Understanding Reconciliation in Appraisal

Chapter: Understanding Reconciliation in Appraisal

Introduction

This chapter delves into the critical process of reconciliation in appraisal, a process central to achieving credible and defensible valuations. As outlined in the “Mastering Appraisal Reconciliation and Reporting” course description, this chapter will equip you with the knowledge to analyze value❓ indicators, reconcile conflicting data, assess reliability, and ultimately, communicate your findings effectively in your appraisal reports, in alignment with USPAP standards. We will explore the theoretical underpinnings of reconciliation and its practical applications, enhancing your appraisal expertise and ensuring you deliver valuations that meet and exceed client expectations, and withstand critical review.

I. Defining Reconciliation in the Appraisal Context

Reconciliation, within the context of appraisal, is not merely averaging values, as noted in the book content. Instead, it’s a rigorous, reasoned judgment process.

• Definition: Reconciliation is the process of critically analyzing and weighing the indications of value derived from different approaches (sales comparison, cost❓, income), different comparable properties, and different units of comparison to arrive at a single, supportable opinion of value.
• Importance: Reconciliation is essential for producing a credible and defensible appraisal, especially when indicators point to divergent values. It is this step that differentiates a seasoned appraiser from a mere data collector.
• Relation to USPAP: The reconciliation process and its explanation in the report are crucial for complying with USPAP Standard 2, which requires appraisers to communicate analyses, opinions, and conclusions in a clear and non-misleading manner. As noted in the book summary, appraisals must be understandable to a non-appraiser reader.

II. The Science Behind Reconciliation: Principles and Theories

Reconciliation is informed by various appraisal principles and theories, including:

• Principle of Substitution: This principle states that a buyer will pay no more for a property than the cost of acquiring an equally desirable substitute. Reconciliation inherently involves weighing the relative desirability and comparability of various substitutes (i.e., comparables), giving more weight to those that are most similar to the subject.
• Principle of Contribution: This principle emphasizes that the value of a component is measured by its contribution to the overall value of the property. When reconciling, the appraiser implicitly assesses the contribution of factors like location, size, and condition to the final value.

• Weighted Average (Conceptual Application): While mathematical averaging is discouraged in the book summary, a weighted average provides a useful framework. Each value indicator is assigned a weight based on its reliability and relevance, impacting the final opinion of value.

  • V_final = ( w₁ * V₁) + ( w₂ * V₂) + … + ( w_n * V_n)
    Where:
    • V_final = Final reconciled value
    • V_i = Value indicator from method i
    • w_i = Weight assigned to method i (Σ w_i= 1)
  • Note: This equation is conceptual. The weights are not explicitly calculated but represent the appraiser’s judgment.
  • Decision Theory: Appraisers implicitly use elements of decision theory when reconciling. They are faced with choices under uncertainty (the true market value is unknown) and must select the opinion of value that maximizes expected utility, considering the potential for error and its consequences.

III. Factors Influencing the Reliability of Value Indicators

As the book content explains, the reliability of a value indicator is paramount. Key factors to consider include:

• Amount of Data: Value indicators based on larger statistical samples are generally more reliable.
  • A larger number of comparable sales in the sales comparison approach.
  • More detailed cost breakdown in the cost approach.
  • Multiple independent sources confirming income and expense data for the income approach.
• Accuracy of Data: Verified data leads to more accurate value indicators.
  • Verification of sales data with both buyer and seller.
  • Confirmation of cost data with local contractors.
  • Audited financial statements for income properties.
• Relevance to the Appraisal Problem: The chosen appraisal technique and data must align with the specific assignment and property type.
  • The income capitalization approach is less relevant for a typical single-family residence, as noted in book quiz question 7.
  • Using comparables with significantly different zoning regulations is less relevant.
  • Using old data is always less reliable.

IV. Practical Application and Related Experiments

The reconciliation process is best understood through practical examples and scenarios.

• Experiment 1: Varying Data Quality: Consider three comparable sales.

  • Comparable A: Verified data, recent sale, minimal adjustments needed.
  • Comparable B: Unverified data, slightly older sale, moderate adjustments.
  • Comparable C: Data from a party to the transaction, significant adjustments.
    The appraiser should assign the most weight to Comparable A, as it exhibits the highest data quality and relevance.
  • Experiment 2: Approach Weighting: A commercial property is appraised using the cost, sales comparison, and income approaches.
  • Cost Approach: Limited market data for depreciation estimates.
  • Sales Comparison: Few truly comparable sales available.
  • Income Approach: Strong market data on rental rates and expenses.
    In this scenario, the income approach should be given the most weight because the data is reliable and the approach is pertinent to a commercial property.
  • Scenario: Conflicting Value Indicators:
  • Sales Comparison Approach: V_SC = \$300,000
  • Cost Approach: V_C = \$320,000
    Possible explanations for the discrepancy:
    • Rapidly appreciating market (Sales Comparison lags behind).
    • Functional obsolescence not fully captured in the cost approach depreciation estimate.
    • Over-improvement (Cost Approach overestimates value).
      The appraiser must investigate these explanations, gather additional data if needed, and provide a clear rationale for the final reconciled value.

V. Mathematical Tools and Equations

While reconciliation is ultimately a judgmental process, certain mathematical concepts can be helpful.

• Sensitivity Analysis: This technique examines how the final value opinion❓❓ changes as key inputs (e.g., capitalization rate, adjustment amounts) are varied. This helps the appraiser understand the impact of uncertainty and make more informed judgments.

  • ΔV ≈ (∂V/ ∂x) Δx
    Where:
    • ΔV= Change in value
    • Δx= Change in input x
    • (∂V/ ∂x)= The derivative of the value with respect to input x.
  • Range Analysis: Determines the statistical mean and standard deviation from comparable properties to use as a range of most likely values to fall within.

VI. Conclusion

Understanding reconciliation is the key to producing credible, defensible, and USPAP-compliant appraisals. By thoroughly analyzing data, assessing reliability, and applying sound judgment informed by appraisal principles, you can navigate conflicting value indicators and deliver valuations that withstand critical review and meet the needs of your clients. Remember that reconciliation is not about finding the “right” answer, but about developing and clearly communicating a supportable opinion of value based on the available evidence. By mastering reconciliation, you elevate your appraisal expertise and provide a valuable service to your clients.