Reconciliation and Final Value Opinion

Chapter: Reconciliation and final value opinion❓❓

Introduction

This chapter delves into the critical stage of the cost approach: reconciliation and the formation of a final value opinion. As highlighted in the course description (“Mastering the Cost Approach to Value”), this step requires a comprehensive understanding of cost estimation, depreciation, and their application in real estate appraisal. This chapter connects directly to the course description by equipping participants with the skills necessary to synthesize the data and analyses developed throughout the cost approach, leading to a defensible and well-supported final value estimate. This process is essential for making informed investment decisions and gaining a competitive edge in the appraisal industry. The final value opinion will be a “Point Estimate”, or, in certain situations, a “Range Value.”

I. Understanding Reconciliation

A. Definition and Purpose

Reconciliation is the process of analyzing the value indicators derived from different methods (in this case, primarily within the cost approach, but also potentially in relation to other approaches such as the Sales Comparison or Income Approach if used) to arrive at a single, supportable value opinion. It is not a mathematical averaging of these indicators. Instead, it involves a critical assessment of the reliability and relevance of each indicator to the specific appraisal problem, leading to a weighted conclusion.

B. Scientific Basis and Theories

The reconciliation process is grounded in the principles of statistical analysis and decision theory.

1. Statistical Significance: The reliability of a value indicator is directly related to the amount and quality of data supporting it. This echoes the principles of statistical inference, where larger sample sizes and reduced standard deviations lead to more reliable estimates of population parameters.

2. Decision Theory: The weighting of different value indicators involves assigning probabilities to their accuracy and relevance. Decision theory provides a framework for making rational choices under uncertainty, where the appraiser must balance the potential risks and rewards associated with each indicator.

C. The Reconciliation Process: A Step-by-Step Approach

1. Reviewing Data and Calculations: The appraiser must meticulously review all data, calculations, and reasoning that led to the different value indicators within the cost approach (e.g., different depreciation estimates, various cost manuals). This includes checking for:

   • Accuracy of Calculations: This is a fundamental step. All calculations must be verified. If errors are found, they must be corrected.

     • Example: Double-check that accumulated depreciation is calculated correctly, considering both straight-line and observed conditions methods.

   • Consistency in Application: Cost estimation, depreciation analysis, and other techniques must be applied consistently to the subject property. Any deviations must be justified and documented.

     • Example: If using different depreciation rates for different components of the building, ensure there is a clear rationale based on observed condition and remaining useful life for each component.

   • Inclusion and Analysis of Pertinent Data: Ensure all relevant data has been considered and adequately analyzed. No data should be omitted that could significantly influence the value opinion.

     • Example: If the subject property has undergone significant renovations, these costs must be factored into the cost estimation and depreciation analysis.

   • Compliance with Assignment Terms: The value indicators must be derived in accordance with the terms of the appraisal assignment, including the definition of value, intended use, and any specific client requirements.

     • Example: If the assignment requires an estimate of market value, the reconciliation process must prioritize indicators that reflect market conditions and investor behavior.

2. Assessing Reliability of Value Indicators: The reliability of a value indicator depends on the amount of data, the level of accuracy, and its relevance to the appraisal problem.

   • Amount of Data: More data generally leads to a more reliable value indicator. This can manifest in different ways:

     • Larger statistical sampling of data.
       • Example: When estimating depreciation using the observed condition method, a more thorough inspection of all building components will lead to a more reliable estimate.
     • More detailed data.
       • Example: When using the quantity survey method for cost estimation, detailed material and labor cost data will yield a more accurate result than relying on broad averages.
     • Support from several independent sources.
       • Example: If using multiple cost estimating manuals, comparing their results can increase confidence in the final cost estimate.

   • Accuracy of the Data: The accuracy of a value indicator depends on the accuracy of the supporting data and the accuracy of the technique used to derive the indicator from the data.

     • Data Verification: The more thoroughly the data has been verified, the more reliable it is.
       • Example: When verifying the cost of recent renovations, obtaining invoices and contractor estimates is more reliable than relying solely on the owner’s recollection.

     • Technique Relevance: The relevance of the appraisal technique to the problem affects the accuracy of the result.

       • Example: The cost approach may be more reliable for new or recently renovated properties where depreciation is minimal, but less reliable for older properties with significant physical deterioration and functional obsolescence.

   • Relevance to the Appraisal Problem:

     • Consistency with Assignment Terms: the indicator itself must be consistent with the terms of the appraisal assignment.

     • Appropriateness of the Appraisal Technique: The appraisal technique used to derive the indicator must be appropriate for the appraisal problem.

3. Final Weighing and Selection: Select a Reconciled Value Supported by the Evidence in the Appraisal. The appraiser’s judgment is the determining factor.

D. Mathematical Considerations

While reconciliation is not a purely mathematical process, quantitative analysis can inform the appraiser’s judgment. Here are some relevant equations:

1. Weighted Average (Illustrative):
   While not a direct replacement for appraiser judgment, it can illustrate the impact of different weights.

   Value = (Weight_1 * Value_1) + (Weight_2 * Value_2) + ... + (Weight_n * Value_n)

   Where:

   • Value is the reconciled value.
   • Weight_i is the weight assigned to the i-th value indicator. (0 ≤ Weight_i ≤ 1, and the sum of all weights equals 1)
   • Value_i is the i-th value indicator.

   Example: Cost Approach, considering Replacement cost of $500,000, weighed at 60% and Depreciated value of the property according to appraiser experience at $400,000 weighed at 40%

   Value = (0.60 * $500,000) + (0.40 * $400,000) = $300,000 + $160,000 = $460,000

E. Practical Application and Experiment

Experiment:

Conduct a simulated appraisal of a subject property. Using different cost manuals and depreciation estimation methods, derive multiple value indicators. Then, using the principles outlined above, reconcile these indicators to arrive at a final value opinion. Document the rationale for weighting each indicator and the impact of these decisions on the final result. This experiment allows you to better understand how you apply the steps.

II. Reaching the Final Value Opinion

A. Reviewing the Entire Appraisal

The process of reaching a final value opinion is essentially the same as the reconciliation process. This step involves reviewing all data, calculations, and reasoning contained in the entire appraisal, not just the cost approach section. The appraiser is looking for internal consistency, logical flow, and a well-supported conclusion.

• The appraiser reviews all data, calculations, and reasoning contained in the entire appraisal.
• The reliability of each value indicator is assessed.
• Additional data is collected and additional analysis is performed as necessary.

B. Completing the Uniform Residential Appraisal Report (URAR)

The URAR’s Reconciliation section requires the appraiser to:

• Indicate if the appraisal was made “as is” or “subject to” the property being altered.
• List any conditioning factors.
• List any appraisal approaches used.
• Reaffirm the purpose of the appraisal.
• Set forth the opinion of market value and sign and date the appraisal report, including his or her appraisal license or certification number.

C. Point Estimate vs. Range Value

• A final value opinion is stated as a single dollar amount, known as a “Point Estimate.”

• Alternatively, 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 for simplicity and clarity.

D. Clarity and Understandability

An appraiser should review his or her work to ensure that it is easily understandable to a non-appraiser reader. The appraisal report should be clear, concise, and free of jargon.

III. Common Challenges and Considerations

• Subjectivity: Reconciliation inherently involves subjective judgment. The appraiser must be aware of their own biases and strive for objectivity. Robust documentation is key.

• Market Volatility: In rapidly changing markets, data can become outdated quickly. appraisers❓❓ need to be particularly careful about the relevance and timeliness of the data used.

• Complexity: Complex properties or appraisal assignments may require more sophisticated reconciliation techniques and a deeper understanding of the underlying market dynamics.

IV. Critical Review and the “Muster Test”

The book content states: “Will the work pass muster in a critical review? If it won’t, don’t send it!”

A. Acting as a Review Appraiser

Constantly challenge your own findings as if you were a review appraiser looking for flaws in the reasoning and conclusions. This includes:

• Data Verification: Have all data sources been properly verified?

• Consistency: Is the cost estimation consistent with the property’s condition and quality?

• Support: Are the adjustments to the cost estimate properly supported by market evidence?

• Rationality: Does the final value opinion make sense given the overall market conditions?

B. Defensible Value Opinion

A defensible value opinion is not necessarily the correct value, but rather one that is supported by credible data, sound reasoning, and a transparent reconciliation process. If the appraisal is well-supported, it should withstand scrutiny from a review appraiser. If an appraiser believes that their work cannot withstand such scrutiny, the appraiser should not send the work.

V. Conclusion

Reconciliation and the formation of a final value opinion are essential skills for any appraiser using the cost approach. This critical phase requires a synthesis of data, a keen understanding of appraisal principles, and sound judgment. By following a structured process, documenting all assumptions and decisions, and constantly challenging your own work, it is possible to arrive at defensible and reliable value opinions. This will allow the appraiser to successfully complete the course, “Mastering the Cost Approach to Value”, to gain a competitive edge in the appraisal industry, and make informed investment decisions.