Reconciliation and Final Value Opinion

Chapter 11: Reconciliation and Final Value Opinion

I. Introduction to Reconciliation

Reconciliation is the critical step in the appraisal process where the appraiser synthesizes the value indications derived from various approaches (Sales Comparison, Cost, and Income) into a single, defensible opinion of value. It’s not a simple averaging of values, but a reasoned analysis that weighs the strengths and weaknesses of each approach based on the specific characteristics of the subject property and the available data. The final value opinion should be a “point estimate,” a single dollar amount representing the appraiser’s best judgment of market value. A “range value” may be an alternative.

A. Importance of Reconciliation:

• Critical Review: The final value opinion must withstand scrutiny from review appraisers, lenders, and other interested parties. The reconciliation process must❓ be transparent and well-supported.
• Evidence-Based Opinion: The reconciled value must be logically supported by the data and analysis presented throughout the appraisal report.

II. Principles of Reconciliation

A. Reconciliation as a Judgment Process:

• Reconciliation is not a mathematical exercise. Averages or weighted averages should not be used as a substitute for informed judgment.
• The appraiser’s experience and understanding of market dynamics are essential in determining the relative reliability of each value indication.

B. Review and Verification:

• The reconciliation process begins with a thorough review of all data, calculations, and reasoning used in each appraisal approach.
• Accuracy Checks: All calculations must be rigorously checked for errors.
• Consistency: Ensure consistent application of appraisal techniques across the subject property and all comparable properties.

C. Assessing Reliability of Value Indicators:

The reliability of a value indicator is a function of:

1. Amount of Data: Value indicators based on larger, more detailed, and independently verified datasets are generally more reliable.

   • Statistical Significance: A larger sample size provides a more robust estimate of market value. For example, if we are adjusting sales prices based on square footage, the formula for statistical deviation (σ) is:

     σ = √[ Σ (xi - μ)² / N ]

     where:

     xi = each individual square footage difference
     μ = the average square footage difference
     N = the number of comparables

     A larger ‘N’ and smaller ‘σ’ indicate a more reliable adjustment.

2. Accuracy: Accuracy is dependent on the quality of supporting data and the appropriateness of the appraisal technique.

   • Data Verification: Data should be verified with reliable sources. For sales data, verification with both buyer and seller is ideal.
   • Technique Relevance: Selecting the proper appraisal technique is important. Use an appraisal technique relevant to the subject property.

3. Relevance: The value indicator must be consistent with the appraisal assignment’s terms and conditions.

   • Consistency with Assignment: For example, an income capitalization approach is less relevant when appraising vacant land intended for single-family residential development.
   • Appropriate Technique: The appraisal technique must be suitable for the property type.

III. Factors Influencing Reliability

A. Data Quantity:

1. Statistical Sampling: Larger sample sizes yield more reliable results.
2. Data Detail: More detailed data provides a clearer picture of market dynamics.
3. Independent Sources: Confirmation from multiple independent sources strengthens the validity of the data.

B. Data Accuracy:

1. Verification: Thorough verification of data enhances its reliability. Direct confirmation with parties involved in transactions is preferred.
2. Technique Suitability: Appropriateness of the applied technique influences accuracy.

C. Data Relevance:

1. Consistency with Assignment: The value indicator should align with the appraisal assignment’s objectives.
2. Technique Appropriateness: The chosen technique should be appropriate for the specific property type. An Income approach may be relevant for a shopping center, but not so much for vacant land.

IV. Mathematical Formulas and Equations

While reconciliation isn’t about averaging, quantitative methods are used within each approach and may impact the reconciliation process. Here are a few examples:

A. Discounted Cash Flow (DCF) Analysis:

The present value of a future cash flow can be determined by using a discount rate❓:

PV = CF / (1 + r)^n

Where:
PV = Present Value
CF = Cash Flow
r = discount rate
n = number of years

B. Capitalization Rate (R):

A lower ‘R’ indicates a higher value assuming constant NOI.

R = NOI / Value

C. Statistical Measures:

1. Range (R): Subtract the lowest data point (L) from the highest (H) for a simplistic expression of data variation.

   R = H - L

   This provides a sense of the data’s spread.

2. Weighted Average: If there’s a reason to weight one approach over others (e.g., a well-supported Sales Comparison in an active market):

   Weighted Average Value = (W1 * V1) + (W2 * V2) + (W3 * V3)

   Where:
   W = Weight (%)
   V = Value from Each Approach
   Note: The use of a weighted average should be justified and explained.

V. Practical Application

A. Example Scenario:

Consider an appraisal of a single-family home where:

• Sales Comparison Approach: Indicates a value of \$500,000 based on three comparable sales with adjustments for location, size, and condition.
• Cost Approach: Indicates a value of \$480,000 based on replacement cost new less depreciation, plus land value.
• Income Approach: Is not applicable given the property’s characteristics and use.

B. Reconciliation Process:

1. Review: Verify all data, calculations, and adjustments in the Sales Comparison and Cost Approaches.
2. Reliability Assessment:
   • Sales Comparison: Assess the comparability of the sales and the validity of the adjustments. Are there any atypical financing concessions or market conditions affecting the sales? The reliability of the sales comparison is high due to the active local market and thorough data collection.
   • Cost Approach: Assess the accuracy of the cost estimates and the depreciation analysis. Is the depreciation estimate supported by market evidence? The reliability is moderate due to the subjective nature of depreciation estimates.
3. Reconciliation Judgment: Weigh the reliability of each approach based on the available evidence.
   • The sales comparison approach is weighted more heavily (70%) due to the active market and strong comparability of the sales.
   • The cost approach is weighted less heavily (30%) due to the subjective nature of depreciation estimates.

C. Final Value Opinion:

Based on the reconciliation, the appraiser forms an opinion of value of $494,000. A more detailed discussion within the report will include the appraiser stating that they placed most weight on the Sales Comparison Approach because it is highly likely that the typical market participant would consider what similar properties are selling for within the market.

VI. Experiments and Data Analysis

A. Paired Sales Analysis:

1. Experiment Setup: Gather data on multiple pairs of properties that are nearly identical except for one key feature (e.g., presence or absence of a swimming pool).
2. Data Analysis: Calculate the difference in sale prices between the pairs. Statistically analyze the sale differences to determine the typical market value of the feature.
3. Application: Use the derived value to make adjustments in the Sales Comparison Approach.

B. Sensitivity Analysis:

1. Experiment Setup: Create a spreadsheet model of the Income Approach, varying key inputs such as vacancy rates, operating expenses, and capitalization rates.
2. Data Analysis: Observe how changes in the inputs affect the final value indication.
3. Application: Use the analysis to understand the sensitivity of the value indication to different market conditions and to refine the reconciliation process.

VII. Final Value Opinion

A. Point Estimate vs. Range:

• Point Estimate: The traditional format, expressing value as a single dollar amount.
• Range Value: Expressing value as a range is permissible, particularly when market data is less conclusive. Rationale must be provided to justify the range chosen.

B. Rounding:

• Round the final value opinion to a level that reflects the precision of the data and analysis. Avoid implying a level of accuracy that is not supported by the evidence.

VIII. Self-Review and Report Quality

A. Clarity and Understandability:

• Review the entire appraisal report to ensure it is easily understandable to a non-appraiser reader. Avoid jargon and explain technical concepts clearly.

B. Consistency and Logic:

• Ensure that the report presents a consistent and logical argument that supports the final value opinion.

C. Compliance:

• Verify that the report complies with all applicable standards, guidelines, and regulatory requirements.

By following a rigorous and transparent reconciliation process, the appraiser can arrive at a credible and defensible opinion of value that meets the needs of the client and stands up to scrutiny.