Reconciling Value Indicators and Final Estimation

Reconciliation of Value Indicators and Final Estimation

After applying the three real estate valuation methods (cost, sales comparison, income), three value indicators are obtained. These indicators are rarely identical, so the next crucial step is “reconciliation” between these indicators to arrive at a single final value estimate. Reconciliation is not just a mathematical process, but an Art❓❓ based on the appraiser’s experience and ability to analyze and evaluate the available data.

Concept and Importance of Reconciliation

Reconciliation is the process of analyzing the valuation problem, selecting the most appropriate method from the three methods, and giving it the greatest weight in determining the final value estimate. This process requires a deep understanding of the strengths and weaknesses of each method, as well as knowledge of the factors that affect the credibility of the data used in each method.

• Why is Reconciliation Necessary?
  • Because each valuation method relies on different assumptions and data, leading to differences in results.
  • Because reconciliation ensures that the final estimate reflects the best possible analysis of the available data.
  • Because reconciliation allows the appraiser to take into account the specific circumstances of the property and the market.

Basic Principles of Reconciliation

There is no fixed mathematical formula for the reconciliation process, but there are some basic principles that the appraiser should consider:

1. Analysis of the Valuation Problem: The appraiser must understand the purpose of the valuation, the property rights to be valued, the valuation date, and any other factors that may affect the value.
2. Evaluation of Data Reliability: The appraiser should review the sources of data used in each method and ensure their accuracy and reliability. For example, in the sales comparison approach, the validity of comparable sales data should be verified, and it should be ensured that they reflect current market conditions❓.
3. Evaluation of the Logic of the Analysis: The appraiser should review the analytical steps taken in each method and ensure that they are logical and sound. For example, in The income approach❓❓, it should be ensured that the capitalization rate used reflects the risks associated with the property.
4. Evaluation of Results: The appraiser should compare the results obtained from each method and identify the potential reasons for the differences.
5. Determining the Most Appropriate Method: The appraiser should determine which method best reflects the characteristics of the property and the market. For example, in the case of valuing a leased commercial property, the income approach may be the most appropriate.
6. Giving the Appropriate Weight to Each Method: The appraiser should give greater weight to the method that he considers the most reliable and appropriate.
7. Determining the Final Estimate: After giving the appropriate weight to each method, the appraiser should determine a single final estimate of value.

Factors Affecting the Reconciliation Process

There are many factors that the appraiser should consider when reconciling value indicators, including:

• Type of Property: The importance of each valuation method varies depending on the type of property. For example, in the case of valuing a residential home, the sales comparison approach may be the most important.
• Purpose of the Valuation: The purpose of the valuation affects the way in which value indicators are reconciled. For example, if the valuation will be used to obtain a mortgage, greater weight may be given to the sales comparison approach.
• Market Conditions: Market conditions affect the reliability of the data used in each method. For example, in a volatile market, historical sales data may be less reliable.
• Data Availability: Data availability affects the ability to apply each method effectively. For example, if sufficient data on comparable sales is not available, the cost approach may be the best option.
• Appraiser Experience: The appraiser’s experience plays a crucial role in the reconciliation process. The appraiser must have the necessary experience to evaluate the reliability of the data, the logic of the analysis, and to determine the most appropriate method.

Practical Examples

Example 1: Similar Results

Suppose an appraiser valued a residential home and obtained the following results:

• Cost Approach: 1,500,000 Saudi Riyals
• Sales Comparison Approach: 1,450,000 Saudi Riyals
• Income Approach (using Gross Rent Multiplier): 1,445,000 Saudi Riyals

Given the similarity of the results, the appraiser can conclude that the value of the property is most likely between 1,445,000 riyals and 1,500,000 riyals. In this case, the appraiser may choose to give equal weight to each method, or may give greater weight to the sales comparison approach if he considers it the most reliable in this market.

Example 2: Divergent Results

Suppose an appraiser valued a commercial property and obtained the following results:

• Cost Approach: 2,000,000 Saudi Riyals
• Sales Comparison Approach: 1,800,000 Saudi Riyals
• Income Approach (using Direct Capitalization): 1,600,000 Saudi Riyals

In this case, there is a significant discrepancy between the results. The appraiser should review the data and analyses used in each method to determine the potential reasons for the differences. The appraiser may find that the income approach is the most reliable because it best reflects the property’s ability to generate income. In this case, the appraiser may choose to give greater weight to the income approach and determine a final estimate of value close to 1,600,000 riyals.

Using Mathematical Formulas (Optional)

Although reconciliation is not a purely mathematical process, some mathematical formulas can be used to help the appraiser give the appropriate weight to each method. For example, a weighted average can be used to calculate the final estimate of value:

Final Value = (Weight of Method 1 * Value of Method 1) + (Weight of Method 2 * Value of Method 2) + (Weight of Method 3 * Value of Method 3)

Where:

• Weight of Method is the percentage that represents the importance of the method (the sum of the weights must be 100%).
• Value of Method is the value obtained using the specified method.

Example:

If the appraiser gives a weight of 50% to the income approach, 30% to the sales comparison approach, and 20% to the cost approach, the final estimate of value will be:

Final Value = (0.50 * 1,600,000) + (0.30 * 1,800,000) + (0.20 * 2,000,000) = 1,740,000 Saudi Riyals

Important Note: Weights should be determined based on a careful analysis of the data and circumstances specific to the property and the market, and not arbitrarily.

Using the Uniform Residential Appraisal Report (URAR)

The URAR form contains a section dedicated to reconciling value indicators, where the appraiser can explain the reasons why he gave greater weight to a particular method. This section helps users (such as lenders) understand how the appraiser arrived at the final estimate of value.

Conclusion

Reconciliation of value indicators is a crucial step in the real estate valuation process. Reconciliation requires experience and in-depth knowledge of valuation methods, as well as the ability to analyze and evaluate the available data. By following the basic principles of reconciliation, the appraiser can arrive at a final estimate of value that reflects the best possible analysis of the data and circumstances specific to the property and the market. The appraiser must remember that reconciliation is not just a mathematical process, but an art based on judgment and experience.