The use of scales goes back to mankind’s early history. One of the first scales designed, consisted of two plates that were attached to a beam. The beam balanced on a center pole. The object being measured was placed on one of the plates. Weighted stones were placed on the other plate until both sides were hanging at an equal level. The different size weights, often stones, were reflective of specific values. Each stone added, to bring balance, indicated an increase in the value of the item being measured.
A scale is simply a tool of measurement. In appraising real estate appraisal, there are many features of a home that are measured. If you look at most real estate appraisals that are documented on a form style report, you will note that there are usually positive and negative adjustments on the grid, next to different features of the comparable sales.
That is where appraisers reflect the measurement of value for that specific feature. For instance, location, lot size, view, room counts, gross living area and so forth. Adjustments, like weighted scale stones, are used to measure value incrementally.
WHAT ADJUSTMENTS INDICATE?
In residential real estate appraising, an appraiser will look for homes that have sold, that are as comparable to the property being appraised as possible. Ideally, it is desirable to use sales that are so similar to the property being appraised, that no adjustments are needed. However, in many areas, is difficult if not impossible to find three or more sales that are nearly identical to the property being appraised. Therefore, adjustments are made. What do the adjustments indicate?
Adjustments are made to reflect the amount buyers are typically paying for specific features of your home. The adjustments are applied to the comparable sales because the appraiser is trying to adjust the sales prices of the comparable sales so that the final adjusted prices reflect the subject’s value. This is like adding or removing the weights on a scale. The appraiser uses adjustments to balance the sales price of the comparable sale being used with its features, with the features of the subject.
How about another analogy? When I was a child, I played the violin. In order to tune the instrument, there are pegs at the top of the neck of the violin. These pegs are tightened or loosened to tune the strings. Adjustments are a way appraisers tune the sales prices of the comparable sales to resonate the typical buyer’s reaction to the differences in specific features.
For instance, say that your home has two bathrooms, and one of the comparable sales used offers only one bathroom. If the appraiser has determined that buyers are typically paying $3,000 more for a home with two bathrooms versus a home with only one, they will make a positive $3,000 adjustment to the sales price of the sale with only one bathroom, in order to reflect what that sale would look like if it had two bathrooms, like the subject.
Before making an adjustment, several questions must be asked. Will the market pay more or less for this amenity? If so, how much more or less? Perhaps there is no difference at all. In other words, if the property being appraised has only one bathroom instead of two, how much less would it sell for, all other things being equal? Making adjustments to reflect buyer’s purchasing habits, for specific features of a home, helps the appraiser to narrow the range of the sales prices of the comparable sales, to a more precise range.
DO ALL DIFFERENCES REQUIRE AN ADJUSTMENT?
The simple answer is no. The market is not sensitive to every difference in every feature in a home. Does a home with hardwood flooring demand a higher price than a home with wall to wall carpeting? Maybe. Maybe not. What about the difference between a patio versus a deck, or casement style windows versus double hung windows? It is up to the appraiser to analyze the market to make that determination.
With some features, there may not be a difference in market value. If buyers are not paying more for a home with a three car garage than they are for a two car garage, then no adjustment is made, even though there is a difference in size. That’s because adjustments should reflect market reaction, not the price to have the amenity installed. If there is no difference in market reaction, then no adjustment is made.
There are some amenities that people pay a lot of money for, that may lessen the market value of a home. I recently visited with an appraiser in another part of the country about swimming pools. They told me that in their market, having an in-ground pool is not desirable due to the constant maintenance needed.
If the feature is viewed negatively by most buyers, a negative adjustment may be made. For instance, if an in-ground pool is typically not desired by most buyers, a negative adjustment may be applied to reflect this.
THINGS APPRAISERS ADJUST FOR
What are some things that often require an adjustment?
The first thing appraisers adjust for is concessions. What are those? Let’s say that your selling your home for $200,000, but you are giving $10,000 back to the buyer to cover their closing costs, points or prepaids. In this case, if the buyer were purchasing your home with cash, you would actually be selling your home for $190,000. That’s called cash equivalency.
Another example would be if you were selling your luxury home for $20 million dollars and threw in your Lamborghini as part of the sale.
The appraiser would have to deduct the value of the car from the sales price by making an adjustment for this concession.
How about some other features’ appraisers adjust for? If home prices in the market area are appreciating or depreciating at certain rates, time adjustments are made. It should be noted that home prices are always fluctuating. If the amount of fluctuation is minimal, no time adjustment may be needed. Especially if the homes being used as comparable sales have sold very recently.
Differences in lot sizes, quality of construction, condition, the number of bedrooms or bathrooms, differences in gross living area square footage, basement finished square footage or room count are things that are often adjusted for. Additionally, differences in energy efficient items, garage size and other features like accessory units, in-ground pools and large outbuildings are adjusted for as well.
What about finishes? Does your home have a stone and/or Hardie Board exterior, ten foot ceilings, upgraded lighting and loads of upgraded interior finishes, such as coffered and/or cathedral ceilings, higher end cabinetry, custom millwork and upgraded counter tops? Appraisers generally don’t adjust for these things individually. However, they are adjusted for. Usually, these things are adjusted for in the quality if construction adjustment.
Condition adjustments may reflect one home offering updates that another home does not. Condition adjustments also reflect repairs that may be needed to the subject. Typically, when an adjustment is made for a repair, the amount will not only reflect the price to correct the repair, but also entrepreneurial incentive. In other words, how much less is the typical buyer going to pay for a home with this repair? Remember that the adjustment reflects what the typical buyer is going to expect as a discount for having to deal with that repair item. The market impact is likely to be more than just the cost of making the repair. That’s where the “incentive” part comes into play.
SOME WAYS APPRAISERS SUPPORT ADJUSTMENTS
There are many ways that appraisers support their adjustments. None of them are perfect! None of them work one hundred percent of the time.
Here are a few methods used by appraisers:
Regression – A mathematical way of showing the relationship between two or more items. For instance, the relationship between the sales price and the lot price per square foot. Regression uses algorithms to measure the relationships, in terms of price, in the different features of a home in relation to the property being appraised. There is single line regression and then multiple regression. Multiple regression can help in developing support for more than one feature, as the name indicates.
Depreciated Cost – This approach takes the cost of the item, as new, and depreciates it, as the name implies.
Paired Sales – This method takes numerous properties that are the same or very similar except for one feature. The price difference is the adjustment. Since it is difficult to find sales that can be used for this, due to most properties having more than one major difference that affects value, I don’t use this method often. It works well in some areas like tract homes or condominiums in which there may be many sales that are very similar, or the same, with the exception of one feature.
Grouped Paired Sales – This method takes a group of generally similar sales, except for one feature, like an in-ground pool or other amenity, and compares the average or median prices with another group of generally comparable sales that do not offer that amenity.
Income Capitalization – This method takes the difference in income between having a specific feature versus not having it. Using a multiplier, the difference in rent is converted into value. For instance, say that an appraiser has determined that the difference in rents between a two bedroom versus a three-bedroom home is $100 per month. The appraiser can apply a rent multiplier to that $100 difference, which will covert the price difference in income into a value. For instance, if the rent multiplier is 50, the adjustment for a two bedroom versus three bedroom would be $5,000. When appraising in neighborhoods in which there is a lot of rental information, this method works well.
There are other methods. But these are some of the more common methods. Just as a home’s market value falls within a range, the same is true with adjustments. There is a range that adjustments fall between. It is up to the appraiser to determine where, within the range, that feature bests reflects the market. Since adjustments are in a range, appraisers typically round their adjustments to the nearest $500 or $1,000. No appraiser is so skilled that they can make an adjustment that is down to the exact dollar. And, for that matter, market reactions are never that specific either!
Since adjustments are supposed to reflect market reactions, the data used should come from the market. If an appraiser just guesses on what the adjustment should be, without any support, this could lead to an opinion of value that does not reflect the market. So how can you tell? Unless you are an appraiser and have access to data from that market, sometimes it can be difficult to tell if an adjustment is supportable or not. That being said, let’s think about what it means to be supportable. If something is supportable, it must be worthy of belief. That is true of the appraiser’s opinion of value. So, doesn’t it make sense that this would also be the case with the adjustments?
I recently reviewed an appraisal that was completed for a bank. The appraiser used $35 per sq. ft. for the gross living area. The appraiser’s opinion of value of the subject was around a million dollars. Let me ask you, does $35 per sq. ft. for gross living area, for a home selling in that price range, sound worthy of belief? I’m certainly not trying to disparage my fellow appraiser. Perhaps they had support for that adjustment. My research and analysis led me to a much higher price per square foot for the gross living area. I used a several methods.
Sometimes an adjustment just doesn’t look right. Kind of like a violin being out of tune. Something can just seem off. Here’s another example. What if comparable sales in a neighborhood are selling at around $375K-$400K and the appraiser makes an adjustment for a full bathroom at $500? Does that sound logical? Does that sound reasonable? Typically, when appraiser’s are guessing at adjustments, at least from what I have witnessed, the adjustments are usually lower than what the market is reflecting.
When it comes to adjustments, it’s good to remember the law of diminishing returns. Typically, as things get larger, the value gets smaller, or diminishes. That is true with land, gross living area, garage size bedroom and bathroom count and many other features of a home. When that is the case, there may be no additional value when the feature gets to a certain size. That’s called being super-adequate or over-improved.
Speaking of size, if an appraiser uses homes that are all superior to the property being appraised, and they use very small adjustments, which are not reflective of the market, the result may be an opinion of value that is inflated above market value. Conversely, if an appraiser uses sales that are all inferior to the property being appraised, and they make minimal token adjustments that are not reflective of the market, this could lead to an opinion of value that is less than what the market is likely to pay. So, using adjustments that are derived from the market, and not made up, is very important because it can have an impact on the appraiser’s opinion of value.
OTHER WAYS OF FINE TUNING THE OPINION OF VALUE
When tuning a violin, once the major tuning is made to the pegs, the instrument can be fine-tuned to make the sound even better. This is accomplished by turning the small fine- tuning heads on the tailpiece, which is located near the bottom of the strings.
Likewise, once all of the major adjustments are made to the comparable sales, appraisers can fine tune their opinion of value by using a weighted average. How does that work?
Say the appraiser has used three sales. They can assign a specific percentage of value to each property, based upon certain criteria. For instance, maybe 50% of the weight was given to the first sale because it is the most similar to the subject. What about the remaining 50%? Perhaps 30% of the weight was given to sale two because it is the next most comparable sale. That would leave the remaining 20% of the weight to the third sale.
The divided percentages must add up to 100%. The percentage amount from each of the sales is added together. Even if no adjustments are made, if there is a sales price range between the comparable sales, this is an effective way of helping to further develop a more precise opinion of value.
Here’s an example:
Sale 1 – Sales price adjusted to $500,000 – It is the most similar, so it was given 50% of the total weight. 50% of $500,000 = $250,000
Sale 2 – Sales price adjusted to $485,000 – It is the second most similar of the three sales used. It was therefore given 30% of the total weight. 30% of $485,000 is = $145,500
Sale 3 – Sales price adjusted to $475,000 – This is the least comparable of the three sales and was therefore given the remaining 20% of the total weight. 20% of $475,000 = $95,000
Now simply add up the weighted totals – $250,000 + $145,500 + $95,000 = Weighted value is $490,500.
That’s generally how a weighted average is made. It is up to the appraiser to determine how much weight is given to each sale.
As already discussed, market adjustments come in ranges. Bracketing is another way of helping to support the opinion of value of a certain feature. Bracketing that feature is a way of determining what might be the high and low ends of the value range for that specific item. When searching for comparable sales, appraisers try to find sales with a little more gross living area, and some with a little less. Some with more land than the subject property, and some with less.
Appraisers try to do this with the different aspects of a home that may add significant value, because it can help demonstrate the value range for that component of value. While it is desired to bracket every component of value, its not always possible or realistic. For instance, using a home that is not really comparable to the property being appraised, in order to bracket a specific component of value, seems a little silly. At least to me.
A FEW MORE THOUGHTS ON ADJUSTMENTS
For most readers of the appraisal, it will not be possible to determine whether or not the adjustments made are supported at a glance. However, the appraiser’s client has the right to ask the appraiser how they supported their adjustments. An appraiser should be more than happy to show how they supported their adjustments.
If you’re a homeowner, an investor or an attorney, you might be wondering why this information should be important to you? If you’re hiring an appraiser, it is important that the appraiser has the ability to adequately support any adjustments that they make. As discussed, if they can’t, their opinion of value might not be as reflective of the market as it could be, or should be. Additionally, if you’re hiring an appraiser who may have to testify in court, such as in the case of a marriage dissolution or some other litigation, if the appraiser cannot adequately explain how they derived their adjustments, the appraisal may not help your case.
Well, that’s a wrap! I’ve strung you along enough on this topic. Hopefully this article has been helpful to you in understanding how adjustments work! I hope that you tune in next time for another post. You can also check out my podcast at Home Value Stories with Jamie Owen.
Thanks for being here!
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Here are some links to other articles and videos I enjoyed recently! I hope you will also…
Housing Sweet Feelings But Still Unsure About KitKats – Housing Notes by Jonathan Miller
We Welcome John Russell with the American Society of Appraisers! – Voice of Appraisal with Phil Crawford
Drop Anchor?!?! – Voice of Appraisal with Phil Crawford
Oh, Please! Not Another Highest and Best use Question?! – The Appraiser’s Advocate with Tim Andersen
9 Appraisal Terms New Real Estate Agents Should Know – Birmingham Appraisal Blog
Newz; Zestimates – Fee Transparency – Science and Appraising – APPRAISAL TODAY
Street names & hot states with an asterisk – Sacramento Appraisal Blog
What is a Statistical Adjustment – George Dell’s Analogue Blog
Shooting Comp Photos Is Not Shooting Us In The Foot – The Appraiser Coach
So You Wanna Be A Mentor! – Real Value Podcast