Ranking and Reconciliation

Republished with permission from Working RE

Ranking and reconciliation

Road to Supporting Value: Ranking & Reconciliation
by Rachel Massey, SRA and Tim Andersen, MAI

Because the Sales Comparison approach and both the Income and Cost approaches are meant to reflect the actions of knowledgeable buyers and sellers active in the marketplace, a brief discussion of ranking andreconciliation is beneficial. The acts of ranking and reconciliation help set the stage for the appraiser’s opinion of value.

We appraisers tend to get caught up in the minutia of the adjustments, as well as supporting our adjustments, as is appropriate. This means we sometimes miss the big picture, and get way too caught up in the details. It is a rare buyer who breaks out each unit of comparison in a dollar amount. Instead, the typical buyer (of residential property at least) expects to pay more for a property than those that are inferior to it, and less for a property than those that are superior to it. This is just common sense and serves as the foundation of ranking properties relative to the subject.

When we are at the point in the appraisal process of analyzing sales that we consider to be the best representatives of comparison to the subject, we should also look at the larger picture and analyze the sales as a whole. Ideally, we have gathered sufficient and meaningful sales data to have properties both inferior and superior to the subject, as well as ones that are generally similar. It is not always possible to attain this data but in most markets it is generally not too difficult.

The process of analysis and summarization of the sales that we use in our reports should guide the intended user to follow us to a very logical conclusion. The following is a type of real-world example, imperfections and all*:

Example

Comparable sale 1 is a similarly sized, ranch-style house with an updated roof, windows, kitchen, and bathrooms. It has a quiet location off a main road, but does require some travel along gravel roads. This house is superior to the subject in the following manner: It is larger and includes an additional half bathroom; has a deck, a finished basement, and a newer kitchen. It is inferior to the subject in that it lacks a breezeway and the quality is not to the same level as the subject.

Sale 1 is similar to the subject in location because its quiet location is offset by the greater distance to town than the subject. Overall, sale 1 is slightly superior to the subject due mainly to size, bathroom count, and basement finish and it sold for $208,000, setting a logical upper limit of the value range.

Comparable sale 2 is noted in the MLS as being newly remodeled, but the selling agent indicates the house needed work, and the exterior of the house is not in good shape. The house has an addition off the back, which may not flow as well as a house built this size to start. This house is located in a different school district from the subject, right at the district border. In our opinion, there is no marked difference in value between the districts in this location and buyers will consider both equally. The house is inferior to the subject, due to overall condition and its location, which is closer to the other community, which is not as good. The road tends to be very busy at certain times of the day. There is a commercial property across the street and south by only a couple of lots, and an animal hospital/dog play park just a few lots south. As an inferior property, this house sets the logical lower end of the value range and it sold for $153,000 in September 2014. As the market has been increasing, and we can measure an increase of approximately 5% from the date of contract to the effective date of our report, the expected value of this house were it to go under contract as of the effective date is $161,000.

Sale 3 is a good comparable property of similar overall quality and appeal. This house is superior to the subject in that it has an extra half bathroom and two fireplaces as well as being larger overall. It is inferior to the subject in overall cosmetic condition and is more dated cosmetically. The location is closer to the subject community and the road does have traffic, although not as much as the subject’s location. The features that are similar, other than style, are that it has a breezeway and updated furnace and A/C (equal to furnace and electrical). Overall, this property is similar due to the size and amenities such as the deck and fireplaces being offset by the inferior condition. This house sold when the market was about 3% lower, with an approximate value on today’s market in the same condition of $183,000, setting another benchmark in value for the subject.

We have also included information about a pending sale that is located in close proximity to the subject and is similar in age, site size, and overall appeal. This house is superior to the subject in having an additional half bath and being slightly larger. Due to having electric heat, and a more dated decor, it is slightly inferior to the subject overall; it is listed for sale for $184,900 and went under contract within 37 days on the market. We expect the house to sell within 3% of the list price based on the list price to sales price ratios found in this market place. This pending sale provides good evidence of current market activity.

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This type of ranking description is not extensive, but it provides the client and intended users a good place to start to understand some of the appraiser’s logic in arriving at a value conclusion. The appraiser has already indicated that the subject has a logical lower limit of value of $153,000 and an upper limit of value of $208,000. This is a relatively wide spread, however, of 35.95 percent based on the unadjusted sales price range. Through the adjustment process, such as with the use of paired-sales data, grouped paired-sales data, regression, depreciated cost, sensitivity, and more, it is logical to conclude this range should narrow considerably as a result of the adjustment process. Consider the following reconciliation of the three sales that were addressed above:

We have included three closed sales in the analysis. The closed sales present one inferior (sale 2), one superior (sale 1), and one generally equal (sale 3). Looking at these sales without any adjustment for any of the units of comparison other than changing market conditions, the superior property sold for $208,000, presenting a logical upper end of the value range. The inferior property sold for $161,000 (accounting for the changing market conditions only), providing a logical lower end of the value range. The similar property sold for $183,000. Together these sales provide a means to indicate that even without adjusting for anything other than changing market conditions, the subject would have a low range of $161,000, high range of $208,000 and a logical price range around $183,000.

After applying the units of comparison that we considered most relevant, namely market conditions, site value, condition, size and bathroom count, the adjusted sales price range narrows significantly from a low of $179,000 to a high of $186,500. The most similar sale adjusts to $179,000, and a similar competitive offering is for sale for $184,900 and expected to be close to list price. All of this information causes us to consider the most likely value for the subject at $183,000, which is the appraised value. This takes into account both the adjusted and unadjusted sales prices of the comparables as described above.

Logical, isn’t it? Notice how the adjusted sales price range has narrowed from 35.95 percent down to 4.19 percent? This would be typical of a well thought out and analyzed adjustment grid. All too often appraisers average these sales data rather than reconcile as to which sale has the most meaning relative to the subject and why. Remember that the Uniform Standards of Professional Appraisal Practice (USPAP) actually requires us to “…reconcile the quality and quantity of data available and analyzed within the approaches used…”(Standard Rule 1-6 (a). It also requires us to “…summarize the information analyzed, the appraisal methods and techniques employed, and the reasoning that supports the analyses, opinions and conclusions…”(Standard Rule 2-2(viii)) when using the Appraisal Report format.

Why is this important? It is important because it shows the logic the appraiser used to go from the general information of the unadjusted comparable sales, to the specific rationale behind the appraiser’s value conclusion. Not only that, it also reflects the way that buyers buy houses. Buyers may consider the cost of a new house as an alternative, as well as weighing the time to completion, particularly on newer houses. When buying a house, most buyers also consider the cost of renting on a monthly basis, so the income approach is also often applicable to the formation of a credible value opinion when buyers in a particular market could rent just as easily as they could buy. At the very least, knowing that their mortgage payment would be in the range of a rental payment is at the forefront of many buyers’ minds, in particular after the recent mortgage crises.

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Recall that standards rule 1-6 requires us, when developing a real property appraisal, to reconcile two areas of our analyses. First, we reconcile the quality and quantity of data available and analyzed within the individual approaches. This means that we discuss the analyses of construction costs, depreciation estimates, site values, comparable sales, comparable rentals, and availability of data, ability to confirm the data, and so forth. Then we reconcile between the various approaches to value that we have applied in the appraisal process. Please consider this language as one example:

Because there were sufficient data from reliable sources, the appraisers were able to analyze the subject using all three of the standard approaches to value. While the Cost approach indicated a value conclusion approximating that of the Sales Comparison approach (after adjustments), it is best used as a secondary method on a house of this age. There was plenty of comparable sales data by which to form a value conclusion. All were relatively close to the subject. Since the houses in the subject’s neighborhood are generally not purchased and sold as investments or income producing properties, the Income approach was not able to yield a reasonable indication of value. For this reason, its details are in the workfile, but the appraiser has omitted it from the report as neither applicable nor necessary to the formation of a credible value opinion.  

Next, Standards Rule 1-6 requires us to reconcile the applicability and relevance of the approaches, methods, and techniques we use to arrive at a credible value conclusion. As we pointed out earlier, this is nothing more than a process where we assign a specific weight to the conclusion of a specific approach. Typically, the more comfortable we are with the value conclusion of a specific approach to value, the greater weight that approach receives in this reconciliation. Consider this language:

For the reasons cited above, the appraiser chose to give the greatest weight to the value conclusion from the Sales Comparison approach. For those same reasons, the appraiser gave some weight to the value conclusion the Cost approach indicated. Finally, for the reasons cited, the Income approach merited no weight in the final analysis. It is for these market-supported reasons the appraiser concludes the market value of the subject property, as of the appraisal’s effective date, was $183,000. 

Notice how we ranked the sales and then provided the “why” behind that ranking? Then we ranked the data in the individual approaches, as well as the “why” of that ranking. Finally, we ranked the individual approaches and, again, explained why we did so. With this ranking we showed both the sales that merited the greatest weight in the final analysis, as well as why we concluded they merited that weight. Then, via the reconciliation to the individual value indications, we indicated (a) which was most persuasive in forming the value opinion, as well as, (b) how and why we arrived at that conclusion. These two steps are in compliance with SR1-6(a, b) as well as the Fannie Mae Selling Guide. This is the quality of appraisals and reports clients and intended users look for, and that, over time, will merit more professional fees.

*We took a real world example and cleaned up some of the language, eliminated a sale to make it more readable and to eliminate any telltale signs of the subject property.

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About annarborappraisal

Veteran of the Ann Arbor market since 1984 (1989 as appraiser). My market is mainly private individuals who need an independent valuation for many reasons - divorce, estates, trust, bankruptcy, litigation, relocation, buy/sell negotiation, etc.

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