’s length sale?”
What does an arm’s length sale mean in real estate?
An arm’s length sale is a transaction between unrelated parties, where each party acts independently and in their own best interests. For example, an individual selling their home to a buyer to whom there is no business or personal relationship nor obligation in place would be an arm’s length transaction.
What does a non-arm’s length sale mean in real estate?
A non-arm’s length sale is a transaction between parties who have a personal or professional connection, such as family, marriage, or work relationships. Due to their relationship, the parties might not act in their own best interests, which can result in a final sale price that does not reflect the property’s true market value.
What is market value?
Market value is generally defined as the most probable price a property should bring in a competitive and open marketplace, as of a specified date, in cash or its equivalent. This requires an arm’s length transaction, where both parties act in their own best interests, without undue haste or duress. Additionally, it requires that both buyer and seller are reasonably informed about the property and the market, and that the property has been exposed to the market for a reasonable period of time.
What are the typical conditions of an arm’s length transaction?
Non-arm’s length transactions extend beyond the relationship between the buyer and seller; additional conditions must be considered to determine whether a transaction qualifies as an arm’s length transaction.
Typical terms and financing
In an arm’s length transaction, the sale terms and financing reflect typical market conditions, without any special arrangements or atypical terms.
Example of a non-arm’s length transaction: A small business owner sells his house to his long-term partner with highly favorable financing terms that are not available in the market, by providing a 40 year, zero-interest loan.
No unusual concessions
In an arm’s length transaction, no party makes unusual concessions that wouldn’t be made under normal market conditions.
Example of a non-arm’s length transaction: An employer sells a property to an employee and agrees to pay 80% of the down payment for a mortgage loan, all the closing costs, the transfer tax, and any and all repairs up to $50,000 in the first 5 years of home ownership.
Parties are not related
In an arm’s length transaction, the buyer and seller do not have any personal or business relationships that could influence the transaction.
Example of a non-arm’s length transaction: A property is sold between siblings, which might involve a discounted price or other favorable terms not reflective of the market.
Parties are acting in their own best interest
In an arm’s length transaction, both the buyer and the seller are independently seeking the best possible outcome for themselves.
Example of a non-arm’s length transaction: A friend sells a property to another friend at a price below market value, despite having higher offers from other buyers, prioritizing the friend’s benefit over personal financial gain.
Parties are not under undue haste or duress
In an arm’s length transaction, neither party is under pressure to complete the sale quickly or under duress, which could affect the sale price.
Example of a non-arm’s length transaction: A homeowner facing foreclosure sells their house quickly and significantly below market value to avoid foreclosure proceedings.
Parties are reasonably informed and knowledgeable
In an arm’s length transaction, both parties have sufficient knowledge about the property and the market conditions.
Example of a non-arm’s length transaction: An elderly couple sells their property to their next-door neighbor without fully understanding its market value, relying solely on the neighbor’s offer.
Property has been exposed, typically, for a reasonable period of time
In an arm’s length transaction, the property has been listed on the open market for a sufficient period, allowing for a fair assessment of market interest and conditions.
Example of a non-arm’s length transaction: A homeowner sells their property directly to a friend without listing it on the market, preventing it from being exposed to market dynamics and competitive offers.
In market value appraisals, the appraiser must analyze comparable sales to determine if they are arm’s length transactions. Using non-arm’s length sales without proper adjustments can compromise the analysis and affect the credibility of the market value opinion.
Learn techniques for analyzing arm’s length sales and more
Learn helpful techniques for analyzing real estate transactions, choosing comparable sales, and more with McKissock’s appraisal CE courses. To learn about the different types of sales, consider these continuing education courses:
- Appraisal of REO and Foreclosure Properties
- Divorce and Estate Appraisals: Elements of Non-Lender Work
- Relocation Appraisal and the ERC Form
With our Unlimited CE Membership, you’ll get full access to our entire course catalog, including the 7-hour National USPAP Update and our entire Learning Library for one low price!
Reference
- The Appraisal Institute, The Dictionary of Real Estate Appraisal, 6th. Ed.
