By Seth Baker
Farmland appraisals are often misunderstood, in part because there are a lot of factors that weigh into every appraisal. And what happens when they’re misunderstood? Often, confusion. Here’s a look at five things to help you better understand farmland appraisals.
1. What is fair market value? Fannie Mae states, “Fair market value(FMV) is the most probable price that a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus.” An appraisal is the determination of that value. Emotions are often a factor in what a buyer is willing to pay, especially with farmland, and an appraisal removes that emotion.
2. Price does not equal value. Warren Buffett is quoted as saying, “Price is what you pay; value is what you get.” Why would a lender need an appraisal for a farm that was just purchased at auction? The final bid is what it’s worth, right? Not necessarily. If two neighbors battle over a tract of land at auction, the final selling price could easily exceed the fair market value. The bank needs to know what that farm is worth if that specific buyer were no longer in the market.
3. Watch the date. In an estate, the appraisal is based on the date of death of the owner. Estates can often take 12 to 18 months to settle before ownership is transferred. If the new heirs use the estate appraisal to determine a selling price, they may be basing their decision on market data that is up to 2 years old. That can be a costly mistake. During the last run-up in farmland values, using a year-old appraisal could have cost a seller 20% or more.
4. A BPO is not an appraisal. A broker’s price opinion (BPO) is not an appraisal. A broker’s role is to provide service and advice to clients to meet their selling or buying needs. Whether a landowner wants to get the best price, sell quickly or a mix of other factors, a BPO will reflect the expectations of meeting those specific goals. Using a BPO when an appraisal is required can result in trouble for the landowner. If a landowner uses a BPO for tax purposes, the IRS can penalize the taxpayer if there is an audit. If the IRS believes the BPO resulted in an underpayment of taxes due, the penalties can be significant.
5. Farm buildings are not so valuable. The buildings on farmland are likely worth less than you think. Utility does not determine value. Grain bins older than 10 years can still have good use for grain storage for years in the future, but in some markets, they will likely add little value to the overall property. Brand-new machine shed? Sorry, even new, machine sheds can lose 25% to 30% of their value as soon as they are built.
In the end, farmland appraisals play an important role in farm ownership. A good understanding of the appraisal approach can smooth the transaction associated with the required appraisal and provide peace of mind to the landowner.
Baker is a certified appraiser with First Illinois Ag Group, Decatur. He is a member of the Illinois Society of Professional Farm Managers and Rural Appraisers, whose members regularly contribute to this column. Have a farm management question or topic you’d like addressed? Email Carroll Merry at email@example.com.