Introduction to Appraisal Reconciliation

Introduction to Appraisal Reconciliation

I. Introduction

This chapter introduces the crucial step in the real estate appraisal process known as reconciliation. Reconciliation is not merely averaging different value indicators, but rather a critical analysis and synthesis of the data and methodologies employed to arrive at a single, supportable opinion of value. This chapter will delve into the scientific underpinnings of this process, emphasizing the appraiser’s judgment, experience, and the reliability of each value indicator.

II. Definition and Purpose of Reconciliation

• Definition: Reconciliation is the process of critically analyzing and weighing the results derived from two or more appraisal approaches (e.g., sales comparison, cost, and income), or from different data points within the same approach, to arrive at a single, supportable value opinion or range. It is the final step of the valuation process and is where the appraiser synthesizes their findings.

• Purpose: The primary purpose of reconciliation is to ensure that the final value opinion is credible, defensible, and reflective of the most pertinent and reliable data available. It acknowledges that each appraisal approach has strengths and weaknesses, and that the market rarely provides perfectly comparable data.

III. Principles of Appraisal Reconciliation

• Not Averaging: Reconciliation is not a mathematical averaging of the value indications derived from different approaches. Averaging implies that each approach is equally reliable, which is rarely the case.
• Weighting: Instead, the appraiser assigns weights to each value indicator based on its relevance, accuracy, and the amount of supporting data. This weighting reflects the appraiser’s judgment and experience.

IV. Factors Influencing the Reliability of Value Indicators

The reliability of a value indicator is not absolute but relative, depending on several key factors:

• A. Amount of Data: A value indicator based on a larger and more detailed statistical sampling is generally considered more reliable.

  1. Statistical Significance: Value indicators are stronger when derived from a statistically significant dataset. Statistical significance can be determined using methods like t-tests or confidence intervals on datasets such as sale prices.
  2. Data Independence: multiple independent sources❓❓ corroborating the same value strengthens the reliability of the indicator.

• B. Accuracy of Data and Techniques: The accuracy of the supporting data and the appropriateness of the chosen appraisal technique significantly impact the reliability of the value indicator.

  1. Data Verification: Thorough verification of data sources (e.g., confirming sales data with both buyer and seller) enhances its accuracy.
  2. Technique Relevance: The appraisal technique must align with the specific property type and market conditions. For instance, the income capitalization approach is more relevant for income-producing properties.

• C. Relevance to the Appraisal Problem: The relevance of a value indicator is determined by its consistency with the appraisal assignment❓ and its appropriateness for the subject property.

  1. Assignment Terms: The indicator must adhere to the appraisal’s defined purpose, intended use, and any specific legal or regulatory requirements.
  2. Appropriate Technique: The appraisal technique must suit the property type and available data.

V. Steps in the Reconciliation Process

• A. Review and Verification:

  1. Data Accuracy: Scrutinize all data for errors and inconsistencies. Mathematical formulas and calculations should be checked.
     Example: Ensure that all adjustments made in the sales comparison approach are correctly calculated and supported by market data.

  2. Technique Consistency: Ensure consistent application of appraisal techniques across the subject property and comparable properties.
     Example: If using the cost approach, verify that depreciation is estimated using a consistent methodology for all properties.

• B. Assessing Reliability:

  1. Data Sufficiency: Evaluate whether each value indicator is supported by an adequate amount of data. The more supporting data, the higher the weight.
     Example: If the sales comparison approach is based on only one comparable, while the cost approach is supported by detailed cost data and market-derived depreciation rates, the cost approach may receive higher weight.

  2. Data Accuracy: Consider the accuracy and reliability of the data used in each approach.
     Example: If sales data is unverified or comes from unreliable sources, the sales comparison approach may receive lower weight.

  3. Relevance: Assess how relevant each approach is to the specific appraisal problem.
     Example: The income approach should be given greater weight in the valuation of income-producing properties.

• C. Assigning Weights:

  1. Assigning appropriate weights to each value indicator is key. If ‘X’, ‘Y’ and ‘Z’ are value indicators (Sales comparison, Cost, Income approach respectively), their weights ‘Wx’, ‘Wy’, ‘Wz’, can be assigned such that Wx + Wy + Wz = 1. The final reconciled value ‘V’ can then be expressed as V = Wx * X + Wy * Y + Wz * Z. The weights are determined by the appraiser’s assessment of each approach’s reliability, accuracy, and relevance.
     Example: If comparable sales are abundant and highly similar to the subject, the sales comparison approach may receive a weight of 0.6, while the cost and income approaches receive 0.2 each. This can be formalized in a weighted average formula.

• D. Developing the Final Value Opinion:

  1. Based on the assigned weights, formulate a single point estimate or a narrow value range. The value opinion should align with the approach that best reflects the market behavior and the property’s characteristics.
     Example: If the weighted average yields a value of $500,000, and the appraiser believes the sales comparison approach is most reflective of the market, the final value opinion may be stated as $500,000.

• E. Supporting the Value Opinion:

  1. The final value opinion must be supported by evidence and analysis from the appraisal process. This should be clearly articulated in the appraisal report.
     Example: Explicitly state why the sales comparison approach was given the most weight and how this decision reflects market dynamics and property characteristics.

VI. Mathematical Representation of Reconciliation (Weighted Average Method)

To illustrate the weighting process, we can use a simple weighted average formula:

• V = (W₁ * V₁) + (W₂ * V₂) + (W₃ * V₃)

Where:

• V = Reconciled Value
• W₁, W₂, W₃ = Weights assigned to each approach (summing to 1)
• V₁, V₂, V₃ = Value indicators from each approach (Sales Comparison, Cost, Income)

VII. Practical Examples

• Example 1: Single-Family Residence:

  • Value Indicators: Sales Comparison ($400,000), Cost ($420,000), Income (Not Applicable)
  • Reconciliation: Sales Comparison is given a weight of 0.7 due to strong market activity; Cost is given a weight of 0.3 to account for physical attributes.
  • Reconciled Value: (0.7 * $400,000) + (0.3 * $420,000) = $406,000

• Example 2: Income-Producing Property:

  • Value Indicators: Sales Comparison ($800,000), Cost ($850,000), Income ($900,000)
  • Reconciliation: Income is given a weight of 0.6 due to the property’s primary function; Sales Comparison is given a weight of 0.3; Cost is given a weight of 0.1.
  • Reconciled Value: (0.3 * $800,000) + (0.1 * $850,000) + (0.6 * $900,000) = $850,000

VIII. Errors to Avoid in Reconciliation

• Averaging Without Justification:

  • Failing to justify the equal weighting of value indicators, resulting in an arbitrary final value.

• Ignoring Market Signals:

  • Disregarding strong market trends or specific property characteristics that significantly influence value.

• Inadequate Support:

  • Providing insufficient evidence or reasoning for the chosen value opinion, making the appraisal less credible.

IX. Reconciliation Section of Appraisal Reports

• The reconciliation section of an appraisal report should clearly state which approach(es) was given the most weight and provide a detailed explanation for this decision. It should also acknowledge any limitations or uncertainties associated with each approach. This section should justify the final value opinion and be easily understandable to a non-appraiser.

X. Conclusion

Appraisal reconciliation is a critical process that requires the appraiser’s expertise, judgment, and thorough understanding of market dynamics. It is not a mere mathematical exercise but a reasoned synthesis of value indicators to arrive at a credible and supportable value opinion. By carefully considering the reliability and relevance of each approach, appraisers can ensure that their final value opinion reflects the true market value of the property.