Reconciliation and Final Value Opinion

Chapter: Reconciliation and Final Value Opinion

Description:

This chapter delves into the critical final stages of the real estate appraisal process: reconciliation of value indicators and the formulation of a final, well-supported value opinion. We’ll explore the scientific reasoning and judgment required to synthesize data from different valuation approaches, ultimately leading to a credible and defensible conclusion. This builds upon the foundations laid in earlier chapters concerning appraisal principles, standards, and valuation methods (cost, sales comparison, and income approaches), while addressing key aspects like data reliability, accuracy, and relevance as they contribute to the final value opinion. Understanding and properly executing reconciliation is paramount for producing appraisals that withstand scrutiny and provide a reliable basis for informed decision-making in the dynamic real estate field. We will address how economic obsolescence and highest and best use analysis inform this process. This chapter addresses how to prepare an appraisal for a review❓.

I. The Science of Reconciliation: Synthesizing Value Indicators

Reconciliation, in the context of real estate appraisal, is not merely averaging results. It’s a scientific process involving critical analysis and weighted consideration of multiple value indicators derived from different appraisal approaches. This step is crucial because real estate valuation is rarely a precise science; each approach has its strengths and weaknesses, and their applicability varies depending on the property type and market conditions.

• Definition: Reconciliation is the systematic process of critically analyzing value indications resulting from one or more appraisal approaches to arrive at a single, supportable final value opinion. This involves assessing the reliability, relevance, and accuracy of each indicator, then weighting them based on the specific characteristics of the subject property and the assignment’s context.

• Scientific Principles:

  • Statistical Inference: Reconciliation leans heavily on the principles of statistical inference. Each value indicator is viewed as a point estimate within a potential distribution of values. The reconciliation process involves considering the characteristics of these distributions (e.g., variance, sample size) to determine the most probable final value.
  • Decision Theory: appraisers❓ apply principles of decision theory, weighing the potential costs and benefits of different value conclusions. This involves assessing the risk associated with each value indicator and choosing a final value that minimizes potential errors or adverse outcomes.
  • Information Theory: The reliability and relevance of the data underlying each value indicator is assessed based on its information content. Indicators based on comprehensive, well-verified data are given greater weight than those relying on limited or less reliable information.

II. Factors Influencing Value Indicator Reliability

The reliability of a value indicator is directly proportional to the quality and quantity of data supporting it, as well as the appropriateness and accurate application of the valuation method.

• Amount of Data (Statistical Significance): A larger statistical sample, detailed data, and multiple independent sources strengthen value indicator reliability.
  • Mathematically, this can be expressed as:
    • Reliability ∝ √n, where n is the sample size (number of comparable sales, income streams, etc.). This signifies that as the sample size increases, the reliability increases, albeit at a decreasing rate.
• Accuracy of Data: Data verification is crucial. Unverified data introduces uncertainty, reducing reliability. Data accuracy is dependent on the appropriateness of the technique used to derive the indicator from the data.
• Relevance of the Value Indicator: This is the most important factor. The indicator must align with the appraisal assignment’s terms and be derived using an appropriate valuation technique for the specific property type.
  • For example, using the Income Capitalization Approach❓❓ for a non-income-producing property (vacant land or a typical single-family residence) would yield a less relevant (and potentially misleading) value indicator.

III. Value Indicators: Weighting and Prioritization

The reconciliation process culminates in assigning weights to the different value indicators, reflecting their relative reliability and relevance. This process is subjective but must be supported by clear reasoning and market evidence.

• sales comparison approach❓❓: Generally receives significant weight for properties where comparable sales data is abundant and market conditions are stable. The reliability of this approach depends on the number of adjustments made to comparable sales prices and the verifiability of the sales data. The less the adjustments are to the comparable sales price, the more weight the comparable should be given.
• Cost Approach: More reliable for new or unique properties where comparable sales are limited. However, accurately estimating depreciation is challenging, introducing a potential source of error.
• Income Capitalization Approach: Crucial for income-producing properties, providing a direct measure of investment value. The reliability of this approach depends on the accuracy of income and expense projections, as well as the appropriateness of the capitalization rate.

IV. Mathematical Considerations and Limitations

While reconciliation relies heavily on judgment, mathematical principles offer a framework for evaluating the reasonableness of value indicators.

• Weighted Average: A weighted average can be used as a tool in analyzing value indicators, not as a determination of a final value. The appraiser might develop the information into a weighted average as follows:
  Final Value = (Weight_Sales * Value_Sales) + (Weight_Cost * Value_Cost) + (Weight_Income * Value_Income)

  • Where, Weight represents the assigned weight (expressed as a decimal) for each approach.
  • Where Value represents the value determined by each approach.
  • Weight_Sales + Weight_Cost + Weight_Income = 1.0

• Range Analysis: Examining the range between the lowest and highest value indicators provides a sense of the potential variability. A wide range signals greater uncertainty and necessitates careful scrutiny of the underlying data.

• Sensitivity Analysis: This involves assessing how changes in key assumptions (e.g., discount rate, growth rate) affect the value indicators. High sensitivity indicates greater risk and potential for error.
• Consider these elements when weighting the indicators:
  • Market Data
  • Number of Adjustments
  • Comparability

V. Practical Application: Reconciliation Experiments

To illustrate the reconciliation process, consider the following scenarios:

• Scenario 1: Single-Family Home Appraisal

  • Sales Comparison Approach: Indicates a value of $450,000 based on five recent comparable sales.
  • Cost Approach: Indicates a value of $425,000, primarily due to estimated depreciation.
  • Income Approach: Indicates a value of $400,000, based on comparable rent for similar houses.
    • Reconciliation: Since comparable sales data is plentiful and reflects current market conditions, the Sales Comparison Approach is given the most weight (70%). The Cost Approach is given secondary weight (20%) because it offers a cost-basis perspective, even though depreciation estimates may be uncertain. The Income Approach, while providing valuable supplementary information, carries less weight (10%) because the subject property is owner-occupied and does not directly generate income.

• Scenario 2: Commercial Building Appraisal

  • Sales Comparison Approach: Indicates a value of $1,000,000 based on three comparable sales with significant adjustments for location and size.
  • Cost Approach: Indicates a value of $950,000.
  • Income Capitalization Approach: Indicates a value of $1,100,000 based on stabilized net operating income and a market-derived capitalization rate.
    • Reconciliation: In this case, the Income Capitalization Approach would likely receive the most weight (60%) because it directly reflects the property’s income-generating capacity. The Sales Comparison Approach (30%) is considered but given less weight due to the substantial adjustments required. The Cost Approach (10%) is least relevant due to the uncertainty of depreciation and economic obsolescence.

VI. Completing the Uniform Residential Appraisal Report’s Reconciliation Section and Ensuring the Appraisal Can Withstand a Review

The URAR requires the appraiser to explicitly state if the appraisal is “as is” or subject to specific conditions. Conditioning factors are listed and the purposes for any of the appraisal approaches that were used are reaffirmed. Most critically, the opinion of market value is stated as a point estimate. This is the “reconciled value” and must be justified within the context of the appraisal.

• “As Is” vs. “Subject To”:
  • As Is: The appraiser gives an opinion of value on the property “as is” on the effective date of the appraisal.
  • Subject To: An appraiser gives an opinion of value as if all assumptions are accurate on the effective date of the appraisal.
  • If the appraisal was made “subject to”, what did the appraiser condition the appraisal on?
• Review of Work:
  • The appraisal must be coherent and understandable. The explanation of the reconciliation has to be logical and flow from the value indicators.
  • The description needs to include all factors used to support the reconciliation such as the data, procedures, and reasoning for all decisions.
  • The appraisal has to have all computational errors corrected.

VII. Appraiser’s Competency and Potential for a Critical Review

The Competency Rule dictates that appraisers only accept assignments for which they possess the necessary knowledge and experience. A review appraiser, when scrutinizing an appraisal, will critically assess the appraiser’s adherence to this rule. The reviewer will look for indications of incompetence, such as:

• Lack of relevant market knowledge: The appraiser demonstrates a poor understanding of local market conditions, trends, or property characteristics.
• Inappropriate valuation methods: Using valuation techniques that are unsuitable for the property type or assignment (e.g., applying the cost approach to a highly speculative investment property).
• Insufficient data verification: Failing to adequately verify data sources or neglecting to identify potential errors or inconsistencies.
• Inadequate reasoning or support: Drawing conclusions that are not logically supported by the data and analysis presented in the appraisal report.

VIII. Conclusion

Reconciliation is a cornerstone of sound real estate appraisal practice. It blends scientific reasoning, statistical analysis, and sound judgment to arrive at a credible and well-supported value opinion. By mastering the principles and techniques outlined in this chapter, appraisers can enhance the reliability and defensibility of their appraisals, building trust with clients and contributing to informed decision-making in the real estate field.