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Reconciliation: Foundation of Value Opinion
Reconciliation: Foundation of Value Opinion
Introduction
Reconciliation is a critical step in the appraisal process. It’s not simply averaging figures, but a reasoned judgment leading to a final value opinion. This chapter delves into the scientific underpinnings of reconciliation, explaining the relevant theories and principles, and providing practical examples.
I. Understanding Reconciliation
A. Definition and Purpose
Reconciliation is the process of analyzing the results obtained from two or more valuation approaches (e.g., sales comparison, cost, income) to arrive at a single, supportable opinion of value. It involves weighing the reliability and relevance of each approach and selecting a final value or range that reflects the property’s true worth. This is consistent with USPAPโs Standard 1 and 2.
B. Why Reconciliation is Essential
- Addressing Complexity: Real estate is complex, and no single valuation approach perfectly captures all its nuances.
- Minimizing Errors: By comparing multiple indicators, reconciliation helps identify and mitigate potential errors or biases in any one approach.
- Providing a Credible Opinion: A reconciled value, grounded in sound judgment, is more credible to clients, stakeholders, and potential reviewers.
C. What Reconciliation is NOT
- Simple Averaging: Mathematical formulas, such as averaging, should never be used in reconciliation. Averaging implies equal weight to all approaches, which is rarely justified.
- Arbitrary Guesswork: The final opinion must be supported by the evidence and reasoning presented in the appraisal.
II. Scientific Principles Underpinning Reconciliation
A. Statistical Weighting and Sample Size
The reliability of a value indicator is directly proportional to the amount of data, the level of accuracy and the relevance to the appraisal problem.
The amount of data is significant because value indicators are considered more reliable when:
1. they are based on a larger statistical sampling of data;
2. they are derived from more detailed data; or
3. they are supported by several independent sources.
Each valuation approach can be seen as a sample or data point in estimating the true value.
The appraiserโ’s judgment assigns weights to each indicator based on the quality and relevance of data.
- Weighting: Assigning importance (weights) to different indicators reflecting the amount of data, the level of accuracy and the relevance to the appraisal problem.
- Example: If the sales comparison approach is based on numerous, recent, highly comparable sales, it should be given more weight than the cost approach, which relies on estimations of depreciation.
Mathematical Explanation:
* Let V = reconciled value
* V<sub>i</sub> = value indicator from approach i
* w<sub>i</sub> = weight assigned to approach i
* Then: V = w<sub>1</sub>V<sub>1</sub> + w<sub>2</sub>V<sub>2</sub> + ... + w<sub>n</sub>V<sub>n</sub>, where w<sub>1</sub> + w<sub>2</sub> + ... + w<sub>n</sub> = 1
- Sample Size: Value indicators are considered more reliable when:
- Based on a larger statistical sampling of data.
- Derived from more detailed data.
- Supported by several independent sources.
- Example: A value conclusion is more reliable when it is supported by independent sources.
B. Bayesian Inference and Prior Knowledge
Bayesian inference provides a framework for updating beliefs (value opinions) in light of new evidence (valuation approaches). The appraiser’s experience and prior knowledge act as the “prior belief,” which is then adjusted based on the “likelihood” of each value indicator.
Mathematical Explanation:
* P(H|E) = [P(E|H) * P(H)] / P(E)
* P(H|E) = posterior probability of hypothesis H (true value) given evidence E (valuation indicators)
* P(E|H) = likelihood of observing evidence E if hypothesis H is true
* P(H) = prior probability of hypothesis H (appraiser's initial belief)
* P(E) = probability of observing evidence E
C. Bias Detection and Reduction
Reconciliation should identify and mitigate potential biases in each approach. This involves understanding the limitations of each technique and adjusting the final value accordingly. The accuracy of a value indicator depends on the accuracy of the supporting data, and the accuracy of the technique usedโ to derive the indicator from the data. The accuracy of data depends on how well it has been verified.
- Common Appraisal Biases: Anchoring bias (relying too heavily on initial information), availability heuristic (overemphasizing easily recalled data), and confirmation bias (seeking evidence that confirms existing beliefs).
- Mitigation Strategies: Sensitivity analysis (assessing the impact of changing key assumptions), independent verification of data, and consulting with other appraisers.
D. Sensitivity Analysis
Sensitivity analysis is a technique used to determine how different values of an independent variable impact a particular dependent variable under a given set of assumptions.
Sensitivity analysis is the study of how the uncertainty in the output of a mathematical model or system (numerical or otherwise) can be apportioned to different sources of uncertainty in its inputs.
Mathematical Explanation:
* Let V = Value
* SA = Sensitivity analysis
* ฮฑ = Assumptions
* V โ โ (ฮฑ * SA)
III. Practical Application of Reconciliation
A. Steps in the Reconciliation Process
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Reviewing the Data: Verifying the accuracy of all calculations, data, and reasoning for each approach.
All calculations must be checked for accuracy, and any mistakes corrected. -
Consistency Checks: Ensuring that appraisal techniques are applied consistently to the subject property and all comparables. The different appraisal techniques must be applied consistently to the subject property and to all comparables.
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Assessing Reliability: Evaluating the amount, accuracy, and relevance of data supporting each value indicator. The appraiser must assess the reliability of each value indicator.
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Pertinent Data Analysis: Ensure all pertinent data is included and analyzed.
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Terms Compliance: Ensure value indicators are derived in accordance with the terms of the appraisal assignment.
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Judgment and Choice: All pertinent data must be included and analyzed. The appraiser’s judgment must be the determining factor.
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Additional Steps: If necessary, additional data is collected and additional analysis is performed.
B. Applying Weighted Averages
Assigning weights to the value indicators based on their relative reliability:
* Let Sales Comparison = 0.6 or 60%
* Let Cost Approach = 0.2 or 20%
* Let Income Approach = 0.2 or 20%
C. Example Scenario
A single-family home was appraised using three approaches:
- Sales Comparison: \$500,000 (based on 5 recent, highly comparable sales)
- Cost Approach: \$480,000 (moderate accuracy due to depreciation estimates)
- Income Approach: \$460,000 (limited relevance due to low rental activity)
Reconciliation:
* V = (0.6 * \$500,000) + (0.2 * \$480,000) + (0.2 * \$460,000) = \$488,000
D. Addressing Review Scrutiny
An appraiser should review his or her work to ensure that it is easily understandable to a non-appraiser reader.
* Clarity: Clearly explain the reconciliation process and the rationale for the final value.
* Justification: Provide compelling evidence to support the assigned weights and the final opinion.
* Anticipate Criticism: Consider how a review appraiser might critique the analysis and address those points proactively.
IV. Conclusion
Reconciliation is a crucial element in mastering the final value opinion. By understanding its scientific foundations and applying reasoned judgment, appraisers can produce credible and supportable value opinions.
Chapter Summary
Reconciliation: Foundation of Value Opinion - A Scientific Summary
This chapter, “Reconciliation: Foundation of Value Opinion,” from the training course “The Art of Reconciliation: Mastering Final Value Opinion in Appraisal,” focuses on the critical process of deriving a singleโ, supportable value opinion in appraisal. Reconciliation is presented not merely as a mathematical averaging but as a reasoned judgment based on data reliability, accuracy, and relevance.
Main Scientific Points:
- Definition and Purpose: Reconciliation is defined as the analytical process of synthesizing two or more value indicatorsโ (derived from different approaches, comparables, or techniques) into a single, final opinion of value. This step is integral to the appraisal process.
- Judgment and Experience: The chapter emphasizes that reconciliation is fundamentally a matter of the appraiserโ’s judgment and experience, not a mechanical calculation. Averaging or other mathematical formulas are explicitly discouraged.
- Data reviewโ and Error Correction: The reconciliation process begins with a meticulous review of all data, calculations, and reasoning underlying each value indicator. This includes verifying the accuracy of all calculations and ensuring consistency in the application of appraisal techniques across the subject property and all comparables.
- Reliability Assessment: The reliability of each value indicator must be rigorously assessed based on:
- Amount of Data: Indicators based on larger, more detailed statistical samples and supported by multiple independent sources are considered more reliable.
- Accuracy of Data and Technique: Accuracy depends on the degree to which supporting data has been verified and the appropriateness of the appraisal technique for the specific appraisal problem.
- Relevance: The relevance of the indicator to the appraisal assignment is paramount. The indicator must be consistent with the assignment’s terms, and the technique used must be suitable for the property type and valuation problem.
- Evidence-Based Support: The final reconciled value must be explicitly supported by evidence presented within the appraisal report. The appraiser’s reasoning and justification for the chosen value must be clear and persuasive.
- Point Estimate vs. Range Value: The reconciled value is typically expressed as a “point estimate” (a single dollar amount). An alternative is a “range value,” representing the appraiser’s opinion of the most probable range within which the property’s value falls.
- Reconciliation Section of URAR and its Components: The section comprises of components such as sales comparison approach, cost and income approach and reconciliation of all three of the approaches.
- An appraiser shall indicate whether appraisal was made is “as is” or “subject to the property being altered.” Also, whether any conditioning factors are listed, any appraisal approaches used are listed, and the purpose of the appraisal is reaffirmed, and that the appraiser signs and dates the appraisal report, and includes his or her appraisal license or certification number.
- Reviewing the work for readability and easy understandability to readers of non-appraiser background.
Conclusions:
The chapter concludes that effective reconciliation is the cornerstone of a credible value opinion. It requires a holistic understanding of the appraisal data, rigorous evaluation of the reliability and relevance of value indicators, and transparent articulation of the appraiser’s judgment.
Implications:
- Appraiser Competency: The emphasis on judgment and experience underscores the need for well-trained and seasoned appraisers who can effectively analyze and synthesize complex data.
- Data Quality: The importance of data reliability highlights the need for appraisers to prioritize accurate and verifiable data sources and to critically evaluate the quality of available information.
- Report Transparency: The requirement for evidence-based support necessitates clear and comprehensive appraisal reports that fully explain the appraiser’s reasoning and justify the final value opinion.
- Critical Review: Appraisals are subject to possible discredit and require critical review, hence should be defensible in such instances.
- USPAP Compliance: Appraisals should conform to USPAP requirements, and should be understandable to a non-appraiser reader.
- Liability: That appraisers need to be careful about how and what they communicate in an appraisal. The liability for any omission should be noted by all parties involved.
- Overall Quality: Reconciliation is not merely a final step but an ongoing process throughout the appraisal, influencing data collection, analysis, and ultimately, the defensibility of the value opinion.
