Understanding Reconciliation in Real Estate Appraisal

Chapter: Understanding Reconciliation in Real Estate Appraisal

Introduction

This chapter will delve into the critical process of reconciliation in real estate appraisal, aligning with the objectives of this “Mastering Real Estate Appraisal: Regulations & Standards” course. As aspiring appraisal professionals, you must master the art of integrating data from multiple sources and methodologies to arrive at a credible and defensible❓ final value opinion❓❓. This is particularly crucial in the context of ever-evolving regulations, such as those imposed by FIRREA, Fannie Mae, and Freddie Mac. We will examine reconciliation from a scientific❓ standpoint, focusing on logical reasoning, data analysis, and the critical role of appraiser judgment, and related to the course description and book content.

I. The Essence of Reconciliation

Reconciliation is not a mere mathematical exercise; it is a critical analysis and judgment process. It is the step in the appraisal process where the appraiser weighs the reliability and relevance of various value indicators derived from the Sales Comparison, Cost, and Income approaches (if applicable), ultimately forming a single, supported opinion of value.

• Definition: Reconciliation is the process of critically examining and weighing the value indications derived from different appraisal approaches and data sources to arrive at a final, supported opinion of value.

• The Course Context: In line with FIRREA and agency guidelines, reconciliation is not just about finding a number, but about justifying that number. A robust reconciliation demonstrates compliance and builds trust in the appraisal’s conclusions.

• Relevance to Book Content: As our book points out, reconciliation begins with a thorough review of all data, calculations, and reasoning supporting the different value indicators. It emphasizes the unreliability of averaging approaches, and the importance of appraiser judgment.

II. Scientific Theories and Principles Underlying Reconciliation

Reconciliation draws on principles from statistics, decision theory, and economics:

• A. Statistical Weighting: While averaging is discouraged, the concept of weighting remains crucial. This aligns with statistical principles where data points are weighted based on their reliability and relevance. In statistics, the weighted average❓❓❓❓ (Σwi*xi) / Σwi gives more influence to data with higher weights (wi). In appraisal, weights aren’t assigned numerically, but through carefully considered judgment.

• B. Decision Theory: Reconciliation involves making choices under uncertainty. Appraisers must consider the potential for errors in each value indicator and make decisions that minimize the risk of a flawed final opinion of value.

• C. Economic Principles: The principle of substitution is fundamental. The final value opinion should reflect the price a prudent buyer would pay, considering the availability of comparable properties and alternative investment opportunities.

• D. Principle of Consistent Use: Each approach must consider the property’s highest and best use. If approaches lead to different use scenarios, reconciliation becomes more complex.

III. Factors Influencing the Reliability of Value Indicators

The reliability of a value indicator is paramount in reconciliation. As stated in our book, reliability depends on the amount of data, its accuracy, and its relevance to the appraisal problem.

• A. Amount of Data: Value indicators based on larger, more detailed statistical samples, and supported by multiple independent sources are generally more reliable.

  1. Statistical Significance: A larger sample size in comparable sales analysis enhances statistical significance, reducing the risk of basing conclusions on outliers.
  2. Data Diversity: Drawing data from diverse, independent sources minimizes bias and strengthens the validity of conclusions.

• B. Accuracy of Data: A value indicator’s accuracy hinges on the reliability of its supporting data and the chosen technique’s precision.

  1. Verification is Key: Rigorous data verification is crucial.
  2. Technique Relevance: The chosen technique must be appropriate for the specific appraisal problem and property type.

• C. Relevance to Appraisal Problem: The indicator must align with the assignment’s terms and the chosen technique must suit the property and market.

  1. Appropriateness: Appraisal techniques must be suitable for the specific property type. For instance, the income capitalization approach is less applicable to single-family residences unless they are being rented.

IV. Practical Applications and Experiments

• A. Experiment: Analyzing Comparable Sales

  1. Objective: To determine the relative reliability of different comparable sales.
  2. Procedure: Gather data on five comparable sales. Assess each comparable based on:
     • Proximity to the subject property
     • Similarity in size, age, and features
     • Date of sale (adjustments for market conditions)
     • Verification of sales data
     • Financing concessions.
  3. Analysis: Rank each comparable based on these criteria. The comparable with the highest ranking should receive the most weight in the reconciliation process. This exercise demonstrates how qualitative judgment translates to quantitative impact.

• B. Case Study: Reconciling Conflicting Value Indicators

  1. Scenario: An appraisal of a single-family home yields the following value indicators:
     • Sales Comparison Approach: $350,000
     • Cost Approach: $375,000
     • Income Approach (based on market rents): $325,000
  2. Reconciliation:
     • Review each approach’s data. Suppose the income approach relies on limited rental data and the cost approach has high depreciation estimates.
     • Sales Comparison Approach might be deemed the most reliable due to robust comparable sales data.
     • The final value opinion might be $350,000, with an explanation of why more weight was given to the Sales Comparison Approach.

• C. Mathematical Applications: While direct averaging is discouraged, understanding mathematical concepts informs the reconciliation process.

  Example: Imagine two value indications: \$400,000 (from Sales Comparison Approach) and \$420,000 (from Cost Approach). You assign a “confidence factor,” CF, to each reflecting its reliability: CF1 = 0.8 (Sales Comparison) and CF2 = 0.6 (Cost). The weighted value is calculated as:
  Value = (CF1 * Value1 + CF2 * Value2) / (CF1 + CF2)
  Value = (0.8 * \$400,000 + 0.6 * \$420,000) / (0.8 + 0.6)
  Value = \$408,571. Although not directly used as the final answer, this process helps visualize the impact of greater confidence in one approach versus another.

V. Reconciliation and Regulatory Compliance

The reconciliation process must clearly demonstrate compliance with appraisal regulations and guidelines.

• A. FIRREA Compliance: The reconciliation must show the appraiser considered all relevant data and used appropriate methodologies per FIRREA standards.
• B. Fannie Mae/Freddie Mac Guidelines: The appraisal report must adhere to specific reporting requirements and must provide supporting data for all adjustments.
• C. USPAP Compliance: USPAP requires the appraiser to analyze and reconcile the different approaches to value, and to adequately explain the reasons for the final value opinion. Failure to do so can result in a violation of USPAP.

VI. Common Pitfalls in Reconciliation

• Averaging without Analysis: Simply averaging value indicators without critical evaluation❓❓ is unacceptable and can lead to misleading results.
• Insufficient Justification: Failing to adequately explain the rationale for the final value opinion can undermine the credibility of the appraisal.
• Ignoring Relevant Data: Overlooking or dismissing pertinent information that contradicts the desired value opinion can lead to bias and ethical violations.
• Lack of Objectivity: As our book content emphasizes, failure to act as a disinterested third party can invalidate the entire appraisal process.

VII. Reconciliation Section in Appraisal Report

The Reconciliation Section of the URAR form must summarize the approaches used and how their values were combined to form an opinion. The book content mentions reaffirming the appraisal’s purpose. The appraiser must indicate if the appraisal was made “as is,” “subject to repairs,” or “subject to hypothetical conditions” along with effective dates.

Conclusion

Understanding reconciliation is a crucial skill for real estate appraisers. By applying statistical principles, sound judgment, and regulatory compliance, you can ensure that your final value opinions are credible, defensible, and aligned with the standards of the appraisal profession.