Final Valuation: Reconciliation and Accuracy

Chapter [Chapter Number]: Final Valuation: Reconciliation and Accuracy

This chapter focuses on the crucial final step in the appraisal process: reconciliation. It explores how appraisers synthesize the various value indications derived from the different approaches (cost, sales comparison, income capitalization) into a single, well-supported final opinion of value. Achieving accuracy through meticulous review, consistent application of principles, and informed judgment is paramount.

1. The Importance of Reconciliation

Reconciliation isn’t simply averaging the value indications. It’s a qualitative and quantitative analysis that identifies strengths and weaknesses within the appraisal, leading to a credible and defensible conclusion. This involves:

• Identifying Potential Flaws: Pinpointing weaknesses in data, methodology, or logic within each approach.
• Emphasizing Reliable Data: Prioritizing value indications supported by the most robust and relevant market data.
• Explaining Discrepancies: Justifying any significant differences between the value indications and the final opinion.
• Ensuring Internal Consistency: Verifying that all parts of the report, including the description, approaches to value, and conclusions, are internally consistent and logically connected.

2. Reviewing and Verifying Previous Work

Before formulating a final opinion, a thorough review of all preceding steps is essential. This includes:

• Data Verification: Confirming the accuracy of all market data (sales prices, rents, expenses, construction costs, etc.) against original sources. Errors such as transposing numbers (e.g., $434,000 entered as $443,000 or $343,000) must be detected and corrected.
• Procedural Checks: Ensuring that all calculations are accurate, adjustments are applied correctly (adding when appropriate and subtracting when appropriate), and techniques are properly implemented.
• Logical Consistency: Examining each approach for internal logic and consistency with the defined highest and best use of the property, both as if vacant and as improved. Appraisers must adhere to the consistent use principle, valuing the land and improvements based on the same use.
• Applicability of Principles: Assessing whether the principles underlying each approach are applicable to the specific appraisal problem and property type. For example, while the income capitalization approach❓❓ is critical for income-producing properties, it might be less relevant for owner-occupied industrial properties where buyers focus more on condition, size, and location.
• Source Verification: Going back to the original data source in order to double check data.

3. Reconciliation Criteria: Weighting the Value Indications

Reconciliation involves assigning weights to the value indications derived from each approach, based on their relevance, reliability, and the availability of supporting data. The following criteria should be considered:

• 3.1 Appropriateness:

  • Different approaches hold varying degrees of relevance depending on the property type and market. For example:
    • sales comparison approach❓❓: Generally applicable but may be limited by data scarcity or lack of transparency.
    • Cost Approach: More relevant for newer properties or when market data is limited. Less reliable for older properties due to the difficulty of accurately estimating depreciation.
    • Income Capitalization Approach: Primary approach for income-producing properties.
  • The chosen approach should mirror the behavior and thought processes of market participants. If buyers primarily rely on comparable listings, the sales comparison approach should receive greater weight.

• 3.2 Accuracy:

  • The accuracy of each value indication depends on the quality and quantity of available data and the extent of necessary adjustments. Consider the following:
    • Sales Comparison Approach: Accuracy decreases with fewer comparables and larger adjustments.
    • Cost Approach: Accuracy decreases with property age, complex depreciation patterns, and functional obsolescence.
    • Income Capitalization Approach: Accuracy depends on reliable income/expense projections and appropriate capitalization rate selection.

• 3.3 Quantity of Evidence:

  • Using more market data (e.g., a greater number of comparable sales) generally improves the reliability of the value indications and reduces the impact of any single inaccurate❓ data point.
  • Statistical Basis: Increasing the sample size (number of comparable sales, etc.) increases the statistical power of the analysis. A larger sample size reduces the standard error and provides a more accurate representation of the market. Consider that misreported data has less of an impact with 7 data points than with 3.

4. Addressing Inconsistencies

Appraisers should actively seek and address inconsistencies within the appraisal. This may involve:

• 4.1 Checklist for Consistency:

  • Building Area: Is the building area consistent throughout the report (description, cost approach, sales comparison approach, etc.)?
  • Property Features: Are property features consistently described and considered across all sections of the report?
  • Conditions/Obsolescence: Are all noted conditions, functional inutilities (functional obsolescence), and locational influences addressed in the relevant approaches to value?
  • Effective Date: Is the effective date consistent with the market data and conditions presented? Are sales and cost data reflective of market conditions as of the effective date?
  • Limiting Conditions: Do the limiting conditions align with the rest of the document?
  • Who Inspects: Who is inspecting the property and are all disclosures noted about this?

• 4.2 Examples of Inconsistencies:

  • Adjusting for a functional problem (e.g., a poor floor plan) in the cost approach but neglecting to address it in the sales comparison approach.
  • Claiming an in-ground pool has no value but failing to acknowledge any functional obsolescence related to its presence.
  • Valuing land and improvements under different highest and best use scenarios.

5. Qualitative and Quantitative Analysis and Mathematical Principles

The reconciliation process combines both qualitative and quantitative analyses. While judgment plays a vital role, it must be supported by objective data and sound mathematical principles. Some relevant concepts include:

• 5.1 Weighted Average: A weighted average can be used to combine the value indications from different approaches, assigning weights based on their perceived reliability.

  • Equation: Final Value = (Weight_Cost * Value_Cost) + (Weight_Sales * Value_Sales) + (Weight_Income * Value_Income)

    • Where:
      • Weight_Cost + Weight_Sales + Weight_Income = 1

  • Example: If the cost approach yields a value of $300,000 (Weight = 0.2), the sales comparison approach yields a value of $320,000 (Weight = 0.5), and the income capitalization approach yields a value of $310,000 (Weight = 0.3), then the final value would be:

    • Final Value = (0.2 * $300,000) + (0.5 * $320,000) + (0.3 * $310,000) = $60,000 + $160,000 + $93,000 = $313,000

• 5.2 Statistical Measures:

  • Range: The range of indicated values can provide a sense of the uncertainty surrounding the valuation.
    • Equation: Range = Highest Indication - Lowest Indication
  • Confidence Intervals: While not always explicitly calculated, the concept of a confidence interval is relevant. A confidence interval represents a range within which the true market value is likely to fall, with a certain level of confidence (e.g., 95%). A wider range implies greater uncertainty.
  • Consider use of Standard Deviation to measure the spread of data.

6. Addressing Specific Challenges: Depreciation and Obsolescence (Referencing Provided PDF)

The provided PDF excerpt highlights common issues related to depreciation and obsolescence. Addressing these accurately is critical for a credible final valuation.

• 6.1 Depreciation Extraction: The example on page 344 demonstrates the calculation of total depreciation, breaking it down into short-lived and long-lived components, as well as curable functional obsolescence.

  • Equation: Total Depreciation = (Depreciation Rate * Effective Age * Reproduction Cost) - Curable Functional Obsolescence - Short-Lived Depreciation
  • Example: Using the information on page 344 of the Student Handbook to the Appraisal of Real Estate, 14th Edition (0.015 * 10 * $128,700) - $1,000 - $16,188 = $2,117.

• 6.2 Functional Obsolescence: Functional obsolescence stems from deficiencies in a property’s design, layout, or features that reduce its utility and marketability.

  • Curable Functional Obsolescence: Refers to items that can be economically remedied, such as the garage door opener issue mentioned on page 344. The cost to cure these items can be directly subtracted from the cost approach value (after accounting for depreciation).
  • Incurable Functional Obsolescence: Refers to items that cannot be economically cured, such as a poor floor plan layout that would require significant structural alterations. The impact of incurable functional obsolescence must be estimated based on market data and the diminished utility it causes.
  • Functional curable obsolescence can also include costs for an excess cost to cure the floor plan problems. In this case a value of $1,000 is listed for the excess cost to cure the floor plan problem.

• 6.3 Consistency in Adjustments: As highlighted on page 346, it’s crucial to adjust for functional obsolescence consistently across all applicable approaches. If a deduction is made in the cost approach for a functional deficiency, a corresponding adjustment should be considered in the sales comparison approach.

• 6.4 Avoiding Double Counting: Carefully avoid double-counting depreciation or obsolescence. If an item is already accounted for in the overall depreciation estimate (e.g., the bathroom problem mentioned on page 344), its cost should not be separately deducted again.

7. Final Opinion of Value and Rounding

The final opinion of value is a single, most probable point estimate (page 347). While a range of values can sometimes be useful, clients typically require a single number.

• 7.1 Rounding: Rounding the final value opinion appropriately is essential to avoid implying an unwarranted level of precision. The degree of rounding should be consistent with the accuracy of the analysis, the market standards, and the price level of the property (page 347).
  • Rounding to the nearest dollar implies a much higher level of precision than rounding to the nearest thousand dollars.

8. Avoiding Common Pitfalls

• 8.1 “Cloning” Reports: Avoid copying and pasting from previous reports, as this can lead to significant errors if data is not updated correctly (page 346).
• 8.2 Neglecting Field Notes: Refer to and review field notes thoroughly to ensure accuracy in the property description and other relevant sections of the report.
• 8.3 Insufficient Data: Always strive to gather sufficient data to support the value opinion. Minimizing inputs increases the risk of reporting skewed or misleading information.
• 8.4 Overstating Support: Do not try to sell a weak value opinion as a well-supported one. Transparency about the limitations of the available data is crucial.

9. Conclusion

Reconciliation is a critical and complex step in the appraisal process. By rigorously reviewing and verifying data, consistently applying appraisal principles, addressing inconsistencies, and exercising sound judgment, appraisers can arrive at a well-supported and credible final opinion of value. Accuracy in this final stage is paramount for maintaining professional standards and providing reliable valuation services.