Final Value Reconciliation: Achieving Accuracy

Chapter 7: Final Value Reconciliation: Achieving Accuracy

This chapter delves into the critical final step of the appraisal process: reconciliation. It explores how to synthesize the various value indications❓ derived from different approaches into a single, well-supported final opinion of value. Accuracy is paramount, and this chapter will provide a scientific framework for achieving it, emphasizing the logical and judgmental processes involved.

7.1 The Scientific Basis of Reconciliation

Reconciliation isn’t merely averaging numbers; it’s a systematic evaluation process rooted in statistical principles and decision theory. It acknowledges that each approach to value provides an estimate subject to error and that some estimates are more reliable than others in specific contexts.

• Statistical Estimation: Each value indication from the cost, sales comparison, and income capitalization approaches can be viewed as a point estimate of the property’s true value. These estimates are derived from sample data (comparable sales, cost data, income streams), making them subject to sampling error and other statistical biases.

• Decision Theory: Reconciliation involves weighing the evidence and making a decision under uncertainty. Decision theory provides a framework for analyzing the risks and rewards associated with different value conclusions. The appraiser aims to minimize the expected error in the final value opinion.

7.2 Review and Verification: Ensuring Data Integrity

The foundation of accurate reconciliation lies in rigorously reviewing and verifying all previous work. This involves scrutinizing data, logic, techniques, and calculations.

• Data Verification: Cross-referencing data sources to ensure accuracy and consistency. This includes verifying sale prices, property characteristics, income/expense data, and cost estimates. Use of public records, multiple listing services (MLS), interviews with market participants are crucial.
• Logical Consistency: Examining the internal consistency of the appraisal report. For instance, if functional obsolescence is identified in the cost approach, it should also be addressed in the sales comparison approach❓❓.
• Technique Validation: Ensuring that the chosen appraisal techniques are appropriate for the property type and market conditions. The selection of the valuation methods must comply with established appraisal standards.
• Calculation Auditing: Thoroughly checking all calculations for errors, including adjustments, capitalization rates, and depreciation estimates. Spreadsheets and other tools are helpful but require verification of formulas and input data.

7.3 Applying Logic and Judgment: The Reconciliation Process

Reconciliation is more than a mechanical process; it requires the application of sound judgment and logical reasoning.

• Weighting the Approaches: Assigning appropriate weight to each approach based on its relevance, reliability, and the availability of credible data. The weight assigned to each approach reflects the market’s reliance on the used methodology.

  • Formula:
    Final Value Opinion = (Weight_Sales * Sales Approach Value) + (Weight_Cost * Cost Approach Value) + (Weight_Income * Income Approach Value)
    Where:

    • Weight_Sales + Weight_Cost + Weight_Income = 1

    The weights represent the appraiser’s judgment on the relative importance of each approach.
    * Addressing Discrepancies: Analyzing and explaining any significant discrepancies between the value indications from different approaches. This may involve revisiting data, refining adjustments, or re-evaluating the applicability of certain techniques.
    * Considering Market Dynamics: Incorporating current market conditions, trends, and investor behavior into the reconciliation process. Market data helps in adjusting the value accordingly.

7.4 Consistency and the Interrelationship of Approaches

The approaches to value are interrelated, and inconsistencies can undermine the accuracy of the final opinion.

• Internal Consistency: Ensures that findings and adjustments are consistent across all sections of the report. For example, addressing functional obsolescence of a floor plan.
• Highest and Best Use: Ensures the final opinion aligns with the determined Highest and Best Use (HBU) of the property, both as vacant and as improved. The valuation considers use types allowed on the property and the marketability of those uses.
• Example: It is inconsistent to adjust the cost approach for a functional problem like a poor floor plan but neglect to compensate for it in the sales comparison approach. This principle underlines the necessity of addressing all critical components.

7.5 Common Pitfalls and Mitigation Strategies

• Averaging Value Indications: Simple averaging is inappropriate because it gives equal weight to all approaches, regardless of their reliability. It ignores that some data have more accurate representations of market value than others.
• Confirmation Bias: Seeking out data that supports a pre-determined value conclusion while ignoring conflicting evidence. This can lead to an inaccurate or biased opinion.
• Over-Reliance on a Single Approach: Favoring one approach over others without adequate justification. All credible approaches must be considered and the justifications for weighting one over another must be provided.
• Cloning Reports: Copying data from previous reports without verifying its accuracy or relevance to the current assignment. This practice increases the risk of perpetuating errors.
• Insufficient Data Verification: Data must be confirmed. If data are not verified, more data are needed to diminish the effect of a misreported sale price.

7.6 Final Opinion of Value: Point Estimate vs. Range

While many clients require a single-point estimate, providing a range of values can be more appropriate in certain situations.

• Single Point Estimate: A single, most probable opinion of market value. Rounding the final value to a level of precision commensurate with the data. Rounding eliminates implications of unwarranted accuracy.
• Range of Values: Indicates the potential range within which the market value falls. This can be useful when there is significant uncertainty or a lack of comparable data.
• Confidence Interval: Representing the uncertainty associated with the value opinion using a confidence interval. This acknowledges that the true value may lie within a certain range.

7.7 Practical Application and Example

Let’s consider an example of reconciling value indications for a residential property:

1. Cost Approach: $300,000
2. Sales Comparison Approach: $320,000
3. Income Capitalization Approach: $290,000 (based on potential rental income)

Reconciliation Process:

• Review: Verify all data and adjustments in each approach.
• Weighting: In this case, the sales comparison approach may be given the most weight (50%) because it directly reflects market transactions. The cost approach may be given moderate weight (30%), while the income capitalization approach may be given less weight (20%) because rental income is not the primary driver of value in this market.

• Weighted Average:

  Final Value = (0.50 * $320,000) + (0.30 * $300,000) + (0.20 * $290,000) = $312,000
  * Rounding: Round the final value to a reasonable level of precision, such as $312,000 or $310,000, depending on the level of accuracy of the supporting data.
  * Explanation: In the appraisal report, justify the weighting assigned to each approach and explain any discrepancies between the value indications.

7.8 The Reconciliation Checklist

• Procedures and Mechanics:
  • Techniques, calculations, and adjustments.
  • Adjustments made the wrong way.
  • Data researched well, but listed incorrectly.
• Consistency within the approaches to value:
  • Subject property has a problem and adjust for it in the cost approach but forget to make an adjustment in the sales comparison approach.
• Analysis in each approach for logic and consistency with the highest and best use as though vacant and as improved:
  • Data inconsistent with the opinion of the highest and best use of a property.
  • Violate the consistent use rule when they value the land under one use and the building improvements under another use.
• Applicability of the principles of each approach or procedure to the appraisal problem and the property being appraised:
  • A technique that buyers and sellers in that market do not use.
• Market data for reliability and accuracy:
  • Misstatements if it is not confirmed.
  • Enough data that one or two pieces of bad data will not affect the conclusion.
  • A minimal amount of data requires a higher level of verification.
  • Surplus data allows a lower level of verification because less emphasis is given to any one piece of data.

7.9 The Consistency Checklist

• Consistency within the approaches to value:
  • Building area is the same as in the three approaches to value.
  • Property features are the same as in the three approaches to value.
• Condition, functional inutility, or locational influence:
  • Items listed in the neighborhood analysis or property description are included in the applicable approaches.
• Effective Date:
  • Consistent with the data presented.
  • Sales or cost data reflect the market on the effective date.
• Limiting Conditions:
  • Consistent with the remainder of the document.
  • Who inspected the property and who is signing the report.

7.10 Conclusion

Final value reconciliation is a critical step in the appraisal process. By applying sound judgment, logic, and a thorough understanding of market dynamics, appraisers can achieve a well-supported and accurate final opinion of value. Remember, the goal is not to arrive at a precise answer but to provide a credible estimate based on the best available data and analysis.