Reconciliation and Final Value Opinion

Chapter: Reconciliation and Final Value Opinion

Introduction

In the specialized field of property appraisal, particularly when dealing with diverse property interests like timeshares, manufactured homes, ground leases, and partial ownership interests, arriving at a credible and defensible final value opinion is paramount. This chapter focuses on the scientific principles and practical techniques involved in reconciliation, the critical process of synthesizing multiple value indications into a single, well-supported conclusion. This process, heavily reliant on the appraiser’s judgment and experience, forms the cornerstone of a robust and reliable appraisal report, especially when the work must pass the scrutiny of a review appraiser.

I. The Science of Reconciliation: Blending Art and Analysis

Reconciliation is not merely averaging different value estimates; it’s a systematic, analytical process underpinned by principles of statistical inference and decision theory.

A. Defining Reconciliation

• Definition: Reconciliation is the process of critically analyzing the range of values indicated by various appraisal approaches and data points, considering their strengths and weaknesses, to arrive at a single, supportable opinion of value. It’s the synthesis of disparate data into a coherent conclusion.
• Application to Specialized Properties: When dealing with diverse property types, the reconciliation process becomes even more critical. Each property type (timeshares, manufactured homes, etc.) possesses unique characteristics and market dynamics that necessitate a nuanced approach to data analysis and weighting.

B. The Role of Statistical Inference

• Principle: Statistical inference involves drawing conclusions about a population based on a sample. In appraisal, the population is the hypothetical market for the subject property, and the sales comparison, cost, and income approaches provide samples of value indicators.
• Relevance: The reconciliation process is, in essence, an exercise in statistical weighting. The appraiser assigns different levels of confidence to each value indicator based on factors like sample size, data accuracy, and relevance to the appraisal problem.

C. Decision Theory Framework

• Concept: Decision theory provides a framework for making rational choices in situations involving uncertainty. The appraiser, faced with multiple value indicators, acts as a decision-maker aiming to minimize the risk of error.
• Application:
  • Risk Assessment: Each value indicator is assessed for its potential for error, considering the quality of data and the appropriateness of the appraisal technique.
  • Weighting: Value indicators with lower risk and higher reliability are given more weight in the final reconciliation.
  • Scenario Planning: The appraiser might consider different scenarios (e.g., different market conditions) and how they would affect the validity of each value indicator.

II. Factors Influencing the Reliability of Value Indicators

A reliable value indicator is essential for a defensible reconciliation. The reliability of a value indicator depends on the amount of data, the level of accuracy, and the relevance to the appraisal problem. The science behind weighing these factors is vital.

A. Amount of Data: Statistical Significance

• Principle: Value indicators based on larger, statistically significant samples are inherently more reliable. This is a core concept in statistics.
• Application:
  1. Larger Statistical Sampling: A sales comparison approach based on numerous, verified comparable sales is generally more reliable than one based on only a few.
  2. Detailed Data: A cost approach based on detailed cost breakdowns and accurate depreciation estimates is stronger than one based on generalized cost factors.
  3. Independent Sources: Value indicators supported by multiple independent sources (e.g., different market data providers) carry greater weight.

B. Accuracy of Data and Techniques: Minimizing Error

• Principle: The accuracy of a value indicator depends on both the precision of the underlying data and the appropriateness of the appraisal technique. This reflects the importance of minimizing both systematic and random errors.
• Applications:
  1. Verification: Verify the accuracy of data through multiple sources (e.g., sales prices confirmed with both buyer and seller).
  2. Technique Selection: Choose appraisal techniques that are appropriate for the specific property type and market conditions. For example, the sales comparison approach is generally favored for residential properties. The income approach is generally most appropriate for income-producing properties, e.g. ground leases.
  3. Consistent Application: Ensure that appraisal techniques are applied consistently to the subject property and all comparables to eliminate bias. All calculations must be checked for accuracy, and any mistakes corrected.

C. Relevance: Aligning with the Appraisal Problem

• Principle: The relevance of a value indicator depends on its consistency with the appraisal assignment and the appropriateness of the appraisal technique. This aligns with the concept of validity in research methodology.
• Applications:
  1. Consistency: Ensure the value indicator aligns with the stated purpose of the appraisal (e.g., market value, investment value).
  2. Appropriateness: Select appraisal techniques that are well-suited to the property type and market conditions. For instance, using the income capitalization approach for a single-family residence is typically inappropriate.
  3. Assignment Terms: Adhere strictly to the terms of the appraisal assignment, including the effective date and the definition of value. Value indicators must be derived in accordance with the terms of the appraisal assignment.

III. mathematical❓ Considerations and Practical Applications

While reconciliation relies heavily on judgment, mathematical formulas and models can assist in the analysis and weighting of value indicators. The process of reconciliation begins with a review of all the data, calculations and reasoning that have led to the different value indicators.

A. Quantitative Analysis

1. Weighted Average:
   • Formula: Value = (w1 * V1) + (w2 * V2) + … + (wn * Vn), where Vi is the value from each approach and wi is the weight assigned to each approach.
   • Application: Assign weights to each approach based on their reliability and relevance. For example, in a stable market, the sales comparison approach might receive a higher weight than the cost approach.
2. Sensitivity Analysis:
   • Concept: Examine how the final value opinion changes when the inputs to each approach are varied. This helps to identify which factors have the greatest impact on value.
   • Application: If the final value opinion is highly sensitive to changes in the capitalization rate in the income approach, the appraiser should dedicate extra effort to validating the chosen rate.

B. Examples and Experiments

1. Timeshare Appraisal:
   • Scenario: Appraising a timeshare unit, with value indications from the sales comparison approach, the cost approach, and the income approach (based on rental income).
   • Experiment:
     • Sales Comparison: Perform a regression analysis of comparable sales data to identify the most significant variables affecting price (e.g., time of year, unit size, amenities).
     • Cost Approach: Evaluate the cost approach by determining if it reflects actual value (very few re-sales are greater than the original purchase price.)
     • Reconciliation: If the sales comparison approach aligns closely with the market, give it the highest weight (e.g., 60%). Assign lower weights to the cost and income approaches based on their limitations and market relevance.
2. Manufactured Home Appraisal:
   • Scenario: Appraising a manufactured home on a leased lot in a rental park.
   • Consider factors: Park amenities, Park rules, Park rental fees, Length of lease, Restrictions on rent increases (rent control)
   • Experiment: The appraiser may consider location in an ocean front park location. Premium values attach to parks having rent control compared to those not subject to rent control.
   • Experiment: Some parks have poor reputations because of rules, tenant/management problems as well as fees. Conversely, some parks have an excellent reputation and re-sales of units are often significantly greater than for other parks, even though the physical plans could be very similar.
   • Reconciliation: After considering all the factors (market trends, rental survey, costs, site data), determine the market value and the effective date of the appraisal.
3. Ground Lease Appraisal:
   • Scenario: A commercial property is subject to a ground lease with a fixed rental rate and a remaining term of 30 years. The value of the leased premises would be based on improvements, length of lease, lease terms and likelihood of lease extensions at reasonable terms.
   • Application: If the market rental rate is now significantly higher than the fixed rent in the ground lease, the value of the leasehold will be increased and the value of the leased fee interest would be reduced.
   • The U.S. Forest Service may refuse to allow extensions to these leases and require the owners to pay for the removal of the improvements, resulting in a negative value to the property.
   • Reconciliation: Determine the appropriate action to take and the specific value for the specific property.

IV. The Final Value Opinion and Review Considerations

• point estimate❓❓ vs. Range Value: An opinion of value of an appraised property is stated as a single dollar amount known as a “Point Estimate.” An alternative to the Point Estimate is the “Range Value,” which is an appraiser’s opinion of the range in which the property’s value is most likely to fall.
• Clarity and Transparency: An appraiser should review his or her work to insure that it is easily understandable to a non-appraiser reader. Value opinions should be rounded.
• Critical Review Preparedness: Before finalizing the report, ask: will the work pass muster in a critical review? If it won’t, don’t send it!
• The final value opinion must❓❓ be supported by the evidence in the appraisal. The appraiser’s judgment must be the determining factor.

Conclusion

Reconciliation is a critical step in the appraisal process, demanding a blend of scientific rigor and experienced judgment. By applying principles of statistical inference, decision theory, and quantitative analysis, appraisers can strengthen the reliability and defensibility of their value opinions, especially when dealing with complex and diverse property interests. This ensures that the final value opinion is a well-reasoned, evidence-based conclusion that can withstand scrutiny and provide a sound basis for real estate decision-making.