Final Valuation: Reconciliation for Accuracy

Chapter 6: Final Valuation: Reconciliation for Accuracy

This chapter delves into the critical final step of the appraisal process: reconciliation. Reconciliation is not simply averaging value indications; it’s a rigorous, scientific process that demands critical thinking, data validation, and a deep understanding of appraisal principles. It’s where the appraiser synthesizes findings from different approaches, identifies potential flaws, and ultimately arrives at a well-supported and defensible final opinion of value.

6.1 The Science of Reconciliation: Beyond Simple Averaging

The goal of reconciliation is to arrive at the most probable indication of value. This is rarely achieved through simple arithmetic averaging. Averaging implies equal weighting, which is almost never justified when the reliability, relevance, and applicability of different approaches vary. Instead, reconciliation relies on weighted averaging, with the weights determined by the scientific judgment of the appraiser.

• Core Principle: The final value opinion is a point estimate derived from a probability distribution of possible values. The reconciliation process aims to identify the point within this distribution that is most representative of market value.

Example: Imagine three approaches yield: Sales Comparison = $300,000, Cost Approach = $320,000, and Income Capitalization = $290,000. Instead of averaging to $303,333, the appraiser might determine the Sales Comparison approach is most reliable given abundant, recent comparable sales. They might weight it at 50%, and the other two at 25% each. This yields a reconciled value of:
(0.50 * $300,000) + (0.25 * $320,000) + (0.25 * $290,000) = $302,500

• Statistical Analogy: The reconciliation process can be understood as a qualitative application of statistical concepts like confidence intervals. While a rigorous statistical analysis is rarely performed in residential appraisals, the concept of a range of possible values and the relative likelihood of different values within that range are central to the reconciliation process. A range of value gives the user of the appraisal more information with the reconciled opinion of value.

6.2 The Reconciliation Process: A Systematic Review

The reconciliation process is comprised of two core steps, as outlined in the PDF document: review and logic based judgment.

• Step 1: Thorough Review and Verification

  This step is critical to ensure the accuracy and reliability of the data and analysis used in each approach. It involves:

  • a) Checking Procedures and Mechanics:

    • Verifying all calculations (e.g., adjustments in the Sales Comparison Approach, depreciation calculations in the Cost Approach, capitalization rate calculations in the Income Approach).
    • Ensuring correct application of adjustment signs (adding vs. subtracting). Mistakes in these mechanics can lead to significant errors.
    • Example: A comparable sale is superior to the subject in lot size. The adjustment should subtract value from the comparable sale’s price to reflect the subject’s smaller lot.

    • Ensuring the data collected is recorded correctly. For example, a sale price of $434,000 can easily be entered as $443,000.

      • b) Internal Consistency Checks:

    • Verifying consistency within and between the three approaches.

    • Example: If functional obsolescence (e.g., a poor floor plan) is identified in the Cost Approach and a cost to cure is estimated, the Sales Comparison Approach must also consider this deficiency when selecting and adjusting comparable sales.

      • PDF 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.”
      • In the PDF example, a garage door opener and shower must be added, subtracted or kept in accordance with being accounted for in depreciation extraction.

    • Ensuring consistency with the Highest and Best Use analysis (both as vacant and as improved).

    • PDF Example: Violating the consistent use rule would involve valuing the land under one use (e.g., commercial) and the improvements under another (e.g., residential).

      • c) Applicability of Appraisal Principles:

    • Evaluating whether the techniques and approaches used align with the behavior of market participants.

    • Example: In a market where buyers primarily focus on location and physical characteristics for industrial properties, an income capitalization approach❓❓ might be less relevant than the Sales Comparison Approach.

      • d) Market Data Reliability and Accuracy:

    • Confirming the accuracy of all market data, including sales prices, rents, expense ratios, and capitalization rates.

    • Addressing incomplete data.
    • Mitigating risks of reporting inaccurate market data by confirming sales data.
    • Using more data if available.
    • Statistical Justification: A larger sample size (more comparable sales) reduces the impact of any single outlier or inaccurate data point, improving the statistical reliability of the analysis.

    • PDF Example: “Reporting inaccurate market data is usually a mistake made by appraisers who are working too quickly or suffer from unreasonable time constraints. If you do not confirm your data, you must use enough data that one or two pieces of bad data will not affect the conclusion.”

      • e) Consistency Checklists:

    • Ensuring consistency of measurements, square footage, lot size and other descriptions across the entire report.

    • Ensuring consistency with effective date of appraisal and sales data.
    • Ensuring the listed items of condition, functional and external utilities and location are mentioned in applicable approaches.
    • Step 2: Application of Logic and Judgment (Reconciliation)

  This step involves synthesizing the findings from each approach, considering their strengths and weaknesses, and arriving at a final opinion of value. This process is guided by:

  • a) Appropriateness of Approaches:

    • Recognizing that each approach has varying relevance depending on the property type and market conditions.
    • PDF Example: The Income Capitalization Approach is crucial for multi-tenant office buildings, while the Cost Approach is less significant for single-family homes in established urban areas.
    • Emphasis should mirror market participant behavior.

    • PDF Example: Appraisers must give more weight to comparable sales than cash flow analysis if comparable sales are the market determinants.

      • b) Accuracy of Value Indications:

    • Evaluating the reliability of each value indication based on the quality and quantity of available data, the extent of required adjustments, and the age and condition of the subject property.

    • Acknowledging any weaknesses in the data that would have occurred.

6.3 Mathematical Considerations in Reconciliation

While reconciliation is largely a qualitative process, mathematical principles underpin the weighting and adjustments applied:

• Weighted Average: As demonstrated earlier, the final value opinion can be calculated as a weighted average of the value indications from each approach:

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

  Where:

  • Weight_Sales, Weight_Cost, Weight_Income are the weights assigned to each approach (0 ≤ Weight ≤ 1, and Weight_Sales + Weight_Cost + Weight_Income = 1)
  • Value_Sales, Value_Cost, Value_Income are the value indications from each approach.

• Sensitivity Analysis: Conducting what-if scenarios to assess the impact of changes in key assumptions on the final value opinion. For example, how would the final value change if the capitalization rate in the Income Approach increased by 0.5%? This helps identify the most sensitive variables and highlights areas where further research is needed.

6.4 Common Pitfalls to Avoid

• a) “Cloning” Reports: Reusing data and analysis from previous appraisal reports without verifying its accuracy for the current assignment. This leads to errors.
  • PDF Example: “That is, appraisers will make a computer copy of the last file they prepared (sometimes including the pictures) and then type over the top of the old report and intend to enter the new data. The problem is that appraisers receive phone calls, people come into the office, or they go out to lunch, and then they return to a file and cannot remember where they left off. It is much better to create a template with macro-level data already in place but no micro-level data. Then, you can complete the appraisal without including data carried over from a previous report. Again, regardless of the techniques used, always read the report on paper after it is completed.”
• b) Over-Reliance on a Single Approach: Failing to adequately consider and analyze all applicable approaches, even if one approach appears to be the most relevant.
• c) Insufficient Data Verification: Accepting data at face value without independent verification or confirmation from reliable sources.
• d) Lack of Transparency: Failing to clearly explain the rationale behind the weighting assigned to each approach and the judgments made in the reconciliation process.

6.5 Rounding the Final Value Opinion

• Importance: Rounding is essential to avoid conveying a false sense of precision. An appraisal is an opinion of value, not an exact measurement.
• PDF Example:
  The degree of rounding implies the level of accuracy of the analysis. If the final opinion of value is reported as
  • $108,653, then the appraiser knows value to the $1 level or the difference between $108,653 and $108,654.
  • $108,660, then the appraiser knows value to the $10 level or the difference between $108,660 and $108,670.
  • $108,700, then the appraiser knows value to the $100 level or the difference between $108,700 and $108,800, and so on.
• Best Practices: The level of rounding should reflect the overall quality and reliability of the data and analysis.
  • For residential properties, rounding to the nearest $500 or $1,000 is generally appropriate.
  • For commercial properties, rounding to the nearest $1,000 or $5,000 may be more appropriate.

6.6 Conclusion

Reconciliation is the most critical and scientifically demanding aspect of the appraisal process. It requires a combination of analytical skills, market knowledge, and sound judgment. By rigorously reviewing data, applying appropriate weighting, and clearly articulating the rationale behind the final value opinion, appraisers can ensure that their valuations are both accurate and defensible.

Review Exercises:

(Answers based on the provided PDF content)

1. c) Be rounded to show that the number is an opinion, not a precise calculation
2. b) Reconciliation
3. c) Allows for a greater probability of correctness
4. d) No, you can choose any one of the numbers or any number between and, in some cases, slightly above or below the range.
5. d) Choose a value opinion that best represents the market for the subject based on all data available as of the date of the appraisal
6. d) Significant because the buyers have made a statement with their checkbook
7. c) The subject property’s market value could be lower than the list price.
8. a) The cost approach needs to be adjusted (or adjusted more) for the loss in value due to functional obsolescence.

9. This exercise requires analyzing the provided sales comparison grid. Here’s a breakdown:

   • Strengths: The grid presents multiple comparable sales, providing a basis for comparison. It identifies data sources.
   • Weaknesses:
     • Minimal adjustments. All adjustments are shown as 0.0%, except for Market Conditions. This suggests a lack of detailed analysis of differences between the subject and comparables.
     • Limited Information. The grid lacks information about the specific characteristics of the land (e.g., zoning, topography, access), making it difficult to assess the appropriateness of the comparables and adjustments.
     • Market Conditions Adjustments may be misapplied. The adjustments for market conditions are positive for earlier sales, but these percentages seem small considering the time differences (up to 18 months).
     • Data may not be timely. The co-op source may not be reliable.
   • Should Adjustments Be Larger or Smaller? The adjustments should be larger. A thorough analysis of property characteristics and market conditions likely warrants more significant adjustments.
   • Should More Recent Sales Be Emphasized? Yes. Generally, more recent sales are more relevant indicators of current market value. However, similarity in size and other characteristics is also important. The appraiser must weigh recency against similarity. If the earlier sales are significantly more similar to the subject in crucial aspects, they might still warrant consideration, albeit with appropriate adjustments for market conditions.