Reconciliation and Final Value Opinion

Chapter 11: Reconciliation and Final Value Opinion

I. Introduction: The Culmination of the Appraisal Process

This chapter, “Reconciliation and Final Value Opinion,” represents the crucial final stage in the appraisal process, where the appraiser synthesizes the diverse data and analyses generated throughout the engagement into a single, defensible, and well-supported conclusion of value. This process is especially critical when dealing with partial interests in real estate, as the valuation of these complex interests often involves multiple appraisal techniques and comparable datasets, each requiring careful consideration and weighting. In the context of this course, “Mastering Partial Interests in Real Estate Appraisal,” a thorough understanding of reconciliation is paramount for accurately valuing leasehold estates, leased fees, easements, and other fractional ownership structures.

II. Defining Reconciliation

• A. Core Definition: Reconciliation is the process of critically analyzing and weighing the value indications derived from two or more appraisal approaches (e.g., sales comparison, cost, income) and/or distinct data sources to arrive at a single, final opinion of value. It is not a simple mathematical averaging but rather a reasoned judgment based on the reliability and relevance of each indicator.

• B. Expanded Definition: For the purpose of this course, reconciliation also encompasses the critical review and weighting of value indications derived from different comparable properties, different units of comparison within a single approach (e.g., price per square foot vs. price per unit), and different variations of a single appraisal technique, adjusted appropriately. In the context of partial interests, this might involve comparing value indications from discounted cash flow analyses with different discount rates or capitalization rates, carefully considering the underlying assumptions and market data that support each.

• C. The Goal: The goal of reconciliation is to produce a credible and defensible point estimate (or range value, as discussed later) that is consistent with the appraisal problem, supported by the evidence presented, and understandable to the intended users of the appraisal report. This final opinion must withstand scrutiny from review appraisers and other stakeholders.

III. Scientific Principles Underlying Reconciliation

• A. Bayesian Inference: While not explicitly a mathematical average, reconciliation shares conceptual similarities with Bayesian inference. Bayesian inference involves updating prior beliefs (represented by the initial value indicators) with new evidence (the reliability and relevance of each indicator) to form a posterior belief (the final value opinion).

  • Formula:
    P(H|E) = [P(E|H) * P(H)] / P(E)
    Where:

    • P(H|E) is the probability of the hypothesis (final value) given the evidence (value indicators).
    • P(E|H) is the probability of observing the evidence if the hypothesis is true.
    • P(H) is the prior probability of the hypothesis (initial value indicators).
    • P(E) is the probability of the evidence.

    In appraisal, the appraiser’s judgment acts as the Bayesian updating mechanism, adjusting the weighting of each value indicator based on its perceived reliability and relevance.

• B. Statistical Weighting: While not a direct mathematical calculation, the appraiser implicitly assigns weights to each value indicator based on several factors. These implicit weights reflect the appraiser’s judgment about the statistical strength and predictive power of the data and methods used to derive each indicator.

  • Example: If the sales comparison approach is based on a large sample of highly comparable sales with minimal adjustments, it might receive a higher implicit weight than the cost approach, which relies on estimated depreciation and replacement costs.

IV. Factors Influencing the Reliability of Value Indicators

The appraiser’s judgment is paramount in determining the reliability of each value indicator. Several factors contribute to this assessment:

1. A. Amount of Data:

   • A value indicator derived from a large statistical sampling is generally more reliable than one based on limited data.

   • Value opinions should be supported by several independent sources.
     2. B. Accuracy of Data:

   • The accuracy of the data directly impacts the accuracy of the value indicator. Verified data from reliable sources (e.g., recorded deeds, verified sales confirmations) is more trustworthy.

   • Accuracy of an Appraisal technique relies on the relevance of that technique.
     3. C. Relevance to the Appraisal Problem:

   • Assignment Consistency: The value indicator must align with the specific terms and conditions of the appraisal assignment.

     • Example: When appraising a leasehold interest, the value indicator needs to accurately reflect the specific terms of the lease agreement.

   • Technique Appropriateness: The appraisal technique used to derive the indicator must be suitable for the specific property type, market conditions, and partial interest being valued.

     • Example: The income capitalization approach may be less relevant when appraising a vacant parcel of land compared to an office building.
       4. D. The Sales Comparison Approach (related to partial interests):

   • The reliability of an indicator will depend on how many adjustments were made to the comparable sales price.

   • The reliability of an indicator depends on how much those adjustments are, made to the comparable sales price.
   • The reliability of an indicator depends on how the data was verified.

V. The Reconciliation Process: A Step-by-Step Approach

1. A. Data Review and Validation:

   • Meticulously review all data, calculations, and assumptions underlying each value indicator. Verify the accuracy of all computations and correct any errors.
   • Assess the quality and reliability of the data sources used to support each indicator.

   • Ensure consistent application of appraisal techniques to both the subject property and comparable properties.
     2. B. Indicator Reliability Assessment:

   • Evaluate the amount, accuracy, and relevance of the data supporting each indicator, and the competence with which the data was processed.

   • Assess the appropriateness of the appraisal technique employed in light of the specific appraisal problem and the characteristics of the property and partial interest being valued.

     • Example: When appraising a leasehold, the appraiser must consider the remaining lease term, renewal options, and creditworthiness of the tenant to assess the reliability of the income approach.
       3. C. Weighing and Balancing:

   • Assign relative weights to each value indicator based on the appraiser’s judgment about its reliability and relevance.

   • Give greater weight to indicators that are supported by robust data, accurate calculations, and appropriate appraisal techniques.
     4. D. Judgment and Final Opinion:

   • Exercise professional judgment to synthesize the weighted value indicators into a single, defensible, and well-supported final opinion of value.

   • The final opinion should be a reasoned conclusion based on the evidence presented, rather than a simple averaging of the indicators.

VI. Practical Application and Examples

• A. Leasehold Estate Valuation: Suppose an appraiser is valuing a leasehold estate. The sales comparison approach, cost approach, and income capitalization approach may all be applicable.

  • The sales comparison approach might rely on sales of comparable leasehold interests, adjusted for differences in lease terms, rent levels, and property characteristics.
  • The cost approach might estimate the cost of constructing a similar building, less depreciation, to indicate the value of the improvements.
  • The income capitalization approach might capitalize the difference between the market rent and the contract rent, reflecting the value of the tenant’s advantageous lease terms.

  In reconciliation, the appraiser would weigh these three indicators based on the reliability of the data, the appropriateness of each approach, and the specific characteristics of the leasehold interest being valued.

• B. Easement Valuation: Consider an appraiser valuing a property burdened by an easement. The sales comparison approach is used.

  • One indicator may compare to properties without any easements.
  • The appraiser must assess that the easements, while beneficial, present a safety risk, which will have a negative effect on value.

  In reconciliation, the appraiser would weigh these indicators based on the relevance of the data, the specific restrictions.

• C. Fractional Interest Valuation: When appraising a fractional interest in a property (e.g., a tenancy in common), the appraiser may consider several factors.

  • One indicator may be the proportionate share of the total fee simple❓ value.
  • Another indicator may reflect the potential discounts or premiums associated with lack of control, illiquidity, or other factors specific to the fractional interest.

  In reconciliation, the appraiser must carefully weigh these indicators, considering the specific rights and responsibilities of the partial owner, the marketability of the interest, and any restrictions on its use or transfer.

VII. The Final Value Opinion

• A. Point Estimate vs. Range Value: The final value opinion is typically expressed as a point estimate – a single dollar amount representing the appraiser’s best estimate of value. In some cases, particularly when dealing with complex partial interests or limited data, a range value may be more appropriate, providing a reasonable range within which the true value is likely to fall.

• B. Rounding: Value opinions should be rounded to a level of precision that is consistent with the accuracy of the data and the appraisal techniques employed. Avoid presenting a value opinion with excessive precision (e.g., to the nearest dollar) when the underlying data is only accurate to the nearest thousand dollars.

• C. Clarity and Understandability: The appraisal report must be clear, concise, and easily understandable to a non-appraiser reader. The appraiser should avoid technical jargon and provide clear explanations of all assumptions, methodologies, and conclusions.

VIII. The Uniform Residential Appraisal Report (URAR) and Reconciliation

• A. Location: The Reconciliation section on page 2❓ of the URAR requires the appraiser to:

  • State the values for the Sales Comparison Approach, and Cost and Income Approaches, if developed.
  • Spells out the effect on value when utilizing a hypothetical condition or an extraordinary assumption in an addendum.
  • Give the market value and effective date of value.

  • B. Justification:

  • The appraiser must clearly and concisely explain how the various value indicators were reconciled into a single, final opinion of value.

  • This explanation should identify the strengths and weaknesses of each approach and justify the weighting assigned to each indicator.

IX. The Importance of Review and Defensibility

The reconciliation process is not complete until the appraiser has thoroughly reviewed their own work to ensure accuracy, consistency, and reasonableness. The final value opinion must be defensible in the face of scrutiny from review appraisers, lenders, and other stakeholders. Remember, an appraiser’s work will be reviewed, and you should ask yourself: “Will the work pass muster in a critical review? If it won’t, don’t send it!”

X. Conclusion

Mastering the art of reconciliation is essential for any appraiser, particularly those specializing in complex partial interests. By carefully analyzing and weighing the diverse data and analyses generated throughout the appraisal process, the appraiser can arrive at a credible, defensible, and well-supported final opinion of value that accurately reflects the unique characteristics of the property and the specific interest being valued. This final opinion forms the basis for sound financial decisions and helps to maintain the integrity of the real estate market.