Written By Jane Helmstadter, Andrew Jeanrie and Meg Tweedlie

In the world of real estate, it is common to use fair market value (FMV) as a way of describing the value of real estate or rents payable. However, perhaps not often considered is the issue that the term FMV can mean different things to different people. For some, FMV may be the price that someone would be willing to pay for the land under its current use. For others, FMV may be the price that someone would be willing to pay for that same land under its highest and best use, such as for redevelopment purposes. Alternatively, for certain unique assets, FMV may have other meanings, such as replacement value. For example, if land is to be sold to a neighbour as part of a land assembly and that neighbour may be willing to pay a premium to get the land, is that premium then part of the determination of the FMV and should that premium be calculated with a risk premium or as of the date where the development value is secured?

This all begs the question—which approach is correct? 

By default, an appraiser would look to the Canadian Uniform Standards of Professional Appraisal Practice (CUSPAP). Under CUSPAP, FMV means: "the most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale, with the buyer and the seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress."¹

In other words, an appraisal of FMV should, as a starting point, be based on the assumption of highest and best use of the property. From this starting point, the appraisal would then take into account the time and risk that goes along with the entitlements process required to achieve the highest and best use (including that it might not be achieved). This is often done in conjunction with a planner who will evaluate the site in the context of provincial policy and local official plans.

While the CUSPAP definition seems clear enough, it is not the universal approach as was made clear in the recent Ontario Court of Appeal (ONCA) case of 1785192 Ontario Inc. v. Ontario H Limited Partnership (1785192 Ontario).²

1785192 Ontario Inc. and 1043303 Ontario Ltd. (collectively referred to as the Landlord) were the landlord corporations of two commercial properties in Whitby, Ontario, which were leased to Ontario H Limited Partnership (the Tenant).  The leases each contained an option for the Tenant to purchase the properties from the Landlord and included a mechanism for setting the price at which the Landlord would be required to sell. The provision stated that the purchase price would be a "purchase price equal to the average of the appraised fair market value of the Leased Premises as determined by two appraisers, one chosen by the Landlord and one chosen by the Tenant."

The Tenant ultimately exercised both options to purchase and the parties engaged appraisers as required. The Landlord obtained an appraisal from Colliers International Group Inc., valuing the properties at a collective $31,200,000 based on a highest and best use assumption, while the Tenant obtained an appraisal from Equitable Value Inc., valuing the properties at a collective $11,746,000 based on a current zoning assumption. While the parties initially disputed each other's appraisals, the Landlord ultimately accepted the Tenant's appraisal, setting the purchase price at the midpoint of the two. However, the Tenant continued to dispute the Landlord's appraisal, wiring only $11,746,000 to the Landlord's solicitor on closing, resulting in the Landlord refusing to close on the basis that the purchase price had not been paid.

At trial, the Tenant argued that the Landlord's appraisal was overpriced as it was premised on speculative and improper assumptions about how the property could be developed if rezoned. However, the application judge, relying on the CUSPAP standards, found that the leases set out a mechanism that was meant to take into account that each party may seek an appraisal using reasonable assumptions that were most favorable to that party. As such, each party was compliant with the FMV mechanism set out in the leases and each party had a valid appraisal, meaning that the purchase price for the properties was the midpoint of the two appraisals and the Landlord had rightfully refused to close on the transaction. On appeal, the ONCA agreed with the application judge finding that what constitutes a valid appraisal is a question of fact and absent a palpable and overriding error, there was no basis on which the ONCA could set that finding aside.

Takeaways

When dealing with a determination of FMV, real estate professionals should be intentional in their drafting. The definition of FMV and the mechanism used for determining the FMV must be clear. If the intention is for FMV to reflect the "as is" use of the property and the "where is" state of it, it should be drafted as such. If the intention is for FMV to reflect the highest and best use of the property, then the CUSPAP definition should be used, perhaps with any special modification applicable to the specific transaction. In addition to a clear definition, it would be prudent for practitioners to include a dispute resolution mechanism to determine FMV so as to establish a clean and efficient process to address a situation where the FMV definition fails to provide a clear answer and appraisals are vastly different. Taking these steps would allow the parties to avoid a failed transaction and potentially costly litigation as was the case in 1785192 Ontario.

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