Why Identifying Arm’s Length Transactions Matters
To many the term “arm’s length transaction” might sound like jargon, but understanding this concept is critical—not just for appraisers, but for anyone buying, selling, or investing in property. To illustrate why, let me share a story from a recent appraisal.
Recently, I was appraising a home for a private sale and received a copy of the purchase contract. Based on my familiarity with the neighborhood, I realized the sale price seemed unusually low. At first glance, there was no clear sign of a relationship between the buyer and seller — different last names, no language in the contract suggesting a family or business connection. I thought, “Well, either there’s a relationship here that I can’t see, or maybe the home is in rough shape.”
When I arrived for the walk through, I quickly ruled out the second possibility. The exterior was in excellent shape: new siding, roof, and windows, with above-average landscaping. Meanwhile, the interior was extremely well-maintained, with updated flooring, fresh paint, and modern fixtures. The kitchen and bathrooms did lack modern updates (original cabinets, no dishwasher), the home’s overall condition was far better than its low sale price suggested. Luckily, the seller was home during my visit. so I quickly learned the reason for the low price: she was selling to her granddaughter.
Why Does the Appraiser Care?
At this point, you might wonder, “Who cares? Of course, a grandmother would want to help her granddaughter. Why does the appraiser need to know?” Because misclassifying this non-arm’s length transaction as a typical market sale could distort property values in the neighborhood.
The Domino Effect of Misclassified Transactions
Let’s imagine that this sale, incorrectly classified as an arm’s length transaction, becomes a comparable sale for the next property appraisal in the neighborhood:
The next month, another three-bedroom, two-bathroom ranch — similar in size and condition — goes up for sale across the street. The agents and appraiser working on that property might see the discounted sale as a perfect comparable, not realizing it wasn’t arm’s length. What about the homeowner? Well, this seller never really knew his neighbor, so he also didn't realize the relationship.
Because of this, the new property is listed and sells for less than its true market value, influenced by the lower comparable. Now, there are two artificially low sales in the area.
When a third home comes up for sale, those two discounted transactions become benchmarks, further driving down perceived property values.
Over time, this creates a downward spiral that affects the entire neighborhood, all because one non-arm’s length transaction wasn’t properly identified and reported.
So, What Defines an Arm’s Length Transaction?
The Dictionary of Real Estate defines an arm’s length transaction as:
"A transaction between unrelated parties who are each acting in his or her own best interests."
In other words, both the buyer and seller act independently, with no relationship or special circumstances influencing the sale. The price reflects the true market value of the property, determined by fair negotiation and market conditions.
Examples of Non-Arm’s Length Transactions
In the story above, the grandmother-granddaughter relationship was obvious once I learned about it. But not all non-arm’s length transactions are as easy to identify. Here are some common examples and addition to obvious familial relationships;
Close Personal Relationships: Sales involving close friends or romantic partners.
Business Ties: Sales between business partners, or companies under common ownership.
Tenant-Landlord Sales: Occasionally, landlords sell to tenants under terms that aren’t market-driven.
How Appraisers Identify Non-Arm’s Length Transactions
Appraisers take steps to uncover non-arm’s length transactions by:
Reviewing public records, MLS data, and contracts for indications of relationships.
Comparing sale prices to similar properties sold under normal conditions.
Asking questions during the property inspection, when possible, to understand the sale circumstances.
Calling any agents involved in a sale and simply asking.
If a sale is non-arm’s length, the appraiser excludes it as a direct comparable or makes adjustments to account for its unique circumstances.
Protecting Market Integrity
Understanding and identifying arm’s length transactions is essential for maintaining accurate property values. Misclassifying non-arm’s length transactions can distort market data, leading to undervaluation or overvaluation of properties, which ultimately affects homeowners, buyers, lenders, and the entire community.
If you’re buying or selling a property, be upfront about any relationships or special circumstances involved. For appraisers, this transparency helps ensure fair and accurate valuations.