Reconciliation and Final Value Opinion

Chapter 11: Reconciliation and Final Value Opinion

I. Introduction to Reconciliation

Reconciliation is the critical process in real estate appraisal where the appraiser analyzes and weighs the value indicators derived from different appraisal approaches (sales comparison, cost, income) to arrive at a single, supportable opinion of value. It is not a simple mathematical averaging but a reasoned judgment based❓ on the reliability and relevance of each approach. This chapter delves into the scientific basis of reconciliation, exploring its principles and offering practical examples to enhance understanding.

II. Scientific Principles Underlying Reconciliation

• A. Decision Theory and Weighted Averages:

  • Reconciliation can be viewed through the lens of decision theory, where multiple sources of information (value indicators) are combined to reduce uncertainty and improve the accuracy of the final decision (value opinion).

  • A weighted average approach, not a simple average, is conceptually relevant. The formula for a weighted average is:

    • V = ∑ (wi * Vi)

      • Where:
        • V = reconciled value opinion.
        • wi = weight assigned to value indicator i.
        • Vi = value indicator i (e.g., sales comparison approach value, cost approach value).
        • ∑ denotes summation.

  • The challenge lies in determining the weights (wi), which are based on the appraiser’s professional judgment and an analysis of the reliability of each approach.

  • B. Statistical Sampling and Data Reliability:

  • The reliability of a value indicator is directly related to the quantity and quality of the data supporting it. Larger, more accurate, and relevant data samples lead to more reliable indicators.

  • Consider the standard error of estimate (SEE) as a way to quantify the precision of an appraisal approach, especially the sales comparison approach. The formula for SEE is:

    • SEE = √[∑ (ei^2) / (n - p)]

      • Where:
        • ei = the difference between the actual sales price and the predicted sales price of comparable i.
        • n = the number of comparable sales.
        • p = the number of independent variables (adjustments) in the model.
        • A lower SEE suggests a more reliable value indicator.
      • C. Regression Analysis and Adjustment Validity:

  • Regression analysis can be used to test the statistical significance and validity of adjustments made in the sales comparison approach. For instance, if the adjustment for a fireplace is not statistically significant, it should be carefully reconsidered.

  • A t-statistic can be used to assess the significance of individual adjustments. The t-statistic is calculated as:

    • t = b / SE(b)

      • Where:
        • b = the coefficient of the adjustment variable.
        • SE(b) = the standard error of the coefficient.
        • A higher absolute t-value suggests a more significant adjustment.

III. Factors Influencing the Reconciliation Process

• A. Data Quantity and Quality:

  • A larger sample size generally increases the reliability of an indicator. A value derived from ten comparable sales is statistically more robust than one derived from three.
  • Experiment: To simulate the effect of sample size, generate a dataset of 100 random property values. Calculate the mean value using subsets of 3, 5, 7, and 10 data points. Observe how the variability of the mean decreases as the sample size increases.
  • Verified data leads to more reliable value opinions. Direct verification with parties involved in the transaction adds credence.

  • B. Accuracy of Appraisal Techniques:

  • The accuracy of the sales comparison approach depends on the relevance of comparables and the validity of adjustments.

  • The accuracy of the cost approach relies on accurate cost estimates and depreciation assessments.
  • The accuracy of the income approach is sensitive to income and expense projections, as well as the capitalization rate.

  • C. Relevance to the Appraisal Problem:

  • The most relevant approach aligns with the property type and market conditions. For example, the income approach is more relevant for income-producing properties, while the sales comparison approach is more applicable for residential properties.

  • Consider the intended use of the appraisal. If the appraisal is for lending purposes, lenders might emphasize the sales comparison approach.

  • D. Appraiser Judgment and Experience:

  • Reconciliation is inherently subjective, relying on the appraiser’s knowledge, experience, and understanding of the market.

  • An appraiser’s experience with similar properties and market conditions will inform their decisions about which value indicators to give the most weight.

IV. Practical Applications and Examples

• A. Residential Appraisal Example:

  • Sales Comparison Approach: \$300,000 (based on 5 recent, similar sales, SEE = \$5,000).
  • Cost Approach: \$290,000 (based on accurate cost data and reasonable depreciation estimates).
  • Income Approach: \$280,000 (based on limited rental data and a less-reliable gross rent multiplier).
  • Reconciliation: In this case, the sales comparison approach is given the most weight due to the larger sample size and lower SEE, resulting in a final value opinion of \$300,000.

  • B. Commercial Appraisal Example:

  • Sales Comparison Approach: \$1,000,000 (based on 3 sales, significant adjustments).

  • Cost Approach: \$950,000 (difficult to estimate depreciation for an older building).
  • Income Approach: \$1,050,000 (well-supported by detailed income and expense data, and a market-derived capitalization rate).
  • Reconciliation: The income approach is given the most weight, leading to a final value opinion of \$1,050,000. The appraiser’s judgment is that the commercial property’s value is driven primarily by its income potential.

  • C. Experiment: Sensitivity Analysis of Value Indicators:

  • Create a spreadsheet model that allows you to adjust the weights assigned to each value indicator. Observe how the final value opinion changes as you vary the weights. This exercise demonstrates the impact of your judgment on the final outcome.

V. Common Mistakes and How to Avoid Them

• A. Simple Averaging: Avoid averaging the value indicators without careful consideration of their reliability. This is not reconciliation.
• B. Over-Reliance on a Single Approach: Ensure that all approaches are adequately considered, even if they are ultimately given less weight.
• C. Failure to Support Judgments: Clearly articulate the reasons for your weighting decisions in the appraisal report.
• D. Inadequate Data Verification: Always verify your data to ensure its accuracy and reliability.

VI. Uniform Residential Appraisal Report (URAR) Reconciliation Section

• The URAR requires the appraiser to summarize the results of the sales comparison, cost, and income approaches (if developed).
• The appraiser must indicate if the appraisal was made “as is” or “subject to” certain conditions.
• The purpose of the appraisal must be reaffirmed.
• The appraiser must state their final opinion of market value.
• The appraiser signs, dates, and includes their license or certification number.

VII. Point Estimate vs. Range Value

• A point estimate is a single dollar amount representing the appraiser’s opinion of value.
• A range value is an appraiser’s opinion of the range in which the property’s value is most likely to fall.
• Value opinions should be rounded to reflect the level of precision inherent in the appraisal process.

VIII. Quality Control and Review

• Before finalizing the appraisal, review your work to ensure it is easily understandable to a non-appraiser reader.
• Consider having another appraiser review your report to identify any potential weaknesses or areas for improvement.

IX. Conclusion

Reconciliation is a critical step in the appraisal process, requiring a blend of scientific analysis and professional judgment. By understanding the principles outlined in this chapter and applying them diligently, appraisers can develop well-supported and credible value opinions.