Reconciliation and Final Value Opinion

Chapter 11: Reconciliation and Final Value Opinion

I. Introduction: Scientific Basis of Reconciliation

Reconciliation is a critical step in the lease valuation process, aligning with the core objective of the “Mastering Lease Valuation” course: to provide a deep dive into the essential elements that influence leasehold and leased fee interests. It is not simply averaging different value indications. Instead, it involves a scientific evaluation and weighting of different value indicator❓s to arrive at a single, supportable opinion of value. This process is underpinned by appraisal theory and principles and reflects the appraiser’s judgment and experience.

II. Principles of Reconciliation

Reconciliation can be defined as the process of analyzing and weighting value indications derived from different approaches (e.g., income capitalization, sales comparison, cost) or different sets of data within the same approach to arrive at a final value opinion.
This aligns with the book’s content where reconciliation is also considered reaching a final value opinion:

• Definition: The process of critically examining different value indications to arrive at a single, supportable conclusion.
• Purpose: To resolve differences in value indications by considering the strengths and weaknesses of each approach and data set.

III. The Reconciliation Process

Reconciliation is a multi-faceted process that requires careful consideration of various factors. It’s essential to link this section to the course DESCRIPTON of analysis of different lease types:

1. Review and Verification:
   • All data, calculations, and reasoning that led to the different value indicators are meticulously reviewed.
   • Calculations are checked for accuracy, and any errors are corrected. Example: Recalculating the present value of future rent payments to ensure accuracy.
   • The different appraisal techniques are applied consistently to the subject property and to all comparables.

2. Assessing Reliability:

   • The reliability of each value indicator is rigorously assessed.

   • Factors influencing reliability:

     Amount of data (n): The more data points available, the greater the statistical confidence in the value indicator. This relates to the principles of statistical inference.
     * Accuracy of Data (α):The extent to which the supporting data and the technique used to derive the indicator are accurate. This relates to error analysis.
     * Relevance to the Appraisal Problem (ρ): The consistency of the indicator with the terms of the appraisal assignment and the appropriateness of the technique used.

3. Weighting the Indicators:

   • Each value indicator is assigned a weight based on its reliability. This weight is not a mathematical❓ average but a reflection of the appraiser’s judgment.

   • Formula for Weighted Average Value:

     • $V = (w_1 * V_1) + (w_2 * V_2) + … + (w_n * V_n)$

     Where:
     * $V$ = reconciled value❓❓
     * $V_i$ = Value indicator i
     * $w_i$ = Weight assigned to value indicator i
     * $\sum{w_i} = 1$

   • Example: A sales comparison approach based on a large number of similar and recent transactions might be given a higher weight than an income capitalization approach❓❓ based on less reliable income data.

4. Considering Lease Terms:

   • The appraiser must review all the terms of the subject property lease to determine whether they convey an advantage to the landlord or tenant.

IV. Factors Influencing the Reliability of Value Indicators

Reliability is a key factor in reconciliation. A reliable value indicator is one that is:

1. Based on a sufficient amount of data:

   • A larger statistical sampling of data is generally more reliable.
   • Data derived from more detailed sources is preferred.

   • Support from multiple independent sources enhances reliability.

     Example: Multiple lease comparables from different brokerage houses❓❓ are more reliable than data from a single source.

2. Accurate:

   • Accuracy depends on the verification of supporting data.
   • Accuracy depends on the relevance of the appraisal technique to the problem.
     Example: The reliability of a direct capitalization approach is limited if the lease data is inaccurate.

3. Relevant:

   • The indicator must be consistent with the terms of the appraisal assignment.

   • The appraisal technique must be appropriate.

     Example: An income capitalization approach would be least relevant in an appraisal of vacant land or a single-family residence.

V. Mathematical Considerations

While reconciliation is not a mathematical average, quantitative methods and formulas can inform the weighting process.

1. Statistical Analysis:

   • Descriptive Statistics: Mean, median, mode, and standard deviation can help identify outliers and assess the variability of the data.
   • Regression Analysis: Can help quantify the relationship between different variables and predict value.

2. Sensitivity Analysis:

   • Experimenting with different assumptions and input variables to determine their impact on the final value indication.
   • Scenario Analysis: Consider best-case, worst-case, and most-likely scenarios to determine a reasonable range of values.

VI. Practical Applications and Related Experiments

1. Case Study: Lease Valuation of an Office Building

   • An appraiser uses three approaches: sales comparison, cost, and income capitalization.
   • The sales comparison approach yields a value of $1,500,000.
   • The cost approach yields a value of $1,400,000.
   • The income capitalization approach yields a value of $1,600,000.
   • The appraiser analyzes the data and determines that the income capitalization approach is the most reliable because it is based on a detailed analysis of the building’s income and expenses and the lease terms.
   • The sales comparison approach is deemed less reliable because the comparable sales are not directly comparable.
   • The cost approach is the least reliable because it is difficult to estimate depreciation.

   • The appraiser reconciles the value indicators by assigning a higher weight to the income capitalization approach.

   • $V = (0.2 * \$1,500,000) + (0.1 * \$1,400,000) + (0.7 * \$1,600,000) = \$1,570,000$
     2. Experiment: Sensitivity Analysis of Discount Rate

   • An appraiser values a leased fee interest using discounted cash flow analysis.
   • The initial discount rate is 10%.
   • The appraiser conducts a sensitivity analysis by varying the discount rate from 9% to 11%.
   • The value of the leased fee interest decreases as the discount rate increases, and vice versa. This demonstrates the sensitivity of value to discount rate assumptions.

VII. Completing the Appraisal Report: The Final Value Opinion

The appraiser completes the Uniform Residential Appraisal Report’s Reconciliation section (as mentioned in the book’s content).
* The appraiser indicates if the appraisal was made as is or is subject to the property being altered.
* Any conditioning factors are listed.
* Any appraisal approaches used are listed.
* The purpose of the appraisal is reaffirmed.
* The opinion of market value is set forth and the appraiser signs and dates the appraisal report, and includes his or her appraisal license or certification number.
* An opinion of value of an appraised property is stated as a single dollar amount known as a “Point Estimate.”
* An alternative to the Point Estimate is the “Range Value,” which is an appraiser’s opinion of the range in which the property’s value is most likely to fall.
* Value opinions should be rounded.

VIII. Review and Understandability

The appraiser should review his or her work to insure that it is easily understandable to a non-appraiser reader.
The work will be reviewed by lending institutions and potentially by external review appraisers. A well-written appraisal that is easily understood will be easier to be defended and will provide a sound basis for lending.

IX. Conclusion

Reconciliation is a crucial step in the lease valuation process. By critically evaluating and weighting different value indicators, appraisers can arrive at a supportable and reliable value opinion. This opinion is fundamental to making informed investment decisions and excelling in real estate appraisal.